It might not appear particularly magical but Merlin CDO 1 BV does stand out as the first synthetic CDO of insurance and reinsurance entities. Structured by SG CIB, the transaction provides Hannover Re with credit protection on 99 reference entities in the reinsurance sector. It has sold reinsurance recoverables credit risk into the capital market.
One way reinsurers manage risk is through buying retrocession from other reinsurers – in other words laying off risk. Historically, Hannover Re was heavily reliant on retrocession but the rating agencies had voiced their unhappiness with the amount of reinsurance recoverables this left on its balance sheet. The obvious problem is that there is credit risk because until Hannover Re actually claims the money from the reinsurer it bought retrocession from, it is exposed to fact that they might not be able to pay when the time comes.
Balance sheet
"In addition to reducing the number on their balance sheet they were looking at ways to manage the remaining credit risk. We developed a solution using CDO technology, in the same ways that banks use CDO technology to securitize loans and other debt obligations; this is a variation of that technology.
