OLDWICK, N.J.-A.M. Best Co. has upgraded the senior and indicative debt ratings of PacifiCare Health Systems Inc. ("PacifiCare") (NYSE:PHS) (Cypress, CA). Concurrently, A.M. Best has upgraded the financial strength ratings to A- (Excellent) from B++ (Very Good) of PacifiCare of California, Inc. and PacifiCare Life and Health Insurance Company (Indiana). A.M. Best has also upgraded the financial strength rating to B++ (Very Good) from B+ (Very Good) of PacifiCare of Texas, Inc. and affirmed the financial strength ratings of all the remaining entities of PacifiCare. The outlook for all ratings is stable.

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These ratings reflect the significant product line expansion, improved earnings at most of the health plans, overall strengthened capitalization at the regulated entities and conservative financial leverage with strong coverage. Offsetting these strengths are the challenges of operating in a highly competitive and regulated environment and Medicare Advantage concentration. PacifiCare's health insurance turnaround is completed, and membership growth has resumed. The introduction of new product designs, including new self-directed health plans, as well as an increased focus on the individual market and small and mid-sized employers has produced good operating earnings growth in 2003 and the first half of 2004. While the improvement is also attributable to the stabilization of the company's business model, improving pricing and health care cost controls and culling unprofitable membership, it has been aided somewhat by lower than anticipated health care cost inflation, which has been experienced by the entire industry. Both revenue and earnings from unregulated affiliates have experienced strong growth, especially through sales to employers outside PacifiCare's target health insurance markets. Earnings in the near term will most likely continue to improve as the company continues to price appropriately and effectively manage its health care costs.

Consolidated statutory capital at regulated subsidiaries, as well as cash and liquid capital at the holding company have grown steadily over the last few quarters. As of June 2004, PacifiCare's debt-to-capital ratio was under a conservative 25%, down from 38% at year-end 2002. Financial leverage is expected to remain under 30-35% in the medium term. Interest expense has been reduced with the redemption of $175 million of the company's outstanding 10.75% senior notes. Financial flexibility is further improved by a borrowing capacity of $150 million from an open bank line of credit and $400 million available under the shelf registration.

In A.M. Best's opinion, PacifiCare of California recovery has relied on profitable growth in commercial products. However, the reliance on Medicare Advantage's contribution remains considerable. A.M. Best views negatively a preponderance of business derived from government reimbursements, although the near-term risk is mitigated by the increased funding under the Medicare Reform bill passed at the end of 2003. Although PacifiCare has recently experienced growth similar to that of its peers in the commercial field, its longer-term ability to compete with larger competitors and future new entrants remains a matter of some concern.

For a complete listing of PacifiCare Health insurance debt and financial strength ratings, please visit http://www.ambest.com/press/080401pacificare.pdf

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