letter of credit (LOC)
A legal commitment issued by a bank or other entity stating that, upon receipt
of certain documents, the bank will pay against drafts meeting the terms of
the letter of credit. Letters of credit are frequently used for risk financing
purposes to collateralize monies owed by an insured under various cash flow
programs such as: incurred but not paid losses in paid loss retrospective rating
programs, a means of meeting the capitalization requirements of captives, and
to satisfy the security requirements of the excess insurer in "fronted" deductible
or retention programs. For captives, LOCs serve two possible purposes: they
may be used in lieu of or in addition to cash or other securities as capital,
and/or to securitize the fronting insurer's reinsurance receivable created by
a non-admitted reinsurer (i.e., the captive).
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