Fitch Rates Kaiser Permanente 2011 Revs ‘A+/F1’; Outlook Stable

SAN FRANCISCO--(BUSINESS WIRE)-- Fitch Ratings has assigned an 'A+' long-term rating and a 'F1' short-term rating to the $204.5 millionCalifornia Health Facilities Financing Authority revenue bonds, series 2011 A-D, expected to be issued on behalf of Kaiser Permanente (Kaiser).

In addition, Fitch affirms the 'A+' and 'A+/F1' ratings on Kaiser's approximately $5.7 billion in outstanding parity debt, including the expected remarketing of:

--$97,280,000California Statewide Communities Development Authority Kaiser Permanente revenue bonds series 2002E;

--$150,000,000California Statewide Communities Development Authority Kaiser Permanente revenue bonds series 2004I;

--$50,000,000California Statewide Communities Development Authority Kaiser Permanente revenue bonds series 2009E-1;

--$50,000,000California Statewide Communities Development Authority Kaiser Permanente revenue bonds series 2009E-2.

Fitch also affirms the 'F1' rating on the Kaiser Foundation Hospitals Commercial Paper Program, and the 'A+' Insurer Financial Strength (IFS) ratings on Kaiser's rated insurance affiliates (listed at the end of this release).

The Rating Outlook is Stable.

The 2011 revenue bonds are expected to be privately placed as floating rate notes. Bond proceeds will be used to fund the cost of redemption of the California Infrastructure and Economic Development Bank revenue bonds (Kaiser Hospital Assistance I - LLC), series 2001A and series 2001B and the California Infrastructure and Economic Development Bank capital certificates (Kaiser Hospital Assistance I - LLC), series 2001C (collectively, the prior bonds), issued to acquire and equip certain physician office buildings, labs and other facilities. The 2011 bonds are expected to price through negotiation during the week of April 18th.

RATING RATIONALE:

--Kaiser's vertically integrated business model, whose insurance, hospital, and physician components provide coordinated services to its membership primarily in California, facilitates cost control and medical case management.

--Kaiser's strong liquidity and light capital related ratios, which generally meet or exceed Fitch's healthcare metrics for the category, are tempered by the health plan's insurance risks.

--The ratings of Kaiser's insurance operating subsidiaries are supported by the strength of the consolidated organization.

--Despite the decline in operating profitability that occurred in 2010 due to management's strategic decision to moderate rate increases in 2010 and increased costs related to Kaiser's ongoing capital program, Kaiser's ability to generate strong cash flow margin despite relatively high levels of capital spending is a strong positive rating factor. Kaiser has a history of solid operating and capital related metrics that generally exceed the 'A' medians for the not for profit healthcare sector.

KEY RATING DRIVERS:

--Continuing pressure on employer health benefit costs and possible reductions in federal funding for Medicare Advantage (MA) products may result in revenue pressure over the near to medium term.

--State budgetary deficits could adversely affect Medicaid and other state supported programs, and the recession could negatively impact membership renewal and membership growth.

--Operating pressures associated with the implementation of health reform legislation are likely to be more intense within Kaiser's non-California business due to the need to contract with unaffiliated care providers in these areas.

--Stringent expense control, achieved through operating efficiency improvements, benefit modifications, and rigorous case management, will become more critical as revenue pressure increases.

SECURITY:

The 2011 revenue bonds will be secured by a guaranty from the Kaiser Credit Group, defined as Kaiser Foundation Hospitals, Kaiser Foundation Health Plan, Inc.Kaiser Hospital Asset Management and Kaiser Health Plan Asset Management, Inc. The guaranty is an unsecured general obligation of the Credit Group.

CREDIT SUMMARY:

The 'A+' rating reflects Kaiser's solid profitability, robust liquidity, strong capital related ratios and the underlying strength of Kaiser's integrated healthcare delivery system. For 2010 fiscal year end Dec. 31, Kaiser's profitability dipped, with operating income of $1.07 billion as compared to $1.46 billion in the prior year. As a result, operating margin and operating EBIDA margins declined to 2.4% and 6.3%, respectively, from 3.5% and 7.3% in 2009. The decline in operating profitability was due to the increased hospital expense associated with Kaiser's ongoing capital program and management's decision to minimize rate increases. While investment performance was stronger in 2010 than in 2009 (Kaiser earned $0.9 billion in investment income in 2010 versus $0.6 billion in 2009) the drop in operating profitability also reduced Kaiser's excess margin, which declined to 4.4% from 4.9% in the prior year.

Relative to Fitch's hospital medians, Kaiser's liquidity and capital related indicators are the strongest among all of Fitch's healthcare credits. However, due to Kaiser's insurance operations and attendant actuarial risks, a higher rating is precluded. Strong investment performance and solid profitability caused Kaiser's unrestricted cash and investments to grow to $20.3 billion at Dec. 31, 2010 from $17.3 billion at the end of the prior year. As a result, Kaiser's liquidity ratios strengthened, with days cash on hand of 178.5, a cushion ratio (based on average annual debt service of $254 million) of 79.9 times (x), and a cash to debt ratio of 367.5%. All of these ratios compare favorably to Fitch's nonprofit hospital 'A' category medians for 2010 of 183.6 days cash on hand, 14.4x cushion ratio and 105.5x cash to debt ratio.

Kaiser's ability to fund a high level of capital investment while maintaining a strong balance sheet is considered a significant credit strength. Kaiser's strong cash flow supported capital expenditures of approximately $2.7 billion in 2010, consisting of facility replacements and expansions, as well as information systems investments. Kaiser anticipates total capital expenditures of over $13 billion through 2014, which management expects to fund from operations and debt, though Fitch is not expecting any additional borrowings over the near term. Kaiser's debt service payments are not level due to the organization's utilization of non-amortizing bullet maturities in its capital structure. Maximum annual debt service (MADS) of $615 million occurs in 2031 while average annual debt service (AADS) is approximately $254 million. In 2010, coverage of MADS by EBITDA was a very solid 6x while AADS coverage by EBITDA was a robust 14.5x.

Kaiser's total health plan membership increased approximately 1.2% in 2010 after two years of modest declines, essentially recovering from the membership losses which had occurred in 2007 and 2008. The company remains the sixth largest player in the U.S. health insurance market, with 8.68 million members at Dec. 31, 2010. While Kaiser's commercial HMO products account for 85% of membership, modest growth in alternative plans and Medicare business continues, mitigating concern over the lack of diversification in Kaiser's product line. However, Fitch takes a cautious view of government funded business such as Medicare Advantage due to the persistent risk of future restrictions on funding.

Credit concerns are mostly unchanged and include the impact of the state of California's budget crisis and the recession on enrollment over the near term, the intense competition among healthcare and health insurance providers, the inherent construction risk associated with the large capital program, and a heavily unionized labor force. Fitch also believes the size and complexity of completing the implementation of KP HealthConnect, which will support system-wide scheduling, registration, and clinical functions, will present challenges that could affect Kaiser's profitability over the short to medium term. Despite this, Fitch continues to believe that this strategic systems investment should allow Kaiser to more fully benefit from its integrated model, enhancing the organization's efficiency and competitiveness in the commercial healthcare insurance sector.

Kaiser's short-term 'F1' rating is supported by its strong liquidity position. Upon the closing of the series 2011 issue, Kaiser will have approximately $3 billion of demand debt outstanding. At Dec. 31, 2010, Kaiser had more than $6.2 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 criteria. Kaiser's $1.45 billion taxable commercial paper program (supported by a $1.45 billion line of credit provided by a consortium of banks) and $14 billion of other investments provide ample liquidity support for other longer-term demand debt.

The Stable Outlook reflects relatively steady health plan enrollment over the past three years, as well as Kaiser's ability to preserve balance sheet strength while maintaining a high level of investment in facilities and systems. A reasonable debt load coupled with consistent bottom-line profitability should provide the basis for a continuation of exceptionally strong debt service coverage, given Kaiser's manageable expected debt needs.

Kaiser Foundation Health Plan, Inc. and Kaiser Foundation Hospitals are not for profit corporations operating primarily as health maintenance organizations. Total revenues in fiscal year 2010 were approximately $44.2 billion and membership at Dec. 31, 2010 was 8.7 million. Kaiser covenants to provide audited financial statements to bondholders within six months of the close of each year, as well as quarterly 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 affirms the following IFS ratings at 'A+':

--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 ;

--Kaiser Foundation Health Plan of Colorado;

--Kaiser Foundation Health Plan of Ohio;

--Kaiser Permanente Insurance Company.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--Revenue Supported Rating Criteria (Dec. 29, 2009);

--Insurance Rating Methodology (March 31, 2011);

--Non-Profit Hospital and Health System Rating Criteria (Dec. 29, 2009);

--U.S. Health Insurance and Managed Care Rating Methodology (March 31, 2011);

--Criteria for Assigning Short-Term ratings based on Internal Liquidity (Dec. 29, 2009);

--Fitch's Approach to Rating Insurance Groups (Dec. 14, 2010);

--Evaluating Corporate Governance (Dec. 12, 2007).

For information on Build America Bonds, visit 'www.fitchratings.com/BABs'.

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=564565

Insurance Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=614266

Nonprofit Hospitals and Health Systems Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493186

U.S. Health Insurance and Managed Care Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=613545

Criteria for Assigning Short-Term Ratings Based on Internal Liquidity

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=493176

Fitch's Approach to Rating Insurance Groups

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=586765

Evaluating Corporate Governance

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=581405

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Fitch Ratings
Primary Analyst
Carolyn Tain, +1-415-732-7576
Senior Director
Fitch, Inc.
650 California Street
San Francisco, CA 94108
or
Secondary AnalystJames LeBuhn, +1-312-368-3347
Senior Director
or
Primary Insurance AnalystBradley Ellis, CFA, +1-312-368-2089
Director
or
Committee ChairpersonJeff Schaub, +1-212-908-0651
Managing Director
or
Media Relations:Cindy Stoller, +1-212-908-0526
Email: [email protected]

Source: Fitch Ratings