Health Net 2009 Annual Report Download - page 54

profitability. The effect of escalating health care costs, as well as any changes in our ability to negotiate
competitive rates with our providers, may impose further risks to our ability to profitably underwrite our
business, and may have a material impact on our business, financial condition or results of operations.
We measure our West Operations and Northeast Operations reportable segments profitability based on
medical care ratio (MCR) and pretax income. The MCR is calculated as health plan services expense (excluding
depreciation and amortization) divided by health plan services premiums. The pretax income is calculated as
health plan services premiums and administrative services fees and other income less health plan services
expense and G&A and other net expenses. See “—Results of Operations—Table of Summary Financial
Information” for a calculation of our MCR and “—Results of Operations—Health Plan Services Results” for a
calculation of our pretax income.
Health plan services premiums include health maintenance organization (HMO), point of service (POS) and
preferred provider organization (PPO) premiums from employer groups and individuals and from Medicare
recipients who have purchased supplemental benefit coverage (which premiums are based on a predetermined
prepaid fee), Medicaid revenues based on multi-year contracts to provide care to Medicaid recipients, and
revenue under Medicare risk contracts, including Medicare Part D, to provide care to enrolled Medicare
recipients. Medicare revenue can also include amounts for risk factor adjustments and additional premiums that
we charge in some places to members who purchase our Medicare risk plans (see Note 2 to our consolidated
financial statements). The amount of premiums we earn in a given year is driven by the rates we charge and
enrollment levels. Administrative services fees and other income primarily include revenue for administrative
services such as claims processing, customer service, medical management, provider network access and other
administrative services. Health plan services expense includes medical and related costs for health services
provided to our members, including physician services, hospital and related professional services, outpatient
care, and pharmacy benefit costs. These expenses are impacted by unit costs and utilization rates. Unit costs
represent the health care cost per visit, and the utilization rates represent the volume of health care consumption
by our members.
G&A expenses include those costs related to employees and benefits, consulting and professional fees,
marketing, premium taxes and assessments, occupancy costs and litigation and regulatory-related costs. Such
costs are driven by membership levels, introduction of new products, system consolidations, outsourcing
activities and compliance requirements for changing regulations. These expenses also include expenses
associated with corporate shared services and other costs to reflect the fact that such expenses are incurred
primarily to support health plan services. Selling expenses consist of external broker commission expenses and
generally vary with premium volume.
We measure our Government Contracts segment profitability based on government contracts cost ratio and
pretax income. The government contracts cost ratio is calculated as government contracts cost divided by
government contracts revenue. The pretax income is calculated as government contracts revenue less government
contracts cost. See “—Results of Operations—Table of Summary Financial Information” for a calculation of our
government contracts cost ratio and “—Results of Operations—Government Contracts Segment Results” for a
calculation of our pretax income.
Government Contracts revenue is made up of two major components: health care and administrative services.
The health care component includes revenue recorded for health care costs for the provision of services to our
members, including paid claims and estimated incurred but not reported claims (IBNR) expenses for which we are
at risk, and underwriting fees earned for providing the health care and assuming underwriting risk in the delivery of
care. The administrative services component encompasses fees received for all other services provided to both the
government customer and to beneficiaries, including services such as medical management, claims processing,
enrollment, customer services and other services unique to the managed care support contract with the government.
Government Contracts revenue and expenses include the impact from underruns and overruns relative to our target
cost under the applicable contracts (see Note 2 to our consolidated financial statements).
52