Health Net 2006 Annual Report Download - page 24

negotiate favorable rates. Changes in utilization rates, demographic characteristics, the regulatory environment,
health care practices, inflation, new technologies, clusters of high-cost cases, continued consolidation of
physician, hospital and other provider groups and numerous other factors affecting health care costs may
adversely affect our ability to predict and control health care costs as well as our financial condition, results of
operations and cash flows. In addition, a large scale public health epidemic, such as the avian flu, could affect
our ability to control health care costs. See “—Large-scale public health epidemics and / or terrorist activity
could cause us to incur unexpected health care and other costs and could materially and adversely affect our
business financial condition and results of operations.”
For several years, one of the fastest increasing categories of our health care costs has been the cost of
hospital-based products and services. Factors underlying the increase in hospital costs include, but are not limited
to, the underfunding of public programs, such as Medicaid and Medicare, growing rates of uninsured individuals,
new technology, state initiated mandates, alleged abuse of hospital chargemasters, an aging population and,
under certain circumstances, relatively low levels of hospital competition. Another significant category of our
health care costs is costs of pharmaceutical products and services. Recently, the rate of increase in
pharmaceutical costs has not been as a great as prior years due to a movement of several high volume drugs to
lower cost generic status. 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.
As a measure of the impact of medical cost on our financial results, relatively small differences between
predicted and actual medical costs as a percentage of premium revenues can result in significant changes in our
financial results. For example, if medical costs increased by 1% without a proportional change in related
revenues for our health plan products, our annual net earnings for 2006 would have been reduced by
approximately $54 million. 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 in order to improve margins on our commercial health plan business. We
lost members as a result of these premium increases. In 2006, our pricing was, we believe, more consistent with
that of our competitors but there can be no assurance that we will not reinstitute higher premiums in the future.
Any future increase in premiums could result in the loss of members. 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.
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