CHICAGO--(BUSINESS WIRE)--Fitch Ratings has upgraded Group Health Cooperative's (GHC) and Group Health Options, Inc.'s (GHO) (collectively Group Health) Insurer Financial Strength (IFS) ratings to 'BBB+' from 'BBB'. Additionally, Fitch has upgraded the ratings assigned to senior secured revenue bonds issued by the Washington Health Care Facilities Authority (WHCFA) on behalf of Group Health to 'BBB+' from 'BBB'. The ratings remain on Rating Watch Positive.
Today's rating action follows the completion of a periodic review of Group Health's ratings. Fitch had previously placed Group Health's ratings on Rating Watch Positive on Dec. 7, 2015 following GHC's announcement that it had entered into an agreement under which it would be acquired by a subsidiary of Kaiser Foundation Health Plan, Inc. (KFHP) whose IFS is rated 'A+' by Fitch. GHC's acquisition by KFHP is subject to various regulatory approvals, the decisions of which Fitch expects to be announced in late 2016 or early 2017.
The rating upgrades reflect on-going improvements in Group Health's financial performance and operating metrics. Fitch notes that Group Health's Rating Outlook was Positive at the time the company's planned acquisition by KFHP was announced. The ratings continue to reflect Group Health's strong but geographically concentrated competitive positon in Washington, comparatively small scale metrics, low financial leverage and strong risk-based capital ratios.
The Positive Rating Watch reflects Fitch's rating benefits expected to be derived from GHC's anticipated acquisition by KFHP. These include Group Health's integration into the KFHP organization, which Fitch views as maintaining a more diverse market position and significantly greater size and scale benefits than Group Health maintains on its own.
'Scores' assigned to rating factors underlying Group Health's ratings and the scores' forward trend are discussed below under Key Rating Drivers. Scores are denoted by lower case letters and follow the scale Fitch uses for its IFS ratings (i.e. 'aaa' through 'c'). Collectively, these scores support Group Health's ratings and Positive Rating Watch status.
KEY RATING DRIVERS
Business Profile scored 'bbb-' with a positive forward trend. The positive forward trend reflects the planned acquisition by KFHP after which Group Health would be part of a much larger and more diverse organization. At June 30, 2016, Group Health had approximately 626,000 members, essentially all of whom are from Washington while KFHP's June 30, 2016 membership totaled 10.6 million members across eight states and the District of Columbia.
Key considerations in Group Health's current score include the company's strong market share in Washington, where based on 2015 direct health premiums and enrollment in the state, Fitch estimates it was the state's largest and fourth largest health insurer respectively. The company's enrollment includes meaningful allocations from different market segments with roughly 60% derived from employer group enrollment and the balance consisting of Medicare, federal employees, and individual enrollment. Group Health's market position is also bolstered by its vertically integrated healthcare delivery system which includes both Group Health employee care providers and care providers provided by an independent medical group that contracts exclusively with Group Health. Also considered in the company's market position and size/scale score are the economic and regulatory risks tied to Group Health's geographically concentrated enrollment and the company's small, size/scale benefits, in comparison with nationally focused health insurers.
Financial Performance and Earnings scored 'a-' with a positive forward trend. The positive forward trend reflects expectations that Group Health's financial performance and earnings would likely benefit from enhanced economies of scale upon inclusion into the larger KFHP organization. The company's first half 2016 (1H16) financial results deteriorated compared to the prior year period reflecting a higher medical benefit ratio, but remain strongly supportive of the 'a-' score. In the 1H16, Group Health generated $116 million of EBITDA, an EBITDA-to-revenue margin of 5.9% and $74 million of net income. The company's 2014 through 1H16 average EBITDA-to-revenue and net income-to-average capital ratios were 6.1% and 11.5% respectively which collectively are consistent with Fitch's 'A' rating category guidelines.
Debt-Service Capabilities and Financial Flexibility scored 'a' with a positive forward trend. The positive forward trend reflects expectations that Group Health's debt services and particularly its financial flexibility, would benefit from becoming part of the KFHP organization. Key considerations in Group Health's score include solid EBITDA-based interest coverage ratios and somewhat limited financial flexibility. Group Health's annual interest and amortization payments are a modest $12 million per year through 2019. Operating EBITDA-based interest coverage ratios have been strong and were 47.2x in 2015 and 20.6x in 1H16. Fitch views Group Health's comparatively small size and non-stock corporate form, as reducing the company's sources of external flexibility but also believes that potential needs for external capital are limited.
Capitalization and Leverage scored 'aa-' with a negative forward trend. The negative forward trend reflects Fitch's view that the KFHP organization utilizes more financial leverage and typically reports lower risk-based capital ratios than Group Health. At June 30, 2016, Group Health's debt-to-annualized EBITDA and financial leverage ratios were 0.5x and 11% respectively. From 2013 through 2015 these ratios averaged 0.7x and 11% respectively. GHC's year-end 2015 NAIC risk-based capital ratio (company-action-level basis) and 2015 premiums-to-total net assets ratio were 437% and 3.1x, respectively, both of which are stronger than Fitch's 'AA' category guidelines. The company's debt obligations consist primarily of secured loan obligations payable to the Washington Health Care Facilities Authority (WHFCA), the terms of which mirror terms of revenue bonds issued on GHC's behalf by the WHCFA in the municipal bond market.
OTHER RATINGS CONSIDERATIONS
Group Rating Methodology: Fitch uses a group rating methodology and refers financial strength from GHC to GHO when evaluating the companies' ratings. This referral reflects Fitch's view that GHO is a 'core' GHC subsidiary and believes that GHC is willing and able to support GHO financially and operationally. Fitch considers GHO a core GHC subsidiary in part because it provides the Group Health organization with preferred provider organization and point of service products that Fitch believes is important to the organization's market position.
Notching Between Ratings: Fitch's rating on senior secured revenue bonds issued on GHC's behalf by the WHCFA are notched up by one notch from GHC's Issuer Default Rating (IDR) to reflect an assumption of 'Good' recoveries (as defined per Fitch criteria) in a default scenario. The one-notch uplift is due to the bonds' security in the form of a security interest in the company's gross receivables and liens on certain real estate and equipment assets. Thus, the revenue bonds are rated at the same level as GHC's IFS rating, since policyholder recoveries are also assumed to be 'Good' under Fitch's rating methodology.
RATING SENSITIVITIES
If Group Health's acquisition by KFHP is completed as planned, Fitch expects to categorize Group Health as a 'core' KFHP subsidiary and to equalize the companies' IFS ratings at 'A+'.
Under this scenario, Fitch expects its view of Group Health's financial profile to primarily be influenced by KFHP's consolidated financial profile.
If GHC's acquisition by KFHP does not receive necessary regulatory approvals and fails to close, Fitch expects to affirm Group Health's ratings at 'BBB+' but would consider the potential adverse effects the disapproval could have on Group Health from a financial, operational and competitive perspective.
Irrespective of the above scenarios, the revenue bonds' ratings could be downgraded and thus rated one notch lower than Group Health's IFS rating, if new information became available indicating that the revenue bonds' recoveries in a liquidation may be lower than currently assumed causing Fitch to change its recovery assumption to a level lower than 'Good'. Fitch notes possible future recoveries are difficult to estimate given lack of regulatory precedent on how funds would be disbursed among policyholders and secured creditors.
Fitch has upgraded the following ratings and the ratings remain on Rating Watch Positive:
--$98 million series 2006 revenue bonds issued by the WHCFA on behalf of Group Health Cooperative to 'BBB+' from 'BBB'.
Group Health Cooperative
--IFS to 'BBB+' from 'BBB'.
Group Health Options Inc.
--IFS to 'BBB+' from 'BBB'.
Group Health Cooperative
--IDR to 'BBB' from 'BBB-'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria
Insurance Rating Methodology (pub. 15 Sep 2016)
https://www.fitchratings.com/site/re/887191
Revenue-Supported Rating Criteria (pub. 16 Jun 2014)
https://www.fitchratings.com/site/re/750012
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1013025
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1013025
Endorsement Policy
https://www.fitchratings.com/regulatory
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