Martin Ellis, manager of Comerica Bank's Global and Captive Insurance Group, explains why letters of credit (LOCs) are the most popular collateral option for captive insurers. An LOC is a simple one-page document that is universally accepted and governed by international customs and practices.

Fronts like LOCs because of their ease of use. An LOC may be filed away until needed, almost like a blank check, and rolls over each year under the evergreen clause. An LOC is irrevocable—meaning that a bank must pay if the LOC is drawn upon.

Captives like LOCs because of their investment flexibility. Banks generally allow investments in equities and lower-rated corporate bonds, generating extra investment income and offsetting added cost. LOCs work well for group captives where members post LOCs to the bank as capital and the bank in turn issues a single LOC to the front.