By Zacks Equity From ZACKS

U.S. health insurer Aetna Inc. (AET – Analyst Report) has announced a five-year reinsurance agreement with Vitality Re V Limited, a newly-formed special purpose insurance company based in the Cayman Islands.

The agreement is part of Aetna’s long-term capital management strategy, through which it will receive $200 million of catastrophe bond-type cover for its commercial group health business.

The transaction is expected to release capital held with respect to its commercial group health business, thereby effectively meeting the risk-based capital requirements set by state regulators.

Aetna’s earlier reinsurance agreement with Vitality Re Limited and Vitality Re II Limited expired on Jan 7, 2014.

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 in 2011 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 like UnitedHealth Group Inc. (UNH – Analyst Report), CIGNA Corp. (CI – Analyst Report), and WellPoint Inc. (WLP – Analyst Report) to follow suit. Moreover, the increasing desire for capital surplus, and perhaps the uncertainty of health care reform and medical inflation, may make offloading such risks a more common practice in the healthcare sector.

We expect to gain more visibility on this transaction during the fourth quarter earnings conference, which is scheduled before the opening bell on Feb 6, 2014. As per the Zacks Consensus Estimate, Aetna is expected to earn $1.38 per share for fourth quarter which translates into year-over-year growth of 47% and $5.87 per share for full year 2013, which implies a growth rate of 14.5%.

Aetna currently retains a Zacks Rank #3 (Hold).

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