U.S. Health Insurers: A Cloudy Prognosis

S&P Ratings expects that a weak economy and uncertainties surrounding health-care reform will lead to more downgrades

By Joseph Marinucci and Robert McNatt

Standard & Poor's Ratings Services is maintaining its negative outlook on the U.S. health insurance sector due to the deteriorating economy of the past year and the uncertainty regarding the state of health-care reform. The ongoing recession is generating high unemployment in the private sector and is putting pressure on earnings at many health insurers. In addition, we believe that competitive conditions will likely add to heath insurers' difficulties in the near term.

Our outlook on the health insurance sector is now influenced less by specific company or industry financial metrics and more by dour economic conditions, an intensified competitive landscape, and the state of industry reform. As a result, we continue to expect that downgrades will exceed upgrades over the next six to 12 months.

National health-care reform remains a wild card, with serious discussions in Washington this year, but the outcome is far from clear. We could revise our outlook to stable if legislative reform doesn't marginalize the industry—and if the economy doesn't deteriorate further than we anticipate. Until the particulars of any reform become clear, the near-term cause of negative rating actions will likely be the state of the economy. Further deterioration in the economy would pressure our expectation for a more stable set of financial metrics. Overall, those metrics now reflect performance below the most recent three-year historical trend.

Increase in Speculative Category

We can see the effects of the recession and operating performance pressure reflected in both the rating outlook distribution and in the actions taken in the last half of 2008 and the first quarter of 2009. Although we've downgraded only one issuer so far this year, the trend has been decidedly negative, as reflected by the ratio of downgrades to upgrades in 2008. In particular, there was significant unfavorable rating action development in the back end of last year, which is when we revised our industry outlook to negative.

The tough economic times partly contribute to the increase of speculative-grade companies. Although the majority of the 35 insurers we rate remain in the A category, the share of insurers in the BBB category has decreased to 23% from 30% three years ago, while the share of speculative-grade issuers has increased to 23% from 13%. The growth in the speculative category has been a function of downgrades from the BBB category as well as new ratings for companies with niche market profiles and riskier balance sheet fundamentals.

Better news, however, is that we've seen a very modest rise in higher-rated companies since 2006. At that time, no health insurers were rated in the AA category or higher. Today, one company falls into this rating category, Health Care Service Corp. (AA-), which conducts business as Blue Cross Blue Shield of Illinois, Oklahoma, New Mexico, and Texas.