Hannover Re launches insurance CDO

Germany-based Hannover Re, the world's third-largest reinsurance group, is to offload up to EUR155 million of credit risk linked to its business with fellow insurance and reinsurance companies in the first transaction of its kind.

The Merlin CDO I transaction is currently being marketed, but once complete will give investors exposure to the defaults of a synthetic portfolio of 100 names in the sector through four tranches of notes totalling EUR95 million. Standard & Poor's has provisionally rated the notes AAA, AA, A and BBB.

It is the latest in a line of similar structures that use securitisation and collateralised debt obligation technology to offload non-tradable risks to the capital markets. Last year, reinsurer Swiss Re collaterised its small and medium-sized enterprise book in the Crystal Credit transaction (Risk February 2006, page 15), and is currently planning to put together a transaction to protect against losses linked to political events such as expropriation and sweeping law changes.

Merlin protects Hannover Re against the default of clients from the insurance and reinsurance sector. The German reinsurer will enter into a credit default swap (CDS) with the structure, a Netherlands-based special-purpose vehicle, and will receive a payout if a set number of referenced entities default.

The capital raised from the notes, together with Hannover Re's initial and quarterly CDS payments, will be invested in a separate investment vehicle run by Netherlands-based Rabobank. Investors will receive a quarterly payout so long as the German reinsurer's clients keep up payments to Hannover Re.

Societe Generale Corporate and Investment Banking is arranging the transaction. Clare Hennings, a managing director in the bank's insurance products department, says the landmark transaction stemmed from Hannover Re's inability to manage such exposure through traditional CDS markets.

"This isn't an arbitrage trade or regulatory capital transaction," she explains. "It's a transaction that transfers risk. The counterparties that Hannover Re has exposure to are not debt issuers, so these names aren't necessarily traded in the market."

The transaction is expected to close this month.

Gareth Gore.

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