Health Net 2006 Annual Report Download - page 103

HEALTH NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
network access and other administrative services. Administrative services fees are recognized as revenue in the
period services are provided.
Health Care Services and Government Contract Expenses
The cost of health care services is recognized in the period in which services are provided and includes an
estimate of the cost of services which have been incurred but not yet reported. Such costs include payments to
primary care physicians, specialists, hospitals, outpatient care facilities and the costs associated with managing
the extent of such care. We estimate the amount of the provision for service costs incurred but not reported using
standard actuarial methodologies based upon historical data including the period between the date services are
rendered and the date claims are received and paid, denied claim activity, expected medical cost inflation,
seasonality patterns and changes in membership. The estimates for service costs incurred but not reported are
made on an accrual basis and adjusted in future periods as required. Any adjustments to the prior period
estimates are included in the current period. Such estimates are subject to the impact of changes in the regulatory
environment and economic conditions. Given the inherent variability of such estimates, the actual liability could
differ significantly from the amounts provided. While the ultimate amount of claims and losses paid are
dependent on future developments, management is of the opinion that the recorded reserves are adequate to cover
such costs. These estimated liabilities are reduced by estimated amounts recoverable from third parties for
subrogation.
Our HMOs, primarily in California, generally contract with various medical groups to provide professional
care to certain of their members on a capitated, or fixed per member per month fee basis. Capitation contracts
generally include a provision for stop-loss and non-capitated services for which we are liable. Professional
capitated contracts also generally contain provisions for shared risk, whereby the Company and the medical
groups share in the variance between actual costs and predetermined goals. Additionally, we contract with certain
hospitals to provide hospital care to enrolled members on a capitation basis. Our HMOs also contract with
hospitals, physicians and other providers of health care, pursuant to discounted fee-for-service arrangements,
hospital per diems, and case rates under which providers bill the HMOs for each individual service provided to
enrollees.
We assess the profitability of contracts for providing health care services when operating results or forecasts
indicate probable future losses. Contracts are grouped in a manner consistent with the method of determining
premium rates. Losses are determined by comparing anticipated premiums to estimates for the total of health care
related costs less reinsurance recoveries, if any, and the cost of maintaining the contracts. Losses, if any, are
recognized in the period the loss is determined and are classified as Health Plan Services cost. We held a
premium deficiency reserve of $0 and $0.3 million as of December 31, 2006 and 2005, respectively.
Under the TRICARE contract for the North Region, we record amounts receivable and payable for
estimated health care IBNR expenses and report such amounts separately on the accompanying consolidated
balance sheet. These amounts are equal since the estimated health care IBNR expenses incurred are offset by an
equal amount of revenues earned.
Medicare Part D
Effective January 1, 2006, Health Net began offering the Medicare Part D benefit as a fully insured product
to our existing and new members. The Part D benefit consists of pharmacy benefits for Medicare beneficiaries.
Part D renewal occurs annually, but it is not a guaranteed renewable product. We report Part D as part of our
health plan services reportable segment. The majority of our Part D members fall into the low-income category.
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