Yesterday, Health Net Inc. ( HNT - Analyst Report ) announced that its subsidiaries have terminated their 3-year contract with 6 hospitals of Tenet Healthcare Corp. ( THC - Analyst Report ) in Southern California. The contract termination resulted due to the inability of the companies to reach an agreement regarding the terms for extension. Health Net was in favor of changing the reimbursement rates offered by Tenet Healthcare considering the present market condition in California.

The company wanted to bring the reimbursement rate at par with the medical consumer price index, which currently exceeds the 3% mark. Additionally, Health Net wanted the reimbursement rate for those programs, which are financed by the state or federal government, to be based on the funding of these programs. However, these terms were not acceptable to Tenet Healthcare.

Consequently, the two companies failed to reach an agreement and Health Net decided to use its contractual option to terminate the agreements with all 6 Tenet Healthcare hospitals. The agreements have been terminated with effect from December 21, 2012. The company had agreements with Desert Regional Medical Center, Fountain Valley Hospital and Medical Center, John F. Kennedy Memorial Hospital, Lakewood Regional Medical Center, Los Alamitos Medical Center and Placentia Linda Hospital.

Health Net believes that the current reimbursement rates were not reasonable and increased the health care costs of its customers. The increasing cost went against the company’s objective of providing reasonably priced health care to its clientele. Thus, it prematurely terminated the contract, which was already on the verge on expiration.

Both Health Net and Tenet Healthcare currently carry a Zacks #2 Rank (Buy). We also maintain a long-term ‘Neutral’ recommendation on the stocks.