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Aetna buys reinsurance coverage for group health


HARTFORD, Conn.—Aetna Inc. has arranged debt-financed reinsurance coverage of a portion of its commercial group health insurance business, freeing up some cash needed to meet risk-based capital requirements set by state regulators.

The three-year reinsurance contract with Vitality Re Ltd., a Cayman Islands-based special-purpose vehicle, gives the Hartford, Conn.-based health insurer $150 million of collateralized excess-of-loss reinsurance that will be triggered if the medical loss ratio on Aetna's fully insured commercial group business tops 104% this year. If its MLR exceeds 114% this year, Aetna can access the full $150 million.

To finance the reinsurance, which will cover the claims payments of Aetna-owned Health Re Inc., Vitality Re will issue two classes of notes: $125 million of Class A notes, which will have an MLR attachment point of $1.3 billion; and $25 million of Class B notes, which attach at $1.225 billion, Aetna said last week.

The Class A notes have received a preliminary rating of “BBB-” from Standard & Poor's Corp., while the Class B notes received a “BB” preliminary rating. Based on risk modeling provided by Milliman Inc., S&P cites pandemic as the biggest risk of loss in the transaction.

HSBC Bank (Cayman) Ltd. is providing administrative services to Vitality Re, while Goldman Sachs & Co. is marketing the notes to finance the reinsurance.

Such debt-financed reinsurance transactions, called insurance-linked securities, are common in the property/casualty insurance industry and usually are in the form of catastrophe bonds, but ILS transactions are rare in the health insurance industry, experts say.

“To our knowledge, the complicated transaction is the first of its kind among managed care companies, and management described the transaction as "the first step in a larger program,'” Kevin Fischbeck, a research analyst at Bank of America Merrill Lynch, said in an update about Aetna last week.

According to a transcript of remarks that Joseph M. Zubretsky, senior executive vp and chief financial offer of Aetna, made during the JPMorgan “Healthcare Conference” last week, “over time you'll see us introduce more tranches of this into our capital structure if, in fact, the market appetite for this type of security stays as active as we just recently experienced it to be.”

State insurance regulators require health insurers to maintain certain risk-based capital levels for fully insured business, and companies typically maintain multiples of the minimum to protect against an adverse capital scenario and achieve targeted subsidiary debt ratings, which are important when marketing to employers.

As of Sept. 30, 2010, Aetna had $7.1 billion of risk-based capital, representing 645% of the required minimum, according to the analysts' note. “While it is unclear to us how much incremental capital Aetna could free up through similar transactions, every 10% of risk-based capital unlocked represents $710 million (5.5% of market cap) of incremental deployable capital.”

During the JPMorgan conference, Mr. Zubretsky described the reinsurance transaction as “a new way to capitalize the business.”

“We recognized that (risk-based capital) formulas arbitrarily allocate more capital to the underwriting cycle than an economic model would suggest you need. So in order to monetize that disparity, you introduce a third party and say, "Are you willing to take this risk?,' and, if you are and you're allocating less capital than is implied by risk-based capital formulas, then you basically have just played an arbitrage between economic capital and risk-based capital,” according to the transcript of Mr. Zubretsky's remarks.

“The way to think about this is we replaced equity capital at an equity cost of 11% pre- and post-tax with equity capital at a cost of 2.7%, the cost of BBB debt. The debt is nonrecourse to Aetna, it does not count as Aetna leverage and does count as risk-based capital, all signed off by a host of state insurance regulators and the rating agencies,” Mr. Zubretsky said.

BofA analysts said they expect other large managed care companies that generally maintain capital levels similar to that of Aetna's to follow Aetna's lead. However, smaller plans and government-focused plans that tend to have risk-based capital in the 300% to 400% of the required amount appear less likely to benefit from such a transaction, they said.