[June 17, 2014]

Fitch Upgrades Groups Health's IFS and Senior Secured Bonds to 'BBB'; Outlook Stable

Fitch Ratings has upgraded Group Health Cooperative's (GHC) and subsidiary Group Health Options, Inc.'s (GHO) (collectively Group Health) Insurer Financial Strength (IFS) ratings to 'BBB' from 'BBB-'. Fitch has also upgraded the ratings on senior secured bonds issued by the Washington Health Care Facilities Authority (WHCFA) on behalf of Group Health, to 'BBB' from 'BBB-'. The Rating Outlooks are Stable. A complete list of rating actions can be found at the end of this comment.

KEY RATING DRIVERS

The rating upgrades reflect significant improvements in Group Health's financial performance and capitalization metrics that Fitch believes are tied to process re-design and head-count and expense reductions the company began implementing in the fourth quarter of 2012 (1Q'12). Fitch's view is that while it will be difficult for Group Health to sustain margins and absolute earnings at current levels, especially in light of industry-wide pressures contributing to Fitch's negative health insurance sector outlook, and pressures the company may face as a non-profit company, margins and earnings will remain supportive of the 'BBB' category ratings.

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 a point-of-sale product line that Fitch views important to the organization's market position.

Fitch's rating of GHC's revenue bonds are notched up by one from GHC's IDR to reflect an assumption of 'Good' recoveries (as defined per Fitch criteria) in a default scenario, given 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' as per customary Fitch practice.

Financial Performance: Group Health's financial performance through 1Q'14 was strong, continuing 2013's favorable trends. Based on these results and given Group Health's longer-term performance trends, Fitch views the company's financial performance as supportive of 'BBB' category IFS ratings. Through 1Q'14 the company generated $80 million of EBITDA and an EBITDA-to-revenue margin of 8.5%. In 2013, Group Health generated $223 million of EBITDA and an EBITDA-to-revenue margin of 6.0%. In contrast, from 2009 through 2012 Group Health's EBITDA averaged $59 million and its EBITDA-to-revenue margin averaged 1.8% as the company struggled to control the cost of healthcare provided by providers from outside its vertically integrated healthcare delivery model.

Capitalization and Leverage: Group Health's capitalization and leverage metrics improved materially over the last 12-15 months and are supportive of 'A' category ratings. Fitch attributes the improvements to strong earnings and a decline in pension plan liabilities due to market conditions and plan changes. At year-end 2013 the company's NAIC risk-based capital (RBC) ratio was 405% (on a company-action level basis) compared to 208% at year-end 2012. In addition, Group Health's annualized debt-to-EBITDA ratios at March 31, 2014 and Dec. 31, 2014 were 0.4x and 0.6x, respectively. From 2009 through 2012 the company's debt-to-EBITDA ratio averaged 2.7x.

Debt-Service Capabilities and Financial Flexibility: Group Health's debt-service capabilities are supportive of 'A' category ratings reflecting relatively modest annual interest and amortization payments of $12 million per year through 2019. The company is a party to an interest rate swap contract that in recent years of declining interest rates has reduced its interest expense. Excluding the impact of the interest rate swap contract, Group Health's operating EBITDA-based interest coverage ratios through March 31, 2014 and in 2013 were very strong at 68.2x and 22.3x, respectively. From 2009 through 2012 this ratio averaged a much weaker 3.5x.

Group Health's enrollment consists primarily of employer group business but includes a meaningful mix of Medicare and individual insurance. The company's enrollment is geographically concentrated in Washington where, based on both enrollment and direct health premiums, it maintains market shares in excess of 10%. The company's market position is bolstered by its vertically integrated healthcare delivery system which includes both employee care providers and care providers provided by an independent medical group that contracts exclusively with Group Health. Fitch's view is that this integrated delivery system and its aligned medical group and ambulatory facilities should allow Group Health to better leverage its position and manage costs in its geographically concentrated market.

RATING SENSITIVITIES

--Fitch currently maintains a negative sector rating on the U.S. health insurance and managed care industry reflecting expectations for industry-wide margin pressure largely derived from the Affordable Care Act's implementation. Key considerations in evaluating Group Health's ratings for upgrades over the next 12-24 months center on the company's ability to overcome these pressures and to maintain financial performance and capitalization metric trends that continue to be favorable in comparison to expectations for the company's current ratings.

Specifically, factors that could lead to rating upgrades include Group Health generating the following on a sustained basis:

--EBITDA/revenue margins greater than 5%;

--Net income/average capital ratios greater than 5%;

--Debt-to-EBITDA ratios and debt-to-capital ratios that are less than 3.0x and 20%, respectively;

--EBITDA-based interest coverage ratios that exceed 7x; and

--Maintaining key contracts with the state of Washington that contribute significantly to enrollment.

Key rating triggers that could lead to a downgrade include run-rate:

--EBITDA/revenue margins that are less than 3%;

--Net income/average capital ratios that are less than 3%;

--NAIC RBC ratios (company action level basis) below 200%;

--Debt-to-EBITDA ratios and debt-to-capital ratios greater than 3.0x and 25%, respectively; and

--Loss of key contracts with the state of Washington that contribute significantly to enrollment.

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 indicated recoveries 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 in a liquidation among policyholders and secured creditors.

Fitch has upgraded the following ratings:

--$98 million series 2006 revenue bonds issued by the Washington Health Care Facilities Authority on behalf of Group Health Cooperative to 'BBB' from 'BBB-';

--$35 million series 2001 revenue bonds issued by the Washington Health Care Facilities Authority on behalf of Group Health Cooperative to 'BBB' from 'BBB-';

Group Health Cooperative

--IFS to 'BBB' from 'BBB-';

--IDR to 'BBB-' from 'BB+'.

Group Health Options, Inc.

--IFS to 'BBB' from 'BBB-'.

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

Applicable Criteria and Related Research:

--'Insurance Rating Methodology' (Nov. 2013).

--'Health Insurance and Managed Care (U.S.) Sector Credit Factors' (Dec. 2013)

--'U.S. Nonprofit Hospital and Health Systems Rating Criteria' (May 30, 2014)

Applicable Criteria and Related Research:

U.S. Nonprofit Hospitals and Health Systems Rating Criteria - Effective May 20, 2013 - May 30, 2014

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=708361

Health Insurance and Managed Care (U.S.)

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

Insurance Rating Methodology

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

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=835056

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON (News - Alert) THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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