AM Best, including the revision of the Insurance Fund Ratings Public Data

A.M. Best Co. recently completed its annual review of public data (pd) financial strength ratings (FSRs) for health maintenance organizations (HMOs). A.M. Best has upgraded the FSRs of 21 HMOs, downgraded 19 HMO FSRs, affirmed 107 HMO FSRs and assigned seven HMO FSRs.

The companies’ Best’s public data (pd) ratings reflect a quantitative analysis of each company’s results based on publicly available financial information. This quantitative analysis includes a review of important tests in three categories: balance sheet strength, operating performance and business profile. Best’s pd ratings do not include analysis based on interaction with insurance company management or non-public financial information.

Over the past year, pd rated HMOs had approximately the same number of downgrades as upgrades. The majority of the companies are single state HMOs, which include Medicaid and Medicare insurers, as well as Delta Dental Plans and Blue Cross Blue Shield Plans. Although the overall health insurance market continues to exhibit continued profitability and improved risk-adjusted capitalization, a number of pd rated HMOs were downgraded.

The pd rated HMO downgrades were due to weak risk-adjusted capitalization, unfavorable operating performance, higher than average asset allocation to equities, negative operating cash flows and product concentration, particularly in Medicare and Medicaid products. In a number of regional markets, local health plans experienced significant competitive pressures from Blue Cross Blue Shield (BCBS) plans and strong regional and national health insurance companies. Unfavorable operating performance was primarily driven by poor results in the commercial line of business. In many cases, the medical loss ratio had spiked 100-basis points or higher to the high 80s or low 90s. Furthermore, due to today’s capital market instability, extra scrutiny was placed on the balance sheet, specifically investment exposures.

While many of the smaller local HMOs generally have conservative investment portfolios comprised mostly of investment grade government securities, there were some that did have some indirect subprime mortgage exposure. In addition, the current market volatility in conjunction with higher than average asset allocation of stocks and non-investment grade bonds resulted in a higher asset risk-based capital charge, which weaken a HMOs’ capital position. However, favorable changes to both Medicare and Medicaid reimbursements have resulted in significant revenue growth for some and concentration risks for a number of local HMOs. This concentration in either Medicare or Medicaid has hindered HMOs’ ability to remain flexible in a market where reimbursements are driven by federal or state governments.

The pd rating upgrades were primarily driven by a combination of considerable capital and surplus growth, return of revenues of approximately 5.0% or higher, continuation of improving operating results and a medical loss ratio in the mid-80s. The combination of lower medical costs and sustained underwriting gains demonstrated pricing discipline and strict underwriting guidelines. This enabled the healthcare organizations to report improvement in their risk-based capitalization.

The pd rating affirmations were a result of favorable performance without operations and risk-adjusted capitalization levels that deviated from outside the norms for current rating levels.

A.M. Best expects that the sustainability of future earnings for any health plans will be challenged by a number of factors. These include the increasing competition from national and regional health insurance companies, continuation of moderating medical trends, investment exposure, constraints on capital raising efforts and reliance on either Medicare or Medicaid for growth.