• Total expenses in 3Q10 were $3.3 billion, down 17.5% from $4.0 billion in 3Q09. Total expenses reported by the Company was higher than the Zacks Digest average estimate of $3.00 billion.

Share Repurchase Update: In the quarter, Health Net repurchased 722,900 shares for approximately $19.4 million at an average price of $26.82 per share. As on September 30, 2010, approximately $208.7 million of authorization under the company’s existing $300 million share repurchase program remained.

Balance Sheet

Health Net’s consolidated balance sheets include the Northeast businesses in 2Q09. Once sold in December 2009, the balance sheets exclude these businesses from 4Q09, 1Q10 and 2Q10.

Cash and investments as of June 30, 2010 were $1.9 billion compared with $2.1 billion as of June 30, 2009.

Reserves for claims and other settlements as of June 30, 2010 were $934.9 million compared with $1.2 billion as of June 30, 2009 and $995.6 million as of March 31, 2010. The year-over-year decline is due to the divestiture of the Northeast businesses. The sequential decline is primarily due to an approximately $30.0 million reduction in claims inventory because of faster claims payment cycles. The faster cycles caused paid claims are expected to be $58.0 million higher in 2Q10 compared with 1Q10. In addition, there was a $21.6 million reduction related to litigation reserve true-ups, and a $12.0 million reduction in the shared-risk reserve as payments related to the prior-year shared-risk accrual are typically made in the second quarter of each year.

The claims payment cycles continued to accelerate during 2Q10. Since December 31, 2009, Western Region claims that inventory declined by approximately $40 million while the Western Region incurred but not reported (IBNR) reserve increased by more than $16 million.

Days claims payable (DCP) in 2Q10 was 39.3 days compared with 41.6 days in 2Q09 and 40.5 days in 1Q10. On an adjusted basis, DCP was 53.6 days in 2Q10 compared with 55.0 days in 2Q09 and 55.8 days in 1Q10. The sequential decline in adjusted DCP was primarily due to a decline in reserves for claims and other settlements.

The company’s debt-to-total capital ratio was 23.4% as of June 30, 2010 compared with 26.2% as of December 31, 2009 and 25.2% as of June 30, 2009.

Cash Flow

Operating cash flow was negative $16.3 million in 2Q10 due to the increase in premiums receivable and the sequential decline in reserves for claims and other settlements primarily resulting from the higher paid claims. The premiums receivable increase was the result of typical seasonal increases in Medicare risk adjuster accruals and also included a $14.0 million increase due to a delayed California Medicaid payment that the company received in early July 2010.

Health Net continues to expect a cash flow guidance of $300 – $325 million for FY10, well above net income plus depreciation and amortization.

New Health Care Reform Legislation

During 1Q10, the U.S. Congress passed and the President signed into law the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010, which represent significant changes to the U.S. health care system and alter the dynamics of the health care insurance industry. The provisions of the new legislation include, among others, imposing significant new taxes and fees on health insurers, including an excise tax on high premium insurance policies, stipulating a minimum medical care ratio, new annual fees on companies in the industry, which may not be deductible for income tax purposes, limiting Medicare Advantage payment rates, mandated additional benefits, elimination of medical underwriting for medical insurance coverage decisions, or "guaranteed issue," increased restrictions on rescinding coverage, prohibitions on some annual and all lifetime limits on amounts paid on behalf of or to our members, requirements that limit the ability of health plans to vary premiums based on assessments of underlying risk, limitations on the amount of compensation paid to health insurance executives that is tax deductible, additional regulations governing premium rate increase requests and requirements that individuals obtain coverage.

Some provisions of the health care reform legislation will become effective in 2010 including those that bar health insurance companies from placing lifetime limits on insurance coverage and those increasing the restrictions on rescinding coverage. However, some of the potentially more significant changes, including the annual fees on health insurance companies, the excise tax on high premium insurance policies, the guaranteed issue requirements and the requirement that individuals obtain coverage do not become effective until 2014 or later. Implementation of other provisions generally varies from as early as enactment or six months from the date of enactment as late as 2018.

Sale of Northeast Health Plan Subsidiaries

On December 11, 2009, the Company completed the Northeast Sale of all of the outstanding shares of capital stock of its New York, New Jersey, Connecticut and Bermuda subsidiaries (collectively, the Acquired Companies or Northeast business) that conducted business in the Northeast Operations. The sale was made pursuant to a Stock Purchase Agreement, dated July 20, 2009, by and among the Company, Health Net of the Northeast Inc. (HNNE), Oxford Health Plans LLC (Buyer), and solely for the purposes of guaranteeing Buyer's obligations thereunder, UnitedHealth Group Incorporated (United).

At the closing, United paid $350 million to the company, consisting of (i) a $60 million minimum payment for the commercial membership of the acquired business and the Medicare and Medicaid businesses of the Acquired Companies, and (ii) $290 million representing a portion of the adjusted tangible net equity (as defined in the Stock Purchase Agreement) of the Acquired Companies at closing. Under the Stock Purchase Agreement, Health Net will receive one-half of the remaining amount of the closing adjusted tangible net equity of the Acquired Companies, estimated to be $160 million on the first anniversary of closing and the other half on the second anniversary, subject to certain adjustments.

After closing, United could pay the additional consideration to Health Net, as the Northeast commercial members, Medicare and/or Medicaid businesses transition to other United products to the extent that such amounts exceed the initial minimum payment of $60 million (referred to as contingent membership renewal). The company’s current estimate of the total future payment for the contingent membership renewal is approximately $106 million. Health Net will continue to serve the members of the Acquired Companies under administrative services agreements entered into on the closing date with United and certain of its affiliates (United Administrative Services Agreements), until all members are either transitioned to a legacy United entity or non-renewed. The company expects the United Administrative Services Agreements to be in effect for approximately two years following the closing of the transaction.

The Northeast Operations had approximately $2,575.4 million, $2,739.3 million and $2,727.6 million of premium revenues in the years ended December 31, 2009, 2008 and 2007, respectively, which represent 21%, 22% and 24% of Health Net’s health plan services premiums for the years ended December 31, 2009, 2008 and 2007, respectively. The Northeast Operations had a combined pre-tax (loss) income of $(53.9) million, $16.9 million and $5.1 million for the years ended December 31, 2009, 2008 and 2007, respectively. As of December 11, 2009, the closing date of the Northeast Sale, the company had approximately 462,000 total health plan members in the Northeast Operations.

TRICARE Contract

During 2Q10, DoD awarded Health Net Pharmaceutical Services (HNFS) the new Managed Care Support Contract for the TRICARE North Region, known as "T3." HNFS is a subsidiary of Health Net and is currently the managed care contractor for the TRICARE North Region.

The new TRICARE award should add roughly $80 – $90 million in 2011 annualized earnings for Health Net. However, since the new contract terms begin on April 1, 2011, the 2011 impact will likely be in the $0.35 per share range. The company believes that extending existing contracts beyond March 31, 2011 (potentially requiring legislative action) would be a positive for Health Net as the existing contract terms are more favorable than those of the new contract.

Firms expect TRICARE earnings to decrease $50 million in 2011 due to the removal of certain underwriting risks from the new contract and profits to decline under the new TRICARE contract, which begins on April 1, 2011. The contract was recently rebid and it is now more of an ASO arrangement than a full risk contract. Health Net anticipates that profit levels will decline by $50 million annually under the new contract, or about $38 million in 2011, since the new contract will only be in place for three quarters. Health Net is looking for TRICARE profits to range from $168 – 185 million this year, implying that profits will approximate between $130 –147 million. The firm assumes that TRICARE earnings will be about $140 million next year. Earnings should drop again in 2012 as the full year impact of the lower margin is realized.

On July 22, 2010, MedeAnalytics, a leading provider of healthcare performance management solutions, announced that it had entered into a multi-year agreement with Health Net to provide performance management solutions for Health Net's health plan operations and Medicare products. The solutions will enhance Health Net's current data analytics capabilities and include Medical Management Analytics, Provider Network Management Analytics and Operations Performance Management.

• Health Net’s historical earnings growth has trailed the overall industry due to an uneven track record of execution and relatively low market share positions in several key markets.
• The company operates in a highly competitive environment that is subject to a significant business flux.
• Participation in the TRICARE program creates dependency issues for the company.
• Recent downgrades in the debt ratings may adversely affect the business, financial condition and results of operations.
• Various aspects of the health care reform legislation could have an adverse impact on the company’s revenues and the cost of operating the business.