MARCH 3, 2014 INSURANCE

CREDIT FOCUS Benefit Are Early Winners in Building Private Health Exchanges Hewitt, , Lead the Way

RATINGS Summary Opinion Aon plc Senior unsecured debt Baa2 (pos) » Private health exchanges will play a growing role in US healthcare distribution. Major Marsh & McLennan Companies, Inc. benefit consulting firms, such as , Mercer and Towers Watson, are investing Senior unsecured debt Baa2 (pos) significant funds and management resources to develop private exchanges, drawing on KEY INDICATORS their knowledge of employee benefit plans, extensive client relationships and ample ($ Millions) FY 2013 FY 2012 financial resources. The investments in private exchanges and the related market Aon plc opportunity are credit positive for leading benefit consultants and brokers. Revenue 11,815 11,514 Net income (controlling) 1,113 993 » Private exchanges are proprietary online marketplaces where employers contract with Total equity 8,195 7,805 Marsh & McLennan Companies, Inc. private vendors to make a range of health insurance and ancillary products available to Revenue 12,261 11,924 employees and/or retirees. We expect enrollments to increase significantly over the next Net income (controlling) 1,357 1,176 Total equity 7,975 6,606 several years. For benefit consultants, exchange-related earnings will be partly offset in the Towers Watson (not rated) near term by the costs of developing exchanges and by the fact that many enrollees in the Revenue 3,597 3,418 Net income (controlling) 319 260 active employee exchanges are existing clients transitioning from company-specific health Total equity 2,745 2,457 plans to exchange-based plans. Note: Fiscal year ends on December 31 for Aon and Marsh & McLennan, and on June 30 for Towers » Private exchanges are distinct from public (government-run) exchanges formed under Watson. Sources: Company reports, Moody's the Patient Protection and Affordable Care Act (PPACA). Nevertheless, PPACA has heightened the national debate regarding healthcare costs and benefits, and has imposed Analyst Contacts: new regulations on employers, prompting many to rethink their employee benefit plans. NEW YORK +1.212.553.1653 » Private health exchanges vary in terms of strategies, target markets, products and how Bruce Ballentine +1.212.553.7212 costs are divided between employers and employees. We believe the most successful Vice President - Senior Credit Officer exchanges will be those that minimize growth (or generate savings) in overall healthcare [email protected] costs, rather than simply shifting costs from employers to employees. Keys to success Ji Liu +1.212.553.2938 include (i) building strong insurance carrier networks, (ii) guiding employees to select Associate Analyst [email protected] appropriate insurance coverage, (iii) promoting employee wellness, (iv) streamlining plan Stephen Zaharuk +1.212.553.1634 administration, and (v) ensuring compliance with regulations. Senior Vice President » Large, mid-sized and small employers are weighing the pros and cons of private health [email protected] exchanges. Potential benefits include curbing the growth of healthcare costs and giving Sarah Hibler +1.212.553.4912 Associate Managing Director employees greater choice with regard to health insurance. Early movers will likely include [email protected] employers operating in multiple jurisdictions, those facing above-average healthcare cost Robert Riegel +1.212.553.4663 inflation and/or those struggling with plan administration. However, we believe many Managing Director - Insurance employers will maintain their existing customized health plans, with the employer closely [email protected] involved in plan design and employee communications, given that healthcare and related

benefits are critical factors in attracting and retaining employees.

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Private Exchange Initiatives Are Credit Positive for Top Benefit Consultants

Private health exchanges will play a growing role in US healthcare distribution. Major benefit consulting firms, led by Aon Hewitt, Mercer and Towers Watson, are investing significant funds and management resources to develop private exchanges. We expect these firms to build successful exchanges based on their knowledge of employee benefit plans, extensive client relationships and ample financial resources. The investments in private exchanges and the related market opportunity are credit positive for leading benefit consultants and brokers.

Private health exchanges are proprietary online marketplaces where buyers and suppliers of health insurance and related products come together to transact. For a number of years, modest-sized private exchanges have served specific markets, such as Medicare-eligible retirees or small businesses in selected states. Today the major opportunity facing private exchanges is in serving active employees of a broad range of employers.

During 2013, private health exchanges enrolled dozens of large, mid-sized and small employers spanning many industries and geographic regions. Such employers contract with an exchange to make various health insurance policies and related products available to their employees. Different exchanges have different selling features, but in general they aim to help employers address persistent challenges related to employee benefits. Such challenges include containing healthcare costs, promoting health and wellness, offering employees multiple options, educating them about those options, administering plans and complying with evolving regulations.

Private health exchanges for active employees have significant growth potential. A recent Aon Hewitt report indicates that 122 million active employees are in employer-sponsored group medical plans today1. Having reviewed exchange-related announcements by various benefit consultants, we estimate that fewer than one million of these individuals were enrolled in private health exchanges at the start of 2014. We believe enrollment in private exchanges could grow to tens of millions of active employees by the end of this decade, based on our discussions with consultants, along with survey results included in the last section of this report. Private exchange operators have a related opportunity to serve Medicare-eligible retirees in employer-sponsored health plans. The same Aon Hewitt report indicates that 12 million Medicare-eligible retirees have some sort of employer-sponsored coverage.

For benefit consultants, we expect exchange-related earnings to be partly offset, at least for the next year or two, by the costs of developing exchanges and by the fact that many enrollees in the active employee exchanges are existing clients transitioning from company-specific health plans to exchange- based plans. The longer-term revenue and earnings potential lies in (i) providing clients with bundled health plan services such as consulting, communications/engagement and administration (such services have been sold separately under most traditional plans), and (ii) sharing in clients’ cost savings when exchanges effectively limit or reduce overall healthcare costs. Benefit consultants might also marginally boost revenues by selling ancillary products through their exchanges and/or by converting certain clients from administrative fees on self-insured plans to more lucrative commissions on fully insured plans as some employers look to transfer risk and earnings volatility to health insurers.

1 Aon plc, “Investor Relations Overview” (February 2014)

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PPACA Heightens National Healthcare Debate; Employers Seek New Solutions

While private health exchanges are distinct from public exchanges formed by federal and state governments under PPACA, PPACA has heightened the national debate with respect to healthcare costs and benefits, different types of insurance coverage, and individual responsibility and choice regarding coverage. PPACA also imposes new regulations on employers, such as requiring firms with 50 or more employees to offer qualified health insurance plans, and imposing an excise tax on Cadillac health plans2. Finally, through the formation of public (government-run) exchanges, PPACA has raised national awareness of exchanges as a healthcare distribution system. We believe the discussion surrounding PPACA has contributed to employers’ pursuit of more effective health plans for their employees, including the potential use of private exchanges. The box below sets forth key traits of private and public exchanges.

Private versus Public Health Exchanges Group private exchanges sell health insurance to a firm’s employees as a variation of the traditional employer-sponsored group benefit model, except with a larger selection of standardized health plans, which may come from multiple competing insurance carriers. An exchange operator enlists health insurers to supply products on the exchange; contracts with employers to oversee their plan design, administration and regulatory compliance; and manages employee education and enrollment through online and phone-based tools and related support. Insurance carriers offer products consistent with the strategy and target market of the given exchange. An employer selects the private exchange that best meets the employer’s objectives in such areas as overall healthcare costs, nature/range of products offered and ease of use. Employees select from an array of insurance products based on individual needs and healthcare budgets.

Individual private exchanges sell individual health insurance, often to Medicare-eligible retirees of sponsoring employers. An exchange operator contracts with employers to make health insurance and related products available to their retirees, who select the individual products. Funding for such products typically includes Medicare payments from the federal government, contributions from former employers and contributions from retirees. Under its interpretation of PPACA, the United States Department of Health and Human Services also allows agents and brokers that operate a “web- based entity” to sell qualified health insurance plans (as defined under PPACA) to individuals. Private exchanges can facilitate consumers’ enrollment in such plans and help them access relevant subsidies via public health exchanges.

Public exchanges, sponsored by federal and state governments, sell individual and family major medical insurance as well as dental products to consumers without access to coverage through an employer or other government program. With the enactment of PPACA, federal and state-run exchanges will be the primary means for uninsured individuals to purchase health insurance. In 2014, businesses with fewer than 50 employees are permitted to purchase healthcare coverage through the public exchanges for their employees. Employers with up to 100 lives will have this opportunity in 2016, and larger employers follow in 2017.

2 The employer requirement to provide health insurance is phased in over the next few years based on the number of employees per firm. The Cadillac tax is an annual 40% excise tax on health plans with premiums exceeding $10,200 for individuals or $27,500 for a family (not including vision and dental benefits) starting in 2018.

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Private Exchanges Vary in Strategies, Target Markets, Products

EXHIBIT 1 Selected Private Health Exchanges and Areas of Focus

Number of Target Inception Active Seasonal/ Individuals Employer Parent/Owner Exchange Name Date Employees Retirees* Part-time Served** Size Aon Aon Active Exchange Apr-2011 X 330,000 Large Aon Retiree Exchange X >300,000 Marsh & McLennan Mercer Marketplace Jan-2013 X >75,000 Large & Mid-mkt Mercer myCustomHealth X >35,000 Mercer Health Advantage Mercer Pharmacy Collectives Mercer Stop Loss Coalition Mercer Voluntary Benefits Towers Watson OneExchange Retirees 2006 X >560,000 Fortune 500 OneExchange Active Jan-2013 X 100,000 OneExchange Access Jan-2013 X 30,000 Liazon\Bright Choices 2007 X >82,000 Small WellPoint/HCSC/ Bloom Health 2009 X 106,000 Small BCBS Buck Consultants RightOpt Feb-2013 X X X 122,000 3000+ (Xerox) employees

* Medicare-eligible retirees over 65 years old ** Estimates as of year-end 2013 excluding covered dependents Other notes: Among active employee exchanges, Aon Active Exchange only offers fully insured plans, whereas other exchanges generally offer both fully insured and self-insured plans. Bloom Health and RightOpt (Buck Consultants) mainly offer single-carrier plans, whereas other exchanges generally offer multi-carrier plans. Sources: Company announcements, Moody’s

Exhibit 1 gives a sampling of private health exchanges being developed by benefit consulting firms. The exchanges vary in terms of strategies, target markets, products offered, suppliers of products (e.g., single or multiple insurance carriers) and how costs are divided between employers and employees. The box below explains some distinguishing characteristics of private health exchanges.

We believe the most successful exchanges will be those that minimize growth (or generate savings) in overall healthcare costs, rather than simply shifting costs from employers to employees. Steps to contain overall healthcare costs will likely include (i) building insurance carrier networks that combine the product and regional strengths of different firms, (ii) providing employee communications and online tools to help them select appropriate insurance coverage (i.e., not over- or under-insuring), (iii) promoting employee wellness, (iv) streamlining plan administration, and (v) ensuring plan compliance with evolving regulations.

In addition to the exchanges being developed by benefit consultants, major health insurers are also developing private health exchanges to market their own products. Aetna, Cigna and United Healthcare have all announced such initiatives, alongside their participation in the private exchanges being built by benefit consultants as well as public exchanges. An insurance carriers’ proprietary

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exchange would likely appeal to an employer that already works directly with that carrier (rather than through a benefit , say), particularly an employer with a highly customized benefit plan.

Characteristics of Private Health Exchanges Self-insured versus fully insured plans – Private health exchanges may offer self-insured plans, fully insured plans or both. With self-insured plans, employers pay fees to insurance carriers for administrative services only, such as access to their networks, medical management and claims processing. According to a 2013 Kaiser Family Foundation survey, 16% of covered workers at small firms (3–199 workers) and 83% of covered workers at larger firms (200 or more workers) are enrolled in either partially or completely self-insured plans3. Based on a recent survey, Towers Watson estimates that employers with self-insured plans would see a 5%-8% increase in costs if they were to shift to a fully insured plan4. Under a fully insured plan, the employer pays premium taxes, the industry PPACA tax and other risk charges. Despite the cost differential, we expect that some employers will favor fully insured plans to transfer yearly cost volatility and the risk of large losses to insurance carriers. Single-carrier versus multi-carrier plans – Private exchanges may offer products and services of a single insurance carrier or of multiple carriers. Proponents of the single-carrier approach maintain that it is easier for one insurer to integrate and manage all health benefits. Proponents of multi-carrier models say that carriers have different capabilities in different geographic regions, and the exchange operator can enlist the strongest carrier(s) per region. Multi-carrier proponents also say this approach encourages competition among carriers. Some market observers argue that multi-carrier exchanges expose certain carriers to adverse selection (the unhealthiest people migrate to one carrier). However, this concern may be mitigated through a risk sharing mechanism within the exchange. Defined benefit versus defined contribution – As part of the national healthcare debate, some employers are considering switching from defined benefit type health plans to defined contribution plans, mirroring the shift that has occurred with retirement savings plans. Private exchanges could facilitate this transition. Under the defined contribution concept, the employer makes a fixed contribution to each employee’s health insurance budget, and allows the employee to choose from a range of insurance policies offered on the exchange. The employee pays the portion of the cost not covered by the employer, and the employee bears the risk of unexpected cost fluctuations. This approach is analogous to a defined contribution retirement savings plan (e.g., 401(k)), where the employer makes a fixed contribution, and the employee selects investments and bears the investment risk.

3 The Kaiser Family Foundation and Health Research & Education Trust, “Employer Health Benefits – 2013 Annual Survey” (August 2013) 4 Towers Watson, “Expanding Options for Employers in Next-Generation Private Exchanges” (July 2013)

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Employers Weigh Pros and Cons of Exchanges

We expect that US healthcare distribution will be largely employer-based for the foreseeable future. Employers are looking for ways to contain healthcare costs, which have increased rapidly for many years. According to the 2013 Employer Health Benefits survey by the Kaiser Family Foundation and the Health Research & Educational Trust, the average premium for employer-sponsored health insurance for families has increased 80% since 2003 (6% per annum), and was $16,351 for families (see Exhibit 2) and $5,884 for singles in 2013. Based on our discussions with benefit consultants, we believe the yearly increase would be 2%-3% higher if we factored in changes in plan design such as higher deductibles.

EXHIBIT 2 Average Annual Health Insurance Premiums – Family Coverage

Employee Contribution Employer Contribution $20,000 6% CAGR from 2003 to 2013 $15,000

11,786 $10,000 10,944 11,429 9,860 9,773 8,824 9,325 8,167 8,508 6,656 7,289 $5,000

3,997 4,129 4,316 4,565 2,412 2,661 2,713 2,973 3,281 3,354 3,515 $0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Kaiser/HRET Surveys of Employer-Sponsored Health Benefits, Moody’s

Employers considering private health exchanges face opportunities and challenges. Potential benefits of an exchange include limiting the growth of overall healthcare costs through a consumer-driven model with more choice and flexibility regarding health insurance. According to an survey, 49% of large employers (more than 3000 employees) surveyed would consider switching to a private exchange if they could realize cost savings of at least 10%, while 23% of employers would switch for other reasons, such as reducing their administrative burden (see Exhibit 3).

EXHIBIT 3 Percentage of Employers Who Would Consider Switching to Private Health Exchange Would consider switching for savings of at least 10% Would consider switching for no savings

100% 90% 80% 20% 70% 26% 26% 60% 23% 50% 40% 62% 30% 57% 55% 49% 20% 10% 0% 10 to 50 51 to 100 101 to 3000 > 3000

Number of employees

Source: Oliver Wyman survey of 1,329 employers, weighted based on employer size (December 2011)

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In an Aon Hewitt survey, employers also cited potential cost savings as the key reason to consider switching to a private health exchange, while other supporting factors included improving access to quality plans, enhancing health and wellness programs, and expanding choice (see Exhibit 4).

EXHIBIT 4 Most Important Corporate Exchange Features

100% 86%

80%

60% 45% 43% 43% 41% 40%

20%

0% Reducing Improving Access to Enhancing Increasing Lowering Employer Costs Quality Plans Health/Wellneess Choices Accountability/ Programs Reducing Risk

Source: Aon Hewitt Corporate Health Care Exchange Survey (2012)

Nevertheless, challenges abound in developing an educational campaign for employees to facilitate a smooth transition. Lessons learned from the transition from defined benefit pension plans to defined contribution plans suggest that workers may be disengaged when presented with too many options.

We expect that early movers to private exchanges will include employers operating in multiple locations that could benefit from accessing multiple insurance carrier networks, those facing above- average increases in healthcare costs and/or those struggling with administration of their health plans. Such employers might decide that their employees would be better served by products and services of an exchange. At the same time, we believe many employers will maintain their existing customized health plans, with the employer closely involved in plan design and employee communications, given that healthcare and related benefits are critical factors in attracting and retaining employees.

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Moody’s Related Research

Credit Opinions: » Aon plc » Marsh and McLennan Companies, Inc » Willis Group Holdings plc Special Comment: » Insurance Brokerage: Industry Scorecard, October 2013 (159418) Rating Methodologies: » Moody’s Global Rating Methodology for Insurance Brokers & Service Companies, February 2012 (138884) » Debt and Equity Treatment for Hybrid Instruments of Speculative- Nonfinancial Companies, July 2013 (155761) » Loss Given Default for Speculative-Grade Non-Financial Companies in the U.S., Canada and EMEA, June 2009 (114838) Rating Implementation Guidance: » Moody’s Approach to Global Standard Adjustments in the Analysis of Financial Statements for Non-Financial Corporations, December 2010 (128137) To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

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Report Number: 161407

Authors Financial Writer Ji Liu Danielle Reed Bruce Ballentine Sarah Hibler

Production Specialist Wing Chan

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9 MARCH 3, 2014 CREDIT FOCUS: BENEFIT CONSULTANTS ARE EARLY WINNERS IN BUILDING PRIVATE HEALTH EXCHANGES