U.S.health insurer Aetna Inc. (NYSE:AET - News) has announced a three-year reinsurance agreement with Vitality Re Limited, a newly-formed special purpose insurance company based in the Cayman Islands. Per the agreement, Aetna will get $150 million of catastrophe bond-type cover for its subsidiary Health Re Inc. against medical benefits claims exceeding pre-determined levels.
The agreement is a part of Aetna’s long-term capital management strategy, which will release capital held with respect to its commercial group health business. It is also expected to effectively meet the risk-based capital requirements set by state regulators.
Aetna will start receiving reimbursements from Vitality Re if its medical ratio, the percentage of premiums spent on medical costs, reaches 97%. The upper limit for the ratio has been set at 117%, implying that in case the ratio reaches the set limit, Aetna will get a full payment of $150 million.
Aetna’s reinsurance agreement signals that the company is trying to tap the capital market to refinance debt maturities, enhance liquidity at favorable interest rates, and fund acquisitions.
Though reinsurance transactions, financed by debt in the form of insurance-linked securities, are common in the property and casualty insurance sector, it is a novel concept in the health insurance sector. It all begun last year when Aetna launched the industry's first collateralized reinsurance transaction financed by health insurance linked to debt securities.
Since the nature of the transaction allows Aetna to replace its equity capital with lower cost capital, we expect other players – UnitedHealth Group Inc. (NYSE:UNH - News), CIGNA Corp. (NYSE:CI - News), and WellPoint Inc. (NYSE:WLP - News) to follow suit.
We expect to get more color on this transaction during the fourth quarter earnings conference, which is scheduled before the opening bell on February 1, 2012. As per the Zacks Consensus Estimates, Aetna’s earnings are expected to be 98 cents per share for fourth quarter 2011 and $5.16 per share for full year 2011.
Aetna currently retains a Zacks # 2 Rank, which translates into a short-term Buy rating. Considering the fundamentals, we are also maintaining our long-term Outperform” recommendation on the shares.
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