Health Net 2005 Annual Report Download - page 22

experienced higher than expected claims costs, especially for inpatient and outpatient hospital claims. These
higher than expected costs contributed to a decline in our net income in 2004 as realized premium yields were
lower than cost trends.
Another significant category of our health care costs is costs of pharmaceutical products and services.
Although pharmaceutical costs have not been increasing at the rate of hospital costs, evolving regulation may
impact the ability of our HMOs to continue to receive existing price discounts on pharmaceutical products for
our members. Other factors affecting our pharmaceutical costs include, but are not limited to, the price of drugs,
utilization of new and existing drugs and changes in discounts. The inability to forecast and manage our health
care costs could have a material adverse effect on our business, financial condition or results of operations.
We face competitive pressure to contain premium prices.
In addition to the challenge of controlling health care costs, we face competitive pressure to contain
premium prices. While health plans compete on the basis of many factors, including service and the quality and
depth of provider networks, price will continue to be a significant basis of competition. Our premium revenue is
set in advance of the actual delivery of services, and, in certain circumstances, before contracting with providers.
While we attempt to take into account our estimate of expected health care costs over the premium period in
setting the premiums we charge, factors such as competition, regulations and other circumstances may limit our
ability to fully base premiums on estimated costs. In addition, many factors may, and often do, cause actual
health care costs to exceed those costs estimated and reflected in premiums. These factors may include increased
utilization of services, increased cost of individual services, catastrophes, epidemics, seasonality, new mandated
benefits or other regulatory changes, and insured population characteristics. Our financial condition or results of
operations could be adversely affected by significant disparities between the premium increases of our health
plans and those of our major competitors or by limitations on our ability to increase or maintain our premium
levels.
Over the course of 2004 and 2005, we instituted premium increases at the high end of the range of premium
increases instituted by our competitors. We lost members as a result of these premium increases and could lose
additional members in the future. Maintaining premiums at the high end of the market also increases the risk that
our health plans are affected by “adverse risk selection.” Adverse risk selection occurs when members who
utilize higher levels of health care services compared with the insured population as a whole choose to remain
with our health plans at the higher premium rates rather than risk moving to another plan. This could cause health
care costs to be higher than anticipated and therefore cause our financial results to fall short of expectations.
Our inability to estimate and maintain appropriate levels of reserves for claims may adversely affect our
business, financial condition or results of operations.
Our reserves for claims are estimates of future costs based on various assumptions. The accuracy of these
estimates may be affected by external forces such as changes in the rate of inflation, the regulatory environment,
the judicious administration of claims, medical costs and other factors. Included in the reserves for claims are
estimates for the costs of services which have been incurred but not reported. These estimates are continually
monitored and reviewed and, as settlements are made or estimates adjusted, differences are reflected in current
operations. Given the uncertainties inherent in such estimates, the actual liability could differ significantly from
the amounts reserved. If our actual liability for claims payments is higher than estimated, it could have a negative
impact on our earnings per share in any particular quarter or annual period. If our actual liability is lower than
estimated, it could mean that we set premium prices too high, which could result in a loss of membership. If we
were to lose membership as a result of our premium prices being set too high, there can be no assurance that we
would be able to regain that membership by reducing premiums.
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