We are an integrated managed care organization that delivers managed health care services through health plans and government sponsored managed care plans. We are among the nation’s largest publicly traded managed health care companies. Our mission is to help people be healthy, secure and comfortable. We provide health benefits to approximately 6.7 million individuals across the country through group, individual, Medicare (including the Medicare prescription drug benefit commonly referred to as “Part D”), Medicaid, TRICARE and Veterans Affairs programs. Our behavioral health services subsidiary, Managed Health Network (MHN), provides behavioral health, substance abuse and employee assistance programs to approximately 6.9 million individuals, including our own health plan members. Our subsidiaries also offer managed health care products related to prescription drugs, and offer managed health care product coordination for multi-region employers and administrative services for medical groups and self-funded benefits programs.
Our Health Plan Services reportable segment includes the operations of our commercial, Medicare (including the Medicare prescription drug benefit commonly referred to as “Part D”) and Medicaid health plans, the operations of our health and life insurance companies, and our behavioral health and pharmaceutical services subsidiaries. We have approximately 3.7 million members, including Medicare Part D members and 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. 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 also provide behavioral health services to military families under the Department of Defense Military Family Life Counseling contract.
Our profitability depends in large part on our ability to, among other things, effectively price our health care products; manage health care costs, including reserve estimates 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 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, and may have a material impact on our business, financial condition or results of operations.
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 the Health Plan Services segment. Selling expenses consist of external broker commission expenses and generally vary with premium volume.
During the fourth quarter of 2008, we announced that the Company’s board of directors directed our Chief Operating Officer to assume responsibility for all operational matters of the Company, and our President and Chief Executive Officer to focus his efforts on the Company’s strategy, with particular emphasis on how best to deploy the Company’s assets in the current competitive and economic environment. This process includes reviewing our health plans in Arizona, Connecticut, New Jersey and New York to determine their long-term strategic position in the Company as well as a possible divestiture among other strategic alternatives. We are continuing with this process and no definitive decisions have been made at this time.
During 2008, we have been actively engaged in the reprocurement process of the TRICARE North contract. In late December 2008, the government requested final proposal revisions from companies bidding on the TRICARE contracts. We submitted our response in early January 2009. We currently expect an award to occur during the first half of 2009.
Net income for the year ended December 31, 2008 decreased to $95.0 million, or $0.88 per diluted share, from $193.7 million, or $1.70 per diluted share, for the same period in 2007, and was impacted by after tax expenses of $104.1 million, or $0.97 per diluted share, and after-tax charges of $222.4 million, or $1.96 per diluted share, related to our operations strategy, litigation and regulatory matters, and other-than-temporary impairment of investment securities (collectively referred to as Charges) for the year ended December 31, 2008 and 2007, respectively;
Total health plan enrollment was 3,720,000 as of December 31, 2008, a decrease of 34,000 members, or approximately 1.0%, compared to December 31, 2007;
Total revenues for the year ended December 31, 2008 increased by approximately 9% to $15.4 billion from the same period in 2007;
Health plan services segment pretax income was $14.4 million, including $175.1 million of Charges, for the year ended December 31, 2008 and was $164.8 million, including $306.8 million of Charges, for the same period in 2007;
Government contracts segment pretax income was $132.7 million and $194.1 million for the years ended December 31, 2008 and 2007, respectively; and
The table below and the discussion that follows summarize our results of operations for the last three fiscal years:
(a) MCR is calculated as health plan services cost divided by health plan services premiums revenue.
(b) Government contracts cost ratio is calculated as government contracts cost divided by government contracts revenue.
(c) The G&A expense ratio is computed as G&A expenses divided by the sum of health plan services premium revenues and administrative services fees and other income.
Net income for 2008 decreased to $95.0 million from $193.7 million in 2007. Earnings per share fell to $0.89 per basic share and $0.88 per diluted share for 2008 compared with $1.74 per basic share and $1.70 per diluted share for 2007. Pretax margin was 1.0% for 2008 compared to 2.5% for 2007. Included in the 2008 operating results are $175.1 million in Charges including the following:
$119.6 million recorded as part of G&A expenses primarily for severance and other costs associated with Health Net’s operations strategy which is aimed at achieving substantial reductions in G&A by 2010. This amount also includes attorney’s fees and regulatory fines associated with our rescission practices and in connection with the settlement agreement for the McCoy, Wachtel and Scharfman lawsuits. See “Item 3. Legal Proceedings” for additional information regarding these matters;
Health Net’s total revenues increased 9% in 2008 to $15.4 billion from $14.1 billion in 2007. Health plan services premium revenues increased 8% to $12.4 billion in 2008 compared to $11.4 billion in 2007. Our total premium revenue yield on a PMPM basis was 5% in 2008 compared to 8% in 2007. The health plan services medical care ratio (MCR) was 86.9% in 2008 compared to 85.4% in 2007. The MCR for 2008 and 2007 included 40 and 180 basis points, respectively, impact from the Charges.
Our Government contracts revenues increased 13% in 2008 to $2.8 billion from $2.5 billion in 2007. The Government contracts cost ratio increased to 95.3% in 2008 compared to 92.2% in 2007.
Net cash used in operating activities totaled $159.0 million for the year ended December 31, 2008 compared to net cash provided by operating activities of $605.5 million for the same period in 2007. This decrease in cash was driven by payments made in 2008 related to operations strategy and regulatory related matters and an increase in our CMS receivables relating to catastrophic and low-income subsidies.
Net income for 2007 decreased to $193.7 million from $329.3 million in 2006. Earnings per share fell to $1.74 per basic share and $1.70 per diluted share for 2007 compared with $2.86 per basic share and $2.78 per diluted share for 2006. Pretax margin was 2.5% for 2007 compared to 3.7% for 2006. The primary drivers of these declines were charges incurred related to litigation and regulatory matters and debt refinancing activities.
Total health plan enrollment, including Medicare Part D, increased to 3,754,000 members at December 31, 2007 from 3,699,000 members at December 31, 2006, primarily due to a 73,000-member increase in our commercial small group/individual membership and a 116,000-member increase in our Medicare membership, partially offset by 140,000-member decrease in our commercial large group and ASO membership. Our strategy of targeting the small group and individual market resulted in changing the mix of our membership: approximately 35% of our commercial risk enrollment was in the small group and individual market at the end of 2007, up from 31% at the end of 2006. We continued to expand our Medicare membership, which increased by 116,000 members in 2007. On January 1, 2007, we began offering Medicare Advantage Private-Fee-For Service plans, and we began marketing our Medicare Part D plans in all 50 states and the District of Columbia. We also increased the number of Part D plan choices that we offer seniors from two in 2006 to three in 2007, one of which provides beneficiaries with coverage of generic drug expenses through the coverage gap, or “donut hole.” Our TRICARE membership was stable at 2.9 million beneficiaries, and we expanded our relationship with the Department of Defense by providing behavioral health counseling services starting in 2006. In addition, our behavioral health care business unit was awarded a five-year contract in 2007 to develop, administer and monitor the non-medical counseling program for military service members known as Military Family and Life Consultant Program (MFLC). The total contract is valued at approximately $250 million.
Health Net’s total revenues increased 9% in 2007 to $14.1 billion from $12.9 billion in 2006. Health plan services premium revenues increased 10% to $11.4 billion in 2007 compared to $10.4 billion in 2006. Our commercial revenue yield was 9.2% in 2007 compared to 7.6% in 2006. The health plan services MCR was 85.4% in 2007 compared to 83.0% in 2006. The MCR for 2007 included the impact of the $201.5 million, or 180 basis points, of health plan services expenses related to the litigation and regulatory-related charge noted above.
We participate in state Medicaid programs in California and New Jersey. California membership, where the program is known as Medi-Cal, comprised 94% and 84% of our Medicaid membership at December 31, 2008 and 2007, respectively. Membership in our Medicaid programs decreased by 34,000 members at December 31, 2008 compared to December 31, 2007 primarily due to our withdrawal from the Connecticut Medicaid Program in April 2008, partially offset by a gain of 53,000 members in California due to higher enrollment in the Fresno and San Diego counties and in the Healthy Families program. We provided administrative services only to Connecticut Medicaid members during the first quarter of 2008 and completed our exit from the Connecticut Medicaid programs as of April 1, 2008.
Total health plan membership increased by 2% to 3.8 million members at December 31, 2007 from 3.7 million members at December 31, 2006. The increase was primarily driven by the addition of 79,000 stand-alone PDP members and 37,000 Medicare Advantage members, partially offset by a decrease of 67,000 commercial and ASO members.
Membership in our Medicaid programs increased by 6,000 members at December 31, 2007 compared to December 31, 2006, primarily due to enrollment increases in Connecticut.
Medicare premiums increased by $742.6 million, or 27%, for the year ended December 31, 2008 as compared to the same period in 2007. This increase was primarily due to an increase in members participating in the Medicare Advantage and Medicare Part D prescription drug program. In addition, we recognized $137.7 million in Medicare risk factor estimates for the 2008 payment year in our health plan services premium revenues in the year ended December 31, 2008. See “-Health Plan Services Costs” for detail regarding the increase in capitation expense related to the Medicare rate adjustment.
Medicaid premiums decreased by $115.4 million, or 10%, for the year ended December 31, 2008 as compared to the same period in 2007 primarily due to a decrease in Connecticut Medicaid membership. We
Medicaid premiums increased by $31.6 million, or 3%, for the year ended December 31, 2007 as compared to the same period in 2006 primarily due to an increase in Medicaid premium PMPM, which was 5% for the year ended December 31, 2007 over the same period in 2006. In the Connecticut Medicaid program, we came to an agreement with the State of Connecticut where we continued to serve approximately 90,000 members on an ASO basis through the first quarter of 2008. We completed our exit from the Connecticut Medicaid Program in April 2008. We recognized approximately $185 million of premium revenue from our Connecticut Medicaid program during 2007.
Commercial health care costs increased by $296.0 million, or 5%, for the year ended December 31, 2008 as compared to the same period in 2007. The increase in the commercial health care cost trend on a PMPM basis was 9% for the year ended December 31, 2008 over the same period in 2007. Commercial MCR increased to 85.9% for the year ended December 31, 2008 from 85.7% for the year ended December 31, 2007. Physician and hospital costs on a PMPM basis rose about 9% and 13% from higher paid claims costs, respectively, while the utilization was relatively flat with commercial bed days increasing by less than one-half of a percent in 2008 over 2007. Pharmacy costs rose approximately 12% due to higher utilization on a PMPM basis for the year ended December 31, 2008 over the same period in 2007. The litigation and regulatory-related charge recorded in 2008 impacted the commercial MCR by 50 basis points and commercial health care cost trend on a PMPM basis by 290 basis points. The litigation and regulatory-related charge recorded in 2007 impacted the commercial MCR by 270 basis points and commercial health care cost trend on a PMPM basis by 360 basis points.
Medicare health care costs increased by $793.1 million, or 33%, for the year ended December 31, 2008 as compared to the same period in 2007, and Medicare MCR, including Medicare Advantage and Part D, increased by 450 basis points for the same comparative periods. These increases were primarily driven by a 37% enrollment growth and were primarily comprised of higher inpatient and outpatient hospital and pharmacy costs and utilization. Medicare Advantage health care cost PMPM increased by 6% for the year ended December 31, 2008, as compared to the same period in 2007. Part D health care cost PMPM increased by 20 basis points for the year ended December 31, 2008, as compared to the same period in 2007. Also contributing to the Medicare health care cost increase is $32.9 million of capitation expense related to the Medicare risk factor estimates for the 2008 plan year. See “-Health Plan Services Premiums” for detail regarding the increase in premium revenue related to the Medicare rate adjustment.
Medicare health care costs increased by $453.5 million, or 24%, for the year ended December 31, 2007 as compared to the same period in 2006. Medicare health care costs increased as a result of higher hospital costs and higher pharmacy costs mainly in Arizona and the Northeast and increased capitation expense from Medicare risk factor adjustments totaling $27.2 million, which was recognized in the year ended December 31, 2007. Of this amount, $22.5 million, $3.9 million and $0.8 million were for the 2007, 2006, and 2003 payment years, respectively. See “-Health Plan Services Premiums” for detail regarding the increase in premium revenue related to the Medicare rate adjustment. Medicare MCR, including Medicare Advantage and Part D, increased by 210 basis points for the year ended December 31, 2007.
Medicaid health care costs increased by $51.4 million, or 5%, for the year ended December 31, 2007 as compared to the same period in 2006. The increase in the Medicaid health care cost PMPM was 8% for the year ended December 31, 2007 over the same period in 2006. These increases were primarily driven by higher hospital and pharmacy costs. Medicaid MCR increased by 220 basis points at December 31, 2007 compared to December 31, 2006.
Administrative services fees and other income decreased by $5.5 million, or 10%, for the year ended December 31, 2007 as compared to the same period in 2006. The decrease was primarily due to loss of ASO membership in our Connecticut health plan.
Net investment income decreased by $29.1 million, or 24%, for the year ended December 31, 2008 as compared to the same period in 2007. This decrease was primarily due to lower short-term interest rates along with a slight decrease in cash balances and a $14.6 million recognized loss from other-than temporary impairments in our available-for-sale investments and money market funds. This decrease was partially offset by a $7 million increase in our interest rate swap value (see Note 2-Summary of Significant Accounting Policies to our consolidated financial statements).
The selling costs ratio was 2.9% for the years ended December 31, 2008 and 2007. The selling costs ratio is a function of changes in our membership mix between large group and small and individual group members, and the growth of our Medicare Advantage business.
Interest expense increased by $10.4 million, or 32%, for the year ended December 31, 2008 as compared to the same period in 2007. The increase was primarily due to increased borrowings on our revolving credit facility and amortization of the discount on our amortizing financing facility completed in December 2007, partially offset by interest on our bridge loan paid off in March 2007 and term loan paid off in May 2007.
G&A costs increased by $110.2 million, or 9%, for the year ended December 31, 2007 as compared to the same period in 2006. The increase in costs was primarily driven by a $105.3 million charge for attorney’s fees and regulatory fines related to the litigation and regulatory-related matters and arbitration settlement. See “Item 3. Legal Proceedings” for additional information on these litigation matters. Our G&A expense ratio decreased to 11.1% for the year ended December 31, 2007 from 11.2% for the same period in 2006. The charge recorded in 2007 impacted the ratio by 90 basis points.
Interest expense decreased by $18.7 million, or 37%, for the year ended December 31, 2007 as compared to the same period in 2006. The decreases were primarily due to lower interest rates on our Senior Notes in 2007 compared with the senior notes we redeemed in the third quarter of 2006, and lower interest on our term and bridge loans and revolver borrowings as a result of lower outstanding balances and early termination of the debt.
Our TRICARE contract for the North Region includes a target cost and price for reimbursed health care costs, which is negotiated annually during the term of the contract with underruns and overruns of our target cost borne 80% by the government and 20% by us. In the normal course of contracting with the federal government, we recognize changes in our estimate for the target cost underruns and overruns when the amounts become determinable, supportable, and the collectibility is reasonably assured. As a result of changes in the estimate during the year ended December 31, 2008, we recognized an increase in revenue of $17 million compared to a decrease in revenue of $58 million in the year ended December 31, 2007. As a result of changes in the estimate during the year ended December 31, 2008, we recognized an increase in cost of $22 million compared to a decrease in cost of $75 million in the year ended December 31, 2007. The administrative price is paid on a monthly basis, one month in arrears and certain components of the administrative price are subject to volume-based adjustments.
Government contracts revenues increased by $125.7 million, or 5%, for the year ended December 31, 2007 as compared to the same period in 2006. Government contracts costs increased by $73.1 million or 3% for the year ended December 31, 2007 as compared to the same period in 2006. The increase was primarily due to an increase in health care services provided under a new option year in the TRICARE contract, Option Period 4, which began April 1, 2007 and growing family counseling business with the Department of Defense. In addition, 2007 includes a $36.5 million favorable settlement with the Federal Government regarding prior Option Period 1 health care cost targets.
During the years ended December 31, 2007 and 2006, we recognized a decrease in the revenue estimate of $58 million and $104 million, respectively, and a decrease in the cost estimate of $75 million and $128 million, respectively, related to the change in our estimate for the target cost underruns and overruns.
The Government contracts ratio decreased by 180 basis points for the year ended December 31, 2007 as compared to the same period in 2006 primarily due to the favorable settlement with the Government regarding prior Option 1 healthcare cost targets and ongoing expansion of our behavioral health services provided to our military men and women and their families.
We recorded the following $175.1 million pretax, or $104.1 million after tax, charges during the year ended December 31, 2008:
In 2007, we recorded a $306.8 million pretax, or $222.4 million after-tax, charge incurred as a result of us reaching an agreement in principle to settle the McCoy, Wachtel and Scharfman class action lawsuits; the proposed resolution of regulatory issues with the New Jersey Department of Banking and Insurance; arbitration settlement; and other immaterial litigation matters. See “Item 3. Legal Proceedings” for additional information regarding these matters. The charge amount was comprised of the following:
During the three months ended December 31, 2006, we recorded a pretax charge of approximately $37.1 million in connection with the McCoy, Wachtel and Scharfman class action lawsuits.
Our income tax expense and the effective income tax rate for the years ended December 31, 2008, 2007 and 2006 are as follows:
The effective income tax rate decreased from 2007 to 2008 primarily due to the favorable outcome related to the prior year nondeductible class action lawsuit expenses. The effective income tax rate increased from 2006 to 2007 primarily due to the establishment of a valuation allowance in 2007 against deferred tax assets for net operating loss carryforwards and tax credits of a particular business unit potentially impacted by the McCoy class action lawsuit, and nondeductible class action lawsuit expenses incurred in 2007.
In the U.S., recent market and economic conditions have been unprecedented in recent history and challenging with tighter credit conditions and slower growth through the third and fourth quarters of 2008. Continued concerns about the U.S. mortgage market, declining real estate market, and the availability of credit have contributed to increased market volatility and diminished expectations for the U.S. economy. In September 2008, added concerns fueled by the federal government conservatorship of the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal National Mortgage Association (Fannie Mae), the declared bankruptcy of Lehman Brothers Holdings Inc., the U.S. government provided loan to American International Group Inc. and other federal government interventions in the U.S. credit markets led to increased market uncertainty and instability in both U.S. and international capital and credit markets. These conditions, combined with volatile oil prices, declining business and consumer confidence and increased unemployment have contributed to volatility of unprecedented levels.
As a result of these market conditions, the cost and availability of credit has been and may continue to be adversely affected by illiquid credit markets and wider credit spreads. Concern about the stability of the markets generally and the strength of counterparties specifically has caused many lenders and institutional investors to reduce, and in some cases, cease to provide funding to borrowers. While we have not experienced a reduction in the capital and funding available to us at this time, continued turbulence in the U.S. and international markets and economies may adversely affect our liquidity and financial condition. If these market conditions continue, they may limit our ability to timely replace maturing liabilities and access the capital markets to meet liquidity needs, which could adversely affect our financial condition and results of operations. Furthermore, if our customer base experiences cash flow problems and other financial difficulties, it could, in turn, adversely impact membership in our plans. For example, our customers may modify, delay or cancel plans to purchase our products, may reduce the number of individuals to whom they provide coverage, or may make changes in the mix or products purchased from us. In addition, if our customers experience financial issues, they may not be able to pay, or may delay payment of, accounts receivable that are owed to us. Further, our customers or potential customers may force us to compete more vigorously on factors such as price and service to retain or obtain their business. A significant decline in membership in our plans and the inability of current and/or potential customers to pay their premiums as a result of unfavorable conditions may adversely affect our business, including our revenues, profitability and cash flow.
As of December 31, 2008, we valued investment securities available-for-sale at $1.5 billion. Approximately 67% of our portfolio holdings is in agency mortgage-backed bonds and municipal bonds. We also hold high-quality corporate bonds. We evaluate and determine the classification of our investments based on management’s intent; currently, we have classified our investments as available-for-sale. We also closely monitor the fair values of our investment holdings and regularly evaluate them for any other-than-temporary impairments.
Our cash flow from investing activities is primarily impacted by the sales, maturities and purchases of our available-for-sale investment securities and restricted investments. Our investment objective is to maintain safety and preservation of principal by investing in a diversified mix of high-quality, investment grade securities while maintaining liquidity in each portfolio sufficient to meet our cash flow requirements and attaining the highest total return on invested funds. We do not own any investments that have direct subprime mortgage exposure.
Our investment portfolio includes $520.0 million, or 34.6% of our portfolio holdings, of mortgage-backed and asset-backed securities. The majority of our mortgage-backed securities are Fannie Mae, Freddie Mac and Ginnie Mae issues, and the average rating of our asset-backed securities is AA+/Aa1. As of December 31, 2008 and December 31, 2007, our asset-backed and mortgage-backed securities had gross unrealized holding losses of $17.2 million and $3.1 million, respectively. We have the intent and ability to hold our debt investments for a sufficient
As discussed in Note 4 to our consolidated financial statements, we recognized a $14.6 million loss from other-than-temporary impairments of investment securities and money market funds in the third quarter of 2008. After this write-down, we had gross unrealized losses of $32.8 million as of December 31, 2008, compared to $7.0 million as of December 31, 2007. While we believe that these impairments are temporary and that we have the intent and ability to hold such securities until maturity or recovery, given the current market conditions, there is a continuing risk that further declines in fair value may occur and additional material other-than-temporary impairments may be recorded in future periods.
In September 2008, The Reserve announced its intention to liquidate all of its money market funds and froze all redemptions until an orderly liquidation process could be implemented. As a result, we reclassified $372 million in estimated net asset value we had invested in The Reserve money market funds from cash equivalents to investments available for sale as of September 30, 2008. As of December 31, 2008, we held $50.4 million of their Primary Fund and $69.2 million of their U.S. Government Fund due to redemptions during the fourth quarter of 2008. On January 16, 2009, The Reserve paid out in full the balance in the U.S. Government Fund and on February 20, 2009, we received $17.1 million of the Primary Fund from the Reserve. The Reserve expects to distribute the remaining amounts in the Primary Fund by the end of 2009.
Our cash flow from operating activities is impacted by, among other things, the timing of collections on our amounts receivable from our TRICARE contract for the North Region. Health care receivables related to TRICARE are best estimates of payments that are ultimately collectible or payable. The timing of collection of such receivables is impacted by government audit and negotiation and can extend for periods beyond a year. Amounts receivable under government contracts were $241.3 million and $190.0 million as of December 31, 2008 and December 31, 2007, respectively. Our cash flow from operating activities is also impacted by the timing of collections on our amounts receivable from CMS. Our receivable related to our Medicare business was $315.5 million, including about $150 million expected to be settled in the fourth quarter of 2009, as of December 31, 2008 and $107.2 million as of December 31, 2007.
During 2008, we recognized $175.1 million in pretax charges related to our operations strategy and litigation and regulatory related matters. The majority of these charges were settled in cash and were funded by cash flow from operating and financing activities. For additional information regarding these charges, see “-Summary of Operating Results” above.
Our total cash and cash equivalents as of December 31, 2008 and 2007 were $668.2 million and $1,007.0 million, respectively. The changes in cash and cash equivalents are summarized as follows:
Net cash used in investing activities increased by $45.3 million compared to the year ended December 31, 2006 primarily due to a net increase in purchases of investments available-for-sale portfolio of $140 million, partially offset by an increase in net proceeds of $93 million from the sales of property and equipment, including our Shelton, CT and Tucson, AZ facilities.
Net cash used in financing activities increased by $38.9 million primarily due to a decrease in stock option exercise proceeds of $66 million, decrease in excess tax benefits from share based compensation of $17 million and a net increase in share repurchases of $11 million, partially offset by an increase in net borrowings of $55 million.
On December 19, 2007, we entered into a five-year, non-interest bearing, $175 million amortizing financing facility with a non-U.S. lender and we entered into amendments to the financing facility on April 29, 2008 and November 10, 2008, which were administrative in nature. The proceeds from the financing facility were used for general corporate purposes.
The financing facility provides that it may be terminated through a series of put and call transactions (1) at the option of one of our wholly-owned subsidiaries at any time after December 20, 2009, or (2) upon the occurrence of certain defined early termination events. These early termination events, include, but are not limited to:
nonpayment of certain amounts due by us or certain of our subsidiaries under the financing facility (if not cured within the related time period set forth therein);
our failure to maintain the following ratings on our senior indebtedness by any two of the following three rating agencies: (1) a rating of at least BB by Standard & Poor’s Ratings Services (S&P), (2) a rating of at least BB by Fitch, Inc. (Fitch), and (3) a rating of at least Ba2 by Moody’s Investors Service, Inc. (Moody’s). As of December 31, 2008 and February 12, 2009, the ratings with S&P, Fitch and Moody’s on our senior indebtedness were BB, BB+ and Ba3, respectively;
noncompliance by Health Net with any material term or provision of the HMO Regulations or Insurance Regulations (as each such term is defined in the financing facility);
In addition, in connection with the financing facility, we entered into a guaranty which will require us to guarantee the payment of the semi-annual distributions and any other amounts payable by one of our subsidiaries to the financing facility participants under certain circumstances provided under the financing facility. Also in connection with the financing facility, we entered into an interest rate swap agreement with a non-U.S. bank affiliated with one of the financing facility participants. Under the interest rate swap agreement, we pay a floating payment in an amount equal to LIBOR times a notional principal amount and receive a fixed payment in an amount equal to 4.3% times the same notional principal amount from the non-U.S. bank counterparty in return in accordance with a schedule set forth in the interest rate swap agreement.
Our revolving credit facility includes, among other customary terms and conditions, limitations (subject to specified exclusions) on our and our subsidiaries’ ability to incur debt; create liens; engage in certain mergers, consolidations and acquisitions; sell or transfer assets; enter into agreements which restrict the ability to pay dividends or make or repay loans or advances; make investments, loans, and advances; engage in transactions with affiliates; and make dividends. In addition, we are required to maintain a specified consolidated leverage ratio and consolidated fixed charge coverage ratio throughout the term of the revolving credit facility.
As of December 31, 2008, we were in compliance with all covenants under our revolving credit facility.
Certain of our subsidiaries must comply with minimum capital and surplus requirements under applicable state laws and regulations, and must have adequate reserves for claims. Management believes that as of December 31, 2008, all of our active health plans and insurance subsidiaries met their respective regulatory requirements, in all material respects.
As necessary, we make contributions to and issue standby letters of credit on behalf of our subsidiaries to meet RBC or other statutory capital requirements under state laws and regulations. During the year ended December 31, 2008, we made capital contributions of $240.6 million to various subsidiaries to maintain RBC or other statutory capital requirements. Health Net, Inc. made a capital contribution in the amount of $3.0 million to one of its subsidiaries to meet RBC or other statutory capital requirements under state laws and regulations thereafter through February 20, 2009.
On March 29, 2007, we sold our 68-acre commercial campus in Shelton, Connecticut (the “Shelton Property”) to The Dacourt Group, Inc. (“Dacourt”) and leased it back from Dacourt under an operating lease agreement for an initial term of ten years with an option to extend for two additional terms of ten years each. The total future minimum lease commitments under the lease are approximately $70.1 million.
Effective January 1, 2005, we entered into an operating lease agreement to renew our leased office space in Woodland Hills, California for our corporate headquarters. The new lease is for a term of 10 years and has provisions for space reduction at specific times over the term of the lease, but it does not provide for complete cancellation rights. The total future minimum lease commitments under the lease are approximately $19.2 million.
We have entered into long-term agreements to purchase various services, which may contain certain termination provisions and have remaining terms in excess of one year as of December 31, 2008.
We have entered into long-term agreements to receive services related to pharmacy benefit management, pharmacy claims processing services and health quality/risk scoring enhancement services with external third-party service providers. The remaining terms are approximately three years for each of these contracts. Termination of these agreements is subject to certain termination provisions. The total future minimum commitments under these agreements are $122.0 million and are included in the table above.
On August 19, 2008, we entered into a five and one-half year agreement with International Business Machines Corporation (IBM) to outsource our IT infrastructure management services including data center services, IT security management and help desk support. The total future minimum commitments under the agreement are $295.0 million.
On September 30, 2008, we entered into a five year and three month agreement with Cognizant Technology Solutions U.S. Corporation (Cognizant) to outsource our software applications development and management activities to Cognizant. Under the terms of the agreement, Cognizant will, among other things, provide us with services including the following: application development, testing and monitoring services, application maintenance and support services, project management services and cross functional services. The total future commitments under the agreement are $107.8 million.
We have excluded from the table above amounts already recorded in our current liabilities on our consolidated balance sheet as of December 31, 2008. We have also excluded from the table above various contracts we have entered into with our health care providers, health care facilities, the federal government and other contracts that we have entered into for the purpose of providing health care services. We have excluded those contracts that allow for cancellation without significant penalty, obligations that are contingent upon achieving certain goals and contracts for goods and services that are fulfilled by vendors within a short time horizon and within the normal course of business.
On January 23, 2009, we also entered into a five year and two months agreement with Cognizant to outsource a substantial portion of our claims processing activities to Cognizant. Under the terms of the agreement, Cognizant will, among other things, provide us with claims adjudication, adjustment, audit and process improvement services. The total future commitments under the agreement are $13.3 million.
As of December 31, 2008, we had no off-balance sheet arrangements as defined under Regulation S-K 303(a)(4) and the instructions thereto.
methodology in trending the claims per member per month for purposes of estimating the reserves for the most recent months. In developing our best estimate of reserves for claims, we consistently apply the principles and methodology described above from year to year, while also giving due consideration to the potential variability of these factors. Because reserves for claims include various actuarially developed estimates, our actual health care services expense may be more or less than our previously developed estimates. Claims processing expenses are also accrued based on an estimate of expenses necessary to process such claims. Such reserves are continually monitored and reviewed, with any adjustments reflected in current operations.
Our HMOs in other states 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. Additionally, we contract with certain hospitals to provide hospital care to enrolled members on a capitation basis.
We assess the profitability of contracts for providing health care services when operating results or forecasts indicate probable future losses. Significant factors that can lead to a change in our profitability estimates include premium yield and health care cost trend assumptions, risk share terms and non-performance of a provider under a capitated agreement resulting in membership reverting to fee-for-service arrangements with other providers. 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 losses are determined and are classified as Health Plan Services. We held no premium deficiency reserves as of December 31, 2008.
Other government contracts revenues are recognized in the month in which the eligible beneficiaries are entitled to health care services or in the month in which the administrative services are performed or the period that coverage for services is provided. Under our TRICARE contract for the North Region we recognize amounts receivable and payable under the government contracts related to estimated health care IBNR expenses which are reported separately on the accompanying consolidated balance sheet as of December 31, 2008. These amounts are the same since all of the estimated health care IBNR expenses incurred are offset by an equal amount of revenues earned.
We record deferred tax assets and liabilities based on differences between the book and tax bases of assets and liabilities. The deferred tax assets and liabilities are calculated by applying enacted tax rates and laws to taxable years in which such differences are expected to reverse. We establish a valuation allowance in accordance with the provisions of Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes (SFAS No. 109). We continually review the adequacy of the valuation allowance and recognize the benefits from our deferred tax assets only when an analysis of both positive and negative factors indicate that it is more likely than not that the benefits will be realized.