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Jan 15 - Fitch Ratings has affirmed the 'BB' rating on Health Net Inc.'s (Health Net) senior unsecured notes, 'BB+' Issuer Default Rating (IDR) and the 'BBB' Insurer Financial Strength (IFS) rating on Health Net's operating subsidiaries. The Rating Outlook is Stable. A complete list of ratings is shown at the end of this commentary. Health Net's ratings continue to reflect the company's overall 'small' market position and size/scale features. Specifically, Health Net is concentrated in California with less geographic diversification and size and scale benefits compared to higher rated peers. The ratings also reflect capitalization metrics that are generally consistent with Fitch's median rating category guidelines for the company's current ratings balanced against a history of uneven operating results. Health Net targets an NAIC risk-based capital (RBC) ratio of 200% of the company action level (CAL) for its underwriting subsidiaries, which is consistent with Fitch's median guidelines for the current rating category but below higher rated peers. Both financial leverage and operating leverage were better than median guidelines for the company's current ratings. Health Net's debt-to-total capital ratio was 25% at Sept. 30, 2012, excluding unrealized bond gains from stockholders' equity, compared to a median guideline of 35% for the rating category. In addition, operating leverage, measured by the ratio of health care premiums to stockholders' equity, was 6.7x compared to a median guideline of 9.0x for the rating category. Health Net reported an elevated ratio of debt-to-EBITDA at 5.3x due to poor operating results through the first nine months of 2012. This ratio was 2.1x at year-end 2011 and is expected to approach 3.0x in 2013 which would be consistent with Fitch's guidelines for the current rating category. Substantially all of Health Net's $116 million in net income for the first nine months of 2012 came from the $117 million gain on sale of its Medicare stand-alone prescription drug plan in April 2012 and from $30 million in realized investment gains. During the fourth quarter of 2012, Health Net and the state of California's Department of Health Care Services (DHCS) entered into a comprehensive agreement covering Health Net's state-sponsored programs. The agreement is expected to reduce earnings volatility by establishing mutually agreed upon margin targets for state-sponsored business and working to improve the process for settling rate disputes. Health Net's EBITDA covered interest expense by 1.7x through the first three quarters of 2012, which is down significantly from 6.5x in 2011. Health Net's run-rate interest coverage is expected to improve beyond 3x to be consistent with Fitch's guideline for the current rating category. KEY RATING DRIVERS Key ratings triggers that could lead to an upgrade for Health Net include: --Solid earnings with less volatility; --Significant capital strengthening with Risk-Based Capital (RBC) sustained above 250% Company Action Level (CAL); --Improved run-rate profitability measured by EBITDA margin; --Profitable geographic diversification and expansion of the company's premium and membership base. Key ratings triggers that could lead to a downgrade for Health Net include: --Unforeseen operational issues that cause Fitch to question the company's risk management practices; --Material loss of commercial membership beyond management's 2013 guidance; --A substantial regulatory fine or litigation charge; --A significant decline in stockholders' equity or increase in financial leverage above 30%. Fitch has affirmed the following ratings with a Stable Rating Outlook: Health Net Inc. --Long-term IDR at 'BB+'; --6.375% senior notes due June 2017 at 'BB'. Health Net Of California, Inc. Health Net of Arizona, Inc. Health Net Plan of Oregon, Inc. --IFS at 'BBB'.