Health Net 1999 Annual Report Download - page 26

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. Mar-
ket risk generally represents the risk of loss that may result
from the potential change in the value of a financial instru-
ment 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 Com-
pany 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 manag-
ing 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 ongoing 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 horizon, subject to appropriate levels of
risk. Each business unit has additional requirements with
respect to liquidity, 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 perfor-
mance measurement and reporting.
The Company uses a value-at-risk (“VAR ”) 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 tech-
niques 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.
The Company assumed a portfolio disposition period
of 30 days with a confidence level of 95 percent for the
1999 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 $2.7 million as of December 31, 1999.
The Company’s calculated value-at-risk exposure rep-
resents 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 market
risk due to its borrowings. Notes payable, capital leases and
other financing arrangements totaled $1.041 billion at
December 31, 1999 with a related average interest rate of
6.78% (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 R esources.”
The table following presents the expected cash outflows
of market risk sensitive debt obligations at December 31,
1999.These cash outflows include both expected principal
and interest payments consistent with the terms of the
outstanding debt as of December 31, 1999.
24 FOUNDATION HEALTH SYSTEMS, INC.
(Amounts in thousands) 2000 2001 2002 2003 2004 Beyond Total
Long-term floating rate
borrowings:
Principal $ – $ – $1,039,250 $ – $ – $ – $1,039,250
Interest 94,302 79,243 39,622 – – – 213,167
Total Cash O utflow $94,302 $79,243 $1,078,872 $ – $ – $ – $1,252,417