Investors are under-appreciating risk in structured reinsurance

The market is increasingly factoring in the benefits of structured finance but potentially under-appreciating the risks, according to Jefferies, a US bank, writing in an equity research note on Hannover Re.

Jefferies said it was “struck by the magnitude of recent demand for structured reinsurance,” with Hannover Re a huge beneficiary of that trend.

Hannover Re is a market leader in structured reinsurance, noted Jefferies, with the business accounting for half of the 23% property and casualty premium growth in 1Q 2019.

“This high premium, low margin, but high ROE product in our view provides substantial risks and rewards for investors,” said Jefferies.

Jefferies argued demand for Hannover Re's structured reinsurance products is an even bigger driver of Hannover Re’s share price than rising rates, while noting the reinsurer’s high ROE and the complex nature of its structures.

“Even where peers offer similar products, Hannover Re's speed of implementation and track record for successful execution is difficult to challenge,” it said.

But, Jefferies added: “On the other hand, we cannot deny that these structures are designed to tackle the cedant's specific accounting, regulatory and balance sheet strain but without much risk transfer. Consequently, though the premium amounts are high, the margin is low and there is typically limited capital required, creating a high ROE but also the remote possibility that the business is under-capitalised for an unknown systemic risk.”

Investors cannot adequately quantify the potential risks, said Jefferies. On balance, the bank remains cautious, it concluded.