Fitch Affirms Health Net’s ‘BBB’ IFS; Outlook Stable

Fitch Ratings affirmed Health Net Inc.'s (Health Net) 'BB+' Issuer Default rating, 'BB' senior unsecured notes rating and the 'BBB' Insurer Financial Strength (IFS) ratings of its insurance company subsidiaries.

The Rating Outlook is Stable. A complete list of rating actions follows below.

KEY RATING DRIVERS

Improved earnings in 2013 were an important consideration in today's affirmation of Health Net's ratings. The affirmation also considers Health Net's overall 'medium' market position and size/ scale features, which typically span the 'A' and 'BBB' IFS rating categories. Further, most of Health Net's capitalization metrics are comparable with Fitch's median guidelines for the 'A' IFS rating category or higher.

Balanced against these ratings positives are uncertainties regarding the Affordable Care Act's (ACA) effect on the composition and profitability of the health insurance market which led Fitch to assign a Negative Sector Outlook to health insurers in Dec. 2013 and the impact of Health Net's shrinking commercial enrollment and growing Medicaid enrollment. Fitch views Medicaid enrollment as lower margin and lower credit-quality than commercial business.

Health Net reported improved earnings in 2013 with an EBITDA margin of 3.1 percent, consistent with Fitch's 'BBB' IFS rating category guideline, and up from 0.9 percent in 2012. The company's return on average capital was 8.1 percent in 2013, up from 6.2 percent in 2012 and comparable to Fitch's 'A' IFS guidelines.

Importantly, earnings disruptions that created material volatility in past years were absent from 2013's results. The company's ability to sustain profitability at 2013 levels, could favorably impact the company's rating outlook and ultimately ratings. Net income from continuing operations was $170 million in 2013, up from $26 million in 2012 due to re-pricing efforts in the company's commercial business and growth in Medicaid earnings.

Fitch considers Health Net's market position consistent with its 'medium' categorization given the company mix of commercial, Medicaid, and Medicare enrollment and large market share in California, and expanding presence in three other Western states. Health Net's size and scale metrics are also considered consistent with Fitch's 'medium' categorization when measured by medical membership of 5.3 million individuals and total revenue of approximately $11 billion for the full year 2013.

Health Net's year-end 2013 NAIC RBC ratio is expected to be near 200 percent of the company action level. Management targets an NAIC RBC ratio of 200 percent excluding its community solutions segment, for its underwriting subsidiaries. This RBC ratio remains consistent with Fitch's median guideline of 175 percent for the 'BBB' IFS rating category.

The company's ratio of debt to EBITDA was 1.5x and operating EBITDA to interest expense was 10.5x during 2013. Both ratios showed significant improvement from 2012's 5.2x debt-to-EBITDA and 1.8x EBITDA to-interest expense. The 2013 ratios were better than Fitch's median guidelines for the current rating category.

RATING SENSITIVITIES

If Health Net's first half 2014 earnings are comparable to 2013's levels and there is no further deterioration in Fitch's macro view of the Health Insurance Sector, Fitch is likely to revise the rating outlook to positive during the second half of 2014. Specific Health Net measurements include: EBITDA margin exceeding 3 percent, return on average capital in the high single digits, and the absence of restructuring and reserve charges that materially disrupt earnings.

If the above conditions are met and maintained through the subsequent 12 - 24 months, and the following conditions are met, Fitch believes that a rating upgrade is possible:

--Maintenance of consolidated Risk-Based Capital (RBC) above 200 percent of the Company Action Level (CAL) and debt-to-EBITDA below 2.5x;

--Flat-to-favorable reserve development.

Key ratings triggers that could lead to a downgrade for Health Net include:

--Poor earnings results or significant volatility in earnings;

--Deterioration in commercial membership relative to relative to year-end 2013 levels.

--A significant decline in consolidated Risk-Based Capital (RBC) below 175 percent of the CAL or debt-to-EBITDA greater than 3.0x.

Fitch has affirmed the following ratings with a Stable Rating Outlook:

Health Net Inc.

--Long-term IDR at 'BB+';

--6.375 percent senior notes due June 2017 at 'BB';

Health Net Of California, Inc

Health Net of Arizona, Inc

Health Net Health Plan of Oregon, Inc

--IFS at 'BBB'.

Applicable Criteria & Related Research:

--'Insurance Rating Methodology' (Nov. 13, 2013);

--'Health Insurance and Managed Care (U.S.)' Sector Credit Factors (Dec. 18, 2013).

Applicable Criteria and Related Research:

Health Insurance and Managed Care (U.S.)

Additional information is available at 'fitchratings.com'.

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