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

The agreement is a part of Aetna’s long-term capital management strategy, through which it will get $150 million of catastrophe bond-type cover for its commercial group health business.

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

Aetna will start receiving reimbursements from Vitality Re if its medical ratio, the percentage of premiums spent on medical costs, reaches 96%. The upper limit for the ratio has been set at 116%, implying that in case the ratio reaches the set limit, Aetna will get a full payment of $150 million.

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 – UnitedHealth Group Inc. (UNH - Analyst Report), CIGNA Corp. (CI - Analyst Report), and WellPoint Inc. (WLP - Analyst Report) – to follow suit.

We expect to get more color on this transaction during the fourth quarter earnings conference, which is scheduled on Jan 31, 2013. As per the Zacks Consensus Estimate, Aetna is expected to earn 96 cents per share for fourth quarter 2012 and $5.13 per share for full year 2012.

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

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