Health Net 2013 Annual Report Download - page 116

HEALTH NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
F-12
We assess the profitability of contracts for providing health care services when operating results or forecasts
indicate probable future losses. Contracts are grouped in a manner consistent with the method of determining premium
rates. Losses are determined by comparing anticipated premiums to estimates for the total of health care related costs
less reinsurance recoveries, if any, and the cost of maintaining the contracts. Losses, if any, are recognized in the period
the loss is determined and are classified as Health Plan Services cost. As of December 31, 2012, we held $9.4 million in
premium deficiency reserves. As of December 31, 2013, we held no premium deficiency reserves.
Government Contracts
On April 1, 2011, we began delivering administrative services under the T-3 contract for the TRICARE North
Region. The T-3 contract was awarded to us on May 13, 2010. We were the managed care contractor for the Department
of Defense's previous TRICARE contract in the North Region, which ended on March 31, 2011.
The T-3 contract has five one-year option periods; however, on March 15, 2011, the DoD exercised option period
2 (without exercising option period 1), due to a delay of approximately one year in the government's initial award of the
T-3 contract. Accordingly, option period 2 commenced on April 1, 2011. On March 22, 2012, the DoD exercised option
period 3, which commenced on April 1, 2012, and on March 28, 2013, the DoD exercised option period 4, which
commenced on April 1, 2013. The Department of Defense has notified us of its intent to exercise option Period 5, which
would extend our T-3 contract through March 31, 2015. The DoD has informed us that it intends to request that we
submit a proposal to add three additional one-year option periods to the T-3 contract.
We provide various types of administrative services under the contract, including: provider network
management, referral management, medical management, disease management, enrollment, customer service, clinical
support service, and claims processing. We also provided assistance in the transition into the T-3 contract, and will
provide assistance in any transition out of the contract. These services are structured as cost reimbursement
arrangements for health care costs plus administrative fees earned in the form of fixed prices, fixed unit prices, and
contingent fees and payments based on various incentives and penalties.
In accordance with GAAP, we evaluate, at the inception of the contract and as services are delivered, all
deliverables in the service arrangement to determine whether they represent separate units of accounting. The delivered
items are considered separate units of accounting if the delivered items have value to the customer on a standalone basis
(i.e., they are sold separately by any vendor) and no general right of return exists relative to the delivered item. While
we identified two separate units of accounting within the T-3 contract, no determination of estimated selling price was
performed because both units of accounting are performed ratably over the option periods and, accordingly, the same
methodology of revenue recognition applies to both units of accounting.
Therefore, we recognize revenue related to administrative services on a straight-line basis over the option period,
when the fees become fixed and determinable.
The T-3 contract includes various performance-based incentives and penalties. For each of the incentives or
penalties, we adjust revenue accordingly based on the amount that we have earned or incurred at each interim date and
are legally entitled to in the event of a contract termination.
The transition-in process for the T-3 contract began in the second quarter of 2010. We had deferred transition-in
costs of $43.8 million and related deferred revenues of $52.5 million, both of which are amortized on a straight-line
basis over the customer relationship period. Fulfillment costs associated with the T-3 contract are expensed as incurred.
Revenues and expenses associated with the T-3 contract are reported as part of government contracts revenues
and government contracts expenses in the consolidated statements of operations and included in the Government
Contracts reportable segment.
The TRICARE members are served by our network and out-of-network providers in accordance with the T-3
contract. We pay health care costs related to these services to the providers and are later reimbursed by the DoD for
such payments. Under the terms of the T-3 contract, we are not the primary obligor for health care services and
accordingly, we do not include health care costs and related reimbursements in our consolidated statement of