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HNT_10Q_8_01
1. UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2001
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number: 1-12718
HEALTH NET, INC.
(Exact name of registrant as specified in its charter)
Delaware 95-4288333
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
21650 Oxnard Street, Woodland Hills, CA 91367
(Address of principal executive offices) (Zip Code)
(818) 676-6000
Registrant’s telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes No
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of
the latest practicable date:
The number of shares outstanding of the registrant’s Class A Common Stock as of August 9, 2001
was 123,278,436 (excluding 3,194,374 shares held as treasury stock) and no shares of Class B Common
Stock were outstanding as of such date.
7. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
Health Net, Inc. (formerly named Foundation Health Systems, Inc., together with its subsidiaries
may be referred to hereafter as the Company, we, us or our) prepared the condensed consolidated
financial statements following the rules and regulations of the Securities and Exchange Commission
(SEC) for interim reporting. As permitted under those rules and regulations, certain footnotes or other
financial information that are normally required by accounting principles generally accepted in the
United States of America (GAAP) can be condensed or omitted if they substantially duplicate the
disclosures contained in the annual audited financial statements.
We are responsible for the unaudited financial statements included in this document. The financial
statements include all normal and recurring adjustments that are considered necessary for the fair
presentation of our financial position and operating results in accordance with GAAP. In accordance
with GAAP, we make certain estimates and assumptions that affect the reported amounts. Actual
results could differ from estimates. As these are condensed financial statements, one should also read
our 2000 consolidated financial statements and notes included in our Form 10-K filed in March 2001.
Revenues, expenses, assets and liabilities can vary during each quarter of the year. Therefore, the
results and trends in these interim financial statements may not be the same as those for the full year.
2. COMPREHENSIVE INCOME
Our comprehensive income for the second quarter and six months ended June 30 is as follows
(amounts in thousands):
Second Quarter Six Months
Ended June 30, Ended June 30,
2001 2000 2001 2000
Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $(14,205) $38,695 $28,210 $72,750
Other comprehensive (loss) income, net of tax:
Net change in unrealized (depreciation) appreciation on
investments available for sale . . . . . . . . . . . . . . . . . . . . . . . (212) 609 3,531 227
Comprehensive (loss) income . . . . . . . . . . . . . . . . . . . . . . . . $(14,417) $39,304 $31,741 $72,977
3. EARNINGS PER SHARE
Basic earnings per share excludes dilution and reflects net income or loss divided by the weighted
average shares of common stock outstanding during the periods presented. Diluted earnings per share
is based upon the weighted average shares of common stock and dilutive common stock equivalents (all
of which are comprised of stock options) outstanding during the periods presented. Common stock
equivalents arising from dilutive stock options are computed using the treasury stock method. There
were 2,165,000 shares of dilutive common stock equivalents for the six months ended June 30, 2001,
and 271,000 and 116,000 shares of dilutive common stock equivalents for the second quarter and six
months ended June 30, 2000, respectively. For the second quarter ended June 30, 2001, 1,886,000
shares of common stock equivalents were excluded from the computation of diluted loss per share due
to their antidilutive effect.
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8. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
3. EARNINGS PER SHARE (Continued)
Options to purchase an aggregate of 7,291,000 shares of common stock during the six months
ended June 30, 2001, and an aggregate of 10,208,000 and 10,301,000 shares of common stock during
the second quarter and six months ended June 30, 2000, respectively, were not included in the
computation of diluted earnings per share because the options’ exercise prices were greater than the
average market price of the common stock.
4. SEGMENT INFORMATION
Our segment information for the second quarter and six months ended June 30, 2001 and 2000 is
as follows (amounts in thousands):
Government
Contracts/
Health Plan Speciality Corporate
Services Services and Other Total
Second Quarter Ended June 30, 2001
Revenues from external sources . . . . . . . . . . . . . . . . $2,104,501 $417,699 — $2,522,200
Intersegment revenues . . . . . . . . . . . . . . . . . . . . . . — 31,897 — 31,897
Income (loss) before income taxes . . . . . . . . . . . . . . 63,645 11,847 $ (98,040) (22,548)
Second Quarter Ended June 30, 2000
Revenues from external sources . . . . . . . . . . . . . . . . $1,795,591 $408,554 — $2,204,145
Intersegment revenues . . . . . . . . . . . . . . . . . . . . . . — 16,948 — 16,948
Income (loss) before income taxes . . . . . . . . . . . . . . 73,281 28,482 $ (38,967) 62,796
Six Months Ended June 30, 2001
Revenues from external sources . . . . . . . . . . . . . . . . $4,179,200 $805,789 — $4,984,989
Intersegment revenues . . . . . . . . . . . . . . . . . . . . . . — 46,781 — 46,781
Income (loss) before income taxes . . . . . . . . . . . . . . 151,266 21,980 $(128,466) 44,780
Six Months Ended June 30, 2000
Revenues from external sources . . . . . . . . . . . . . . . . $3,583,567 $797,534 — $4,381,101
Intersegment revenues . . . . . . . . . . . . . . . . . . . . . . — 33,594 — 33,594
Income (loss) before income taxes . . . . . . . . . . . . . . 140,854 49,180 $ (71,976) 118,058
5. DIVESTITURES AND OTHER INVESTMENTS
In January 2001, we entered into a definitive agreement, and subsequently amended the
agreement, to sell our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc., to
Florida Health Plan Holdings II, LLC. Effective August 1, 2001, we completed the sale. In connection
with the sale, we received approximately $49 million which consists of $23 million in cash and
approximately $26 million in a secured six-year note bearing eight percent interest per annum. We also
sold the corporate facility building used by our Florida health plan to DGE Properties, LLC for
$15 million, payable by a secured five-year note bearing eight percent interest per annum. We
estimated and recorded a $76.1 million pre-tax loss on the sales of our Florida health plan and the
related corporate facility building during the second quarter ended June 30, 2001.
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9. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
5. DIVESTITURES AND OTHER INVESTMENTS (Continued)
Pursuant to SFAS No. 121, we evaluated the carrying values of the assets for Florida health plan
and adjusted the carrying value of certain long-lived assets to their estimated fair value. Included in the
$76.1 million pre-tax loss on net assets of Florida health plan and the related corporate facility building
were $40.8 million in non-cash asset impairment charges consisting of $18.5 million for goodwill
impairment on Florida health plan, $4.4 million write-down to its fair value of the corporate facility
building owned by one of our subsidiaries and used by Florida health plan, $15.3 million reserve for
other contractual receivables and $2.6 million write-off of an unrealizable deferred tax asset related to
Florida health plan. The carrying value of the net assets of Florida health plan, before the goodwill
impairment of $18.5 million, was $41.5 million as of June 30, 2001. The net assets were primarily
comprised of cash and cash equivalents and reserves for claims and other settlements. These net assets
are included as part of our Health Plan Services segment as of June 30, 2001. In addition, obligations
under the terms of the amended definitive agreement to provide up to $28 million of reinsurance to
guarantee against claims costs in excess of certain medical care ratio levels of the Florida health plan
for the 18-month period subsequent to the close of the sale were recorded as a liability as of June 30,
2001. Other accrued costs resulting from the sale of the Florida health plan totaled $7.3 million.
Our Florida health plan, excluding the $76.1 million loss on net assets held for sale, had premium
revenues of $147.9 million and a net loss of $13.2 million for the second quarter ended June 30, 2001,
and premium revenues of $303.9 million and a net loss of $15.2 million for the six months ended
June 30, 2001. The effect of the suspension of the depreciation on the corporate facility building was
immaterial for the six months ended June 30, 2001.
Throughout 2000 and the six months ended June 30, 2001, we have provided funding in the
aggregate amount of approximately $6.3 million to MedUnite, Inc., an independent company, funded
and organized by seven major managed health care companies. MedUnite, Inc. is designed to provide
on-line internet provider connectivity services including eligibility information, referrals, authorizations,
claims submission and payment. The funded amounts are included in other noncurrent assets. In
August 2001, we provided additional funding in the amount of approximately $3.7 million to
MedUnite, Inc.
6. LEGAL PROCEEDINGS
SUPERIOR NATIONAL INSURANCE GROUP, INC.
We and our former wholly-owned subsidiary, Foundation Health Corporation (FHC), which
merged into the Company in January 2001, were named in an adversary proceeding, Superior National
Insurance Group, Inc. v. Foundation Health Corporation, Foundation Health Systems, Inc. and
Milliman & Robertson, Inc. (M&R), filed on April 28, 2000, in the United States Bankruptcy Court for
the Central District of California, case number SV00-14099GM. The lawsuit relates to the 1998 sale of
Business Insurance Group, Inc. (BIG), a holding company of workers’ compensation companies
operating primarily in California, by FHC to Superior National Insurance Group, Inc. (Superior).
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10. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
6. LEGAL PROCEEDINGS (Continued)
On March 3, 2000, the California Department of Insurance seized BIG and Superior’s other
California insurance subsidiaries. On April 26, 2000, Superior filed for bankruptcy. Two days later,
Superior filed its lawsuit against us, FHC and M&R. Superior alleges in the lawsuit that:
• the BIG transaction was a fraudulent transfer under federal and California bankruptcy laws in
that Superior did not receive reasonably equivalent value for the $285 million in consideration
paid for BIG;
• we, FHC and M&R defrauded Superior by making misstatements as to the adequacy of BIG’s
reserves;
• Superior is entitled to rescind its purchase of BIG;
• Superior is entitled to indemnification for losses it allegedly incurred in connection with the BIG
transaction;
• FHC breached the Stock Purchase Agreement; and
• we and FHC were guilty of California securities laws violations in connection with the sale of
BIG.
Superior seeks $300 million in compensatory damages, unspecified punitive damages and the costs
of the action, including attorneys’ fees.
On August 1, 2000, a motion filed by us and FHC to remove the lawsuit from the jurisdiction of
the Bankruptcy Court to the United States District Court for the Central District of California was
granted. The lawsuit is now pending in the District Court under case number SACV00-0658 GLT. The
parties are currently engaged in discovery.
We intend to defend ourselves vigorously in this litigation.
FPA MEDICAL MANAGEMENT, INC.
Since May 1998, several complaints have been filed in federal and state courts seeking an
unspecified amount of damages on behalf of an alleged class of persons who purchased shares of
common stock, convertible subordinated debentures and options to purchase common stock of FPA
Medical Management, Inc. (FPA) at various times between February 3, 1997 and May 15, 1998. The
complaints name as defendants FPA, certain of FPA’s auditors, us and certain of our former officers.
The complaints allege that we and such former officers violated federal and state securities laws by
misrepresenting and failing to disclose certain information about a 1996 transaction between us and
FPA, about FPA’s business and about our 1997 sale of FPA common stock held by us. All claims against
our former officers were voluntarily dismissed from the consolidated class actions in both federal and
state court. We have filed a motion to dismiss all claims asserted against us in the consolidated federal
class actions but have not formally responded to the other complaints. We intend to vigorously defend
the actions.
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11. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
6. LEGAL PROCEEDINGS (Continued)
ROMERO (FORMERLY PAY) V. FOUNDATION HEALTH SYSTEMS, INC.
On November 22, 1999, a complaint was filed in the United States District Court for the Southern
District of Mississippi in a lawsuit entitled Pay v. Foundation Health Systems, Inc. (2:99CV329). The
complaint seeks certification of a nationwide class action and alleges that cost containment measures
used by our health maintenance organizations, preferred provider organizations and point-of-service
health plans violate provisions of the federal Racketeer Influenced and Corrupt Organizations Act
(RICO) and the federal Employee Retirement Income Security Act (ERISA). The action seeks
unspecified damages and injunctive relief.
The case was stayed on January 25, 2000, pending the resolution of various procedural issues
involving similar actions filed against Humana Inc. On June 23, 2000, the plaintiffs filed amended
complaints in a Humana action that had been consolidated pursuant to the multi-district litigation
statute in the Southern District of Florida to add claims against other managed care organizations,
including us. On October 23, 2000, the court allowed the plaintiffs to further amend the complaint
against us to add two new named plaintiffs and withdraw the originally named plaintiff, Kerrie Pay,
from the action. Consequently, this case will now be entitled Romero v. Foundation Health Systems, Inc.
On October 23, 2000, the Judicial Panel on Multi-District Litigation ruled that the action originally
filed against us in the Southern District of Mississippi should be consolidated, for purposes of pre-trial
proceedings only, with other cases pending against managed care organizations in the United States
District Court for the Southern District of Florida in Miami. We filed a motion to dismiss the case and
on June 12, 2001, the court entered an order dismissing all claims brought against Health Net with
leave for the plaintiffs to re-file an amended complaint. On this same date, the court stayed discovery
until after the court rules upon motions to dismiss the amended complaints and any motions to compel
arbitration. On June 29, 2001, the plaintiffs filed a third amended class action complaint which
re-alleges causes of action under RICO, ERISA, common law civil conspiracy and common law unjust
enrichment. The third amended class action complaint seeks unspecified compensatory and treble
damages and equitable relief. On July 24, 2001, the court heard oral argument on class certification
issues. We intend to vigorously defend the action.
SHANE V. FOUNDATION HEALTH SYSTEMS, INC.
On August 17, 2000, a complaint was filed in the United States District Court for the Southern
District of Florida in a lawsuit entitled Shane v. Humana, Inc., et al. (including Foundation Health
Systems, Inc.) (00-1334-MD). The complaint seeks certification of a nationwide class action on behalf
of physicians and alleges that the defendant managed care companies’ methods of reimbursing
physicians violate provisions of RICO, ERISA, certain federal regulations and various state laws. The
action seeks unspecified damages and injunctive relief.
On September 22, 2000, we filed a motion to dismiss, or in the alternative to compel arbitration.
On December 11, 2000, the court granted in part and denied in part our motion to compel arbitration.
Under the court’s December arbitration order, plaintiff Dennis Breen, the single named plaintiff to
allege a direct contractual relationship with us, was compelled to arbitrate his direct claims against us.
We have filed an appeal in the United States Court of Appeals for the 11th Circuit seeking to overturn
the portion of the district court’s December ruling that did not order certain claims to arbitration. On
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12. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
6. LEGAL PROCEEDINGS (Continued)
April 26, 2001, the court modified its December arbitration order and is now retaining jurisdiction over
certain direct claims of plaintiff Breen relating to a single contract. On March 2, 2001, the District
Court for the Southern District of Florida issued an order granting the dismissal of certain claims with
prejudice and the dismissal of certain other claims without prejudice, and denying the dismissal of
certain claims. On March 26, 2001, a consolidated amended complaint was filed in this action against
managed care companies, including us. This consolidated complaint adds new plaintiffs, including
Leonard Klay and the California Medical Association (who, as set forth below, had previously filed
claims against the Company), and has, in addition to revising the pleadings of the original claims,
added a claim under the California Business and Professions Code. On May 1, 2001, we filed a motion
to compel arbitration of the claims of all individual plaintiffs that allege to have treated persons insured
by us. On that same date, we filed a motion to dismiss the action. Preliminary discovery and briefing
regarding the plaintiffs’ motion for class certification has taken place. On May 7, 2001, the court heard
oral argument on class certification issues. On May 9, 2001, the court entered a scheduling order
permitting further discovery. On May 14, 2001, Health Net joined in a motion for stay of proceedings
in Shane v. Humana, Inc., et al. (including Foundation Health Systems, Inc.) (00-1334-MD) in the United
States District Court for the Southern District of Florida pending appeal in the 11th Circuit Court of
Appeals. On June 17, 2001, the district court stayed discovery until after the district court rules upon
motions to dismiss and motions to compel arbitration. This order staying discovery also applies to other
actions transferred to the district court by the Judicial Panel on Multidistrict Litigation, namely
California Medical Association v. Blue Cross of California, Inc. et al. and Klay v. Prudential Ins. Co. of
America, et al. On June 25, 2001, the 11th Circuit Court of Appeals entered an order staying all
proceedings in the district court pending resolution of the appeals relating to the district court’s ruling
on motions to compel arbitration. We intend to vigorously defend the action.
STATE OF CONNECTICUT V. PHYSICIANS HEALTH SERVICES, INC.
Physicians Health Services, Inc. (PHS), a subsidiary of ours, was sued on December 14, 1999 in the
United States District Court in Connecticut by the Attorney General of Connecticut, Richard
Blumenthal, acting on behalf of a group of state residents. The lawsuit was premised on ERISA, and
alleged that PHS violated its duties under ERISA by managing its prescription drug formulary in a
manner that served its own financial interest rather than those of plan beneficiaries. The suit sought to
have PHS revamp its formulary system, and to provide patients with written denial notices and
instructions on how to appeal. PHS filed a motion to dismiss which asserted that the state residents the
Attorney General purported to represent all received a prescription drug appropriate for their
conditions and therefore suffered no injuries whatsoever, that his office lacked standing to bring the
suit and that the allegations failed to state a claim under ERISA. On July 12, 2000, the court granted
PHS’ motion and dismissed the action. The State of Connecticut has appealed the dismissal and
argument on the appeal was held before the United States Court of Appeals for the Second Circuit on
May 1, 2001. We intend to vigorously defend the action.
Meanwhile, on September 7, 2000, the Attorney General of Connecticut, Richard Blumenthal, filed
another lawsuit against Physicians Health Services of Connecticut, Inc. (PHS-CT). This new suit also
names Foundation Health Systems, Inc., Anthem Blue Cross and Blue Shield of CT, Anthem Health
Plans, Inc., CIGNA Healthcare of CT, Inc., Oxford Health Plans of CT, Inc. as defendants, and asserts
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13. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
6. LEGAL PROCEEDINGS (Continued)
claims against PHS-CT and us that are similar, if not identical, to those asserted in the previous lawsuit
that was dismissed on July 12, 2000. On November 30, 2000, the clerk of the Judicial Panel on Multi-
District Litigation entered an order conditionally transferring this case to the United States District
Court for the Southern District of Florida to be consolidated for pretrial proceedings only with the
other cases against managed care organizations pending in that court. The clerk of the Judicial Panel
on Multi-District Litigation stayed the conditional transfer order on December 15, 2000 pending
briefing and argument concerning whether transfer is appropriate.
On April 17, 2001, the Judicial Panel on Multi-district Litigation transferred this action to the
Southern District of Florida for coordinated or consolidated pretrial proceedings. We intend to
vigorously defend the action.
ALBERT V. PHYSICIANS HEALTH SERVICES OF CONNECTICUT, INC.
On September 7, 2000, a complaint was filed in the United States District Court for the District of
Connecticut in a lawsuit entitled Albert v. CIGNA Healthcare of Connecticut, Inc., et al. (including
Physicians Health Services of Connecticut, Inc. and Foundation Health Systems, Inc.)
(300CV1717-CJS). The complaint seeks certification of a nationwide class action and alleges that the
defendant managed care companies’ various practices violate provisions of ERISA. The action seeks
unspecified damages and injunctive relief. On November 30, 2000, the clerk of the Judicial Panel on
Multi-District Litigation entered an order conditionally transferring this case to the United States
District Court for the Southern District of Florida to be consolidated for pre-trial proceedings only with
the other cases against managed care organizations pending in that court. The clerk of the Judicial
Panel on Multi-District Litigation stayed the conditional transfer order on December 18, 2000 pending
briefing and argument concerning whether transfer is appropriate. On March 20, 2001, the Judicial
Panel on Multi-district Litigation transferred this action to the Southern District of Florida for
coordinated or consolidated pretrial proceedings. We intend to vigorously defend the action.
CALIFORNIA MEDICAL ASSOCIATION V. BLUE CROSS OF CALIFORNIA, INC., PACIFICARE
HEALTH SYSTEMS, INC., PACIFICARE OPERATIONS, INC. AND FOUNDATION HEALTH
SYSTEMS, INC.
In May 2000, the California Medical Association filed a lawsuit, purportedly on behalf of its
member physicians, in the United States District Court for the Northern District of California against
several managed care organizations, including the Company, entitled California Medical Association v.
Blue Cross of California, Inc., PacifiCare Health Systems, Inc., PacifiCare Operations, Inc. and
Foundation Health Systems, Inc. The plaintiff alleges that the manner in which the defendants contract
and interact with its member physicians violates provisions of RICO. The action seeks declaratory and
injunctive relief, as well as costs and attorneys’ fees. We filed a motion to dismiss the action on various
grounds. In August 2000, plaintiffs in other actions pending against different managed care
organizations petitioned the Judicial Panel on Multi-District Litigation to consolidate the California
action with the other actions in the U.S. District Court for the Northern District of Alabama. In light
of the pending petition, the California court stayed the action and the hearing on the Company’s
motion to dismiss the complaint for ninety days pending a determination of the petition to consolidate.
On October 23, 2000, the Judicial Panel on Multi-District Litigation ruled that this case should be
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14. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
6. LEGAL PROCEEDINGS (Continued)
consolidated, for purposes of pre-trial proceedings only, with other cases pending against managed care
organizations in the United States District Court for the Southern District of Florida in Miami. On
February 22, 2000, the California Medical Association filed an amended complaint in the Southern
District of Florida adding claims under certain federal regulations and the California Business and
Professions Code. As set forth above, on March 26, 2001, the California Medical Association was
named as an additional plaintiff in the consolidated amended complaint filed in the Shane action. As
further noted above, on June 17, 2001, the district court entered an order which applies to this case
and stays discovery until after the court rules upon motions to dismiss and motions to compel
arbitration. We intend to vigorously defend the action.
CONNECTICUT STATE MEDICAL SOCIETY V. PHYSICIANS HEALTH SERVICES OF
CONNECTICUT, INC.
On February 14, 2001, the Connecticut State Medical Society filed a complaint in Connecticut
State Court against Physicians Health Services of Connecticut, Inc. alleging violations of the
Connecticut Unfair Trade Practices Act. The complaint alleges that PHS-CT engaged in conduct that
was designed to delay, deny, impede and reduce lawful reimbursement to physicians who rendered
medically necessary health care services to PHS-CT health plan members. The complaint, which is
similar to others filed against us and other managed care companies, seeks declaratory and injunctive
relief. On March 13, 2001, the Company removed this action to federal court. On March 28, 2001, the
plaintiffs moved to remand the action to state court. On April 19, 2001, we filed with the Judicial Panel
on Multi-district Litigation our motion to transfer this case to the Southern District of Florida for
consolidated pretrial proceedings with the managed care litigation already pending there. On April 25,
2001, we filed our opposition to the plaintiffs’ motion for remand. On April 27, 2001, the court
consolidated this action and Lynch v. Physicians Health Services of Connecticut, Inc., along with similar
actions against Aetna, CIGNA and Anthem, into one case entitled CSMS v. Aetna Health Plans of
Southern New England, et al. PHS-CT has not yet responded to the complaint, but intends to
vigorously defend the action.
KEVIN LYNCH, M.D. AND KAREN LAUGEL, M.D. V. PHYSICIANS HEALTH SERVICES OF
CONNECTICUT, INC.
On February 14, 2001, a purported class action lawsuit was filed in Connecticut State Court against
Physicians Health Services of Connecticut, Inc. by Kevin Lynch, M.D. and Karen Laugel, M.D. on
behalf of physicians members of the Connecticut State Medical Society who provide health care
services to PHS-CT health plan members pursuant to provider service contracts. The complaint alleges
that PHS-CT engaged in improper, unfair and deceptive practices by denying, impeding and/or delaying
lawful reimbursement to physicians. The complaint, similar to the complaint referred to above filed
against PHS-CT on the same day by the Connecticut State Medical Society, seeks declaratory and
injunctive relief, and damages. On March 13, 2001, we removed this action to federal court. On
March 28, 2001, the plaintiffs moved to remand the action to state court. On April 19, 2001, we filed
with the Judicial Panel on Multi-district Litigation our motion to transfer this case to the Southern
District of Florida for consolidated pretrial proceedings with the managed care litigation already
pending there. On April 25, 2001, we filed our opposition to the plaintiffs’ motion for remand. On
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15. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
6. LEGAL PROCEEDINGS (Continued)
April 27, 2001, the court consolidated this action and CSMS v. Physicians Health Services of
Connecticut, Inc., along with similar actions against Aetna, CIGNA and Anthem, into one case entitled
CSMS v. Aetna Health Plans of Southern New England, et al. PHS-CT has not yet responded to the
complaint, but intends to vigorously defend the action.
LEONARD KLAY, M.D. V. PRUDENTIAL INS CO OF AMERICA, UNITED HEALTHCARE,
AETNA, INC., AETNA US HEALTHCARE, CIGNA CORP., CONNECTICUT GENERAL CORP.,
FOUNDATION HEALTH SYSTEMS, INC., PACIFICARE HEALTH SYSTEMS AND WELLPOINT
HEALTH NETWORKS, INC.
On February 22, 2001, a purported class action complaint was filed in the United States District
Court for the Southern District of Florida against several managed care companies, including us, on
behalf of individual physicians in California who provided health care services to members of the
defendants’ health plans. The complaint alleges violations of RICO, ERISA, certain federal regulations,
the California Business and Professions Code and certain state common law doctrines, and seeks
declaratory and injunctive relief, and damages. As set forth above, on March 26, 2001, Leonard Klay
was named as an additional plaintiff in the consolidated amended complaint filed in the Shane action.
As further noted above, on June 17, 2001, the district court entered an order which applies to this case
and stays discovery until after the court rules upon motions to dismiss and motions to compel
arbitration. We intend to vigorously defend the actions.
KAREN L., ET AL. V. PHYSICIANS HEALTH SERVICES, INC.
This action was instituted on November 17, 1999 on behalf of a putative state-wide class against
PHS, a subsidiary of ours, in the United States District Court for the District of Connecticut seeking
injunctive relief for alleged violations of the Federal Medicaid statute, 42 U.S.C. §1396a(a)(3), the Due
Process Clause of the Fourteenth Amendment to the United States Constitution, the Connecticut
Unfair Trade Practices Act, Conn. Gen. Stat. §42-110a et seq., and the Connecticut Unfair Insurance
Practices Act, Conn. Gen. Stat. §38a-815 et seq. The plaintiffs in this action allege that PHS failed to
adequately notify class members of adverse actions regarding coverage of claims made by enrollees of
PHS’ Medicaid managed care plans and that PHS failed to adequately ensure that those Medicaid
enrollees can apply for and be furnished with prescription drug benefits without delay. On July 6, 2001,
the district court granted plaintiff’s motion for class certification certifying a class consisting of all past,
present and future Medicaid recipients who were, are or will be enrolled in any managed care plan
offered by PHS to Medicaid recipients, under contract with the Commissioner of the State of
Connecticut, Department of Social Services. We intend to vigorously defend this action.
MISCELLANEOUS PROCEEDINGS
We and certain of our subsidiaries are also parties to various other legal proceedings, many of
which involve claims for coverage encountered in the ordinary course of our business. Based in part on
advice from our litigation counsel and upon information presently available, management is of the
opinion that the final outcome of all such proceedings should not have a material adverse effect upon
our results of operations or financial condition.
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16. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board (FASB) issued the following Statements of Financial
Accounting Standards (SFAS) that are effective in 2000 or 2001:
• In July 2001, the Financial Accounting Standards Board (‘‘FASB’’) issued two new
pronouncements: Statement of Financial Accounting Standards (‘‘SFAS’’) No. 141, Business
Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS 141 is effective
as follows: a) use of the pooling-of-interest method is prohibited for business combinations
initiated after June 30, 2001; and b) the provisions of SFAS 141 also apply to all business
combinations accounted for by the purchase method that are completed after June 30, 2001
(that is, the date of the acquisition is July 2001 or later). There are also transition provisions
that apply to business combinations completed before July 1, 2001, that were accounted for by
the purchase method. SFAS 142 is effective for fiscal years beginning after December 15, 2001
for all goodwill and other intangible assets recognized in an entity’s statement of financial
position at that date, regardless of when those assets were initially recognized. We are currently
evaluating the provisions of SFAS 141 and SFAS 142.
• In September 2000, the FASB issued SFAS No. 140, ‘‘Accounting for Transfers and Servicing of
Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125)’’
(SFAS No. 140). SFAS No. 140 provides accounting standards that are based on consistent
application of financial-components approach that focuses on control. SFAS No. 140 is effective
for transfers and servicing of financial assets and extinguishments of liabilities occurring after
March 31, 2001. SFAS No. 140 is effective for recognition and reclassification of collateral and
for related disclosures for fiscal years ending after December 15, 2000. The adoption of SFAS
No. 140 has had no material effect on our consolidated financial position or results of
operations.
• In March 2000, the FASB issued Interpretation No. 44, ‘‘Accounting for Certain Transactions
Involving Stock Compensation’’ (Interpretation No. 44). Interpretation No. 44 provides guidance
on certain implementation issues related to Accounting Principles Board Opinion 25,
‘‘Accounting for Stock Issued to Employees.’’ Interpretation No. 44 was effective July 1, 2000
and did not have an impact on our consolidated financial position or results of operations.
• In December 1999, the Securities and Exchange Commission issued, then subsequently amended,
Staff Accounting Bulletin No. 101 ‘‘Revenue Recognition in Financial Statements’’ (SAB 101).
SAB 101, as amended, provides guidance on applying generally accepted accounting principles to
revenue recognition issues in financial statements. We adopted SAB 101 effective October 1,
2000. The adoption of SAB 101 did not have a material effect on our consolidated financial
position or results of operations.
• In June 1998, the FASB issued, then subsequently amended, SFAS No. 133 ‘‘Accounting for
Derivative Instruments and Hedging Activities’’ (SFAS No. 133). SFAS No. 133, as amended by
SFAS No. 138 ‘‘Accounting for Certain Derivative Instruments and Certain Hedging Activities,’’
is effective for all fiscal years beginning after June 15, 2000. SFAS No. 133 establishes
accounting and reporting standards requiring that all derivatives be recorded in the balance
sheet as either an asset or liability measured at fair value and that changes in fair value be
recognized currently in earnings, unless specific hedge accounting criteria are met. We adopted
16
17. HEALTH NET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(Unaudited)
7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (Continued)
SFAS No. 133, as amended, effective January 1, 2001. The adoption of SFAS No. 133 had no
effect on our consolidated financial position or results of operations.
8. SENIOR NOTES AND CREDIT FACILITIES
On April 12, 2001, we completed our offering of $400 million aggregate principal amount of
8.375 percent Senior Notes due in April 2011 at a discount of $1.4 million. The net proceeds of
$395.1 million from the Senior Notes were used to repay outstanding borrowings under our
then-existing revolving credit facility. We have agreed to exchange the Senior Notes (aggregate principal
amount of $400 million) issued in April 2001 for Senior Notes (aggregate principal amount of
$400 million) registered under the Securities Act of 1933, as amended, pursuant to an Exchange and
Registration Rights Agreement, a copy of which was filed as Exhibit 4.6 to the Company’s Form 10-Q
for the quarter ended March 31, 2001.
On June 28, 2001, we entered into credit agreements for two new revolving syndicated credit
facilities with Bank of America, N.A. as administrative agent, that replaced our previous credit facility.
The new facilities, providing for an aggregate of $700 million in borrowings, consist of a $175 million
364-day revolving credit facility and a $525 million five-year revolving credit and competitive advance
facility.
As of June 30, 2001, the net carrying value of the Senior Notes and the credit facilities were
$398.6 million and $230 million, respectively. The $230 million outstanding under the credit facilities is
under the five-year facility.
9. SUBSEQUENT EVENT
Effective August 1, 2001, we completed the sale of our Florida health plan, known as Foundation
Health, a Florida Health Plan, Inc., to Florida Health Plan Holdings II, LLC as discussed in Note 5.
17
18. ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Health Net, Inc. (formerly named Foundation Health Systems, Inc., together with its subsidiaries
may be referred to herein as the Company, we, us or our) is an integrated managed care organization
which administers the delivery of managed health care services. Through our subsidiaries, we offer
group, individual, Medicaid and Medicare health maintenance organization (HMO), point of service
(POS) and preferred provider organization (PPO) plans; government sponsored managed care plans;
and managed care products related to administration and cost containment, behavioral health, dental,
vision and pharmaceutical products and other services.
We currently operate within two segments: Health Plan Services and Government Contracts/
Specialty Services. Effective January 1, 2000, as a result of certain previously disclosed divestitures, we
consolidated and reorganized our Health Plan Services segment into two regional divisions:
• Northeast Division (consisting of Connecticut, Florida, New Jersey, New York, Ohio,
Pennsylvania and West Virginia), and
• Western Division (consisting of Arizona, California and Oregon)
In 2000, we decided to exit the Ohio, West Virginia and Western Pennsylvania markets and
provided notice of our intention to withdraw from these service areas to the appropriate regulators. As
of February 2001, we no longer had any members in these markets. As of June 30, 2001, we still have
3,000 commercial members in Washington to be transitioned out as part of the Washington health plan
sale in 1999.
In January 2001, we entered into a definitive agreement, and subsequently amended the
agreement, to sell our Florida health plan, known as Foundation Health, a Florida Health Plan, Inc., to
Florida Health Plan Holdings II, LLC. Effective August 1, 2001, we completed the sale. In connection
with the sale, we received approximately $49 million which consists of $23 million in cash and
approximately $26 million in a secured six-year note bearing eight percent interest per annum. We also
sold the corporate facility building used by our Florida health plan to DGE Properties, LLC for
$15 million, payable by a secured five-year note bearing eight percent interest per annum. We
estimated and recorded a $76.1 million pre-tax loss on the sales of our Florida health plan and the
related corporate facility building during the second quarter ended June 30, 2001.
Pursuant to SFAS No. 121, we evaluated the carrying values of the assets for Florida health plan
and adjusted the carrying value of certain long-lived assets to their estimated fair value. Included in the
$76.1 million pre-tax loss on net assets of Florida health plan and the related corporate facility building
were $40.8 million in non-cash asset impairment charges consisting of $18.5 million for goodwill
impairment on Florida health plan, $4.4 million write-down to its fair value of the corporate facility
building owned by one of our subsidiaries and used by Florida health plan, $15.3 million reserve for
other contractual receivables and $2.6 million write-off of an unrealizable deferred tax asset related to
Florida health plan. The carrying value of the net assets of Florida health plan, before the goodwill
impairment of $18.5 million, was $41.5 million as of June 30, 2001. The net assets were primarily
comprised of cash and cash equivalents and reserves for claims and other settlements. These net assets
are included as part of our Health Plan Services segment as of June 30, 2001. In addition, obligations
under the terms of the amended definitive agreement to provide up to $28 million of reinsurance to
guarantee against claims costs in excess of certain medical care ratio levels of the Florida health plan
for the 18-month period subsequent to the close of the sale were recorded as a liability as of June 30,
2001. Other accrued costs resulting from the sale of the Florida health plan totaled $7.3 million.
Our Florida health plan, excluding the $76.1 million loss on net assets held for sale, had premium
revenues of $147.9 million and a net loss of $13.2 million for the second quarter ended June 30, 2001,
and premium revenues of $303.9 million and a net loss of $15.2 million for the six months ended
18
19. June 30, 2001. As of June 30, 2001, we had 163,000 members in the discontinued Florida plan. The
effect of the suspension of the depreciation on the corporate facility building was immaterial for the six
months ended June 30, 2001.
Throughout 2000 and the six months ended June 30, 2001, we have provided funding in the
aggregate amount of approximately $6.3 million to MedUnite, Inc., an independent company, funded
and organized by seven major managed health care companies. MedUnite, Inc. is designed to provide
on-line internet provider connectivity services including eligibility information, referrals, authorizations,
claims submission and payment. The funded amounts are included in other noncurrent assets. In
August 2001, we provided additional funding in the amount of approximately $3.7 million to
MedUnite, Inc.
We are one of the largest managed health care companies in the United States, with approximately
4.2 million at-risk and administrative services only (ASO) members in our Health Plan Services
segment. We also own health and life insurance companies licensed to sell PPO, POS and indemnity
products, as well as certain auxiliary non-health products such as life and accidental death and disability
insurance in 35 states and the District of Columbia.
Our Government Contracts/Specialty Services segment administers large multi-year managed health
care government contracts. Certain components of these contracts, including administrative and
assumption of health care risk, are subcontracted to affiliated and unrelated third parties. We
administer health care programs covering approximately 1.5 million eligible individuals under
TRICARE. We have three TRICARE contracts that cover Alaska, Arkansas, California, Hawaii,
Oklahoma, Oregon, Washington and parts of Arizona, Idaho, Louisiana and Texas. The Department of
Defense extended all three contracts in 2000 for periods up to two years. Through this segment, we
also offer behavioral health, dental and vision services as well as employee and occupational services
comprising managed care products related to bill review, administration and cost containment for
hospitals, health plans and other entities.
This discussion and analysis and other portions of this Form 10-Q contain ‘‘forward-looking
statements’’ within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended,
and Section 27A of the Securities Act of 1933, as amended, that 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’’ and similar expressions are intended to identify forward-looking
statements. Factors that could cause actual results to differ materially from those reflected in the
forward-looking statements include, but are not limited to, the matters described in the ‘‘Cautionary
Statements’’ section and other portions of our Annual Report on Form 10-K for the fiscal year ended
December 31, 2000 and the risks discussed in our other filings with the SEC. You should not place
undue reliance on these forward-looking statements, which reflect management’s analysis, judgment,
belief or expectation only as of the date hereof. Except as required by law, we undertake no obligation
to publicly revise these forward-looking statements to reflect events or circumstances that arise after
the date of this report.
19
20. CONSOLIDATED OPERATING RESULTS
Our net loss for the second quarter ended June 30, 2001 was $14.2 million, or $0.12 per basic
share and diluted share, compared to net income for the same period in 2000 of $38.7 million or $0.32
per basic and diluted share. Our net income for the six months ended June 30, 2001 was $28.2 million,
or $0.23 per basic share and diluted share, compared to net income for the same period in 2000 of
$72.8 million or $0.59 per basic share and diluted share.
Included in our results for the second quarter and six months ended June 30, 2001, is a
$76.1 million loss on assets held for sale in connection with the divestiture of our Florida operations.
The table below and the discussions that follows summarize our financial performance for the
second quarter and six months ended June 30, 2001 and 2000, respectively. Certain 2000 amounts have
been reclassified to conform to the 2001 presentation. These reclassifications did not affect net income
or earnings per share.
Second Quarter Ended Six Months Ended
June 30, June 30,
2001 2000 2001 2000
(Amounts in thousands, except per member per month data)
Revenues:
Health plan services premiums . . . . . . . . . . . . . . $2,104,501 $1,795,591 $4,179,200 $3,583,567
Government contracts/Specialty services . . . . . . . 417,699 408,554 805,789 797,534
Investment and other income . . . . . . . . . . . . . . . 24,503 25,455 49,838 47,834
Total revenues . . . . . . . . . . . . . . . . . . . . . . . . 2,546,703 2,229,600 5,034,827 4,428,935
Expenses:
Health plan services . . . . . . . . . . . . . . . . . . . . . 1,816,199 1,530,497 3,583,593 3,053,015
Government contracts/Specialty services . . . . . . . 302,300 272,694 575,335 527,357
Selling, general and administrative . . . . . . . . . . . 332,724 314,885 672,302 633,982
Depreciation . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,088 17,072 33,060 33,952
Amortization . . . . . . . . . . . . . . . . . . . . . . . . . . . 9,460 9,723 18,839 19,304
Interest . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16,408 21,933 30,846 43,267
Loss on assets held for sale . . . . . . . . . . . . . . . . 76,072 — 76,072 —
Total expenses . . . . . . . . . . . . . . . . . . . . . . . . 2,569,251 2,166,804 4,990,047 4,310,877
(Loss) income before income taxes . . . . . . . . . . . . (22,548) 62,796 44,780 118,058
Income tax (benefit) provision . . . . . . . . . . . . . . . . (8,343) 24,101 16,570 45,308
Net (loss) income . . . . . . . . . . . . . . . . . . . . . . . . . $ (14,205) $ 38,695 $ 28,210 $ 72,750
Health plan services medical care ratio (MCR) . . . . 86.3% 85.2% 85.7% 85.2%
Government contracts/Specialty services MCR . . . . 72.4% 66.7% 71.4% 66.1%
Administrative (SG&A + Depreciation) ratio . . . . . 13.8% 15.1% 14.1% 15.2%
Health plan premiums per member per month . . . . $ 167.38 $ 155.15 $ 167.93 $ 153.75
Health plan services per member per month . . . . . $ 147.25 $ 135.23 $ 146.83 $ 133.91
20
21. Enrollment Information
The table below summarizes our enrollment information at June 30, 2001 and 2000.
June 30, Percent
2001 2000 Change
(Enrollees in
Thousands)
Health Plan Services:
Commercial . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,002 2,786 7.8 %
Medicare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224 222 1.0 %
Medicaid . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 735 592 24.2 %
Continuing plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,961 3,600 10.0 %
Discontinued plans . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166 167 (0.6)%
Total Health Plan Services . . . . . . . . . . . . . . . . . . . . . . . . . 4,127 3,767 9.6 %
Government Contracts:
TRICARE PPO and Indemnity . . . . . . . . . . . . . . . . . . . . 558 564 (1.1)%
TRICARE HMO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 906 891 1.7 %
Total Government Contracts . . . . . . . . . . . . . . . . . . . . . . . . 1,464 1,455 0.6 %
ASO . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80 84 (4.8)%
The following discussion on enrollment changes relates to our continuing plans only and excludes
our discontinued plans. Discontinued plans include Colorado, Florida and Washington. As of June 30,
2001, we had membership in Florida and Washington. We no longer had any membership in Colorado
as of June 30, 2001. Membership in these plans is expected to decline due to completion of divestitures
or as the operations in these plans continue to wind down.
Commercial membership increased 7.8% to 3.0 million members at June 30, 2001 compared to
2.8 million members at June 30, 2000 primarily due to the following:
• 13.6% increase in California primarily in small group, individual sales of POS products and small
business and individual/family plan PPO products,
• 9.1% increase in New York primarily in small group POS and HMO products, and
• 6.8% increase in New Jersey primarily in small group POS and HMO products.
Medicare membership remained at a constant level across all markets at June 30, 2001 compared
to June 30, 2000.
Medicaid membership increased 24.2% to 735,000 members at June 30, 2001 compared to 592,000
members at June 30, 2000 primarily due to increased sales of children’s health programs in California,
particularly the Healthy Families program.
Government contracts covered approximately 1.5 million eligible individuals under the TRICARE
program at June 30, 2001 and 2000. Dependents of active-duty military personnel and retirees and their
dependents are automatically eligible to receive benefits under the TRICARE program. Any changes in
the enrollment reflect the timing of when the individuals become eligible.
21
22. Health Plan Services Premiums
Health Plan Services premiums increased $308.9 million or 17.2% for the second quarter ended
June 30, 2001 and $595.6 million or 16.6% for the six months ended June 30, 2001 as compared to the
same periods in 2000 primarily due to the following:
• 9.2% increase in per member per month (PMPM) premiums due to rate increases for the six
months ended June 30, 2001, and
• 9.6% increase in net membership as compared to June 30, 2000.
Government Contracts/Specialty Services Revenues
Government Contracts/Specialty Services revenues increased $9.1 million or 2.2% for the second
quarter ended June 30, 2001 and $8.3 million or 1.0% for the six months ended June 30, 2001, as
compared to the same periods in 2000 primarily due to the following:
• Increase in revenues from TRICARE contracts from higher health care costs resulting in higher
risk share revenues from the government and increased change orders, offset by
• Decrease in revenues from the mental health portion of the TRICARE contracts shifting from
fee-for-service to ASO.
Investment and Other Income
Investment and other income decreased $1.0 million or 3.7% for the second quarter ended
June 30, 2001, for short-term investments, partially offset by higher investable assets, as compared to
the same period in 2000. The $1.0 million decrease in investment and other income reflects the
decrease in the average yield during the second quarter ended June 30, 2001, as compared to the same
period in 2000. Investment and other income increased $2.0 million or 4.2% for the six months ended
June 30, 2001, as compared to the same period in 2000. The $2.0 million increase in investment and
other income was due to higher investable assets partially offset by a decrease in the average yield rate
during the six months ended June 30, 2001, as compared to the same period in 2000. This decrease in
the average yield is consistent with the continued decline in short-term interest rates during the second
quarter ended June 30, 2001.
Health Plan Services Medical Care Ratio (MCR)
Health Plan Services costs rose 8.9% on PMPM basis for the second quarter ended June 30, 2001
and 9.6% on PMPM basis for the six months ended June 30, 2001 as compared to the same periods in
2000. This increase in the second quarter ended June 30, 2001 as compared to the same period in 2000
includes a 9% increase in pharmacy costs, an 8% increase in hospital costs and a 4.5% increase in
physician costs on a PMPM basis. The MCR for the second quarter ended June 30, 2001 increased to
86.3% and to 85.7% for the six months ended June 30, 2001 from 85.2% as compared to the same
periods in 2000, respectively.
Government Contracts/Specialty Services MCR
Government Contracts/Specialty Services MCR increased to 72.4% and 71.4% in the second
quarter and six months ended June 30, 2001, respectively, as compared to 66.7% and 66.1% for the
same periods in 2000, respectively. The increases are primarily due to the following:
• Decrease in revenues from the mental health portion of the TRICARE contracts shifting from
fee-for-service to ASO, and
22
23. • Increased benefit payments from our behavioral health care subsidiary due to parity provisions
requiring behavioral health service providers to offer the same level of services to all current
health plan members as well as increased benefit levels on new businesses.
Selling, General and Administrative (SG&A) Expenses
The administrative expense ratio (SG&A and depreciation as a percentage of Health Plan
premiums and Government Contracts/Specialty Services revenues) decreased to 13.8% and 14.1% for
the second quarter and six months ended June 30, 2001, respectively, from 15.1% and 15.2% for the
same periods in 2000, respectively. This decrease is primarily attributable to our ongoing efforts to
control our SG&A expenses. We continue to focus efforts on ways to adopt technology to our business
processes to improve efficiencies.
Amortization and Depreciation
Amortization and depreciation expense for the second quarter and six months ended June 30, 2001
decreased by $1.2 million or 4.7% and $1.4 million or 2.5%, respectively, as compared to the same
periods in 2000. The decrease is primarily due to various leasehold improvements, personal computer
equipment and software being completely depreciated prior to or during the second quarter ended
June 30, 2001.
Interest Expense
Interest expense decreased by $5.5 million or 25.2% for the second quarter ended June 30, 2001
and by $12.4 million or 28.7% for the six months ended June 30, 2001, as compared to the same
periods in 2000. This decrease reflects the $364.4 million decline in long-term debt to $628.6 million
from $993.0 million as of June 30, 2000. During the first quarter ended March 31, 2001, we used the
net proceeds of $284.0 million, after certain payments to vendors, from our global settlement of the
outstanding TRICARE receivables to paydown our long-term debt.
Income Tax Provision
The effective income tax rate was 37.0% for the second quarter and six months ended June 30,
2001, as compared with 38.4% for the same periods in 2000, respectively. The rate declined primarily
due to tax minimization strategies.
The effective tax rate of 37.0% for the second quarter and six months ended June 30, 2001,
respectively, differed from the statutory federal tax rate of 35.0% due primarily to state income taxes,
goodwill amortization, and tax-exempt investment income.
IMPACT OF INFLATION AND OTHER ELEMENTS
The managed health care industry is labor intensive and its profit margin is low, so it is especially
sensitive to inflation. Increases in medical expenses or contracted medical rates without corresponding
increases in premiums could have a material adverse effect on us.
Federal and state legislators continue to propose various legislative initiatives regarding the health
care industry, including federal ‘‘patients’ bill of rights’’ legislation. See ‘‘Item 5—Recent
Developments—Legislation.’’ If federal or state legislatures enact further health care reform or similar
legislation, the legislation could affect us. Management cannot at this time predict the specifics of any
of these initiatives, whether federal or state legislatures will enact any of these initiatives or, if enacted,
how any of these initiatives will financially impact us.
Our ability to expand our business depends, in part, on competitive premium pricing and our
ability to secure cost-effective contracts with providers. Achieving these objectives is becoming
23
24. increasingly difficult due to the competitive environment. In addition, our profitability depends, in part,
on our ability to maintain effective control over health care costs while providing members with quality
care. Factors such as health care reform, regulatory changes, increased cost of medical services,
utilization, new technologies and drugs, hospital costs, major epidemics and numerous other external
influences may affect our operating results. Accordingly, past financial performance is not necessarily a
reliable indicator of future performance. Investors should not use historical records to anticipate results
or future period trends.
Our HMO and insurance subsidiaries are required to maintain reserves to cover their estimated
ultimate liability for expenses with respect to reported and unreported claims incurred. These reserves
are estimates of future payments and are based on various assumptions. External forces such as
changes in the rate of inflation, the regulatory environment, medical costs and other factors may affect
reserves. Establishment of appropriate reserves is an inherently uncertain process. There can be no
certainty that currently established reserves will prove adequate in light of subsequent actual
experience. Reserve estimates in the past have been, and in the future may be, too high or too low.
Future loss development or governmental regulators could require reserves for prior periods to be
increased, which would adversely impact earnings in future periods. In light of present facts and current
legal interpretations, management believes that adequate provisions have been made for claims and loss
reserves.
Our California HMO subsidiary contracts with providers in California primarily through capitation
fee arrangements. Our HMO subsidiaries in other areas contract with providers, to a lesser degree,
through capitation fee arrangements. Under a capitation fee arrangement, our subsidiary pays the
provider a fixed amount per member on a regular basis and the provider accepts the risk of the
frequency and cost of member utilization of services. The inability of providers to properly manage
costs under capitation arrangements can result in financial instability of such providers. Any financial
instability of capitated providers could lead to claims for unpaid health care against our HMO
subsidiaries, even though such subsidiaries have made their regular payments to the capitated providers.
Depending on state law, our HMO subsidiaries may or may not be liable for such claims. In California,
the issue of whether HMOs are liable for unpaid provider claims has not been definitively settled. The
California agency that until July 1, 1999 acted as regulator of HMOs had issued a written statement to
the effect that HMOs are not liable for such claims. However, there is currently ongoing litigation on
the subject among providers and HMOs, including our California HMO subsidiary.
LIQUIDITY AND CAPITAL RESOURCES
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. Certain of our
subsidiaries must maintain ratios of current assets to current liabilities pursuant to certain government
contracts. We believe we are in compliance with these contractual and regulatory requirements in all
material respects.
We believe that cash from operations, existing working capital and lines of credit are adequate to
fund existing obligations, introduce new products and services, and continue to develop health
care-related businesses.
We regularly evaluate cash requirements for current operations and commitments, and for capital
acquisitions and other strategic transactions. We may elect to raise additional funds for these purposes
through additional debt or equity, the sale of investment securities or otherwise.
On April 12, 2001, we completed our offering of $400 million aggregate principal amount of
8.375 percent (or all-in cost rate of 8.54%) Senior Notes due in April 2011. The net proceeds of
$395.1 million from the Senior Notes were used to repay outstanding borrowings under our
then-existing revolving credit facility. We have agreed to exchange the Senior Notes (aggregate principal
24
25. amount of $400 million) issued in April 2001 for Senior Notes (aggregate principal amount of
$400 million) registered under the Securities Act of 1933, as amended, pursuant to an Exchange and
Registration Rights Agreement, a copy of which was filed as Exhibit 4.6 to the Company’s Form 10-Q
for the quarter ended March 31, 2001.
On June 28, 2001, we completed the refinancing of our credit facility maturing in July 2002. The
previous credit facility was refinanced with two new credit facilities, a 364-day $175.0 million revolving
credit facility and a five-year $525.0 million revolving credit and competitive advance facility.
Government health care receivables are best estimates of payments that are ultimately collectible
or payable. Since these amounts are subject to government audit, negotiation and appropriations,
amounts ultimately collected may vary significantly from current estimates. Additionally, the timely
collection of these receivables is also impacted by government audit and negotiation and could extend
for periods beyond a year.
In December 2000, our subsidiary, Health Net Federal Services, Inc., and the Department of
Defense agreed to a settlement of approximately $389 million for outstanding receivables related to our
three TRICARE contracts and for the completed contract for the Civilian Health and Medical Program
of the Uniformed Services Reform Initiative. Approximately $60 million of the settlement amount was
received in December 2000. The majority of the remaining settlement that was received on January 5,
2001 was used to reduce the amounts receivable under government contracts. The receivable items
settled by this payment include change orders, bid price adjustments, equitable adjustments and claims.
These receivables developed as a result of TRICARE health care costs rising faster than the forecasted
health care cost trends used in the original contract bids, data revisions on formal contract adjustments,
and routine contract changes for benefits. Net proceeds of $284 million, after paying vendors, providers
and amounts owed back to the government, were applied to the continuing operating needs of the
three TRICARE contracts and to reducing the outstanding balance of the notes payable.
Effective August 1, 2001, we completed the sale of our Florida health plan, known as Foundation
Health, a Florida Health Plan, Inc., to Florida Health Plan Holdings II, LLC. In connection with the
sale, we received approximately $49 million which consists of $23 million in cash and approximately
$26 million in a secured six-year note bearing eight percent interest per annum. We also sold the
corporate facility building used by our Florida health plan to DGE Properties, LLC for $15 million,
payable by a secured five-year note bearing eight percent interest per annum. We recorded a
$76.1 million pre-tax loss on the sales of our Florida health plan and the related corporate facility
building for the second quarter ended June 30, 2001.
Operating Cash Flows
Net cash provided by operating activities was $316.9 million for the six months ended June 30,
2001 compared to net cash used in operating activities of $65.2 million for the same period in 2000.
This change was primarily due to the net proceeds of $284 million, after certain payments to vendors,
from our global settlement of the outstanding TRICARE receivables.
In July and August 2001, we paid approximately $21.0 million to certain former minority
shareholders of a current subsidiary in connection with a merger involving that subsidiary in 1999. We
are obligated to pay up to an additional $12.7 million to former minority shareholders in connection
with the merger, approximately $6 million of which is contingent on our New Jersey health plan
meeting certain financial performance criteria. These amounts totaling $33.7 million were recorded as a
current liability as of December 31, 2000. See ‘‘Item 5—Recent Developments—FOHP’’ for a more
complete description.
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