S&P comment on rating methodology for medical benefit linked securitizations

Standard & Poor’s has issued a press release which provides commentary on their approach to rating medical benefit linked securitization transactions such as the Vitality Re Ltd. and Vitality Re II Ltd. deals which were issued on behalf of insurer Aetna. The commentary provides some information on the factors that S&P consider during their analysis of the ceding insurer in this type of insurance-linked security transaction.

The two Vitality Re transactions saw them securitize medical benefit claims and sell the resulting notes to capital markets investors, in typical ILS or catastrophe bond style. The notes covered health insurer claims payments on an excess of loss basis to  a reinsurer (Health Re Inc.) and ultimately the direct writer (Aetna). The special purpose entities, Vitality Re and Vitality Re II, will pay out if a medical benefit ratio ( a measurement of medical benefit claims costs as a percentage of revenues) exceeds a specified attachment level and triggers a loss to the deal.

S&P explain that in their analysis of the ceding insurer they;

“Exclude the statutory capital in the SPEs from total adjusted capital (TAC) in our capital model. We also assess pricing risk (C-2 risk) and business risk (C-4 risk) capital charges on a net basis (excluding premium ceded to the reinsurer SPEs), and we treat related debt as operating leverage “.

The reason for this is because the note holders have no recourse to either the direct writer or to the holding company parent, which S&P says keeps this transaction in line with ILS deals with a fully independent reinsurer involved. Health Re Inc. is Aetna’s own reinsurance vehicle. For the same reason S&P treat the transaction as operational leverage and not financial leverage when they calculate holding company ratios. As a result S&P says they don’t include the capital model of the reinsurer in their capital model, but reduce the pricing and business risk charges by the amounts associated with the ceded premiums which reflects the risk transfer to the reinsurer.

This approach is in line with S&P’s treatment of other structured transactions such as XXX term life insurance reserve funding and property-casualty sidecar deals which are treated as collateralized reinsurance arrangements.