Inflation Causing Captive Insurers to Re-Think LC Use

Inflationary pressures and resulting interest rate hikes are forcing captive insurers that have relied on letters of credit as a form of low cost credit to re-evaluate the cost of collateral. According to Charles Baker of Computershare Trust Company based in Kentucky, as quoted in Captive International, captive insurance companies and managers will need to consider cost implications. “Is the cost of a letter of credit now more than the cost of posting cash or securities into a trust? I think there’s going to be some conversations around doing a cost analysis of whatever collateral they may need or be currently posting.” As LCs come up for renewal, Baker said this could prompt new trusts to be established in place of LCs.

Although Baker does not necessarily think this development will impact the formation of new captives, he contends the nature of collateral will become a point of discussion with fronting carriers. New captives will carefully weigh the costs of a trust against those of an LC.

One DCW reader whose institution services captive insurers indicated that they do not offer cash trusts because this encroaches on the investment decisions of the captive. Since the primary insurer may like to control the placement of cash investments, the captive would lose the benefits of investing cash in the most effective way.

In other facets of use, LCs that are issued under syndicates as unsecure lending do not involve cash collateral. For banks asking applicants for cash to guarantee LC obligations, if would-be applicants are not offered adequate interest on that cash, that could affect use of LCs.