Vitality Re V Ltd. (Series 2014-1)

Vitality Re V Ltd. sees life and health insurer Aetna once again using its captive Health Re Inc. as the ceding reinsurer for this transaction, with the protection ultimately reinsuring the health insurance portfolio of its Aetna Life Insurance Company subsidiary.

Two tranches of notes are being issued, with a preliminary total deal size of $200m, sources told Artemis. A Class A tranche of notes with a preliminary size of $140m and a Class B tranche sized at $60m are both being offered to ILS investors.

Through the issuance of Vitality Re V Limited Aetna is seeking a fully-collateralized source of reinsurance protection for its health insurance portfolio. The risk period is said to be for four years, from the beginning of 2014 to the end of 2018.

The reinsurance protection provided by Vitality Re V will cover Aetna against unusual or unexpected rises in its medical benefit claims ratio, providing indemnity protection for claims above a predefined ratio attachment point. The protection provided by Vitality Re V will be on an annual aggregate basis, Artemis understand.

The protection is provided through Aetna’s captive reinsurance vehicle Health Re Inc., which enters into excess-of-loss agreements with Vitality re V Ltd., as the ceding reinsurer for the transaction and the protection ultimately reinsures the health insurance portfolio of its Aetna Life Insurance Company (ALIC) subsidiary. ALIC enters into a quota-share agreement with Health Re. The notes will cover the claims payments related to the covered insurance business above a pre-defined medical benefit ratio for each tranche of notes.

Under the terms of the quota share reinsurance agreement ALIC will cede on a quota-share basis annually $1 billion of covered business premium to Health Re. ALIC will retain 10% of all medical benefit claims obligations. Health Re then enters into the excess-of-loss reinsurance contracts with Vitality Re V Ltd. which is collateralized through the sale of the notes over the five-year term.

The covered business is the commercial insured accident and health business (PPO, point of service, and indemnity lines) directly written by ALIC and reported in its annual statutory statements as “Accident and Health-Group,” except for a number of specified exclusions.

The $140m Class A tranche of notes has a medical benefit ratio attachment point of 102% and a medical benefit ratio exhaustion point of 116%. These equate to an attachment point of $1.02 billion and an exhaustion point of $1.16 billion. This gives the notes an attachment probability of just 5bps and an expected loss of just 1bps.

The Class B tranche of $60m notes has a medical benefit ratio attachment point of 96% and a medical benefit ratio exhaustion point of 102%. These equate to an attachment point of $960m and an exhaustion point of $1.02 billion. This gives the notes an attachment probability of 53bps and an expected loss of 21bps.

The Class B tranche is the riskier of the two, reflected in the price guidance which is detailed below. The transaction as a whole will provide Aetna with protection from an attachment of $960m up to an exhaustion of $1.16 billion, so as this is a $200m layer it’s likely that the deal will not upsize unless Aetna chooses to expand the protection further.

Price guidance for the expected coupon to be paid to investors from each tranche of notes is a range of 2% to 2.75% for the Class A notes and 2.75% to 3.5% for the Class B tranche.

As well as covering fluctuations in the medical benefit ratio the Vitality Re ILS deals also provide Aetna with tail risk cover for severe pandemics. In fact pandemic risk makes up a large proportion of the expected loss on this transaction, as much as 88.58% of the expected loss for the Class B notes and 99.55% for the Class A notes.

Standard & Poor’s Ratings Services said that it has assigned its preliminary ratings of ‘BBB+(sf)’ and ‘BB+(sf)’ to the Class A and Class B notes, respectively. These ratings are currently based on the underlying medical benefit ratio risk factor, however S&P noted that if it lowered the rating on ALIC to less than the MBR risk factor, it would lower the rating on the notes accordingly.

S&P noted in its pre sale report that the highest that the medical benefit ratio has been for the covered business since 2006 is 88.5% in 2009. This remains well below the attachment point of these, or any of the previous, Vitality Re tranches of notes.

From 1996 through the first nine months of 2013, for a broader block of business and other related lines of health insurance policies, the medical benefit ratios (MBR) ranged from 76.0% in 2003 to 89.3% in 2001; and 79.5% for the first nine months of 2013.

Vitality Re I and Vitality Re II both matured on the 7th January 2014 which means that this transaction will replace at least some of the cover from those two deals for Aetna.

Update:

The Class A tranche saw pricing settle right down at 1.75%, a decline of around 26% from the mid-point of the launch range.

The Class B tranche, which is a little riskier in terms of attachment probability, settled down at 2.5%, a decline of 20% from the mid-point of the launch price guidance.

These two tranches in the Vitality Re V transaction sit directly alongside the two from Vitality Re IV, issued a year earlier. The Class A tranche issued in 2013 pays investors 2.75%, so the 2014 deal is a whole percentage point lower (36% lower coupon rate). The Class B tranche from 2013 pays 3.75%, so the 2014 deal is 1.25% lower in terms of coupon paid on that layer, which is around a 33% reduction in coupon cost to the sponsor.

This clearly demonstrates the reduction in ILS pricing over the last year and also the low cost-of-capital that ILS capital can bring to sponsors of catastrophe bonds and ILS.