Health Net 2007 Annual Report Download - page 29

Regulatory activities and litigation relating to the rescission of coverage, if resolved unfavorably, could
adversely affect us.
In our individual business in certain states, persons applying for insurance policies are required to provide
information about their medical history as well as that of family members for whom they are seeking coverage.
These applications are subjected to a formal underwriting process to determine whether the applicants present an
acceptable risk. If coverage is issued and the health plan or insurer subsequently discovers that the applicant
materially misrepresented their or their family members’ medical history, the health plan or insurer has the legal
right to rescind the policy in accordance with applicable legal standards. Although rescission has long been a
legally authorized practice, the decisions of health plans to rescind coverage and decline payment to treating
providers, as well as the procedures used to do so, have recently generated public attention, particularly in
California. As a result, there has been both legislative and regulatory action in connection with this issue.
As of January 1, 2008, health plans and insurers in California, under certain defined circumstances, are
obligated to pay providers for services they have rendered despite the rescission of a member’s policy. On
October 23, 2007, the California Department of Managed Health Care (“DMHC”) and the California Department
of Insurance (“DOI”) announced that they would be issuing joint regulations that would restrict the ability of
health plans and insurers to rescind a member’s coverage and deny payment to treating providers. The DMHC
has issued draft proposed regulations and it is expected that the DOI will do so as well in the near future. On
October 16, 2007, the DMHC initiated a survey of Health Net of California’s activities regarding the rescission
of policies for the period 2004 through 2006. This survey is similar to ones the DMHC has already conducted of
other health plans in California, which have resulted in administrative penalties. The results of the survey are
expected to be made public some time in 2008. During the course of the survey, which is still ongoing, the
DMHC alleged that Health Net of California had failed to timely provide information to the DMHC’s survey
team. As a result of this allegation, Health Net of California and the DMHC agreed that Health Net of California
would pay an administrative penalty of $1 million, which it has paid. The penalty does not affect the ongoing
survey or the corresponding enforcement investigation of the DMHC, the results of either or both of which could
result in further penalties and corrective actions. The DOI recently announced that it was imposing administrative
penalties on another insurer relating to its rescission practices, and in the future we also may be subject to a
survey by the DOI relating to our rescission practices.
We are also party to arbitrations and litigation, including a putative class action, in which rescinded
members allege that we unlawfully rescinded their coverage. The lawsuits generally seek reimbursement for the
cost of medical services that were not paid as a result of the rescission, and also seek to recover for emotional
distress, attorneys’ fees and punitive damages. One of these arbitrations was decided on February 21, 2008, and
resulted in an award to the claimant of approximately $10 million, including estimated attorneys’ fees, which
amount has yet to be determined. Recent court of appeal decisions in California adverse to health plans and
insurers have increased the risks associated with rescissions of policies based on applications containing material
misrepresentations of medical history, and may make it more difficult to rescind policies in the future.
Additionally, the Los Angeles City Attorney recently filed a complaint against us relating to our underwriting
practices and rescission of certain individual policies. The complaint seeks equitable relief and civil penalties for,
among other things, alleged false advertising, violations of unfair competition laws and violations of the
California Penal Code. These developments, together with increased media scrutiny of health plans’ and insurers’
rescission practices, may also increase the risk of additional litigation in this area.
We cannot predict the outcome of the anticipated regulatory proposals described above, nor the extent to
which we may be affected by the enactment of those or other regulatory or legislative activities relating to
rescissions. Such legislation or regulation, including measures that would cause us to change our current manner
of operation or increase our exposure to liability, could have a material adverse effect on our results of
operations, financial condition and ability to compete in our industry. Similarly, given the complexity and scope
of rescission lawsuits, their final outcome cannot be predicted with any certainty. It is possible that in a particular
quarter or annual period our results of operations and cash flow could be materially affected by an ultimate
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