Fitch Affirms Kaiser Permanente (CA) Revs at ‘A+/F1’

Fitch Ratings has affirmed the ‘A+’ long-term rating on approximately $7.5 billion of revenue bonds issued by or on behalf of Kaiser Permanente (Kaiser) through the following conduit issuers:

–California Statewide Communities Development Authority;

–California Health Facilities Financing Authority;

–Maryland Health & Higher Educational Facilities Authority.

Further, Fitch affirms the ‘F1’ short-term rating on approximately $1.4 billion of tax exempt variable rate bonds, $1.55 billion of tax exempt bonds in a commercial paper (CP) mode and the $1.5 billion Kaiser Foundation Hospitals taxable commercial paper program. The ‘F1’ short-term rating is based on Kaiser’s self liquidity.

The Rating Outlook is Stable.

SECURITY

Debt service is unsecured general obligation of the Credit Group which is composed of the Kaiser Foundation Hospitals, Kaiser Foundation Health Plan, Inc., Kaiser Hospital Asset Management and Kaiser Health Plan Asset Management, Inc.

KEY RATING DRIVERS

UNIQUE BUSINESS MODEL: Kaiser’s vertically integrated, closed health maintenance organization (HMO) with a network of owned hospitals is unique among the health care and health insurance and managed care companies rated by Fitch. Combined with its exclusive contract with the Kaiser Permanente Medical Groups, Fitch believes that Kaiser’s fully integrated delivery model allows the company a higher level of control over its pricing and cost structure relative to Fitch’s other rated hospitals and health insurance companies.

LEADING MARKET POSITION, SIGNIFICANT SCALE: Based on premium revenues, Kaiser maintains the largest market share in the large and important California health insurance and managed care market. Using other metrics such as revenues, capital, and annual earnings as benchmarks, Kaiser is the largest not for profit health care system in the country and is among the largest health insurance and managed care organizations in Fitch’s rating universe.

STRONG FINANCIAL PROFILE: Certain of Kaiser’s liquidity and capital related ratios are among the strongest among all of Fitch’s rated not-for-profit hospital and health care systems. Further, historical profitability has been steady with operating and operating EBITDA margins at or above 3.1% and 6.8%, respectively, in each of the last three years.

SIZABLE PENSION LIABILITY: Kaiser’s pension and post retirement liabilities increased to $19.6 billion at Dec. 31, 2014 from $14.2 billion at the prior year-end due largely to a reduction in the discount rate assumptions. While Kaiser funds its pension plan above ERISA requirements, Fitch believes Kaiser’s pension obligations are significant and could depress the company’s liquidity and profitability in a sustained low interest rate environment.

CONCENTRATION IN CALIFORNIA: With 77% of revenues and 78% of membership generated in California, Kaiser’s results are heavily influenced by changes in the economic, political, regulatory and competitive environment in the State of California which presents an elevated risk profile relative to its managed care peer group.

MULTIPLE RATING CRITERIA USED: Recognizing Kaiser’s unique business model, Fitch’s ratings on Kaiser incorporates aspects from Fitch’s nonprofit hospital and U.S health insurance and managed care criteria.

RATING SENSITIVITIES

MEMBERSHIP GROWTH AND IMPROVED FINANCIAL PROFILE: Fitch believes Kaiser’s vertically integrated, fully aligned HMO model positions the organization well in a reduced reimbursement environment. Upward movement in the ratings could occur if there is measured and profitable growth in membership in markets outside of California; further improvement in liquidity and leverage and meaningful reductions in the underfunded status of the organization’s pension plans.

CREDIT PROFILE

Kaiser Foundation Health Plan, Inc. and Kaiser Foundation Hospitals are not for profit corporations operating primarily as health maintenance organizations. On a combined basis, Kaiser’s total revenues in fiscal year 2014 (Dec. 31 year end; audited) were approximately $56.4 billion.

UNIQUE BUSINESS MODEL

Fitch considers Kaiser Permanente a unique vertically integrated health-care delivery network that is composed of the Kaiser Foundation Health Plan (KFHP), owned hospitals and outpatient facilities that staffed by physicians who contract exclusively with KFHP. In total Kaiser operates 38 hospitals and 618 outpatient facilities staffed by over 17,000 Permanente Medical Group physicians. The fully integrated model provides a high degree of control in managing medical costs and given its business model, Fitch believes Kaiser will have continued success in a post healthcare reform environment.

LARGE SCALE IN CALIFORNIA

Fitch views the Kaiser Permanente business model as a key contributor to KFHP’s leading market share and strong competitive position in the large California health insurance market. While KFHP maintains large market shares in Colorado, Hawaii, and Oregon and smaller, but generally meaningful, market share in seven other states, 78% of its 9.6 million members are located in California. Relative to its insurance peer group, Fitch views Kaiser Permanente’s higher single-state concentration as a negative factor due to the company’s corresponding significant exposure to the economic and political environments in California.

STRONG FINANCIAL PROFILE

In 2014, Kaiser generated operating income of $1.97 billion on total revenues of $56.4 billion (operating and operating EBITDA margins of 3.5% and 7.4%, respectively) as compared to operating income of $1.65 billion on total revenues of $53.1 billion (operating and operating EBITDA margins of 3.1% and 6.8%, respectively) in the prior year. The improved operating results reflect strong membership growth of approximately 5.6% (513,000 members) combined with effective cost management.

Relative to Fitch’s hospital medians, Kaiser’s liquidity and capital related indicators are very strong compared to Fitch’s not for profit hospitals universe. However, due to Kaiser’s insurance operations and attendant actuarial risks, a higher rating is precluded at this time. Unrestricted cash and investments at Dec 31, 2014 increased almost 11% to $32.8 billion from $29.2 billion at the prior year end. Liquidity metrics remained strong with 227.9 days cash on hand (DCOH) and cash-to-debt of 471.4% as compared to Fitch’s nonprofit hospital 2014 ‘A’ category medians of 199.2 DCOH and 131.2% cash-to-debt ratio. Cushion ratio using average annual debt service (see below) equates to a very strong 103.9x at Dec. 31, 2014.

Kaiser has been able to fund a high level of capital investment while maintaining a strong balance sheet. Consistent cash flow generation has allowed the company to fund its sizable capital plan which includes seismic hospital replacements and upgrades, new hospital construction and investment in clinical information technology. Since 2010, investment in property, plant and equipment has ranged between $2.7 billion and $3.5 billion annually; averaging 178.5% of depreciation expense over five years. Kaiser’s very high level of capital investment spending reflects, in part, the company’s investment required to bring its facilities in compliance with California’s Hospital Seismic Safety Act of 1983 (Senate bills 1953 and 1664). At the end of 2014, all of Kaiser’s California hospitals are seismically compliant which is viewed positively by Fitch. Kaiser’s high level of capital spending also reflects the organization’s commitment to and investment in its electronic health record (EHR) and platform. Of the 200 hospitals that have achieved HIMSS Stage 7 certification nationwide, 37 are Kaiser hospitals.

Fitch believes Kaiser’s EHR and IT platform will allow it to improve efficiency, better leverage its existing human and physical assets, improve clinical outcomes and improve patient satisfaction.

Kaiser’s debt and leverage metrics are light relative Fitch’s hospital and health system rated entities. Because Kaiser utilizes non-amortizing bullet maturities in its capital structure, the aggregate debt service structure is not level. Maximum annual debt service (MADS) of $1.66 billion occurs in 2042. Fitch views the 10 year average annual debt service (AADS) from 2015-2024 of approximately $315.3 million as a more accurate measure of debt burden as large bullet maturities are expected to be refinanced prior to maturity. AADS equates to a very light 0.6% of Kaiser’s 2014 total revenues. Coverage of MADS by EBITDA was an adequate 3.2x in 2014. However, AADS coverage by EBITDA was a robust 16.7x and 14.7x in 2014 and 2013, respectively, which well exceeds the ‘A’ category median of 3.8x.

SIZABLE PENSION/POST-RETIREMENT LIABILITIES

At FYE 2014, Kaiser’s pension and post retirement liabilities totaled $19.6 billion which is increase from $14.2 billion at the prior year-end and reflects the impact of a 90-95 basis point decline in the discount rate used to calculate projected benefit and accumulated postretirement benefits. Under the defined benefit pension plan the fair value of plan assets at Dec 31, 2014 was $9.37 billion, which represents a weak 42% of Kaiser’s projected benefit obligation (PBO) and 55% of accumulated benefit obligation (ABO). In 2014, Kaiser made pension contributions totaling $1.08 billion (compared to a $985 million contribution in 2013) while the plan paid approximately $838 million in benefits. Additionally, the unfunded status for postretirement health care and life insurance increased to $6.8 billion from $5.5 billion in 2013 due largely to a decrease in the discount rate. While Fitch acknowledges that pension and post retirement liabilities are a conditional liability that is highly sensitive to changing regulatory, interest rate and actuarial assumptions, Kaiser’s pension obligations are significant and could depress the company’s liquidity and profitability in a sustained low interest rate environment. Kaiser anticipates pension funding of $1 billion in fiscal 2015 and funding has been maintained above ERISA requirements.

SHORT TERM RATING

Kaiser’s short-term ‘F1’ rating is supported by the liquid position of its investment portfolio. At Jan 31, 2015, Kaiser had approximately $2.9 billion of tax exempt bonds in a variable demand or commercial paper (CP) mode that are supported by self-liquidity. Kaiser has a taxable CP program authorized for up to $1.5 billion of which $653 million was outstanding at Jan 31. Kaiser had more than $7.8 billion of “eligible assets” (including a $1.5 billion bank line of credit) at Jan 31, 2014 which would cover Kaiser’s outstanding self-liquidity obligations in excess of 1.25x as required under Fitch’s US Public Finance Short Term Debt rating criteria. Kaiser’s $1.5 billion line of credit expires in Aug 2016 and is supported by a consortium of banks.

DISCLOSURE

Kaiser covenants to provide audited financial statements to bondholders within six months of the close of each fiscal year, as well as quarterly unaudited financial statements no later than 60 days after each quarter. Disclosure to Fitch to date has been excellent and includes quarterly earnings calls and subsequent distribution of detailed financial statements. Kaiser also provides a quarterly earnings press release detailing the quarterly performance.

Fitch currently has an IFS rating of ‘A+’ on the following:

–Kaiser Foundation Health Plan, Inc.;

–Kaiser Foundation Health Plan of the Northwest;

–Kaiser Foundation Health Plan of Georgia, Inc.;

–Kaiser Foundation Health Plan of the Mid-Atlantic States, Inc.;

–Kaiser Foundation Health Plan of Colorado;

–Kaiser Permanente Insurance Company.

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

Applicable Criteria and Related Research:

–‘Revenue-Supported Rating Criteria’ (June 16, 2014);

–‘Insurance Rating Methodology’ (Sept. 4, 2014);

–‘Nonprofit Hospital and Health System Rating Criteria’ (May 30, 2014);

–‘Rating U.S. Public Finance Short Term Debt, (Jan. 7, 2015).

Applicable Criteria and Related Research:

Revenue-Supported Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=750012

Insurance Rating Methodology

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=756650

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=981535