Health Net 2000 Annual Report Download - page 29

Management’s Discussion and Analysis of Financial Condition and Results of Operations HEALTH NET 27
dures to protect PHI, and (c) enter into specific written
agreements with business associates to whom PHI is dis-
closed.The regulations establish significant criminal
penalties and civil sanctions for non-compliance. In addi-
tion, the regulations could expose the Company to addi-
tional liability for, among other things, violations by its
business associates. In February 2001, the DHHS stated
that the regulations in their current form would require
compliance by April 2003.The Company believes that
the costs required to comply with the regulations will be
significant and may have a material adverse impact on the
Company’s business or results of operations.
quantitative and qualitative
disclosures about market risk
The Company is exposed to interest rate and market risk
primarily due to its investing and borrowing activities.
Market risk generally represents the risk of loss that may
result from the potential change in the value of a financial
instrument as a result of fluctuations in interest rates and in
equity prices. Interest rate risk is a consequence of main-
taining fixed income investments.The Company is
exposed to interest rate risks arising from changes in the
level or volatility of interest rates, prepayment speeds
and/or the shape and slope of the yield curve. In addition,
the Company is exposed to the risk of loss related to
changes in credit spreads. Credit spread risk arises from the
potential that changes in an issuer’s credit rating or credit
perception may affect the value of financial instruments.
The Company has several bond portfolios to fund
reserves.The Company attempts to manage the interest
rate risks related to its investment portfolios by actively
managing the asset/liability duration of its investment
portfolios. The overall goal for the investment portfolios
is to provide a source of liquidity and support the ongo-
ing operations of the Company’s business units.The
Company’s philosophy is to actively manage assets to
maximize total return over a multiple-year time hori-
zon, subject to appropriate levels of risk. Each business
unit has additional requirements with respect to liquid-
ity, current income and contribution to surplus.The
Company manages these risks by setting risk tolerances,
targeting asset-class allocations, diversifying among assets
and asset characteristics, and using performance mea-
surement and reporting.
The Company uses a value-at-risk (“VA R”) model,
which follows a variance/covariance methodology, to
assess the market risk for its investment portfolio.VAR is
a method of assessing investment risk that uses standard
statistical techniques to measure the worst expected loss
in the portfolio over an assumed portfolio disposition
period under normal market conditions.The determina-
tion is made at a given statistical confidence level.
The Company assumed a portfolio disposition
period of 30 days with a confidence level of 95 percent
for the 2000 computation of VAR.The computation
further assumes that the distribution of returns is normal.
Based on such methodology and assumptions, the
computed VAR was approximately $2.3 million as
of December 31, 2000.
The Company’s calculated value-at-risk exposure
represents an estimate of reasonably possible net losses
that could be recognized on its investment portfolios
assuming hypothetical movements in future market rates
and are not necessarily indicative of actual results which
may occur. It does not represent the maximum possible
loss nor any expected loss that may occur, since actual
future gains and losses will differ from those estimated,
based upon actual fluctuations in market rates, operating
exposures, and the timing thereof, and changes in the
Company’s investment portfolios during the year.The
Company, however, believes that any loss incurred would
be offset by the effects of interest rate movements on the
respective liabilities, since these liabilities are affected by
many of the same factors that affect asset performance;
that is, economic activity, inflation and interest rates, as
well as regional and industry factors.
In addition, the Company has some interest rate mar-
ket risk due to its borrowings. Notes payable, capital leases
and other financing arrangements totaled $766 million at
December 31, 2000 with a related average interest rate of
7.5% (which interest rate is subject to change pursuant to
the terms of the Credit Facility). See a description of the
Credit Facility under “Liquidity and Capital Resources.”
The following table presents the expected cash outflows of market risk sensitive debt obligations at December 31,
2000.These cash outflows include both expected principal and interest payments consistent with the terms of the out-
standing debt as of December 31, 2000.
(Amounts in thousands) 2001 2002 2003 2004 2005 Beyond Total
Long-term floating
rate borrowing:
Principal $ –$766,450 $ – $ – $ – $ – $766,450
Interest 55,725 27,860 – –––83,585
Total cash outflow $55,725 $794,310 $ – $ – $ – $ – $850,035