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Fitch Maintains Health Net on Rating Watch Evolving Following Medicare Announcement

Fitch's action follows Friday's announcement from the Centers for Medicare & Medicaid Services (CMS) indicating that the company was required to suspend marketing and enrolling new beneficiaries into their prescription drug and Medicare Advantage plans.

Fitch views the magnitude of the CMS sanction's adverse impact on Health Net as uncertain. The announcement comes during the open enrollment period which Fitch believes may heighten sensitivity to renewing existing members. At this time it is unclear how this announcement will affect the company's Medicare membership and earnings for 2011. It is also unclear whether Health Net will incur any fines or penalties as a result of the announcement.

Fitch notes that outside CMS sanctions, Health Net's credit fundamentals have improved in recent quarters. Positive developments include favorable earnings momentum, debt reductions, and perhaps most significantly, in Fitch's view, the renewal of the company's TRICARE contract for the north region.

As of year-end 2009, Health Net's TRICARE membership was 3 million and pre tax earnings were $165 million. Retention of the contract helps Health Net keep roughly half its total membership and a significant source of its earnings. New features of the contract imply the earnings will be somewhat lower than in previous years as it moves from a partially underwritten product to a more administrative services only (ASO) type of arrangement.

Fitch lowered Health Net's ratings on July 14, 2009 on the announced loss of the TRICARE contract. Upon the successful appeal and announced retention of the contract on May 6, 2010, Fitch placed the ratings on ratings watch 'evolving' with the expectation that the ratings would like be higher pending review of the new contract. The ratings watch also considers the potential for the ratings to be further lowered due to new guidelines anticipated as part of the Patient Protection and Affordable Care Act (PPACA). Fitch is waiting to review the anticipated affect of the CMS announcement before taking any rating action.

Fitch recognizes Health Net's improving financial fundamentals. YTD 2010 earnings are significantly improved over 2009 results. The company reported pre-tax earnings of $207 million through Sept. 30, 2010 versus $9 million for the same period in 2009. The increase is attributed to administrative cost restructuring, better than expected utilization, and the positive effects from prior period reserve development.

In addition, some proceeds received as part of the sale of the company's Northeast operation to United Health Group in December 2009 were used to pay down the company's amortizing bank note. As a result, the company's financial leverage declined from 26% as of YE 2009 to 23% as of Sept. 30, 2010 with expectations that it will decline further by year end 2010. Cashflow based financial leverage also improved. Debt to EBITDA improved from 8.8 times (x) as of YE 2009 to 1.4x as of Sept. 30, 2010. Similarly, interest coverage improved from 0.4x in 2009 to 8.7x in the nine months ended Sept. 30, 2010.

Fitch's view on Health Net also considers operating company capitalization that is lower than most of its health insurance sector peers and earnings volatility stemming from significant one-time charges. The ratings also consider modest enrollment gains in the California commercial market in the third quarter of 2010 following multiple quarters of material enrollment losses, as well as Health Net's increased geographic concentration in the California market, and its high proportion of underwritten commercial business relative to its peers.

Fitch maintains the following ratings on Rating Watch Evolving:

Health Net Inc
--Long-term IDR 'BB-';
--6.375% senior notes due June 2017 'B+'.

Health Net Of California, Inc
Health Net of Arizona, Inc
Health Net Plan of Oregon, Inc
--IFS 'BBB-'.

Additional information is available www.fitchratings.com.

Related Research:
--'Insurance Rating Methodology' (Aug. 13, 2010);
--'Fitch's Approach to Rating Insurance Groups' (March 24, 2010);
--'U.S. Health Insurance and Managed Care Rating Methodology' (March 24, 2010).

Applicable Criteria and Related Research:
Fitch's Approach to Rating Insurance Groups
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=506368
U.S. Health Insurance and Managed Care Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=506365
Insurance Rating Methodology
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=547766

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Fitch Ratings
Manish Patel, +1-312-368-3188
Associate Director
Fitch, Inc.
70 West Madison St.
Chicago, IL 60602
or
Bradley S. Ellis, CFA, +1-312-368-2089
Director
or
Douglas L. Meyer, CFA, +1-312-368-2061
Managing Director
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Media Relations:
Brian Bertsch, +1-212-908-0549 (New York)
brian.bertsch@fitchratings.com