Health Net 2004 Annual Report Download - page 63

recognition, health care costs, reserves for contingent liabilities, amounts receivable or payable under government contracts, goodwill
and recoverability of long-lived assets and investments. Accordingly, we consider accounting policies on these areas to be critical in
preparing our consolidated financial statements. A significant change in any one of these amounts may have a significant impact on
our consolidated results of operations and financial condition. A more detailed description of the significant accounting policies that
we use in preparing our financial statements is included in the notes to our consolidated financial statements which are included
elsewhere in this Annual Report on Form 10-K.
Health Plan Services
Health plan services premiums include HMO, POS and PPO premiums from employer groups and individuals and from
Medicare recipients who have purchased supplemental benefit coverage, for which premiums are based on a predetermined prepaid
fee, Medicaid revenues based on multi-year contracts to provide care to Medicaid recipients, and revenue under Medicare risk
contracts to provide care to enrolled Medicare recipients. Revenue is recognized in the month in which the related enrollees are
entitled to health care services. Premiums collected in advance of the month in which enrollees are entitled to health care services are
recorded as unearned premiums.
From time to time, we make adjustments to our revenues based on retroactivity. These retroactivity adjustments reflect changes
in the number of enrollees subsequent to when the revenue is billed. We estimate the amount of future retroactivity each period and
accordingly adjust the billed revenue. The estimated adjustments are based on historical trends, premiums billed, the volume of
contract renewal activity during the period and other information. We refine our estimates and methodologies as information on
actual retroactivity becomes available.
On a monthly basis, we estimate the amount of uncollectible receivables to reflect allowances for doubtful accounts. The
allowances for doubtful accounts are estimated based on the creditworthiness of our customers, our historical collection rates and the
age of our unpaid balances. During this process, we also assess the recoverability of the receivables, and an allowance is recorded
based upon their net realizable value. Those receivables that are deemed to be uncollectible, such as receivables from bankrupt
employer groups, are fully written off against their corresponding asset account, with a debit to the allowance to the extent such an
allowance was previously recorded.
Reserves for claims and other settlements and health care and other costs payable under government contracts include reserves
for claims (incurred but not reported claims (“IBNR”) and received but unprocessed claims), and other liabilities including capitation
payable, shared risk settlements, provider disputes, provider incentives and other reserves for our two reporting segments, Health Plan
Services and Government Contracts. As of December 31, 2004, Health Plan Services reserves for claims comprised approximately
68% of reserves for claims and other settlements, and Government Contracts reserves for claims comprised approximately 81% of
health care and other costs payable under government contracts. See Note 16 to our accompanying consolidated financial statements
for a reconciliation of changes in the reserve for claims.
We estimate the amount of our reserves for claims primarily by using standard actuarial developmental methodologies. This
method is also known as the chain-ladder or completion factor method. The developmental method estimates reserves for claims
based upon the historical lag between the month when services are rendered and the month claims are paid while taking into
consideration, among other things, expected medical cost inflation, seasonality patterns, product mix, benefit plan changes and
changes in membership. A key component of the developmental method is the completion factor which is a measure of how complete
the claims paid to date are relative to the estimate of the claims for services rendered for a given period. While the completion factors
are reliable and robust for older service periods, they are more volatile and less reliable for more recent periods since a large portion
of health care claims are not submitted to us until several months after services have been rendered. Accordingly, for the most recent
months, the incurred claims are estimated from a trend analysis
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