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Fitch Affirms Groups Health’s IFS and Senior Secured Bonds at ‘BBB-‘; Outlook Stable

CHICAGO–(BUSINESS WIRE)–Fitch Ratings has affirmed Group Health Cooperative’s (GHC) and

subsidiary Group Health Options, Inc.’s (GHO) (collectively Group

Health) Insurer Financial Strength (IFS) ratings at ‘BBB-‘. Fitch has

also affirmed the ratings on senior secured bonds issued by the

Washington Health Care Facilities Authority (WHCFA) on behalf of Group

Health at ‘BBB-‘. The Rating Outlooks are Stable. A complete list of

rating actions can be found at the end of this comment.

KEY RATING DRIVERS

Group Health’s ratings continue to reflect the company’s strong market

position in Washington, leverage and capitalization metrics that are

consistent with or better than Fitch’s ‘BBB’ rating category guidelines,

and support for the company’s various obligations provided by its

high-quality investment portfolio.

The ratings also reflect the impact of the company’s geographically

concentrated membership and operating profile, comparatively small size

and scale benefits, and weak long-term financial results.

Based on 2012 direct premiums, Group Health is the largest health

insurance and managed care-company in Washington. The company’s

membership consists primarily of employer-group business but also

includes meaningful contributions from Medicare (principally Medicare

Advantage) and individual products.

Group Health’s market position is bolstered by its vertically integrated

health care delivery system which includes both employee care providers

and care providers provided by an independent medical group that

contracts exclusively with Group Health. These care providers deliver

health care services at 26 primary and specialty care facilities owned

and operated by GHC.

Group Health has developed urgent care facilities in areas of

concentrated health plan membership to facilitate providing care in a

lower cost setting. However, Fitch’s view is that expenses need to be

better managed for the company to achieve positive ratings momentum.

Group Health’s large market share in Washington results in a

concentrated geographic footprint, which exposes the company to overall

economic and competitive conditions in the state. Fitch notes that this

market concentration also enables Group Health to more effectively

manage utilization management with its provider network.

GHC’s key capitalization metrics are generally consistent with or better

than ‘BBB’ rating category median guidelines and Fitch views the

company’s premium and asset leverage to be comparably low. The company’s

year-end 2012 NAIC risk-based capital (RBC) and premiums-to-surplus

ratios were 208% and 5.2x respectively. GHC’s year-end 2012

debt-to-EBITDA ratio was 3.1x while its Financial Leverage Ratio was 19%.

Group Health’s 2008-2012 financial results were weak as the company

struggled to cope with operational issues that resulted from its gradual

expansion outside its traditional strength HMO plan. The company’s

2008-2012 average EBITDA-to-revenue and average net return on average

capital ratios were 1.42% (0.1%) respectively.

In an effort to improve its financial performance, Group Health

implemented a study in the fourth quarter 2012 of its internal processes

and expense structure. In connection with this study, the company

anticipates re-designing many of its processes and eliminating a

significant number of full-time equivalent positions. Group Health

estimates the annual expense savings from this headcount reduction at

$200 million-$220 million by the end of 2013.

The company generated strong first quarter 2013 (1Q’13) financial

results as higher premium rates and a decline in expenses, particularly

in medical expenses incurred for external delivery services, generated

EBITDA-to-revenue and net annualized return on average capital ratios of

11.8% and 13.8% respectively. Both of these metrics are significantly

higher than Fitch’s ‘BBB’/’BB’ rating category median guidelines.

At March 31, 2013, Group Health had obligations to the Washington Health

Care Facilities Authority (WHCFA) totaling approximately $140 million.

The WHCFA in turn has issued a like amount of senior amortizing bonds,

secured by a security interest in Group Health’s gross receivables and

liens on certain Group Health real estate assets and equipment.

Group Health’s annual coupon and amortization payments are relatively

modest at $12 million per year through 2019.

EBITDA-based interest coverage ratios, excluding the impact of an

interest rate swap contract Group Health has entered into that reduces

the company’s interest rate expense during periods of declining interest

rates, was 4.9x in 2012 and averaged 7.3x from 2008 through 2012.

RATING SENSITIVITES

Key rating triggers that could lead to an upgrade include run-rate:

–EBITDA/revenue margins approximating 5%;

–Net income/average capital ratios approximating 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.

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

35%, respectively;

–Loss of key contracts that contribute significantly to membership.

Fitch has affirmed the following ratings:

–$99.7 million series 2006 revenue bonds issued by the Washington

Health Care Facilities Authority on behalf of Group Health Cooperative

at ‘BBB-‘;

–$45 million series 2001 revenue bonds issued by the Washington Health

Care Facilities Authority on behalf of Group Health Cooperative at

‘BBB-‘;

–Group Health Cooperative – IFS at ‘BBB-‘;

–Group Health Cooperative – IDR at ‘BB+’;

–Group Health Options, Inc. – IFS at ‘BBB-‘.

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

Applicable Criteria and Related Research:

–‘Insurance Rating Methodology’ (Jan. 11, 2013).

Applicable Criteria and Related Research:

Insurance Rating Methodology – Amended

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=698731

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=794038

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 THE AGENCY’S PUBLIC WEBSITE ‘WWW.FITCHRATINGS.COM‘.

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CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH

WEBSITE.

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