We lease office space for our principal executive offices in Woodland Hills, California. Our executive offices, comprising approximately 115,448 square feet, are occupied under a lease that expires December 31, 2014. A significant portion of our California HMO operations are also housed in Woodland Hills, in a separate 333,954 square foot leased facility. The lease for this two-building facility expires December 31, 2011. Combined rent and rent related obligations for our Woodland Hills facilities were approximately $14.4 million in 2005.
We also lease an aggregate of approximately 512,110 square feet of office space in Rancho Cordova, California for certain Health Plan Services and Government Contract operations. Our aggregate rent and rent related obligations under these leases were approximately $9.4 million in 2005. These leases expire at various dates ranging from 2006 to 2016. We also lease a total of approximately 109,285 square feet of office space in San Rafael and Pointe Richmond, California for certain specialty services operations.
In addition to the office space referenced above, we lease approximately 89 sites in 25 states, totaling approximately 1,000,376 square feet of space.
We also own facilities comprising, in the aggregate, approximately 523,195 square feet of space. These facilities include operations or headquarters for our health plan subsidiaries in Arizona and Connecticut, respectively, as well as a data center facility in Rancho Cordova, California.
The following discussion and other portions of this Annual Report on Form 10-K contain “forward-looking statements” within the meaning of Section 21E of the Exchange Act, and Section 27A of the Securities Act, regarding our business, financial condition and results of operations. These forward-looking statements involve risks and uncertainties. All statements other than statements of historical information provided or incorporated by reference herein may be deemed to be forward-looking statements. Without limiting the foregoing, the words “believes,” “anticipates,” “plans,” “expects,” “may,” “should,” “could,” “estimate” and “intend” and other similar expressions are intended to identify forward-looking statements. Managed health care companies operate in a highly competitive, constantly changing environment that is significantly influenced by, among other things, aggressive marketing and pricing practices of competitors and regulatory oversight. Factors that could cause our actual results to differ materially from those reflected in forward-looking statements include, but are not limited to, the factors set forth under “Item 1A. Risk Factors” and the risks discussed in our other filings from time to time with the SEC.
We wish to caution readers that these factors, among others, could cause our actual financial or enrollment results to differ materially from those expressed in any projections, estimates or other forward-looking statements relating to us. In addition, those factors should be considered in conjunction with any discussion of operations or results by us or our representatives, including any forward-looking discussion, as well as comments contained in press releases, presentations to securities analysts or investors or other communications by us. You should not place undue reliance on any forward-looking statements, which reflect management’s analysis, judgment, belief or expectation only as of the date thereof. Except as may be required by law, we undertake no obligation to publicly update or revise any forward-looking statements to reflect events or circumstances that arise after the date of this report.
This Management’s Discussion and Analysis of Financial Conditions and Results of Operation should be read in its entirety since it contains detailed information that is important to understanding Health Net, Inc. and its subsidiaries’ results of operations and financial condition.
Our Health Plan Services reportable segment includes the operations of our health plans, which offer commercial, Medicare and Medicaid products in Arizona, California, Connecticut, New Jersey, New York and Oregon, the operations of our health and life insurance companies and our behavioral health and pharmaceutical services subsidiaries. We have approximately 3.3 million at-risk and 0.1 million administrative services only (ASO) members in our Health Plan Services segment.
Our Government Contracts segment includes our government-sponsored managed care federal contract with the U.S. Department of Defense (the Department of Defense) under the TRICARE program in the North Region and other health care related government contracts that we administer for the Department of Defense. Under the TRICARE contract for the North Region, we provide health care services to approximately 3.0 million Military Health System (MHS) eligible beneficiaries (active duty personnel and TRICARE/Medicare dual eligible beneficiaries), including 1.8 million TRICARE eligibles for whom we provide health care and administrative services and 1.2 million other MHS-eligible beneficiaries for whom we provide ASO.
We measure our Health Plan Services segment profitability based on medical care ratio and pretax income. The medical care ratio is calculated as Health plan services expense divided by Health plan services premiums. The pretax income is calculated as Health plan services premium 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 medical care ratio (MCR) and “-Results of Operations-Health Plan Services Segment Results” for a calculation of our pretax income.
Health plan services premiums include HMO, POS and PPO premiums from employer groups and individuals and from Medicare recipients who have purchased supplemental benefit coverage, for 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 to provide care to enrolled Medicare recipients. The amount of premiums we earn in a given year is driven by the rates we charge and the enrollment levels. 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.
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 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.
(a) The administrative ratio is computed as the sum of general and administrative (G&A) and depreciation expenses divided by the sum of health plan services premium revenues and other income.
The increase in commercial premium PMPM was 10.9% for the year ended December 31, 2005 compared to the same period in 2004. We believe we are now in a better position to be more competitive and manage premium rate increases that are consistent with the favorable health care cost trends that we are experiencing.
We believe that in order to remain competitive in our Health Plan Services segment in 2006, we will need to continue our focus on improving profit margins in commercial and Medicare health plans, stabilize commercial health plan membership, successfully launch the Medicare Part D drug benefit and complete the Universal Care acquisition.
We expect general and administrative expenses to increase in 2006 as we focus more on investing in growth and on our ongoing investment in Medicare.
In 2004, our overall financial results fell short of our expectations. Earnings per share fell by 81% to $0.38 per basic and diluted share for 2004, compared with $2.02 per basic share and $1.98 per diluted share in 2003, primarily as a result of higher than anticipated commercial health care costs and lower membership. In addition, as described below, we recorded a $252 million pretax earnings charge in the fourth quarter ended December 31, 2004, which had a significant impact on our overall 2004 financial results.
Beginning in the latter part of the first quarter ended March 31, 2004, we began to implement a plan designed to improve financial performance (2004 Financial Performance Improvement Plan). As part of the 2004 Financial Performance Improvement Plan, we increased prices in our commercial health plans and commenced a series of initiatives designed to reduce the growth rate of our commercial health care costs. Following implementation of the 2004 Financial Performance Improvement Plan, the rate of increase in commercial PMPM premium yields climbed from a 6.9% increase in the first quarter ended March 31, 2004 compared with the first quarter ended March 31, 2003, to a 10.7% increase in the fourth quarter ended December 31, 2004 compared with the fourth quarter ended December 31, 2003.
In the fourth quarter ended December 31, 2004, we recorded a $252 million pretax earnings charge which was comprised of the following:
The following table summarizes the operating results of our reportable segments for the last three fiscal years.
The following table below summarizes our health plan membership information by program and by state.
Membership in our commercial health plans, including ASO members, decreased 9% at December 31, 2005 compared to December 31, 2004. This decrease was primarily attributable to the continued impact of premium pricing increases implemented in early 2004 to address higher health care costs and network provider issues. The enrollment decline was primarily seen in our California plan which had a net decline of 17,874 members in the large group market and a net decline of 85,867 members in the PPO/POS products for the small group and individual market reflecting a lapse rate of approximately 25%. Our New Jersey plan experienced a net decline of 45,571 members in the large group market and a net decline of 37,041 in the small group market. The Northeast health plans collectively had a lapse rate of approximately 23%.
Enrollment in our commercial health plans, including ASO members, decreased 8% at December 31, 2004 compared to December 31, 2003. This decrease was primarily attributable to the premium pricing increases implemented in early 2004 to address higher health care costs and network provider issues. The enrollment decline was seen in the large and small group markets in all of our commercial health plans except our Arizona and Oregon plans. Overall, small group and individual enrollment declined 12% from 2003 to 2004 and large group enrollment declined 6%.
Membership in our federal Medicare Risk program increased 1% at December 31, 2004 compared to the same period in 2003, primarily as a result of membership growth in our Oregon health plan, partially offset by
We participate in state Medicaid programs in California, Connecticut and New Jersey. California membership, where the program is known as Medi-Cal, comprised 84% of our Medicaid membership at December 31, 2004. Overall Medicaid membership decreased 2% at December 31, 2004 compared to December 31, 2003, primarily as a result of competition in New Jersey, a change in law that eliminated certain members eligibility in Connecticut and the State of California’s efforts to tighten eligibility requirements for participation in the Medi-Cal and Healthy Families program. In the third quarter of 2004, we added a new county in California, accounting for approximately 33,000 new members. Despite ongoing concerns about the states’ ability to adequately fund these Medicaid programs, we believe that the significant savings generated by Medicaid managed care will provide ongoing future growth opportunities, as states may move more Medicaid enrollees into managed care plans.
Total Health Plan Services premiums decreased by $6.7 million, or 0.1%, for the year ended December 31, 2005 as compared to the same period in 2004, and increased by $467.0 million, or 5.1%, for the year ended December 31, 2004 as compared to the same period in 2003 as shown in the following table:
Commercial premiums increased by $430.9 million, or 6.6%, for the year ended December 31, 2004 compared to the same period in 2003. Of this increase, 8.4% is attributable to our implementation of higher rates (including renewal rates) in our large and small group markets in all of our health plans to account for higher health care costs, partially offset by membership losses as discussed earlier with an impact of (1.8)%.
Commercial health care costs decreased by $485.1 million, or 7.9%, for the year ended December 31, 2005 as compared to the same period in 2004. The decrease in commercial health care costs is primarily attributable to membership losses, primarily in California and New Jersey, and $143.5 million of costs recorded in 2004 associated with provider settlements relating to claims processing and payment issues that have been or are being resolved. The increase in the commercial health care cost trend on a PMPM basis was 4.3% for the year ended December 31, 2005 over the same period in 2004 due to an increase in our pharmacy and physician costs, partially offset by moderating health care cost trends in our commercial market reflecting, in part, improvement in our hospital cost experience due to lower inpatient utilization.
Medicare Risk health care costs increased by $48.0 million, or 3.5%, for the year ended December 31, 2005 as compared to the same period in 2004. The increase in the Medicare Risk health care cost PMPM was 2.8% for the year ended December 31, 2005 compared to the same period in 2004. Medicare Risk health care costs increased primarily as a result of higher physician and inpatient claim costs and increased capitation expense related to Medicare rate adjustments for 2003 and 2004 totaling $9.7 million which were recognized in 2005. See “-Health Plan Services Premiums” for detail regarding the increase in premium revenue related to the 2003 and 2004 Medicare rate adjustment. These increases were partially offset by provider settlements of $14.6 million recorded in the fourth quarter of 2004.
Medicaid health care costs decreased by $57.8 million, or 6.0%, for the year ended December 31, 2004 compared to the same period in 2003 primarily as a result of lower physician costs combined with membership losses. The decrease in the Medicaid health care cost PMPM was 1.3% for the year ended December 31, 2004 over the same period in 2003.
The selling costs ratio (selling costs as a percentage of Health Plan Services premiums) decreased to 2.3% for the year ended December 31, 2005 from 2.5% for the same period in 2004. The decrease is primarily due to a decline in our small group and individual membership which have lower commission cost structures.