Spring 2015 11
For part a) & b),
Provision of reinsurance: it measures the uncollectible part of reinsurance coverable. Thus, it's effective in measuring the credit risk associated with reinsurance contracts.
The letter of credit: it's issued by the bank. Thus, it's effective because the bank gives the credit and can help when the insurer has trouble collecting the fund.
What do you think about the answer above?
Comments
For letter of credit, the appropriate item to cite would be "funds held by companies under reinsurance treaties." That is the item that embodies the collateral laid out by the reinsurers. For provision of reinsurance, the explanation of effectiveness can be a bit more robust: see the sample answer for this one.
Is the funds held by companies part of letter of credit?
Reinsurance company deposits in a bank an amount commensurate with the collaretal demanded from it by the cedent. The bank, in return, issues a letter of credit, to the tune of this amount, to the cedent. Letter of credit is an instrument for the cedent to hold funds under a reinsurance treaty.