Fitch Affirms Kaiser Permanente (CA) Revs at ‘A+/F1’; Outlook Stable

Fitch Ratings has affirmed the 'A+' rating on approximately $7.7 billion of revenue bonds issued by or on behalf of Kaiser Permanente (Kaiser) through the following conduit issuers:

--California Statewide Communities Development Authority;

--California Health Facilities Financing Authority;

--Maryland Health & Higher Educational Facilities Authority.

In addition, Fitch affirms the 'F1' short-term rating on approximately $1.4 billion variable rate demand bonds, $1.6 billion of bonds in a commercial paper (CP) mode, as well as the $1.5 billionKaiser Foundation Hospitals taxable CP program. The 'F1' short-term rating is based on Kaiser's self-liquidity.

The Rating Outlook is Stable.

SECURITY

Debt service is an unsecured general obligation of the Credit Group which is composed of the Kaiser Foundation Hospitals, Kaiser Foundation Health Plan, Inc., Kaiser Hospital Asset Management and Kaiser Health Plan Asset Management, Inc.

KEY RATING DRIVERS

UNIQUE BUSINESS MODEL: Kaiser's vertically integrated, closed health maintenance organization (HMO) is unique among the health care and health insurance and managed care companies rated by Fitch. Combined with its exclusive contract with the Kaiser Permanente Medical Groups, Fitch believes that Kaiser's fully integrated model allows the company a higher level of control over its pricing and cost structure relative to Fitch's other rated hospitals and health insurance companies.

LEADING MARKET POSITION, SIGNIFICANT SCALE: Based on premium revenues, Kaiser maintains the largest market share in the large and important CA health insurance and managed care market. Using other metrics such as revenues, capital, and annual earnings as benchmarks, Kaiser is the largest not-for-profit health care system in the country and is among the largest health insurance and managed care organizations in Fitch's rating universe.

STRONG FINANCIAL PROFILE: Certain of Kaiser's liquidity and capital related ratios are among the strongest among all of Fitch's rated not-for-profit hospital and health care systems. Further, historical profitability has been steady with operating and operating EBITDA margins at or above 3 percent and 6.7 percent, respectively, in each of the last three years.

SIZABLE PENSION LIABILITY: At Dec 31, 2013, Kaiser's pension liabilities totaled $17.5 billion, which is improved from $18.6 billion at Dec. 31, 2012. Under the defined benefit pension plans the fair value of plan assets at Dec 31, 2013 was $8.5 billion, which represents a weak 49 percent of Kaiser's projected benefit obligation (PBO) and 65 percent of accumulated benefit obligation (ABO).

CONCENTRATION IN CALIFORNIA: With 77 percent of revenues and 79 percent of membership generated in CA, Kaiser's results are heavily influenced by changes in the economic, political, regulatory and competitive environment in the state.

MULTIPLE RATING CRITERIA USED: Recognizing Kaiser's unique business model, Fitch's ratings on Kaiser incorporate aspects from Fitch's nonprofit hospital and U.S health insurance and managed care criteria. The ratings place a heavier emphasis on the hospital criteria, since Kaiser's hospital operations represent the majority of the organization's earnings and assets.

RATING SENSITIVITIES

MEMBERSHIP GROWTH AND IMPROVED FINANCIAL PROFILE: Fitch believes Kaiser's vertically integrated, fully aligned HMO model is well- positioned for the transition to a value-based health care environment. Upward movement in the ratings could occur if there is measured and profitable growth in membership in markets outside of CA; further improvement in liquidity and leverage, and meaningful reductions in the underfunded status of the organization's pension plans.

CREDIT PROFILE

Kaiser Foundation Health Plan, Inc. and Kaiser Foundation Hospitals are not-for-profit corporations operating primarily as health maintenance organizations. On a combined basis, Kaiser's total revenues in fiscal 2013 were approximately $53.1 billion.

UNIQUE BUSINESS MODEL

Fitch considers Kaiser Permanente a unique vertically integrated health-care delivery network, composed of the Kaiser Foundation Health Plan (KFHP), owned hospitals and outpatient facilities that are staffed by physicians who contract exclusively with KFHP. In total Kaiser operates 38 hospitals and 611 outpatient facilities staffed by 16,000 physicians (Permanente Medical Group physicians). The fully integrated model provides a high degree of control in managing medical costs. Because of its vertically integrated delivery model, Fitch believes Kaiser will have continued success in a post-healthcare reform environment.

LARGE SCALE IN CALIFORNIA

Fitch views the Kaiser Permanente business model as a key contributor to KFHP's leading market share and strong competitive position in the large CA health insurance market. While KFHP maintains large market shares in CO, HI, and OR, and smaller, but generally meaningful, market share in seven other states, 78 percent of its 9.2 million members are located in CA. Relative to its insurance peer group, Fitch views Kaiser Permanente's higher single- state concentration as a negative factor because of the company's corresponding significant exposure to the economic and political environments in CA.

STRONG FINANCIAL PROFILE

In 2013, Kaiser generated operating income of $1.65 billion on total revenues of $53.1 billion (operating and operating EBITDA margins of 3.1 percent and 6.8 percent, respectively) as compared to operating income of $1.57 billion on total revenues of $50.1 billion (operating and operating EBITDA margins of 3.1 percent and 6.8 percent) in the prior year. The 5.9 percent growth in revenues in 2013 reflects continued membership growth and improved pricing.

Relative to Fitch's hospital medians, Kaiser's liquidity and capital-related indicators are among the strongest in Fitch's not- for-profit healthcare universe. However, due to Kaiser's insurance operations and attendant actuarial risks, a higher rating is precluded at this time. Despite heavy capital spending above $3 billion annually in each of the last three years (195 percent of depreciation expense), Kaiser has been able to grow its unrestricted cash and investments position to $29.2 billion at Dec. 31, 2013 from $21.9 billion at Dec. 31, 2011. Kaiser's days cash on hand (DCOH) of 214.5, cushion ratio of 39.2x and cash-to-debt of 412.9 percent exceed Fitch's nonprofit hospital 2013 'A' category medians of 196.3 DCOH, 15.6x cushion ratio and 129.2 percent cash-to-debt ratio.

Kaiser has been able to fund a high level of capital investment while maintaining a strong balance sheet. Consistent cash flow generation has allowed the company to fund its sizable capital plan which includes seismic hospital replacements and upgrades, new hospital construction, and investment in clinical information technology. Investment in property plant and equipment (PP&E) has averaged $3.3 billion annually over the last three years or almost 200 percent of annual depreciation. Management reports that its CA facilities will be seismically compliant under CA's SB 1661 in 2014. Annual capital spending is expected to be lower going forward now that its seismic reinvestment is nearly complete.

Kaiser's debt and leverage metrics are light relative to Fitch's hospital and health system rated entities. Because Kaiser utilizes non-amortizing bullet maturities in its capital structure, the aggregate debt service structure is not level. Maximum annual debt service (MADS) of $744 million occurs in 2031 while average annual debt service (AADS) is approximately $320 million. MADS equates to a very light 1.4 percent of Kaiser's 2013 total revenues. Coverage of MADS by EBITDA was a very solid 6.2x and 5.9x in 2013 and 2012, respectively which exceeds the 'A' category median of 3.8x Coverage of AADS by EBITDA was a robust 14.5x and 13.8x in 2013 and 2012, respectively.

SIZABLE PENSION LIABILITY

At FYE 2013, Kaiser's pension liabilities totaled $17.5 billion which is improved from $18.63 billion at Dec. 31, 2012. Under the defined benefit pension plans the fair value of plan assets at Dec. 31, 2013 was $8.5 billion, which represents a weak 49 percent of Kaiser's PBO and 65 percent of ABO. The weak funding level reflects the low interest rate environment which impacts discount rate assumptions used to calculate future benefit obligations and pension expense. In 2013, Kaiser made pension contributions totaling $985 million (compared to $1.5 billion in 2012) while the plan paid $627 million in benefits. Additionally, the unfunded status for post- retirement health care and life insurance benefits fell to $5.5 billion from $7.3 billion in 2013 due to a change in plan design. While Fitch acknowledges that pension and post-retirement liabilities are a conditional liability that is highly sensitive to changing regulatory, interest rate and actuarial assumptions, Kaiser's pension obligations are significant and could depress the company's liquidity and profitability in a sustained low interest rate environment.

SHORT-TERM RATING

Kaiser's short-term 'F1' rating is supported by the strong liquid position of its investment portfolio. Upon the closing of the series 2012 issue, Kaiser will have approximately $3.1 billion of variable rate and demand debt due within a year. At Dec. 31, 2011, Kaiser had more than $5.8 billion of same-day settlement funds, which would cover Kaiser's outstanding demand debt in excess of 1.25x as required under Fitch's self-liquidity rating criteria. Kaiser's $1.5 billion taxable CP program is supported by a $1.5 billion line of credit provided by a consortium of banks.

DISCLOSURE

Kaiser covenants to provide audited financial statements to bondholders within six months of the close of each fiscal year, as well as quarterly unaudited financial statements no later than 60 days after each quarter. Disclosure to Fitch to date has been excellent and includes quarterly earnings calls and subsequent distribution of detailed financial statements. Kaiser also provides a quarterly earnings press release detailing the quarterly performance.

Fitch currently has an IFS rating of 'A+' on the following:

--Kaiser Foundation Health Plan, Inc.;

--Kaiser Foundation Health Plan of the Northwest;

--Kaiser Foundation Health Plan of Georgia, Inc.;

--Kaiser Foundation Health Plan of the Mid-Atlantic States, Inc.;

--Kaiser Foundation Health Plan of Colorado;

--Kaiser Permanente Insurance Company.

Additional information is available at 'fitchratings.com'

Applicable Criteria and Related Research:

--'Revenue-Supported Rating Criteria' (June 3, 2013);

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

--'Nonprofit Hospital and Health System Rating Criteria' (May 20, 2013);

--"Health and Managed Care (U.S.) Sector Credit Factors Special Report' (Dec. 18, 2013);

--'Rating U.S. Public Finance Short Term Debt, (Dec. 9, 2013)

Applicable Criteria and Related Research:

Rating U.S. Public Finance Short-Term Debt

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=724680

Health Insurance and Managed Care (U.S.)

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=724819

2002 Nonprofit Hospital and Health Care Systems Outlook

http://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=139482

Additional Disclosure

Solicitation Status

http://fitchratings.com/gws/en/disclosure/ solicitation?pr_id=824213

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