Fitch Revises Outlook on Health Net’s ‘BBB’ IFS to Positive

The following is from Fitch Ratings on October 15:

Fitch Ratings has affirmed Health Net'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 revised to Positive from Stable. A complete list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The revised Rating Outlook on Health Net reflects improved and more consistent earnings and Fitch's expectation that these trends will continue through the balance of 2014. The rating 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.

Profitability of individual business sourced on exchanges established through the Affordable Care Act (ACA) remains a concern. Further, Fitch is monitoring the impact of Health Net's growing Medicaid enrollment, which is typically viewed as lower margin and lower credit-quality than commercial business.

Health Net's earnings in the first half of 2014 remained consistent with the improvement seen during 2013. The company reported EBITDA margin of 3 percent during the first six months of 2014, which is consistent with Fitch's 'BBB' IFS rating category guideline. The company's return on average capital was 13.4 percent in the first half of 2014. The return ratio was elevated by a one- time tax benefit of nearly $73 million from the loss on the stock of a subsidiary.

Health Net appears to have successfully repositioned its commercial business and has reported favorable experience in its growing Medicaid business. Importantly, earnings disruptions that created material volatility in past years were absent from 2013 and year-to-date 2014 results.

Fitch considers Health Net's market position consistent with its 'medium' categorization given the company mix of commercial, Medicaid, and Medicare enrollment and sizeable 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 5.8 million individuals and total revenue of approximately $11 billion for the full year 2013.

Health Net's year-end 2014 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 Health Net Community Solutions, 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 1.4x and operating EBITDA to interest expense was 12.4x during the first half of 2014. Both ratios were better than Fitch's median guidelines for the current rating category. Fitch does not expect Health Net to materially change its capitalization profile and a significant increase in financial leverage would put downward pressure on ratings.

RATING SENSITIVITIES

Key ratings triggers that could lead to an upgrade for Health Net include:

--Continuation of current operating results, specifically, EBITDA margin exceeding 3 percent or greater and return on average capital in the high single digits;

--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 downgrade for Health Net include:

--Poor earnings results measured by EBITDA margin below 1 percent;

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

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

Health Net

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

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

Health Net Of California

Health Net of Arizona

Health Net Health Plan of Oregon

--IFS at 'BBB'.

More information:

fitchratings.com

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