Health Net 2006 Annual Report Download - page 80

We file tax returns in many tax jurisdictions and, often, application of tax rules within the various
jurisdictions is subject to differing interpretation. Despite our belief that our tax return positions are fully
supportable, we believe that it is probable certain positions will be challenged by taxing authorities, and we may
not prevail on the positions as filed. Accordingly, we maintain a reserve for the estimated amount of contingent
tax challenges by taxing authorities upon examination, in accordance with SFAS No. 5, “Accounting for
Contingencies.” The reserve is comprised of amounts for specific issues arising in periods subject to
examination, and amounts are released from the reserve upon closure of such examinations or upon closure of the
statute of limitations for assessment. The estimates of contingent tax costs comprising the reserve balance have
been developed after careful analysis of the applicable statutory authority and court case precedent. As such, we
believe that the reserve reflects the probable outcome of contingent tax challenges and that the probability of
material assessments above the reserve balance is remote. The reserve is included in accounts payable and other
liabilities in our consolidated balance sheets.
In 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes—an interpretation of FASB Statement 109” (FIN 48). This interpretation clarifies
the accounting for uncertain taxes recognized in a company’s financial statements in accordance with SFAS
No. 109, “Accounting for Income Taxes.” 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.
Additional disclosure in the footnotes to the audited financial statements will be required concerning the income
tax liability for unrecognized tax benefits, any interest and penalties related to taxes that are included in the
financial statements, and open statutes of limitations for examination by major tax jurisdictions. FIN 48 is
effective for annual periods beginning after December 15, 2006 and any cumulative effect of adopting FIN 48
will be recorded as a change in accounting principle in the financial statements for the three months ended
March 31, 2007. We anticipate the impact to be an immaterial reduction to the beginning balance of retained
earnings.
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 that
changes in an issuer’s credit rating or credit perception may affect the value of financial instruments.
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
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