Fitch Affirms Groups Health's IFS and Sr Secured Bonds at 'BBB'; Outlook Revised to Positive
Today's rating action follows the completion of a periodic review of Group Health's ratings. The revision in the Outlook to Positive reflects Group Health's favorable financial performance trends and financial metrics that are generally better than 'BBB' rating category guidelines.
'Scores' assigned to the factors underlying Group Health's ratings are discussed below under Key Rating Drivers, along with their relative influence on the ratings, and the factor's forward trend, Collectively, they support the ratings and their Positive Outlooks.
KEY RATING DRIVERS
Financial Performance and Earnings scored 'bbb'; 'higher' influence on ratings, positive forward trend - The positive forward trend reflects expectations that the financial performance metrics Group Health has reported in recent years will be maintained, resulting in a higher financial performance and earnings score. Through the first half of 2015 (1H15) the company generated \\$140 million of EBITDA, an EBITDA-to-revenue margin of 7.6%, and \\$101 million of net income. The company's EBITDA-to-revenue and net income-to-average capital ratios averaged 6.1% and 15.1, respectively, from 2013 through 1H15. From 2010 through 2012, these ratios averaged 1.5% and (1.2%). Fitch attributes the bulk of the improvement to headcount reductions, operational restructurings and process redesigns that reduced expenses, particularly expenses for external healthcare delivery expenses.
Market Position and Size/Scale scored 'bbb-'; 'higher' influence on ratings, stable forward trend - Key considerations include Group Health's strong market share in Washington, where based on 2014 direct health premiums and enrollment in the state, Fitch estimates it was the state's largest and third largest health insurer. The company's enrollment includes meaningful allocations from different market segments with roughly 60% derived from employer group enrollment and the balance consisting of Medicare, federal employees, and individual enrollment. Fitch views the company's contract with the state of Washington as a key factor supporting Group Health's market positon and size/scale characteristics. Group Health's market position is also bolstered by its vertically integrated healthcare delivery system which includes both Group Health employee care providers and care providers provided by an independent medical group that contracts exclusively with Group Health. Also considered in the company's market position and size/scale score are the economic and regulatory risks tied to Group Health's geographically concentrated enrollment, essentially all of which is derived from Washington, and the company's small, size/scale benefits, in comparison with nationally focused health insurers.
Debt-Service Capabilities and Financial Flexibility scored 'a'; lower' influence on rating, stable forward trend - Key considerations include solid EBITDA-based interest coverage ratios and somewhat limited financial flexibility. Group Health's annual interest and amortization payments are a modest \\$12 million per year through 2019. The company is a party to an interest rate swap contract that results in lower interest expense in declining interest rate environments and higher interest expense in rising interest rate environments. Through 1H15, Group Health's EBITDA-based interest coverage ratio, including the effect of the interest rate swap contract, was a very strong 39.3x. From 2012 to 2014, Group Health's operating EBITDA-based interest coverage ratio averaged 62.7x including the effect of the interest rate swap contract and 17.4x excluding the effect of the contract. Fitch views Group Health's comparatively small size and non-stock corporate form, as reducing the company's sources of external flexibility but also believes that potential needs for external capital are limited.
Capitalization and Leverage scored 'aa-'; 'lower' influence on rating, stable forward trend - At June 30, 2015, Group Health's debt-to-annualized EBITDA and financial leverage ratios were 0.5x and 11%, respectively. From 2010 to 2014 these ratios averaged 2.2x and 16%. GHC's year-end 2014 NAIC risk-based capital ratio (company-action-level basis) and 2014 annualized premiums-to-total net assets ratio were 395% and 3.4x, respectively, both of which are better than Fitch's 'aa' score guidelines. The company's debt obligations consist primarily of secured loan obligations payable to the Washington Health Care Facilities Authority (WHFCA), the terms of which mirror terms of revenue bonds issued on GHC's behalf by the WHCFA in the municipal bond market.
OTHER RATINGS CONSIDERATIONS
Group Rating Methodology: Fitch uses a group rating methodology and refers financial strength from GHC to GHO when evaluating the companies' ratings. In its assessment, Fitch considers GHO a 'core' company within the Group Health organization and believes that GHC is willing and able to support GHO financially and operationally. Fitch considers GHO a core company in part because it provides the Group Health organization with preferred provider organization and point of service products that we view important to the organization's market position.
Notching between Ratings: Fitch's rating on senior secured revenue bonds issued on GHC's behalf by the WHCFA are notched up by one notch from GHC's Issuer Default Rating (IDR) to reflect an assumption of 'Good' recoveries (as defined per Fitch criteria) in a default scenario. The one-notch uplift is due to the bonds' security in the form of a security interest in the company's gross receivables and liens on certain real estate and equipment assets. Thus, the revenue bonds are rated at the same level as GHC's IFS rating, since policyholder recoveries are also assumed to be 'Good' under Fitch's rating methodology.
Fitch would likely upgrade Group Health's ratings and the ratings assigned to revenue bonds issued by the WHCFA on Group Health's behalf by one notch within the next 12-24 months if the company's financial performance remains consistent with recent results and Group Health's debt service capabilities and financial flexibility and capitalization and leverage ratings factors retain their respective current scores of 'a' and 'aa-'. Key financial performance metrics that Fitch would view as supporting an upgrade are EBITDA-to-revenue margins approximating 4% and annual EBITDA of roughly \\$150 million. Conversely, if Group Health's financial metrics fail to reach these guidelines over the next 12-24 months, or the company's debt service capabilities and financial flexibility or capitalization and leverage scores deteriorate from current levels, the ratings would likely be affirmed and the Rating Outlook revised to Stable.
In addition, the revenue bonds' ratings could be downgraded if Fitch changed its recovery assumption to a level lower than 'Good', should new information become available that indicates the revenue bonds' recoveries in a liquidation may be lower than currently assumed. Fitch notes possible future recoveries are difficult to estimate given lack of regulatory precedent on how funds would be disbursed among policyholders and secured creditors.
Fitch has affirmed the following ratings :
--\\$98 million series 2006 revenue bonds issued by the WHCFA on behalf of Group Health Cooperative at 'BBB'.
Group Health Cooperative
--IFS at 'BBB'; Outlook revised to Positive;
--IDR at 'BBB-'; Outlook revised to Positive.
Group Health Options Inc.
--IFS at 'BBB'; Outlook revised to Positive.