Health Net 2010 Annual Report Download - page 90

Accounting Standards Codification. The interpretation requires us to analyze the amount at which each tax
position meets a “more likely than not” standard for sustainability upon examination by taxing authorities. Only
tax benefit amounts meeting or exceeding this standard will be reflected in tax provision expense and deferred
tax asset balances. The interpretation also requires that any differences between the amounts of tax benefits
reported on tax returns and tax benefits reported in the financial statements be recorded in a liability for
unrecognized tax benefits. The liability for unrecognized tax benefits is reported separately from deferred tax
assets and liabilities and classified as current or noncurrent based upon the expected period of payment.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
We are exposed to interest rate and market risk primarily due to our 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 maintaining variable interest rate earning investments and fixed rate liabilities or fixed income
investments and variable rate liabilities. We are 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, we are
exposed to the risk of loss related to changes in credit spreads. Credit spread risk arises from the potential
changes in an issuer’s credit rating or credit perception that will affect the value of financial instruments.
We attempt to manage the interest rate risks related to our investment portfolios by actively managing the
asset 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 2010. The computation further assumes that the distribution of returns is normal. Based on such
methodology and assumptions, the computed VAR was approximately $13.8 million as of December 31, 2010.
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.
Except for those securities held by trustees or regulatory agencies (see Note 2 to our consolidated financial
statements), all of our investment securities are designated as “available-for-sale” assets. As such, they are
reflected at their estimated fair value, with the difference between cost and estimated fair value reflected in
accumulated other comprehensive income, net of tax, a component of Stockholders’ Equity (see Note 4 to the
consolidated financial statements). All of our investment securities are fixed income securities. Approximately
39% of our available-for-sale investment securities are asset-backed securities (ABS)/mortgage-backed securities
(MBS). Approximately 81% of the ABS/MBS are agency securities. Therefore, we believe that our exposure to
credit-related market value risk for our MBS is limited. Generally, in a rising interest rate environment, the
estimated fair value of fixed income securities would be expected to decrease; conversely, in a decreasing
interest rate environment, the estimated fair value of fixed income securities would be expected to increase.
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