Health Net 2013 Annual Report Download - page 115

HEALTH NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
F-11
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 and pay-for-performance bonuses, 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 capitated 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 estimate the amount of the provision for health care service costs IBNR in accordance with GAAP and using
standard actuarial developmental 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, among other things. Our IBNR best estimate also includes a provision
for adverse deviation, which is an estimate for known environmental factors that are reasonably likely to affect the
required level of IBNR reserves. This provision for adverse deviation is intended to capture the potential adverse
development from known environmental factors such as our entry into new geographical markets, changes in our
geographic or product mix, the introduction of new customer populations, variation in benefit utilization, disease
outbreaks, changes in provider reimbursement, fluctuations in medical cost trend, variation in claim submission patterns
and variation in claims processing speed and payment patterns, changes in technology that provide faster access to
claims data or change the speed of adjudication and settlement of claims, variability in claim inventory levels, non-
standard claim development, and/or exceptional situations that require judgmental adjustments in setting the reserves
for claims. As part of our best estimate for IBNR, the provision for adverse deviation recorded at December 31, 2013
and 2012 was approximately $53.4 million and $53.4 million, respectively. There were no material changes in the
amount of these reserves, or the amount of these reserves as a percentage of reserve for claims and other settlements,
during the year ended December 31, 2013.
We consistently apply our IBNR estimation methodology from period to period. Our IBNR best estimate is 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. As additional information becomes known to us, we adjust our assumptions accordingly
to change our estimate of IBNR. Therefore, if moderately adverse conditions do not occur, evidenced by more complete
claims information in the following period, then our prior period estimates will be revised downward, resulting in
favorable development. However, any favorable prior period reserve development would increase current period net
income only to the extent that the current period provision for adverse deviation is less than the benefit recognized from
the prior period favorable development. If moderately adverse conditions occur and are more acute than we estimated,
then our prior period estimates will be revised upward, resulting in unfavorable development, which would decrease
current period net income. For the year ended December 31, 2013, we had $56.2 million in favorable reserve
developments related to prior years. We believe this favorable development was primarily due to the absence of
moderately adverse conditions. The reserve developments related to prior years for the year ended December 31, 2013,
when considered together with the provision for adverse deviation recorded as of December 31, 2013, did not have a
material impact on our operating results or financial condition. For the year ended December 31, 2012, we had $34.5
million in unfavorable reserve developments related to prior years. We believe this unfavorable reserve development for
the year ended December 31, 2012 was primarily due to significant delays in claims submissions for the fourth quarter
of 2011 arising from issues related to a new billing format required by the Health Insurance Portability and
Accountability Act of 1996 ("HIPAA") coupled with an unanticipated flattening of commercial trends.
The majority of the IBNR reserve balance held at the end of each year is associated with the most recent months'
incurred services because these are the services for which the fewest claims have been paid. The degree of uncertainty
in the estimates of incurred claims is greater for the most recent months' incurred services. Revised estimates for prior
periods are determined in each year based on the most recent updates of paid claims for prior periods. Estimates for
service costs incurred but not yet reported are subject to the impact of changes in the regulatory environment, economic
conditions, changes in claims trends, and numerous other factors. Given the inherent variability of such estimates, the
actual liability could differ materially from the amounts estimated.