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TEXT-S&P affirms Health Care Service Corp ratings

(The following statement was released by the rating agency)

Overview

-- Health Care Service Corp. has a very strong financial risk profile underpinned by excellent balance sheet strength and very strong business risk profile.

-- We are affirming our 'AA-' financial strength on Health Care Service Corp. and our 'AA-' issue rating on its $500 million senior notes.

-- The outlook is stable reflecting our view that, although operating performance may decline slightly from the past few years, the financial profile will remain supportive of the current ratings.

Rating Action On Oct. 4, 2012, Standard & Poor's Ratings Services affirmed its 'AA-' financial strength rating on Health Care Service Corp. (HCSC). At the same, we also affirmed our 'AA-' issue rating on the company's $500 million senior notes. The outlook is stable.

Rationale

The insurer financial strength rating on HCSC--which does business as Blue Cross Blue Shield of Illinois, Texas, Oklahoma, and New Mexico--reflects the company's excellent balance sheet, very strong liquidity profile, and leading market position in its core markets. These strengths are somewhat offset by its more limited geographic and product breadth than its publicly held for-profit peers.

We consider HCSC's capitalization to be excellent and relatively stronger than that of all health insurance companies that we rate. Its quality of capital, with low debt leverage and high tangible net worth, adds to this balance sheet strength. According to Standard & Poor's risk-based insurance capital model, HCSC's capital remains very well redundant at the 'AAA' level. It has a strong and growing capital base--as of the end of second-quarter 2012, total adjusted capital was $9.5 billion, an increase of more than 50% over the past five years. As a mutual company, HCSC does not face pressure from public shareholders (as its for-profit peers do) to pay dividends from earnings. Consequently, it has accumulated a significant capital base from its retained earnings. We believe the amount of surplus available gives the company very strong financial flexibility, allowing it to comfortably absorb any short-term earnings volatility or fund potential acquisitions without imperiling its ability to pay policyholder claims.

We view HCSC's competitive position to be very strong. It maintains a leading market position in its four core states, underpinned by strong brand equity, well-developed distribution channels, long-standing provider relationships, and competitive servicing capabilities. As of June 30, 2012, HCSC provided health insurance and related services to about 13 million members, making it the fourth-largest insurer in the U.S. in terms of membership. We view its business profile as relatively stronger than other privately owned not-for profit companies. However, it is relatively weaker than public for-profit insures, since HCSC has limited product and geographic diversity. Although it has national presence through the Blue card program and national self-insured group accounts, the majority of its membership and earnings come from its four Blue branded states. About 90% of its members are commercially insured; some of its public peers have wider geographic presence and more diverse product portfolios that include commercial as well as Medicare and Medicaid lines of business.

A key development in 2012 was the company's announcement that it had formed an alliance with Blue Cross Blue Shield of Montana (BCBSMT). The full extent of this alliance is not clear right now, but we don't expect this to have a material impact on HCSC given BCBSMT's comparatively smaller membership and capital base. But it does provide some additional geographic diversity to HCSC's business profile.

We view the company's liquidity profile as being very strong and supportive of the rating. As per our liquidity model, HCSC has a liquidity ratio of about 240% as of year-end 2011, which we consider to be very strong. The company's liquidity profile is also supported by its investment portfolio that comprises low risk, good quality, and highly liquid assets.

We consider HCSC's operating performance to be strong, but relatively weaker compared with public for-profit insurers we rate. Since 2010, the company has been performing above our expectations. HCSC reported statutory pretax return on revenue (ROR), excluding investment related realized gains and losses, of 7% or higher in 2010 and 2011. This positive earnings trend has continued through the first six months of 2012. The higher-than-expected results stem from favorable market conditions, such as lower-than-expect medical cost trends, that have had a positive affect on the health insurance industry in general. HCSC recently lowered its premium rates on certain product lines to intentionally increase its medical loss ratios (MLR) in order to be compliant with the regulatory MLR requirements. In our view, HCSC's more sustainable level of profitability is probably around 5%-6% ROR, which we would still consider to be strong and in the top quartile of our rated not-for-profit insurers, but at the lower end of the profitability range of our rated for-profit publicly held insurance companies. We don't consider this expected dip in profitability to be a threat to the current ratings since HCSC's capitalization and liquidity measures offset any relative downside risk to its earnings profile.

Outlook

The stable outlook reflects our expectation that there will not be any ratings movement for HCSC over of the next two years. We expect the company to maintain its excellent capitalization, leading competitive positions in key markets, and strong operating performance, with ROR around 5%-6% for 2012 and 2013. Although there is limited downside risk at this time, we could consider lowering the ratings if HCSC's ROR were to decline to less than 4% on a sustained basis or capitalization fell below the 'AA' level as per our risk-based insurance capital model. On the other hand, we could raise the rating (beyond the 24 month horizon) if HCSC successfully expands its business profile by profitably (maintaining at least 5% ROR) diversifying into new regions and related product lines.

Related Criteria And Research

-- Methodology for Assessing U.S. Insurers' Capital Adequacy Beyond The Financial Crisis, May 31, 2011

-- Evaluating Insurers' Competitive Position, April 22, 2009

Ratings List Ratings Affirmed Health Care Service Corp. d/b/a Blue Cross Blue Shield of Illinois, New Mexico, Oklahoma, and Texas Counterparty Credit Rating Local Currency AA-/Stable/-- Financial Strength Rating Local Currency AA-/Stable/-- Fort Dearborn Life Insurance Co. Fort Dearborn Life Insurance Co. of New York Counterparty Credit Rating Local Currency A+/Stable/-- Financial Strength Rating Local Currency A+/Stable/--

Health Care Service Corp. d/b/a Blue Cross Blue Shield of Illinois, New Mexico, Oklahoma, and Texas

$500 mil sr unsec notes AA-

(Caryn Trokie, New York Ratings Unit)

((Caryn.Trokie@thomsonreuters.com; 646-223-6318; Reuters Messaging: rm://caryn.trokie.reuters.com@reuters.net))

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