Fitch Affirms PacifiCare's Debt Ratings

Business Wire, Sept 15, 2004

NEW YORK -- Fitch Ratings today has affirmed all debt ratings assigned to PacifiCare Health Systems Inc. (PacifiCare). The Rating Outlook is Stable. The rating actions affect approximately $615 million of debt outstanding.

The affirmation follows PacifiCare's announcement that it intends to acquire all of the outstanding shares of American Medical Security Group, Inc. (AMS), a publicly traded health insurer based in Green Bay, Wisconsin, for $502 million in cash plus $30 million of assumed debt. The addition of AMS would add close to 314,000 fully insured commercial health members, split roughly equal between individual and small group, and is expected to be closed in the first quarter of 2005, subject to customary approvals.

Fitch believes that the acquisition of AMS makes good strategic sense given PacifiCare's stated goal to grow its individual and small group membership and to further diversify away from the large block of government business. Fitch expects that AMS will provide PacifiCare with increased operating scale, improved geographical diversification, and management expertise in the individual and small group business.

While the transaction offers a number of strategic benefits and cost-saving opportunities, Fitch will monitor the company's ability to manage any potential integration risk. PacifiCare intends to fund the purchase price with a $400 million term loan to be negotiated under its new bank agreement and the remainder from internally generated cash. On a pro forma basis, PacifiCare's financial leverage (as defined by the ratio of total debt/capital) is expected to increase from 25% at June 30, 2004 to approximately 33%. Fitch does expect PacifiCare to reduce outstanding debt following the acquisition and reduce financial leverage to approximately 25% by year-end 2005. Fitch expects EBIT/interest coverage ratios to remain above 10 times.

PacifiCare's ratings also reflect its well established competitive position in several major markets, improved outlook for the Medicare Advantage program following the passage of the Medicare Modernization Act in 2003, and the positive steps taken over the past two years to improve profitability and strengthen its balance sheet. The Company's strategy has focused on expanding its operating margins in both the senior and commercial segments through termination of unprofitable accounts, improved underwriting and pricing actions, benefit design, and reduced overhead. While Fitch believes that improvements in margins in 2004 will be modest compared with 2003, profitability is expected to improve, driven mainly by expanding membership growth in the senior and small group and individual segments. The ratings also consider PacifiCare's large Medicare exposure, Fitch's outlook for increased commercial pricing competition in 2004-2005, and challenges associated with rising medical costs and evolving regulatory environment.

PacifiCare Health Systems, Inc. affirmations as follows:

-- 3.0% convertible subordinated debentures 'BB'/Stable;

-- 10.75% senior unsecured notes due 2009 'BB '/Stable;

-- Bank loan rating 'BB '/Stable;

-- Long-term rating 'BB '/Stable.