Standby letters of credit (L/Cs) are still the most popular collateral choice for captive insurance companies according to the senior vice president and manager of Comerica Bank's global and captive insurance group, Martin Ellis.

He says that usage of standby L/Cs is also continuing to grow amongst the insurance companies set up and wholly owned by non-insurance companies to act as a direct insurer or reinsurer for a parent company and its subsidiaries.

Collateral choice

In an article for Captive Insurance Times, Ellis explains that captives are generally required to provide collateral to their insurance carriers on fronted programmes, in which an insurance company (the fronting carrier) issues a policy and transfers some or all of the risk back to the insured.

The two main types of collateral provided are standby L/Cs and reinsurance trusts. According to industry surveys, Ellis says L/Cs continue to be the most popular collateral option.

Benefits

One of their biggest benefits is the investment flexibility, in which the banks generally allow some higher yielding bonds and equities to secure their L/Cs, which should result in more investment income to the captive which many argue far outweighs any added costs.Additionally, captives like the fixed dollar amount on L/Cs, which caps their liability with the front.

Playing by the same rules

One of the less talked about benefits of L/Cs, and the focus of the article by Ellis, is that they are governed by international customs and practices, so all parties to the L/C, including the issuing bank, the captive and the fronting insurance carrier, should know and play by the same rules.

He explains how L/Cs are governed by a common set of international rules developed by the International Chamber of Commerce such as UCP 600 or ISP 98, the latter of which Ellis says Comerica prefers since it is exclusively designed for standby L/Cs with more detail covering current practices.

Either way, he concludes that all parties to the L/C are playing by a consistent set of rules.

The article by Martin Ellis published in Captive Insurance Times, Standby LOC, can be found here.

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