Consolidated Appropriations Act causes downgrade of Vitality Re V & VI health ILS’

As a result of a piece of health care and health insurance related U.S. legislation named the Consolidated Appropriations Act, 2016 (CAA), signed into law in December, all tranches of Aetna’s Vitality Re V Ltd. and Vitality Re VI Ltd. ILS deals have had their ratings downgraded.

The Consolidated Appropriations Act, 2016 (CAA) amends various provisions in the Affordable Care Act, including suspending the industry-wide health insurer fee (HIF) for the calendar year 2017.

According to rating agency Standard & Poor’s, and based on Milliman’s, which provided the risk modelling for all the Vitality Re ILS deals, assessment on the amendment and new data received; “Due to the changes, per Milliman Inc., the expected result would be upward pressure on the covered business medical benefits ratio (MBR) in 2016 and 2017 relative to the immediately preceding calendar year (as premiums are likely to be reduced, reflecting the one-year suspension of the industry-wide HIF) followed by a downward movement in the covered business MBR in 2018 and 2019 relative to the immediately preceding calendar year (as premiums are likely to be increased to re-incorporate the HIF after the one-year suspension expires).”

As a result the HIF suspension was taken into account when remodelling these two medical benefit claims ratio ILS or catastrophe bond deals, as well as being considered in the rating of Aetna’s newest ILS deal, the just issued Vitality Re VII Ltd. (Series 2016-1).

As a result, Milliman estimates that the covered business medical benefit ratio (MBR) impact will be an increase of approximately 250 basis points (bps) for 2017 compared to 2016. For 2018, S&P says the the suspension phase-out impact should reduce the covered business MBR by 250 bps from 2017.

With no provision for any adjustment in the Vitality Re V or VI deals, due to issues such as this, S&P has taken the data provided by Milliman and Aetna and re-assessed the rating for the notes issued under Vitality Re V and Vitality Re VI.

S&P has lowered its ratings on Vitality Re V Ltd.’s Series 2014 Class A and B notes, and Vitality Re VI Ltd.’s Series 2015 Class A and B notes by two notches.

This has downgraded the Vitality Re V Ltd. Series 2014 Class A notes to BBB-(sf) from BBB+(sf) and the Series 2014 Class B to BB-(sf) from BB+(sf), while the Vitality Re VI Ltd. Series 2015 Class A  notes have been downgraded to BBB-(sf) from BBB+(sf) and the Series 2015 Class B to BB-(sf) from BB+(sf).

S&P said that the Vitality Re IV Ltd. (Series 2013-1) Class A and B notes, which are still in force, mature January 9th 2017, so they are not affected by this rating change.

S&P said that as the Vitality Re V notes mature in 2019 if the one-year estimated increase of 250 bps in the covered business MBR for 2017 is followed by a similar decrease in 2018, it would likely raise the ratings back to their initial level. The Vitality Re VI notes mature on in January 2018 so S&P does not anticipate taking any additional ratings actions related to the CAA-adjustment for those tranches at this time.

This is a good example of something that potentially affects the likelihood of an ILS or catastrophe bond being triggered, as it could raise the MBR against which these transactions triggers are linked, that is unrelated to the actual risks covered.

Of course a regulatory or legislative change is unlikely to threaten the majority of ILS and catastrophe bonds, but the more exotic such as health insurance linked are potentially exposed to changes in the law.

It could happen in a catastrophe bond, particularly an indemnity structure, if say a U.S. law forced property insurers to pay for claims they had previously excluded. It demonstrates the importance of robust wording and legal oversight in the deal issuance process.

In the case of these transactions Aetna actually benefits by the coverage being flexible enough to reflect the change in law, something certainly attractive to the sponsors, although perhaps not so welcomed by the ILS investors.