Recently, the debt rating on Humana Inc.’s ( HUM - Analyst Report ) senior unsecured notes were raised to “BBB” from “BBB-” by Fitch Ratings, according to Reuters. Additionally, the insurer financial strength rating (IFS) of the company’s insurance subsidiaries was upgraded to “A” from “A-”. The outlook on both ratings was reduced to stable from positive.

The upgrade was driven by Humana’s favorable operating results and financial strength, which are evident in the long-term trend of improving revenues, earnings, and return on capital. The company’s shareholders’ equity has also been witnessing impressive growth for quite sometime, while premium growth has moderated. These factors have resulted in enhanced National Association of Insurance Commissioners (NAIC) risk-based capital (RBC) ratios and underwriting leverage ratios, which are also partly responsible for the upgrade.

Moreover, Fitch expects Humana to aggressively engage in capital management in the upcoming months in order to meet its targeted debt-to-capital ratio of 25–30%. The ratio has stayed between 15% and 20% over the past 12-24 months due to slower capital management compared to earnings growth and capital formation.

The rating agency also expects Humana to move on with its inorganic growth strategy by vigorously acquiring companies to augment its medical membership, healthcare services and technological capacity. However, since the company has funded most of its recent acquisitions from cash reserves and these acquisitions are not expected to have a material impact on the earnings in the near term, these have not affected the ratings of the company. Nevertheless, these are expected to enhance Humana’s competitive position and financial strength in the long term.

Humana’s ratings were also influenced by the company’s reliance on its Medicare Advantage business for a large portion of its premium revenues and membership growth. This is considered to be unfavorable by Fitch since Medicare Advantage providers have limited command over pricing due to the government’s role as the primary financer. On the other hand, the increasing age of the U.S. population is boosting the demand for Medicare Advantage products.

While the revision of the outlook to stable indicates that Fitch does not expect any rating revision in the near term, certain rating triggers can lead to change in ratings. Triggers such as lower downward pressure on premium rates due to enhanced Medicare environment, slowdown in growth of medical care cost trends leading to lower cost pressure on providers, decline of targeted debt-to-capital ratio to 20%, rise of company-wide NAIC RBC to 350% and maintenance of important financial metrics at the present level, can lead to an upward revision of ratings.

Meanwhile, if there is a freeze or decline in Medicare Advantage rates for multiple years, Humana’s financial leverage target is raised beyond 30%, organization-wide NAIC RBC ratio target is lowered below 25%, run-rate EBITDA-based interest coverage falls below 7x or EBITDA/revenue ratios decline beyond 5%, then a rating downgrade is possible. Moreover, if Humana undertakes an acquisition involving high integration risk or which is financed aggressively in the opinion of Fitch, then also a downward revision of ratings is probable.

Humana is one of the largest health care plan providers in the U.S. and competes with other industry heavyweights like WellPoint Inc. ( WLP - Analyst Report ) and Aetna Inc. ( AET - Analyst Report ) . The company currently carries a short-term Zacks #4 rank (Sell). We maintain our long-term ‘Underperform’ recommendation on the stock.