Fitch Affirms Blue Shield of California's IFS at 'A'; Outlook Stable

CHICAGO--()--Fitch Ratings has affirmed Blue Shield of California's (BSC) Insurer Financial Strength (IFS) rating at 'A'. The Rating Outlook is Stable.

KEY RATING DRIVERS

Today's affirmation follows a periodic review of BSC's rating and recent financial performance. The rating action reflects the company's strong competitive position and large market share in California, high-quality balance sheet and comparative lack of leverage and overall strong capitalization.

BSC's rating also reflects exposure to the California economy and insurance market derived from its concentrated operations in the state and the uncertain impact that market changes tied to the Affordable Care Act's (ACA) implementation, are likely to have on the California health insurance market and on BSC.

BSC's financial performance generally trails Fitch's 'A' rating category guidelines, due in part to the company's status as a non-profit company and BSC's policy of limiting annual net earnings to two percent of revenues. In contrast, the company's capitalization metrics are generally better than Fitch's 'A' rating category guidelines.

Through Sept. 30, 2013, BSC reported $235 million of net income on $8.2 billion of revenues. Fitch calculates the company's medical benefits ratio through the first nine months of 2013 at 83.9% and EBITDA-to-revenue margin at 4.9%, both of which are moderate improvements relative to 2012 results.

Going forward into 2014, Fitch's believes that BSC's, as well as health insurers in general, margins are likely to be pressured in 2014 due to ACA-related industry-wide fees, comparatively low Medicare reimbursement rates and the uncertain profitability of government sponsored exchange sourced enrollment.

Based on metrics such as state-wide direct premiums and enrollment, Fitch considers BSC the third-largest health insurer and managed-care company in California. The company's large market share is bolstered by its ability to use the Blue Shield brand, which Fitch believes is highly-recognized and favorably-viewed by consumers.

BSC has no outstanding debt and funds its operations through internally generated cash flows. Risk-based capital ratios are very strong and asset and reserve leverage is low. Fitch's expectation is that BSC's stabilization fund (i.e. net worth) will continue to grow at a rate that is commensurate with premium, assets and reserves.

Fitch considers the quality of BSC's balance sheet to be strong and characterized by a high quality and liquid fixed maturities portfolio, stable claim reserves, and relatively few potential claims on the company's capital. Like many Blue Cross/Blue Shield licensees, BSC has a higher allocation to equity investments than publicly-traded competitors. However, Fitch believes that the company maintains the capital strength to ride-out reasonably-foreseeable equity market downturns.

In terms of size and scale, and using medical membership and revenues as measurement metrics, BSC overlaps Fitch's 'small' and 'medium' categorizations. Fitch typically uses medical membership and revenues as key size/scale metrics because it believes that they have a significant impact on a company's ability to realize scale benefits, generate earnings and capital formation and build competitive provider networks.

Fitch believes that BSC's concentrated focus on the California market, where the company generates essentially all of its revenues and earnings, makes it very difficult for BSC to obtain an IFS rating higher than the 'A' rating category. Fitch's view is that single-state concentrations result in exposure to economic and political conditions that limit feasible strategic alternatives and expose companies' capital bases to concentrated risks.

RATINGS SENSITIVITIES

Rating triggers that could lead to a rating upgrade within the 'A' rating category include:

--Market share gains within the company's core California market;
--Enhanced size and scale of BSC's revenue and earnings base;
--Run-rate EBITDA/revenue and net income/average capital ratios that more closely approximate Fitch's 'A' rating category guidelines of 7% while maintaining risk-based capital ratios (company action level basis) greater than 350%.

Rating triggers that could lead to a rating downgrade:

--BSC losing the ability to market itself as a Blue Shield company could result in a multi-notch downgrade;
--BSC choosing to price its products such that premiums, assets, and liabilities grew at materially faster rates than its stabilization fund for a multi-year period;
--Losses in capital that reduced run-rate risk-based capital ratio below 350%;
--Run-rate ratios of premiums to stabilization fund (i.e. net worth) that exceed 5.0x.

Fitch has affirmed the following rating:

California Physicians Service dba Blue Shield of California
--IFS rating at 'A'; Outlook Stable.

Additional information is available at www.fitchratings.com.

Applicable Criteria and Related Research:
--'Insurance Rating Methodology' (November 2013);
--'Health and Managed Care (U.S.) Sector Credit Factors Special Report' (August 2013).

Applicable Criteria and Related Research:
Insurance Rating Methodology -- Amended
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=723072
Health Insurance and Managed Care (U.S.) Sector Credit Factors
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=686930

Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=811374
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Contacts

Fitch Ratings
Primary Analyst:
Mark Rouck CPA, CFA, +1-312-368-2085
Senior Director
Fitch Ratings, Inc.
70 West Madison St.
Chicago, IL 60602
or
Secondary Analyst:
Doug Pawlowski, CFA, +1-312-368-2054
Senior Director
or
Committee Chairperson:
Julie Burke, CPA, CFA, +1-312-368-3158
Managing Director
or
Media Relations:
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com

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Contacts

Fitch Ratings
Primary Analyst:
Mark Rouck CPA, CFA, +1-312-368-2085
Senior Director
Fitch Ratings, Inc.
70 West Madison St.
Chicago, IL 60602
or
Secondary Analyst:
Doug Pawlowski, CFA, +1-312-368-2054
Senior Director
or
Committee Chairperson:
Julie Burke, CPA, CFA, +1-312-368-3158
Managing Director
or
Media Relations:
Brian Bertsch, +1-212-908-0549
brian.bertsch@fitchratings.com