The Lloyd's of London insurance market has imposed variable limits on exposures to letters of credit (L/Cs) that ensure an insurer or reinsurer meets capital and risk management requirements. The limits are based on issuing banks' credit ratings.

The move will help to mitigate any future negative impacts from its L/Cs, which the corporation says are it's "most material" exposure according to the corporation.

Material exposure

"L/Cs present the most material exposure to Lloyd's and we have therefore adopted a number of overarching rules as a way to help mitigate this risk," according to a 10 January 2024 market bulletin issued by the corporation.

This new requirements may be a response to the alleged widespread use of forged L/Cs in the multi-billion dollar fraud involving insurance fintech, Vesttoo (DC World News, 19 July 2023).

Banks' credit ratings

For banks with long-term credit ratings at 'AA-' and above, the limit on L/C exposure is £750 million (US$955 million); for those rated 'A+' or 'A' the limit is £600 million, and for those rated A- (stable or above) it is £350 million.

These limits may change over time and if a bank is downgraded to an 'A-' negative outlook, by any of Moody's, S&P and Fitch, any member who holds an L/C will have thirty days to replace the L/C with an alternative acceptable asset

Focus on L/Cs

Even if a bank meets the rating criteria and other acceptability criteria, they may still be deemed as an unsuitable counterparty according to the latest Lloyds market bulletin to impact on the use of L/Cs in the insurance and reinsurance sectors.

Last October, Lloyds issued a market bulletin, again possibly motivated by the Vesttoo fraud, which updated requirements around the provision of Tier 2 capital, which typically includes L/Cs, bank guarantees and life insurance policies that ensure an insurer or reinsurer meets capital and risk management requirements (DC World News, 9 October 2023).

Lloyd's is one of the world's leading and oldest insurance markets. However, it is not an insurance company but a marketplace where multiple insurance underwriters (individuals or syndicates) come together to provide insurance and reinsurance services.

Lloyd's of London's market bulletin, Letter of Credit Eligibility Update, can be found here.

Lloyd's of London's market bulletin, Revised guidance on Tier 2 capital limits; timing and open year solvency requirements, can be found here.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.