Health insurer Aetna is making its first trip to the catastrophe bond market since being acquired by CVS Health Corp.
Cat bonds are a form of reinsurance. Proceeds from issuance are held in a trust and invested in money market funds; in the case of a triggering event - in this case, excess medical claims - the issuer can retain some or all principal to pay insurance claims.
Aetna is entering into an agreement with a Vermont subsidiary, Health Re, which in turn will purchase reinsurance from Vitality Re X, a special-purpose vehicle. Vitality Re X then issues two tranches of notes totaling $200 million. S&P Global Ratings expects to assign a BBB+ to $140 million of senior notes, which will be “triggered,” or begin to surrender principal, once the medical benefit ratio, or the percentage of annual premium paid out in claims, rather than expenses and profit provision, exceeds 104%. There is also a $60 million tranche of Class B notes that is triggered when the medical benefit ratio exceeds 98%, it will be rated BB+.
Goldman Sachs is the sole bookrunner and sole structuring agent; Munich Re is the co-manager and co-structuring agent.
In its presale report, S&P noted that the medical benefit ratio for the business covered by the transaction has not reached the trigger level for the subordinate notes since before 2008; the highest level it has reached over the past 11 years was 88.5% in 2009.
In addition, for the four quarters ended Sept. 30, 2018, the reported MBR for the covered business was 84.78%, above the multiyear average MBRs (ended Sept. 30, 2018), but below the MBR attachment levels. This higher recent MBR is primarily due to the 2017 suspension of the HIF and the reduction in small-group premiums as a percentage of covered business premiums in 2017 and 2018.
More recently, the medical benefit ratio has been trending downward; it was 83.3% for the first nine months of 2018, versus 85% for the same period of 2017. This reflects the reinstatement of an industry-wide health insurer fee under the Patient Protection and Affordable Care Act, according to S&P.
According to Milliman, the initial modeling and reset agent, the primary drivers of historical financial fluctuations have been the volatility in per-capita claim cost trends and lags in insurers' reactions to these trend changes in their premium rating increase actions. Other volatility factors include changes in expenses and target profit margins, and enrollment growth and declines. “Although these factors cause the majority of claims volatility, the extreme tail risk is affected by severe pandemic,” the presale report states.
S&P also thinks CVS Health Corp.'s acquisition of Aetna could materially affect the covered business. In November 2018 the rating agency lowered its issuer credit rating on Aetna to BBB/A-2 from A/A-1, and the financial strength rating on its operating subsidiaries to A- from AA- based on Aetna's acquisition by a lower-rated group (CVS Health Corp.) that is taking on significant debt and integration risks.
