Category: Reinsurance fundamentals · Reviewed by Matt Bartlett, Director · Founder · Last reviewed 2026-06-05
A letter of credit (LOC) in reinsurance is a collateral structure under which a bank, on behalf of the reinsurer, irrevocably undertakes to pay the cedant on demand up to a stated maximum amount, securing the reinsurer’s obligations under the contract. The LOC is the most flexible and commonly used form of reinsurance collateral in the London market.
Category: Reinsurance fundamentals Also known as: LOC reinsurance, evergreen letter of credit Related concepts: collateralised reinsurance, trust account reinsurance, funds withheld
A reinsurance LOC is an irrevocable, unconditional undertaking by a bank to pay the beneficiary (the cedant) on simple written demand. The bank earns a commission from the reinsurer for issuing the LOC and is itself secured by cash, securities or credit committed by the reinsurer. From the cedant’s perspective the LOC converts the reinsurer’s credit risk into the credit risk of the issuing bank.
LOCs are typically issued as ‘evergreen’ (annually renewable, with provision for the bank to give notice of non-renewal — the cedant draws the LOC in full if non-renewal notice is given without a satisfactory replacement). The standard form follows the International Chamber of Commerce Uniform Customs and Practice for Documentary Credits (UCP 600) [1] or the International Standby Practices (ISP98).
For Solvency II purposes, an LOC is recognised as a credit risk mitigant where: it is irrevocable and unconditional; the issuing bank has a credit quality at least equivalent to the recognised threshold (typically Step 3 — broadly A-); and the cedant has unfettered right to draw on the LOC on the occurrence of a contractual default event. Recognition is set out in the PRA Insurance Rulebook.
LOCs are commonly used in the London and Bermuda markets to secure reinsurance recoverables of non-admitted or unrated reinsurers. The reinsurer pays a commission to the issuing bank (typically 0.5–1.5 per cent of the LOC amount annually, varying with the reinsurer’s credit standing). The bank may take security from the reinsurer (cash collateral or a charge on assets) sufficient to discharge its own credit exposure.
The cedant monitors the credit rating of the issuing bank, the LOC expiry date and the LOC amount relative to the reinsurer’s exposure. Where the bank’s credit deteriorates, the cedant may require a replacement LOC from a higher-rated bank.
The LOC structure is particularly common for working-layer XL and surplus treaty reinsurance written by Bermudian reinsurers, where the reinsurer is not admitted to write in the cedant’s jurisdiction and the cedant requires security to recognise the recoverable.
An illustrative example: a UK insurer reinsures part of its casualty book with a Bermudian reinsurer. The reinsurer arranges a £40m evergreen LOC from a London branch of a UK clearing bank in favour of the cedant. The LOC is renewable annually; if the bank gives notice of non-renewal, the cedant has the right to draw the full £40m unless a replacement LOC of equivalent standing is provided.
This entry is part of the Apex Insurance Wiki. Last reviewed by Matt Bartlett on 2026-06-05. Next review: 2026-12-05.
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