Health Net 2014 Annual Report Download - page 144

HEALTH NET, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
F-34
Note 7—Fair Value Measurements
We record certain assets and liabilities at fair value in the consolidated balance sheets and categorize them based
upon the level of judgment associated with the inputs used to measure their fair value and the level of market price
observability. We also estimate fair value when the volume and level of activity for the asset or liability have
significantly decreased or in those circumstances that indicate when a transaction is not orderly.
Investments measured and reported at fair value using Level inputs are classified and disclosed in one of the
following categories:
Level 1—Quoted prices are available in active markets for identical investments as of the reporting date.
The types of investments included in Level 1 include U.S. Treasury securities and listed equities. We do not adjust
the quoted price for these investments, even in situations where we hold a large position and a sale could
reasonably impact the quoted price.
Level 2—Pricing inputs are other than quoted prices in active markets, which are either directly or
indirectly observable as of the reporting date, and fair value is determined through the use of models and/or other
valuation methodologies that are based on an income approach. Examples include, but are not limited to,
multidimensional relational model, option adjusted spread model, and various matrices. Specific pricing inputs
include quoted prices for similar securities in both active and non-active markets, other observable inputs such as
interest rates, yield curve volatilities, default rates, and inputs that are derived principally from or corroborated by
other observable market data. Investments that are generally included in this category include asset-backed
securities, corporate bonds and loans, and state and municipal bonds.
Level 3—Pricing inputs are unobservable for the investment and include situations where there is little, if
any, market activity for the investment. The inputs into the determination of fair value require significant
management judgment or estimation using assumptions that market participants would use, including assumptions
for risk. Level 3 includes an embedded contractual derivative asset and/or liability held by the Company
estimated at fair value. Significant inputs used in the derivative valuation model include the estimated growth in
Health Net health care expenditures and estimated growth in national health care expenditures. The growth in
these expenditures was modeled using a Monte Carlo simulation approach. Level 3 also includes a state-
sponsored health plans settlement account deficit asset estimated at fair value based on the income approach. See
Note 2 for additional information on our state-sponsored health plans rate settlement agreement.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In
such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant
to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement in
its entirety requires judgment and considers factors specific to the investment.