Health Net makes key hire amid turbulence in market.

WHEN Health Net of California hired Gov. Arnold Schwarzenegger's former chief of staff last month, the move underscored the close relationship between the state and managed care--and the big opportunities for insurer growth in the state.

The appointment of Patricia "Pat" Clarey as chief operating officer of Health Net of California, the largest subsidiary of Health Net Inc., comes on the heels of proposals by Gov. Schwarzenegger to move patients in Medi-Cal, the health care program for the poor, and Healthy Families, a program that aids the working poor, into less expensive managed programs.

State and federal managed care programs have become big growth opportunities for providers such as Health Net, which is based in Woodland Hills and gets 42 percent of its total revenue from state, federal and local governments.

Though Health Net provides commercial health insurance to 6.3 million people in 27 states, the company expects strong growth in California from the services it offers to 720,000 Medi-Cal and Healthy Families beneficiaries in nine counties.

"Health Net is just like other health maintenance organizations in that government is both a client and a regulator," said Beth Capell, a policy consultant at Health Access California, a consumer advocacy group in Oakland.

The expansion of managed care so far has been limited to the enrollment of 262,000 parents and children in managed care in 13 additional counties in California. Proposals that did not make it into the current state budget include adding 545,000 seniors and disabled individuals to managed care throughout the state, and beginning testing of programs for acute and long term care projects in Contra Costa, Orange and San Diego counties.

However, Health Net expects to benefit from expansions in Imperial, Ventura and Marin counties, and Clarey has deep connections in Sacramento--where her hiring is seen as a way for Health Net to steer through the treacherous political waters as Medi-Cal and Healthy Family move more toward a managed care model, an initiative has come under assault by some Democrats and consumer advocates.

Clarey was replaced in the Schwarzenegger Administration by Susan Kennedy, a top aide to former Gov. Gray Davis. She previously served as deputy chief of staff to former Gov. Pete Wilson, and was a vice president of governmental affairs at Health Net before she left in 2003 to work on Schwarzenegger's gubernatorial campaign.

David Olsen, a Health Net spokesman, said the company has teams of employees in both Sacramento and Pasadena that deal exclusively with Medi-Cal and Healthy Kids--programs that "predated Pat' s arrival."

"Pat's history with us was the primary reason for wanting her to come back. She was brought on board because she's got experience with this company and has tremendous managerial skills."

The company said Clarey was not available last week for an interview.

Sector turmoil

Health Net has suffered from a reversal of fortunes in the past few months that analysts say mirrors problems in the larger health care sector.

After nearly four years of massive growth, health care insurers witnessed a sell-off by investors due to skyrocketing medical costs and a scandal at UnitedHealth Group involving stock options granted to its chief executive. Shares of Health Net have fallen 25 percent so far this year to $39.04 a share, down from $52.05 a share in January.

Health Net is one of the "smaller insurers nationally and has long been rumored as a takeover candidate by UnitedHealth Group, Aetna Inc., or Wellpoint Inc. However, the acquisition has yet to take place, and already there has been a backlash by public officials and consumer interest groups against mergers in the sector given its strong earnings amid a continued sharp increase in premiums.

(UnitedHealth purchased PacifiCare Health Systems Inc. last year, while Wellpoint Inc. is the creation of the merger of Anthem Inc. and Wellpoint Health Networks Inc. in 2004.)

Even so, investors weren't pleased when Aetna reported strong first-quarter earnings earlier this month, pointing instead to lower margins as medical costs increased; the company's shares plunged 20 percent, dragging down other sector stocks.

"The managed care group as a whole has taken a significant hit," said Carl McDonald, an analyst at CIBC World Markets. "But for the last couple of years, Health Net has done very well with margin improvement and strong earnings."

Health Net's earnings more than tripled in the first-quarter due to increased government contracts, higher enrollment in Medicare prescription drug programs and strong comparisons with its profits last year, when it took hefty charges.

The company posted a 72 percent jump in net income to $76.6 million (65 cents per diluted share), compared with $21.3 million (19 cents per diluted share) in the year-ago period.

The company has had a string of management changes in the past month. As part of a reorganization in California, Health Net eliminated the roles of chief sales officer and health care delivery officer, amid other personnel changes.