Fitch Ratings has affirmed the 'A' (Strong) Insurer Financial Strength (IFS) ratings assigned to various Humana Inc. (HUM) insurance company subsidiaries.

In addition, Fitch has affirmed HUM's 'BBB+' Long-Term Issuer Default Rating (IDR) and the 'BBB' ratings assigned to HUM's senior notes. The Rating Outlook on the company's IFS ratings is Stable. The Rating Outlook on the company's IDR has been revised to Negative from Stable.

The Outlook Revision on HUM's IDR reflects the recent increase in financial leverage, as measured by both its financial leverage ratio and by debt/EBITDA. While Fitch expects the company's financial leverage ratio to move closer to expectations incorporated in its current IDR over the next twelve months, the company's debt/EBITDA is expected to remain significantly above expectations through 2024. This is due to continued pressure on operating earnings, driven by elevated utilization in the senior market on which HUM focuses.

While a meaningful improvement in the company's financial leverage metrics over the next 12-18 months will likely result in an Outlook revision for the IDR to Stable, a lack of meaningful improvement may result in a downgrade of the IDR and the ratings on the company's senior unsecured debt. Further, continued negative trend in earnings performance may also pressure HUM's IFS ratings.

Key Rating Drivers

Company Profile: Fitch considers HUM's company profile to be favorable and a heavily weighted factor in its ratings. The company's business profile reflects a favorable competitive position, primarily in the Medicare Advantage (MA) market, large operating scale, and favorable geographic diversification and business risk profile. HUM's profile also reflects Fitch's view that the MA business is more influenced by U.S. government intervention and typically generates moderately lower EBITDA-based margins than commercial business.

Financial Performance and Earnings: Fitch considers HUM's financial performance and earnings, which is a heavily weighted factor in its ratings, to be historically strong, reflecting consistent mid-single-digit operating EBITDA/revenue margins. However, reported earnings over the past five years exhibited a gradual, modest decline in margins and moderate volatility, due to nonrecurring items and varying utilization partially associated with the pandemic.

Like many of its peers, HUM's 2023 operating performance within its Medicare Advantage business was weakened by elevated utilization in the senior population. Since the vast majority of HUM's underwritten enrollment is comprised of Medicare Advantage members, the impact on its consolidated operating performance is more pronounced relative to its large peers.

Management forecasts a significant reduction in operating earnings in 2024 driven by a higher expectation for utilization than the level used in assumptions incorporated in 2024 bids. However, performance is expected to improve moderately in 2025 as benefits and pricing for the year will incorporate expectations for the elevated utilization.

Capitalization and Leverage: HUM maintains adequate capitalization and leverage, which is a moderately weighted factor in its ratings. Financial leverage increased significantly following the company's August 2021 acquisition of the remaining 60% of Kindred at Home it did not own. Following the sale of a 60% interest in the hospice business of Kindred at Home to a third party in August 2022, HUM's financial leverage improved, but remains moderately above the run-rate levels maintained prior to 3Q21.

While HUM's financial leverage ratio (FLR) was within Fitch's expectations of 40% or below at YE 2023, the issuance of $2.25 billion of senior notes in March 2024 resulted in an FLR of approximately 43% at March 31, 2024. Additionally, although the company's debt/EBITDA ratio was only slightly above Fitch's expectations in 2023, margin pressure in 2024 is expected to result in debt/EBITDA near 3.0x. In terms of operating company capitalization, Fitch anticipates that the company's combined risk-based capital (RBC) ratio will be managed at 200%-225% in the longer term.

Debt Service and Financial Flexibility: HUM's debt service capabilities and financial flexibility, which are moderately weighted factors in its ratings, are strong, but are also pressured by recent operating performance. Fitch expects near-term operating EBITDA/interest expense ratios to remain between 7x and 9x, rising above 11x on a run-rate basis. Financial flexibility is maintained through strong cash flow from subsidiaries, $4.0 billion of credit facilities, and proven debt and equity market access under typical market conditions.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

Sustained EBITDA-based margin above 7%;

A reduction in targeted and run-rate financial leverage ratio (FLR) to 25%-30%; and

An increase in targeted and run-rate, organization-wide RBC ratio above 250% of the company action level.

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

Sustained EBITDA-based margin below 4%;

A reduction in targeted or sustained organization-wide RBC ratio below 200% of the company action level;

An increase in targeted or sustained financial leverage ratio above 43% and debt-to-EBITDA ratio above 2.8x.

Acquisitions that add meaningful integration risk.

Factors that Could, Individually or Collectively, Lead to a Stable Outlook on Holding Company IDR:

A return of financial leverage ratio below 40% and material improvement of debt/EBITDA ratio toward 2.3x.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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