Fitch Downgrades Health Care Service Corp.'s IFS to 'A'; Outlook Stable

CHICAGO--()--Fitch Ratings has downgraded Health Care Service Corporation's (HCSC) Insurer Financial Strength (IFS) rating to 'A' from 'A+' and senior unsecured debt rating to 'A-' from 'A'. The Ratings Outlook is Stable. A complete list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The rating downgrade follows deterioration in HCSC's capitalization from sustained net losses. In addition, HCSC has increased borrowing from the FHLB and allocations to risky assets increased. The company's concentration in the two key markets of Illinois and Texas continues to be a limiting factor on the ratings.

Favorably, the rating continues to reflect HCSC's sizeable market position as well as its Blue Cross Blue Shield (BCBS) branding. The Stable Rating Outlook is supported by Fitch's expectation that HCSC's balance sheet will remain strong and any future profitability challenges will not materially impact capitalization.

HCSC reported an underwriting profit through the first half of 2016 after two years of material losses related to Affordable Care Act (ACA) exchange-sourced business as well as lesser losses on Medicare Advantage and Medicaid business. The operating problems have lasted more than a couple of years with HCSC reporting net losses of $282 million and $66 million for full-years 2014 and 2015, respectively.

Fitch believes it will be difficult for HCSC to restore profitability to historic levels in the near future given the large volume of lower margin business sourced from ACA exchanges. Profitability issues began with HCSC's ACA exchange-sourced business, leading to the establishment of premium deficiency reserves and consequently several years of poor operating results. Premium deficiency reserves have fluctuated since year-end 2013, but are currently $508 million at June 30, 2016.

HCSC's financial leverage ratio increased to 13% at June 30, 2016 due to FHLB borrowing used for liquidity management purposes. Investments in "risky assets" increased to 14% of surplus at the end of the second quarter 2016 and consisted mostly of unaffiliated common stocks with a modest, but growing allocation to below investment-grade bonds. HCSC's historically excellent capitalization, measured by the NAIC RBC ratio, continues to deteriorate from heavy operating losses. Fitch estimates the company's RBC ratio was approximately 350% of the company action level at June 30, 2016. RBC is down from 383% at year-end 2015, falling substantially and steadily from 614% at year-end 2013.

The company's dominant market share in a limited number of states made ACA exchange-sourced business a greater priority for HCSC relative to national competitors. HCSC has a substantial market position in multiple states and is the nation's fourth-largest health insurer and the largest nonpublic health insurer in the U.S. by membership. HCSC's membership was approximately 14.8 million at June 30, 2016. HCSC's revenue continues to be concentrated in Illinois and Texas, accounting for 83% of premium through the first half of 2016. The company's next largest state in terms of premiums is Oklahoma, accounting for approximately 9% of premium.

A key competitive advantage remains HCSC's exclusive right to use the BCBS trademarks in its five core states. These rights, as well as the company's access to Blue Card -- the BCBS Association's national account platform -- have helped establish and grow the company's sizeable market position.

RATING SENSITIVITIES

The key rating triggers that could result in a downgrade include:

--An inability to achieve EBITDA margins and return on capital ratios in the low-single-digits over the next 12-to-24 months.

--An RBC ratio decline below 300% or an increase in financial leverage above 15%.

The key rating triggers that could result in an upgrade include:

--EBITDA margin and return on capital above 7% over a sustained period.

--Maintain an RBC ratio above 400% of the company action level.

Fitch has downgraded the following ratings:

Health Care Service Corporation

--IFS to 'A' from 'A+'; Outlook Stable;

--Issuer Default Rating to 'A-' from 'A'; Outlook Stable;

--$500 million 4.7% senior notes due January 2021 to 'A-' from 'A'.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Insurance Rating Methodology (pub. 15 Sep 2016)
https://www.fitchratings.com/site/re/887191

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013011

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Contacts

Fitch Ratings
Primary Analyst:
Douglas M. Pawlowski, CFA, +1-312-368-2054
Senior Director
Fitch Ratings, Inc.
70 W. Madison St.
Chicago, IL 60602
or
Secondary Analyst:
Mark E. Rouck, CPA, CFA, +1-312-368-2085
Senior Director
or
Committee Chairperson, +1-312-606-2321
Brian Schneider, CPA
Senior Director
or
Media Relations:
Hannah James, +1-646-582-4947
New York
hannah.james@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst:
Douglas M. Pawlowski, CFA, +1-312-368-2054
Senior Director
Fitch Ratings, Inc.
70 W. Madison St.
Chicago, IL 60602
or
Secondary Analyst:
Mark E. Rouck, CPA, CFA, +1-312-368-2085
Senior Director
or
Committee Chairperson, +1-312-606-2321
Brian Schneider, CPA
Senior Director
or
Media Relations:
Hannah James, +1-646-582-4947
New York
hannah.james@fitchratings.com