[May 08, 2014]

Fitch Affirms Blue Shield of California's IFS at 'A'; Outlook Stable

Fitch Ratings has affirmed Blue Shield of California's (BSC) Insurer Financial Strength (IFS) rating at 'A'. The Rating Outlook is Stable.

Today's affirmation completes a periodic review of BSC's rating and recent financial performance. Key factors considered in the review include expectations for comparatively rapid growth in BSC's membership due to the company's participation on the California health insurance exchange and pressure on profitability and capitalization derived from industry-wide pressures and from decisions made by BSC to partially fund strategic initiatives with existing capital.

KEY RATING DRIVERS

Industry Profile and Operating Environment: BSC's membership consists primarily of employer group and, to a lesser extent, individual insurance membership. The company's membership from the Medicare/Medicaid business is comparatively modest. Under Fitch's rating methodology probable IFS ratings for health insurers that focus on the employer group and individual markets (i.e. commercial market) range from 'A' to 'BBB'.

Market Position and Size/Scale: Fitch views BSC as maintaining 'medium'-sized market profile and size/scale characteristics indicating a probable IFS ratings range from 'A' to 'BBB'. Key factors underlying BSC's market position include the comparatively high concentration of the company's membership by product type and geography, and large market share in California. Approximately 85% of the company's consolidated membership base is derived from employer group products with the balance derived from individual and senior market membership. BSC generates essentially all of its revenues in California where based on direct premiums, Fitch estimates it is the third largest health insurer. With 2.9 million members at year-end 2013, $4.1 billion in stabilization funds, and $11 billion in revenues in 2013, BSC's size/scale metrics that overlap Fitch's 'small' and 'medium' categorizations.

Capitalization, Leverage and Financial Flexibility: Fitch views BSC's capitalization and leverage metrics to be consistent with those expected at the 'AAA' IFS rating category. Key factors underlying Fitch's view are the company's very strong risk-based capital ratio (RBC), low operating leverage ratio and lack of financial leverage. Fitch anticipates pressure on BSC's capitalization metrics over the next several years as the company plans to partially fund strategic initiatives such as large scale information technology projects, and potential acquisitions, with existing capital.

Fitch believes that BSC maintains adequate financial flexibility which is supported by the company's strong competitive position in California, consistent earnings and comparative lack of financial commitments. Partially offsetting these strengths is the company's status as a non-stock corporation which prevents access to public equity markets.

Financial Performance: Fitch considers BSC's financial performance to be consistent with that expected at the 'BBB' IFS rating category. BSC's 2009-2013 average medical benefit, EBITDA-to-revenues and annualized net return on average capital ratios were 86.1, 3.2%, and 5.2% respectively and are generally consistent with Fitch's 'BBB' median rating category guidelines. Fitch's view is that BSC's nonprofit status and pledge to policyholders that it will limit its net income to 2% of revenues is likely to suppress the company's financial performance metrics at the 'BBB' rating category.

Fitch believes that the financial results of policies BSC sources from the California health insurance exchange, like those of policies sourced by other insurers from various states' health insurance exchanges, are uncertain. The agency attributes this to the lack of historical utilization and cost trend data on exchange populations. As part of its ratings review of BSC, Fitch stress-tested its projection of BSC's 2014 financial results and year-end 2013 risk-based capital ratio by altering the benefit ratio assumptions on BSC's projected exchange-sourced business. The results of the stress test did not have a meaningful impact on Fitch's expectations of BSC's 2014 financial performance or RBC expectations.

RATINGS SENSITIVITIES

Fitch believes that BSC's single-state profile makes it very difficult for the company to obtain an IFS rating higher than the 'A' rating category. Fitch's view is that single-state concentrations result in exposure to economic and political conditions that limit feasible strategic alternatives and expose companies' capital bases to concentrated risks.

Rating triggers that could lead to a rating upgrade within the 'A' rating category include:

--Profitable market share gains within the company's core California market;

--Growth in the size and scale of BSC's revenue and earnings base while maintaining the company's 2% of revenues run-rate net earnings target;

--Run-rate EBITDA/revenue and net income/average capital ratios that more closely approximate Fitch's 'A' rating category guidelines of 7% while maintaining risk-based capital ratios (company action level basis) greater than 350%.

Rating triggers that could lead to a rating downgrade:

--BSC losing the ability to market itself as a Blue Shield company could result in a multi-notch downgrade;

--Run-rate risk-based capital ratios (company action level basis) below 350%;

--Run-rate ratios of premiums to stabilization fund (i.e. net worth) that exceed 5.0x;

--Membership growth that causes Fitch to question BSC's ability to generate run-rate net earnings consistent with the company's 2% of revenue-target.

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

Applicable Criteria and Related Research:

--'Insurance Rating Methodology' (November 2013);

--'Health and Managed Care (U.S.) Sector Credit Factors Special Report' (December 2013).

Applicable Criteria and Related Research:

Insurance Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=723072

Health Insurance and Managed Care (U.S.)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=724819

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=829220

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