Letters of Credit for Insurance Companies
April 1, 2022
A letter of credit from the Federal Home Loan Bank of Chicago (FHLBank Chicago) may be issued to a third-party beneficiary on a member’s behalf as an independent guarantee of its obligation to a third-party beneficiary. Letters of credit are commonly used for guarantees of lease payments, insurance premiums, or legal judgment payment, or by counterparties under swap agreements.
Members frequently use FHLBank Chicago letters of credit as a substitute for collateral (e.g., securities or cash) they are required to pledge to a third-party regulatory beneficiary. For an insurance company member, the third-party beneficiary may be a federal or state regulatory authority (such as a state-specific department of insurance, a workers’ compensation board, or a federal agency).
Benefits of FHLBank Chicago Letters of Credit
- FHLBank Chicago’s Aaa/AA+ rating (as of February 25, 2022) makes its letters of credit product ideal for situations that require a letter of credit from a highly rated institution.
- FHLBank Chicago letters of credit are competitively priced.
- FHLBank Chicago letters of credit are a cost-effective way to manage investment allocation—for example, by permitting reinvestment of low-yield securities that otherwise would have been posted as collateral to secure an obligation.
- FHLBank Chicago letters of credit are operationally convenient and offer easier access to underlying collateral than securities pledged directly to third-party beneficiaries.
- While letters of credit must be collateralized, FHLBank Chicago offers greater flexibility than third-party beneficiaries in the types of assets a member may use to collateralize its obligation. Example: Special Regulatory Deposit Replacement
Example: Special Regulatory Deposit Replacement
FHLBank Chicago provides greater flexibility to members in the collateral types that may be pledged to secure their letter-of-credit obligations. By substituting collateral pledged to third-party beneficiaries with collateral pledged to the FHLBank Chicago, members gain greater flexibility to reallocate the distribution of their investment portfolios and potentially earn income from higher-yielding assets, such as mortgage-backed securities.
For instance, suppose an insurer pledges 5-year U.S. Treasury securities for its state-specific statutory requirement to guarantee its performance of workers’ compensation insurance obligations. This collateral pledge requires the insurer to hold more Treasurys than it might otherwise desire. As an alternative, the insurer may substitute its 5-year Treasury securities with an FHLBank Chicago letter of credit. This substitution would provide the insurer flexibility in managing its investment portfolio according to its preferences—for example, by selling its Treasury assets and purchasing higher-yielding 5-year mortgage-backed securities, which in turn it might pledge to securitize the issuance of the FHLBank Chicago letter of credit.
To Learn More
Contact your Sales Director or email email@example.com to learn more about how your insurance company may benefit from FHLBank Chicago letters of credit.
Director, Client Strategy
Sales, Strategy, and Solutions
Sales, Strategy, and Solutions