Fitch Downgrades Group Health Cooperative’s IFS to ‘BBB’; Places Revs on Rating Watch Negative [Professional Services Close – Up]

Fitch Ratings has downgraded Group Health Cooperative's (GHC) and Group Health Options, Inc. (GHO) Insurer Financial Strength (IFS) ratings to 'BBB' from 'A-' and GHC's Issuer Default Rating (IDR) to 'BBB-' from 'BBB+'.

The Rating Outlook on the long-term ratings for GHC and GHO is Stable.

Additionally, Fitch has placed its 'A-' long-term ratings on revenue bonds issued through the Washington Health Care Facilities Authority (WHCFA) on behalf of GHC and the short-term rating on GHC on Rating Watch Negative. Fitch anticipates that the Rating Watch will be resolved in the near term.

The downgrades reflect Fitch's expectations for a meaningful decline in GHC's and GHO's (collectively Group Health) 2011 operating results and capitalization metrics. Fitch views the company's anticipated 2011 operating performance as indicative of difficulties projecting and managing costs particularly those associated with external delivery services, and establishing appropriate premium rates in light of competitive pressures. Further, Fitch believes that these difficulties are exacerbated by the company's comparatively small size and concentrated geographic focus that limits the company's pricing power.

The downgrades also reflect Fitch's concerns about Group Health's ability to implement processes and controls required to generate profitability and capital stability expectations at the company's previous ratings levels.

Based on statutory accounting statements, GHC reported a $13 million net loss through Sept. 30, 2011 and a $36 million loss excluding net realized gains. These results follow a difficult 2010 during which the company reported a net loss of $33 million on a statutory basis. The company's earnings over the longer 2007-2009 period were modest with statutory accounting basis net income averaging $19 million per year.

Given statutory results over the first nine months of 2011 and incorporating an adverse approximate $39 million change in GHC's unrealized capital gain (loss) position and a $17 million charge to surplus from an increase in the company's minimum pension liability, Fitch estimates Group Health's 2011 organization-wide NAIC risk- based capital (RBC) ratio will decline to approximately 300 percent compared to 339 percent at year-end 2010.

Favorably, Group Health's outstanding series 2001 and series 2006 notes are amortizing notes, and annual principal and interest payments are modest at no more than $12 million in any one year from 2012 through 2036. Additionally, operating cash flow remains solid as the previously mentioned change in the unrealized capital gain (loss) position and pension-related charge are non cash items. Group Health generated $53 million of net cash flow from operations on a statutory accounting basis the first nine months of 2011.

Fitch views Group Health as moderately leveraged from a debt-to- capital perspective but much more leveraged from a debt-to-EBITDA perspective. At year-end 2010 the company's debt-to-capital ratio was a moderate 19 percent and including the previously mentioned $55 million swing in Group Health's unrealized gain (loss) position and the $17 million pension-related charge on a pro forma basis has little impact on the ratio. However, Fitch believes that the company's leverage measured by its ratio of debt-to-EBITDA (excluding net realized gains and losses) will be materially higher than that typically reported at the 'BBB' level.

The 'BBB' IFS rating on GHO reflects Fitch's view that the company is a core subsidiary under the agency's rating criteria, primarily due to GHO's relative contribution to the group's overall revenues and earnings and significant operational interaction and common management between the two companies.

KEY RATING DRIVERS:

Key rating drivers that could lead to an upgrade of Group Health's ratings include:

--Run rate growth in members' equity that exceeds the growth rate in premiums by a meaningful margin;--Moderate earnings levels likely indicated by run-rate EBITDA and net margins approximating 5 percent and 3 percent respectively;--Run-rate debt-to-EBITDA ratios and debt- to-capital ratios less than 2.5x and 25 percent respectively.

Key rating drivers that could lead to a downgrade of Group Health's ratings include:

--Run rate growth in premium revenues that exceeds the growth rate in members' equity by a meaningful margin;--Lack of favorable earnings trends and evidence that the company's medical cost trends are expanding faster than associated revenues;--Earnings charges or balance sheet adjustments that are expected to reduce the company's NAIC RBC ratios (company action level basis) below 250 percent;-- Run-rate debt-to-EBITDA ratios and debt-to-capital ratios greater than 3.0x and 30 percent respectively;--Loss of key contracts that contribute significantly to membership.

Additional information is available at fitchratings.com. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.

Applicable Criteria and Related Research:--'Insurance Rating Methodology' (Sept. 22, 2011);--'U.S. Health Insurance and Managed Care Rating Methodology' (March 31, 2011);--'Revenue-Supported Rating Criteria' (Oct. 8, 2010);--'Nonprofit Hospitals and Health Systems Rating Criteria' (Dec. 29, 2009).

Applicable Criteria and Related Research:Insurance Rating Methodologyhttp://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=651018U.S. Health Insurance and Managed Care Rating Methodologyhttp://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=613545Revenue-Supported Rating Criteriahttp:/ /fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=637130Nonprofit Hospitals and Health Systems Rating Criteriahttp://fitchratings.com/creditdesk/reports/ report_frame.cfm?rpt_id=648836

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