Letter of credit

A letter of credit is a bank's undertaking to pay the cedant, against a conforming demand and without raising defenses under the reinsurance contract, an amount covering a reinsurer's obligations. It must be irrevocable, unconditional, and issued by an institution approved by the cedant's supervisor in order to unlock reinsurance credit. The problem it solves is asset immobilization: unlike a trust deposit, which requires real assets to be locked away, a letter of credit uses only a bank line and leaves the reinsurer the use of its investments. Its cost is limited to the bank's commission, a function of the reinsurer's credit standing. Its weakness is that it moves credit risk rather than removing it: the cedant now depends on the issuing bank and on its availability in stressed conditions. Banking crises have shown that these lines become scarce at exactly the moment cedants need them, which explains the partial return toward asset trusts.

A Bermudian reinsurer provides letters of credit totaling 140 million euros to fourteen European cedants in 2026, at an average cost of 78 basis points, or 1.09 million a year. During a tightening of bank credit, two of its lines are renewed only at 95 basis points and a third is cut by 20 million, forcing it to establish a replacement asset trust within thirty days.

Letter of credit, LOC, LC, Crédit documentaire de réassurance, Lettre de crédit stand-by