Health Net 2013 Annual Report Download - page 65

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"—Recent Developments" sections below, we expect to undertake a comprehensive review of our reportable segments in
2014.
How We Measure Our Profitability
Our profitability depends in large part on our ability to, among other things, effectively price our health care
products; manage health care and pharmacy costs; contract with health care providers; attract and retain members; and
manage our general and administrative (“G&A”) and selling expenses. In addition, factors such as state and federal
health care reform legislation and regulation, competition and general economic conditions affect our operations and
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. Each of these
factors may have a material impact on our business, financial condition or results of operations.
We measure our Western Region Operations reportable segment profitability based on medical care ratio
(“MCR”) and pretax income. The MCR is calculated as health plan services expense 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, including selling expenses. See “—Results
of Operations—Western Region Operations Reportable Segment—Western Region Operations Segment Results” for a
calculation of MCR and pretax income.
Health plan services premiums generally 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 (which includes
retroactive and retrospective premium adjustments) and revenue under Medicare risk contracts to provide care to
enrolled Medicare recipients. Medicare revenues 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. The amount of premiums
we earn in a given period is driven by the rates we charge and enrollment levels. Administrative services fees and other
income primarily includes revenue for administrative services such as claims processing, customer service, medical
management, provider network access and other administrative services. Health plan services expense generally
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, among other things, those costs related to employees and benefits, consulting and
professional fees, marketing, business expansion initiatives, premium taxes and assessments, occupancy costs and
litigation and regulatory-related costs. Such costs are driven by membership levels, introduction of new products or
provision of new services, system consolidations, outsourcing activities and compliance requirements for changing
regulations, among other things. 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 pretax income, which is calculated as
Government Contracts revenue less Government Contracts cost. See “—Results of Operations—Government Contracts
Reportable Segment—Government Contracts Segment Results” for a calculation of the government contracts pretax
income.
Under the T-3 contract for the TRICARE North Region, we provide various types of administrative services
including provider network management, referral management, medical management, disease management, enrollment,
customer service, clinical support service, and claims processing. 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. We recognize revenue related to administrative
services on a straight-line basis over the option period, when the fees become fixed and determinable. The TRICARE
North Region 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 statements of operations. The T-3
contract also 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