No, Moody's Did Not Downgrade The Health Insurance Sector, But Yes ...

This week Moody's changed its outlook to 'negative' from 'stable' for the health insurance industry, and that's triggered a raft of inaccurate headlines blaring that Moody's 'downgraded' the sector. This also triggered backlash from some on the right who worry this will be politicized by the Obama administration in light of rival rating agency Standard & Poor's allegation that it's being sued by the Justice Department as retribution for downgrading U.S. sovereign debt.

Washington Post columnist Charles Krauthammer, a favorite political writer of mine, wondered whether Moody's would be punished for going negative on health insurance due to rocky rollout of Obama's signature endeavor, the Affordable Care Act (ACA). Yet these scenarios involving two rating agencies are very different, and they beg some analysis to set the record straight. Moody's outlook change was far less impactful than a sovereign debt rating change because it technically did not affect any specific health insurance company and was a comment on the operating environment for some companies in a sub-sector of an industry that's a fraction of the GDP.

In full disclosure, I worked for Moody's as a bond analyst in the not-for-profit hospital sector, and I occasionally collaborated on healthcare projects with Stephen Zaharuk, a senior vice president and the lead author of Moody's health insurance outlook change. I also concede that political retaliation is not out of the realm of possibility given the Internal Revenue Service's harassment of Tea Party Groups that didn't toe a leftist line.

In its new report, Moody's says a driving trigger for the health insurance outlook change was what the agency calls an 'unstable and evolving regulatory environment' characterized by 'ad hoc changes' that disrupted planning about the Affordable Care Act 'well after product and pricing decisions had been finalized.' This uncertain operating environment factored into Moody's lowering its expected earnings by the health insurance industry this year to a net margin of 2 percent from 3 percent.

Unfortunately, the Obama administration delayed many Obamacare regulations until after the 2012 elections so they couldn't be discussed during the campaign. This is troubling because it played politics with serious policy and compressed the time that health industry leaders could manage these enormous changes.

Moody's Ratings 101

Headlines describing Moody's action as a 'downgrade' are inaccurate because it's not a rating action. Moody's has a very specific vocabulary for what it means to 'downgrade' or 'upgrade' something, and that applies only to a specific series of debt or preferred stock that has been issued by a specific organization (for example, the Aa1 rating for Apple 's obligations).

On Wednesday, Moody's changed what it calls an Industry Outlook, or a 'forward-looking assessment of fundamental credit conditions that will affect the creditworthiness of the US health insurance sector over the next 12-18 months.' This isn't the first time in recent history that Moody's has gone negative from stable on health insurance; this happened in October 2008 (before Obama's election) and remained there until January 2012, when it was changed back to stable.

Moody's rates 14 specific insurance companies with a combined market share (by U.S. membership) of approximately 60 percent. This Moody's chart below shows that 86% of those companies-all but two-are above investment grade, which means they are fundamentally creditworthy enough to not be viewed as 'speculative' or in colloquial terms, 'junk bonds.' In short, most of these guys are doing just fine, for now, and none of them were downgraded this week.

Since nobody's got a crystal ball, the credit rating agency can't say for sure whether analysts expect to downgrade or upgrade more health insurance companies in 2014, but Zaharuk told me, 'the negative outlook suggests that negative rating actions are more likely on average.' However, Zaharuk also said Moody's believes not all insurers will weather these ACA changes equally, with the most geographically and strategically diversified companies faring better.

'I think you can infer from the actions taken by several large national insurers, that decided to limit their participation on the exchanges, that they were not confident about the financial outcome of the exchange business for their companies,' Zaharuk said. 'The open enrollment period has a few months to go, and if the results at that point are below expectations, the administration will likely look for solutions or changes to improve enrollment for future years.'

Moody's=Apples/S&P=Oranges

Since changing an industry outlook does not equate to downgrading a specific entity, we can turn to the S&P case, which involves a 2011 one-notch downgrade of a specific issuer, the U.S. government, to AA+ from AAA. Fast forward to 2013, when S&P got hit with a lawsuit by Justice alleging the company defrauded banks by placing high ratings on mortgage-backed securities. This month S&P swatted back and accused then-Treasury Secretary Timothy Geithner of threatening the agency just before the downgrade.

Moody's and S&P, as well as smaller competitor Fitch, release both industry outlooks and issue specific ratings. Neither Moody's nor Fitch downgraded the United States' rating, though making things a bit more confusing is Fitch's 'negative' outlook on that AAA while Moody's has the Aaa at 'stable.'

So in general, what happened this week is a fairly small change in terms of how Moody's officially views healthcare, yet other industry outlook changes for sectors within the broader healthcare marketplace could happen, too. This Moody's chart below is from earlier this month (prior to the 'negative' on health insurance) and shows most other lines of business within healthcare are deemed, 'stable.'

Generally speaking, industry outlooks are less fluid than specific ratings. Specific rating changes can happen rapidly, for say, M&A or some catastrophic event. Moody's practice is to review the outlook at least annually, however, if there is a significant change in any of the key factors impacting a sector they can change anytime. In the age of Obamacare, these industry outlooks may prove to be even more fluid.

'Clearly, as a result of the Affordable Care Act, there have been significant changes in the operating environment for health insurers over the last few years,' Zaharuk said. 'We expect the next few years to bring more challenges and as a result the sector could be more volatile.'

Let's hope that the Obama administration has better things to do than harangue a credit agency like Moody's for telling the truth: the ACA is creating headwinds for the healthcare industry. If not, you can be sure that observers like Krauthammer will be quick to cry foul ball.