Health Net 2005 Annual Report Download - page 75

We have several bond portfolios to fund reserves. We attempt to manage the interest rate risks related to our
investment portfolios by actively managing the asset/liability duration of our investment portfolios. The overall
goal for the investment portfolios is to provide a source of liquidity and support the ongoing operations of our
business units. Our philosophy is to actively manage assets to maximize total return over a multiple-year time
horizon, subject to appropriate levels of risk. Each business unit has additional requirements with respect to
liquidity, current income and contribution to surplus. We manage these risks by setting risk tolerances, targeting
asset-class allocations, diversifying among assets and asset characteristics, and using performance measurement
and reporting.
We use a value-at-risk (VAR) model, which follows a variance/co-variance methodology, to assess the
market risk for our 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 determination is made at a given statistical confidence level.
We assumed a portfolio disposition period of 30 days with a confidence level of 95% for the computation of
VAR for 2005. The computation further assumes that the distribution of returns is normal. Based on such
methodology and assumptions, the computed VAR was approximately $11.9 million as of December 31, 2005.
Our calculated VAR exposure represents an estimate of reasonably possible net losses that could be
recognized on our 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 our investment
portfolios during the year.
In addition to the market risk associated with its investments, we have interest rate risk due to our fixed rate
borrowings.
We use interest rate swap contracts (Swap Contracts) as a part of our hedging strategy to manage certain
exposures related to the effect of changes in interest rates on the fair value of our Senior Notes. On February 20,
2004, we entered into four Swap Contracts related to the Senior Notes. Under the Swap Contracts, we agree to
pay an amount equal to a specified variable rate of interest times a notional principal amount and to receive in
return an amount equal to a specified fixed rate of interest times the same notional principal amount. The Swap
Contracts are entered into with a number of major financial institutions in order to reduce counterparty credit
risk.
The Swap Contracts have an aggregate principal notional amount of $400 million and effectively convert
the fixed interest rate on the Senior Notes to a variable rate equal to the six-month London Interbank Offered
Rate plus 399.625 basis points. See Note 6 to our consolidated financial statements for additional information
regarding the Swap Contracts.
The interest rate on borrowings under our senior credit facility, of which there were none as of
December 31, 2005, is subject to change because of the varying interest rates that apply to borrowings under the
senior credit facility. For additional information regarding our senior credit facility, see “Management’s
Discussion and Analysis of Financial Condition and Results of Operation—Liquidity and Capital Resources.”
Our floating rate borrowings, if any, are presumed to have equal book and fair values because the interest rates
paid on these borrowings, if any, are based on prevailing market rates.
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