moodys ma report

8/12/2019 Moodys MA Report

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CREDIT FOCUS

INSURA JULY 31, 2014

RATINGS

Aetna Inc.Senior Unsecured Debt Baa2Insurance Financial Strength (IFS)* A2Rating Outlook Stable

Cigna CorporationSenior Unsecured Debt Baa2Insurance Financial Strength (IFS)* A2Rating Outlook Positive

Humana Inc.Senior Unsecured Debt Baa3Insurance Financial Strength (IFS)* A3Rating Outlook Stable

UnitedHealth Group Inc.Senior Unsecured Debt A3Insurance Financial Strength (IFS)* A1Rating Outlook Stable

WellPoint, Inc.Senior Unsecured Debt Baa2Insurance Financial Strength (IFS)* A2Rating Outlook Stable* IFS rating on domestic operating companies

Key Indicators continued on page 13

Analyst Contacts:

NEW YORK +1.212.553.1653

Stephen Zaharuk +1.212.553.1634Senior Vice [email protected] Fagin +1.212.553.1650 Associate [email protected]

Robert Riegel +1.212.553.4663Managing Director - [email protected]

Medicare Advantage Cuts: Prognosis Not BadFor Most Health Insurers

Summary Opinion

With continued pressure on Medicare Advantage (MA) reimbursements to health insurers,there will likely be credit implications in terms of membership growth and income. In thisreport, we compare the expected impact on five large national health insurers of a no-growtmembership and reduced margin scenario over a one-year and three-year horizon, focusing their MA revenue and earnings. Our key findings are:

Although not insignificant, the MA exposure for four of the largest health insurers -UnitedHealth, Aetna, WellPoint, and Cigna - is manageable given these companiesoverall diversification. However, Humana, with a much larger MA exposure, wouldappear to be vulnerable to experiencing a larger negative financial impact fromcontinued reimbursement reductions.

Despite the reimbursement rate changes mandated by the Affordable Care Act and othreductions being proposed by the Centers for Medicare and Medicaid Services, webelieve that in the near term the product is sustainable although with lower membershgrowth rates than experienced over the last several years. In addition, it is likely that ptax margin will be somewhat lower that the current 4% range.

Given their track record and our expectation of health insurers adaptability, the scena we have used to gauge the credit rating sensitivity for each insurer to the MA productsegment - a pretax margin of 2.5% to 3% and no membership growth - is a bit severe,especially over a three year horizon.

Nevertheless, under this scenario, our analysis finds that for all five health insurers, this no significant credit deterioration after one year.

However, reflecting the higher revenue and income exposure Humana has to thisproduct, our analysis indicates a negative impact to Humanas overall credit profileunder the unlikely event the scenario assumptions continue for a three-year time horizand Humana is unable to grow its other business segments.
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2 JULY 31, 2014 CREDIT FOCUS: MEDICARE ADVANTAGE CUTS: PROGNOSIS NOT BAD FOR MOST HEALTH INSUR

The Current State of Medicare Advantage Reimbursements

Insurers demonstrate resiliency to cuts

MA reimbursement rates to insurance companies have been reduced over the last several years as aresult of a combination of lower MA benchmark rates established by the Centers for Medicare andMedicaid Services (CMS), reductions mandated in the Affordable Care Act (ACA), and sequestrati1Under the ACA, federal payments to MA plans are scheduled to decrease over time, bringing themcloser to parity with traditional Medicare fee-for-service program costs. The recently released CMS2015 MA benchmark rates reflect further reductions to MA payments. As shown in the table belowthe compounded reduction in reimbursement rates over the last several years projected through 201is over 23%, after factoring in the impact of medical inflation.

EXHIBIT 1

Medicare Advantage Change in Reimbursement Rate

Change in Reimbursement

Level

Annual Increase in Medicare

Expenditures1

Projected Future AnnualIncrease in Medicare

Expenditures

Compounded Net

Reimbursement Change2010 -5.0% 1.3% -6.3%

2011 -1.6% 2.4% -10.0%

2012 -1.5% 0.7% -12.0%

2013 -0.9% 1.5% -14.1%

2014 -4.7% 1.5% -19.5%

2015 -3.8% 1.5% -23.7%1Source: Centers for Medicare & Medicaid Services (CMS)

As an additional challenge to these reimbursement reductions, insurers need to incorporate into theipremiums the impact of the ACA Industry Tax 2. This surcharge became effective in 2014 and willcontinue to increase through 2018, adding approximately 1% each year to premiums.

For the most part, the companies responses to these reductions have been a combination of reducedbenefits and/or higher premiums for seniors, which at some point would likely result in reducedmembership in these products. Additionally, some insurers have exited locations where they did notbelieve they could offer a viable and profitable product. Another tactic MA insurers are using to offsome of the reimbursement reductions is to limit provider choice in their plans. By using thesenarrow networks, similar to what weve seen in individual products offered on the ACA healthcaexchanges, insurers can negotiate deeper discounts from physicians and hospitals in exchange for thexpectation of additional patient volume. However, these more limited networks are not very popula

with seniors or regulators, especially when seniors have been under the care of one physician and would be required to change doctors if they remained in their MA plan.

Offsetting the reimbursement reductions, health insurers are eligible to have their MA rates enhanceby CMS quality bonuses based upon specified clinical and operational performance standardsmeasured through a star rating system. In 2015, quality bonus payments will be paid only to 4, 4.5,

1 Sequestration refers to federal spending cuts beginning in 2013 which were mandated by the Budget Control Act of 2011. As a result, MA plans were impacted with2% reduction to the Net Capitation Payment made by the federal government.

2 The Affordable Care Act imposes an annual fee on the health insurance industry of $8 billion in 2014. The fee increases annually to $14.3 billion in 2018 and is indeto premium growth rates thereafter. Each healthcare insurers portion of the fee is based on its market share of total insured premiums.

This publication does not announce

a credit rating action. For researchpublications that reference CreditRatings, please see the ratings tabon the issuer/entity page onwww.moodys.com for the mostupdated Credit Rating Actioninformation and rating history.
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and 5 star rated plans. For 2014, CMS reported that 3% of MA plans were rated 5 stars and 35% haratings of 4.5 or 4 stars. Approximately 58% of MA plans were rated 3 or 3.5 stars and receivedbonuses in 2014. But, unless these plans are able to increase their rating, they would no longer beeligible for bonuses in 2015.

However, if the reimbursement rates continue to be meaningfully reduced, we expect that MA plans would at some point lose their premium/benefit advantage over traditional Medicare plans. In fact, athe premium/benefit difference between the two plans becomes less significant, we believe the wideprovider choice available in the traditional Medicare plan could tip the scale in favor of thegovernment plan for seniors, dampening growth in Medicare Advantage. The Congressional BudgeOffice had a similar view in 2010, estimating that the MA changes incorporated in the ACA wouldresult in reduced benefits and lower enrollment in private plans3, estimating that enrollment in MAplans in 2019 would be 4.8 million lower than previously projected.

Medicare Advantage Exposures for the Five Large National Insurers

Humanas significant MA exposure an outlier

In the current environment, the challenge for insurers is to continue to provide MA products that areboth affordable and attractive to seniors, while still earning a favorable margin. For some insurers, tissue is more crucial, because MA represents a significant portion of their revenue and earnings proThe table below provides reported MA membership for the five largest health insurers along with thestimated proportion of their total revenue attributable to Medicare Advantage. We have estimatedthese percentages based on average premium rates charged to MA members.

EXHIBIT 2

Estimated Percentage of Medicare Advantage Revenue

Insurance Financial Strength (IFS)Rating and outlook

Medicare Advantage MembershipMarch 31, 2014

Estimated Percentage of RevenueAttributable to MedicareAdvantage

UnitedHealth Group A1, stable 2,985,000 25% to 30%

Humana A3, stable 2,808,400 70% to 75%

Aetna A2, stable 1,101,000 20% to 25%

WellPoint A2, stable 538,000 15% to 20%

Cigna A2, positive 458,000 20% to 25%

Source: CMS, Company Filings, and Moody's estimates

Given the limited data available, estimating the percentage of earnings attributable to MA is moredifficult. As expected, MA earnings have fluctuated from year to year because of medical utilizationtrends and other marketplace disruptions; therefore, using historical results can be misleading. In ouanalysis, we have used as our assumption the marketplace consensus that MA pre-tax earnings margare typically targeted in the 4% to 4.5% range. Applying this assumption to our estimated premiumranges, we have developed a 2014 projected range of target earnings for each company and theresulting estimated percentage of earnings expected to be attributable to Medicare Advantage.

3 Congressional Budget Office: Comparison of Projected Enrollment in Medicare Advantage Plans and Subsidies for Extra Benefits Not Covered by Medicare UnderCurrent Law and Under Reconciliation Legislation Combined with H.R. 3950 as Passed by Senate, 19 March 2010.


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EXHIBIT 3

Estimated Contribution Of Medicare Advantage Earnings

Projected Range of Annual Medicare AdvantagePre-tax Earnings ($ billions)

Estimated Percentage of Pre-tax EarningsAttributable to Medicare Advantage

UnitedHealth Group 1.2 - 1.3 15% to 25%

Humana 1.0 - 1.1 60% to 70%

Aetna 0.4 - 0.5 10% to 20%

WellPoint 0.4 - 0.5 10% to 20%

Cigna 0.2 - 0.3 10% to 20%

Although not insignificant, the earnings risk from MA exposure for UnitedHealth, Aetna, WellPoinand Cigna is manageable given these companies overall diversification. Humana, however, clearlysignificant risk exposure to Medicare Advantage, and the recent changes to the reimbursement rateshave a potentially greater impact on the companys financial results.

Medicare Advantage to Remain Viable, with Lower Margins and Slower Growth While we cannot project the long term durability of the MA product, which is very much subject tofederal fiscal policy and political debate, we believe that in the near term, the product is sustainablealthough it is unlikely that the pre-tax margin can be maintained in the 4% range.

Our rationale for the continued viability of the product, but with slowing growth, is based in part onthe historical growth in MA enrollment as shown in the table below despite the concurrentreimbursement cuts discussed above.

EXHIBIT 4

National Medicare Advantage Membership Growth by Year

Medicare Advantage Membershipbeginning of year Membership Growth Rate Compounded Growth Rate

2009 10,746,489

2010 11,373,044 5.8% 5.8%

2011 12,164,095 7.0% 13.2%

2012 13,315,182 9.5% 23.9%

2013 14,575,311 9.5% 35.6%

2014 15,917,380 9.2% 48.1%

Source: Centers for Medicare & Medicaid Services (CMS)

With CMS reporting MA enrollment of over 16 million seniors, or 30% of all Medicare beneficiarieas of 1 June 2014, the popularity of these plans continues to grow.

We believe there are two reasons for this significant historical growth: 1) the senior populationenrolled in these products tends to be sticky, and despite some erosion in benefits over time, manstill favor the MA value proposition over traditional Medicare (paying a fixed co-pay rather than avariable coinsurance amount) and 2) the senior population currently aging into Medicare is morefamiliar and accepting of the HMO/PPO network plan typically offered under Medicare AdvantageGiven the membership growth trend, the potential for enhanced reimbursements under the star bonu


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program, and the political clout of the 16 million seniors enrolled in Medicare Advantage, we believthe product still has some growth potential remaining.

Although we believe MA membership will continue to grow, but at a slower pace, insurers earning will likely be pressured in order for companies to retain existing membership and maintain thisgrowth. In addition, lower membership growth will eventually translate into an older and less healthpopulation, with relatively fewer younger, healthy lives enrolling, resulting in higher medical costs lower margins over time.

Credit Implications of a Less Robust Medicare Advantage Product: One ScenarioTo gauge the credit rating impact of a no-growth MA scenario with reduced margins, we modeled apotential no growth/reduced margin scenario and ran the results through Moodys InsuranceScorecard metrics for US Health Insurance Companies4 over a one-year and three-year time horizon.This exercise has obvious limitations in that these companies are dynamic and well-diversified, andexercise only measures the impact arising from negative developments in one segment of the compa

while holding everything else static. Because of insurers demonstrated ability to adapt to MA

reimbursement cuts and given the static nature of the scenario, we believe our scenario is fairlyconservative over a relatively short time horizon. However, the exercise does provide some insight the sensitivity of each companys credit profile to the MA segment.

We have made the following assumptions in our scenario:

MA net membership growth: 0% for each of the next three years

Annual MA pre-tax margin: 2.5% to 3.0%

As a starting point, we have used the 2014 earnings guidance provided by each company. We haveassumed the results from other product segments are in line with historical results and there was nochange in the companys capital or debt. Based on this scenario, the key metrics used in the ratingmethodology that are impacted are: Organic Membership Growth, Premium and EarningsConcentration, EBITDA Margin, Debt-to-EBITDA, and EBITDA Interest Coverage. The resultsdisplayed in the Appendix for each of the five health insurers we tested reflect the unadjusted rawscores obtained from applying the methodology to the metrics using the assumptions listed above, ado not reflect any analytical adjustments.

In summary, the analysis indicates that for all five health insurers, there is no significant creditdeterioration after one year. After three years, however, there is more significant downward pressurthe financial profiles of all five companies. Only for the two insurers with the largest MA exposure(i.e., UnitedHealth and Humana) is there also a negative credit impact on the business profile, as theno-growth scenario is a sharp departure from the historical growth each company has experienced ithis product.

From an overall credit perspective, only Humanas credit profile is negatively impacted, and onlyunder the three-year time horizon. This is a reflection of the higher exposure Humana has to thisproduct from both a revenue and income perspective. We would expect to take rating action if the Msegment showed signs of potential significant deterioration (e.g., the scenario modeled here) and thcompany did not take corrective action.

4 Moodys Rating Methodology for U.S. Health Insurance Companies, May 2011 (133040)
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As noted, this analysis does not reflect any change in strategy that these insurers might implement tfocus and grow their other business segments if the MA product came under the pressures tested in scenario. We note that all five companies have developed other strong business segments includingcommercial, Medicaid, and international.

The Appendix contains the Insurance Scorecard unadjusted results for each company, over both a oyear and three-year horizon.


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Appendix of Insurance Scorecard Results

Raw Scorecard Results Aetna

Scorecard2014

Guidance

Impact ofLower MA

results after1 year

Impact ofLower MA

results after3 years Comments

Business Profile

Market Position and Brand Mid A No change No change Although Aetna's Medicare Advantage business hbeen growing, Medicare Advantage membershiprepresents less than 5% of Aetna's total medicalmembership. As a result, the metrics and resultingscores for these two factors are relatively unchanged

Product Risk andConcentration

Weak Aa No change No change

Financial Profile

Capital Adequacy & Quality Weak A No change No change No changes in metrics for this factor

Profitability Strong A No change The lower score after 3 years reflects the impact oflower Medicare Advantage earnings. The impact,

however, is not significant enough to lower theoverall score for the factor. Since the methodologyuses 3 year average of EBITDA margins, the impact lower earnings is lessened in year 1.

Financial Flexibility Weak A While no change in level of debt is assumed, thelower earnings assumptions for Medicare Advantageimpacts both coverage and earnings leverage metricshowever, the impact for both time horizons is notsignificant enough to change the overall factor score

Composite Score

A2 No change No change Under both time horizons (1 year and 3 years)Aetna s Business Profile remains unchanged.However, due to the lower earnings marginassumed for the Medicare Advantage product,

there is some downward pressure on the FinancialProfile, but it is not significant enough to changethe overall credit score.

Key:

No change Score for factor virtually unchanged - no upward or downward pressure

or Some upward/downward pressure, but not significant enough to change score by one notch.

or Upward/Downward pressure to change by one notch

or More significant upward/downward pressure to change score or rating by more than one notch


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Raw Scorecard Results Cigna

Scorecard2014

Guidance

Impact ofLower MA

results after1 year

Impact ofLower MA


Business Profile

Market Position and Brand Strong A No change No change Although Cigna's Medicare Advantage business habeen growing, Medicare Advantage membershiprepresents less than 5% of Cigna's total medicalmembership. As a result the metrics and resultingscores for these two factors are relatively unchanged


Weak Aa No change No change

Financial Profile

Capital Adequacy & Quality Weak A No change No change No changes in metrics for this factor

Profitability Strong A No change The lower score after 3 years reflects the impact oflower Medicare Advantage earnings. However, due tthe strength and diversity of Cigna's other business,the impact is not significant enough to lower thefactor score. Since the methodology uses 3 yearaverage of EBITDA margins, the impact of lowerearnings is lessened in year one.

Financial Flexibility Strong Baa No change While no change in level of debt is assumed, thelower earnings assumptions for Medicare Advantageimpacts both coverage and earnings leverage metricsHowever, in the first year the impact is negligible aneven after year 3, the impact is not significantenough to change the overall factor score

Composite Score

A2 No change No change Under the no-growth, lower margin MedicareAdvantage scenario, Cigna s Business Profile andFinancial Profile remain unchanged after one yearHowever, due to the lower earnings marginassumed for the Medicare Advantage product,there is some downward pressure on the FinancialProfile after 3 years, but it is not significantenough to impact the overall credit score.

Key:






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Raw Scorecard Results - Humana

Scorecard2014

Guidance

Impact ofLower MA

results after1 year

Impact ofLower MA


Business Profile

Market Position and Brand Weak Aa The lower score reflects no growth assumption forMedicare Advantage membership vs. 13.2% CAGRMedicare Advantage membership growth over last 5 years


Strong Baa The improved score reflects a lower revenueconcentration in Medicare Advantage, providingHumana with a more diversified premiumdistribution

Financial Profile

Capital Adequacy & Quality Strong Baa No change No change No changes in the metrics for this factor

Profitability Mid-range A No change The score for this factor is impacted both positivelyand negatively based on the assumptions made.

Since Medicare Advantage growth is assumed to bezero, earnings become less concentrated in MedicareAdvantage improving the factor score; however, thelower margins assumed to be earned in MedicareAdvantage lower the factor score. In the first year thepositive and negative impact cancel each other outand the score remains unchanged. However, afterthree years the more heavily weighted EBITDA metrhas more impact on the overall factor score, resultingin downward pressure on the overall rating.

Financial Flexibility Strong A While no change in the level of debt is assumed, thelower earnings assumptions for Medicare Advantageimpact both the earnings coverage and earningsleverage metrics, lowering the score for this factor.Since the EBITDA coverage metric is a 3 yearweighted average, the impact is lessened in year onebut lowers the score by 1 notch after 3 years.

Composite Score

A3 After one year, even though there is downwardpressure on Humana s Business Profile as a resultof the no membership growth assumption, it ispartially offset by the improved revenuediversification. Overall, the impact in year 1 is nosignificant enough to change ratings. However, ifthis pattern persisted for three years, continuedpressure on the Business Profile from the nogrowth assumption combined with downwardpressure on Humana s Financial Profile as a resulof the assumed lower earnings margins, result indownward pressure on the overall credit rating of

one notch.Key:






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Raw Scorecard Results UnitedHealth

Scorecard2014

Guidance

Impact ofLower MA

results after1 year

Impact ofLower MA


Business Profile

Market Position and Brand Strong Aa No change The lower score after 3 years reflects the no growthassumption for Medicare Advantage membership vs.UnitedHealth's 10.8% CAGR Medicare Advantagemembership growth over the last 5 years. There is noimpact in the score after one year as a result ofUnitedHealth's strong diversification and themethodology employing a 3 year average for themembership growth metric.


Weak Aa No change No change Despite the no growth assumption for MedicareAdvantage, the change is not sufficient enough toalter the score for this factor as a result ofUnitedHealth's well diversified revenue streams.

Financial Profile

Capital Adequacy & Quality Strong Baa No change No change No changes in metrics for this factorProfitability Mid Aa No change As a result of UnitedHealth's strong earnings

diversity and profit margins, the lower earningsmargin assumed for Medicare Advantage only have aminimal impact to the factor score after 3 years

Financial Flexibility Strong A While no change in the level of debt is assumed, thelower earnings assumptions for Medicare Advantageimpact both the earnings coverage and earningsleverage metrics. However, due to UnitedHealth'soverall strong earnings and diversified earningsprofile, the impact to the factor score as a result oflower earnings in one business segment is minimal.

Composite Score

A1 No change

Despite some downward pressure on the FinanciaProfile score in the first year, the change is notsignificant enough to impact the overall score.After 3 years, however, the combined effect of nomembership growth and lower margins increasethe downward pressure on the overall score;however, the impact is less than a notch.

Key:






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Raw Scorecard Results WellPoint

Scorecard2014

Guidance

Impact ofLower MA

results after1 year

Impact ofLower MA


Business Profile

Market Position and Brand Weak Aa No change No change Although WellPoint's Medicare Advantage busineshas been growing, Medicare Advantage membershiprepresents less than 5% of WellPoint's total medicalmembership. As a result the metrics and resultingscores for these two factors are relatively unchanged


Strong A No change No change

Financial Profile

Capital Adequacy & Quality Strong Baa No change No change No changes in metrics for this factor

Profitability Mid A No change The lower score after 3 years reflects the impact oflower Medicare Advantage earnings. However, due tthe strength and diversity of WellPoint's otherbusiness, the impact is not significant enough tolower the factor score. Since the methodology uses 3 year average of EBITDA margins, the impact of lowearnings is lessened in year one.

Financial Flexibility Mid Baa No change While no change in level of debt is assumed, thelower earnings assumptions for Medicare Advantageimpacts both coverage and earnings leverage metricsHowever, in the first year the impact is negligible aneven after year 3, the impact is not significantenough to change the overall factor score

Composite Score

A2 No change No change Under both time horizons (1 year and 3 years)WellPoint s Business Profile and Financial Profilescores remain relatively unchanged While there isome downward pressure on the Financial Profileafter 3 years due to the lower earnings marginassumed for the Medicare Advantage product, the

impact is not significant enough to change theoverall credit score.

Key:






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Moodys Related Research

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Highmark-WPAHS Affiliation Is Negative for Highmark, Positive for WPAHS, May 2013(153613)

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13/14

INSURANCE


KEY INDICATORS

Aetna Inc.($ millions) 2013 2012 2011Revenue 47,295 36,600 33,782Net income 1,914 1,658 1,986Total Equity 14,078 10,429 10,120

Cigna Corporation($ millions) 2013 2012 2011Revenue 32,380 29,119 21,865Net income 1,476 1,623 1,260Total Equity 10,677 9,883 7,994

Humana Inc.($ millions) 2013 2012 2011Revenue 41,313 39,126 36,832Net income 1,231 1,222 1,419Total Equity 9,316 8,847 8,063

UnitedHealth Group Inc.($ millions) 2013 2012 2011Revenue 122,489 110,618 101,862Net income 5,625 5,526 5,142

Total Equity 33,324 33,299 28,292

WellPoint, Inc.($ millions) 2013 2012 2011Revenue 71,024 61,497 60,711Net income 2,490 2,656 2,647Total Equity 24,765 23,803 23,288

Source: Company reports (form 10-K filings).


14/14

INSURANCE

Report Number: 173285

AuthorsStephen ZaharukEllen Fagin

Production SpecialistShubhra Bhatnagar

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