Credit risk hedges
The adoption of capital market techniques in improving the performance of reinsurance assets is increasing, but the pace of change is slow. There have been a few transactions whereby reinsurance portfolios have been securitized with the intention of limiting the scope for asset impairment through counterparty rating agency downgrades or other credit risk issues. Most such transactions are available only to major portfolios with sufficient scale to attract hedge funds and banks.
The essence of creating a hedge is in understanding the exposures and identities of different counterparties. In the reinsurance world, there are complex interrelations amongst reinsurers as both debtors and creditors. This is particularly true of the major international reinsurance groups and specialised markets such as Lloyd’s.
With information as to the connectedness of counterparties a variety of structures are possible with which to create offsetting financial positions in relation to poorly rated reinsurers. Offset is a widely used approach where a single legal entity has a counterparty as both creditor and debtor but the possibility of artificially creating an offset hedge has been largely overlooked.
James, Brennan & Associates believes that the reinsurance market is likely to adopted the hedging instruments widely used in the banking sector as a means of enhancing the performance of reinsurance assets. We have carried out extensive research in this area and developed various deal structures to achieve an effective credit risk hedge in the reinsurance sector.
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