Health Net 2007 Annual Report Download - page 24

accurately predict health care costs and to control future health care utilization and costs through underwriting
criteria, utilization management, product design and negotiation of favorable professional and hospital contracts.
Periodic renegotiations of hospital and other provider contracts, coupled with continued consolidation of
physician, hospital and other provider groups, may result in increased health care costs or limit our ability to
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 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 and the constant pressure that places on
rates from commercial health plans, 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 caused by market concentration. Another significant category of our
health care costs is costs of pharmaceutical products and services. 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 2007 would have been reduced by
approximately $97 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 or bid, 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 or bids. 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.
In 2007, our pricing was, we believe, generally consistent with that of our competitors but there can be no
assurance that we will not institute higher premiums in the future. In addition, we continue to see increases in our
small group and individual business while our large group enrollment declines as we seek to improve margins by
changing the mix of our commercial business to smaller accounts. Any future increase in premiums could result
in the loss of members. Additionally, there is always the possibility that adverse risk selection could occur when
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