Health Net 2004 Annual Report Download - page 70

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actual fluctuations in market rates, operating exposures, and the timing thereof, and changes in our investment portfolios during the
year. We believe, however, that any loss incurred would be substantially offset by the effects of interest rate movements on our
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 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, 2004, 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 Operations—
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.
The fair value of our fixed rate borrowing as of December 31, 2004 was approximately $481 million which was based on bid
quotations from third-party data providers. The following table presents the expected cash outflows relating to market risk sensitive
debt obligations as of December 31, 2004. These cash outflows include both expected principal and interest payments consistent with
the terms of the outstanding debt as of December 31, 2004 prior to entering into the Swap Contracts.
67
2005
2006
2007
2008
2009
Thereafter
Total
(
Amounts in millions
)
Fixed-rate borrowing:
Principal
$
—
$
—
$
$
—
$
—
$ 400.0
$400.0
Interes
t
35.4
39.5
39.5
39.5
39.5
98.8
292.2
Valuation of interest rate swap contracts (a)
(5.9)
(3.8)
(1.6)
(0.2)
1.4
9.4
(0.7)
Cash outflow on fixed-rate borrowing
$29.5
$35.7
$37.9
$39.3
$40.9
$508.2
$691.5
(a) Expected cash (inflow) outflow from Swap Contracts as of the most recent practicable date of February 28, 2005 is $(2.3)
million, $0.2 million, $1.2 million, $2.1 million, $2.8 million and $5.7 million for 2005, 2006, 2007, 2008, 2009 and thereafter,
respectively.