Can a Bank Accept a Counter-Guarantee Issued by an Insurance Company?

Introduction

Mr. Old Man received an inquiry about the risks a bank may face when issuing a local guarantee against a counter-guarantee issued by an insurance company rather than a bank. Although the counter-guarantee may contain wording similar to that of a standard bank counter-guarantee, would a bank be willing to accept it? Let’s look at the practical considerations.

Question

Dear Mr. Old Man,

I hope you are well.

I have a question regarding guarantees issued by insurance companies.

If an insurance company issues a counter-guarantee using wording similar to that of a standard bank counter-guarantee, enabling us, as a bank, to issue a local guarantee, what risks would we face in accepting it?

Thank you in advance for your assistance.

Best regards,
H

______

Answer

Dear H.,

Thank you for your inquiry.

In principle, an insurance company may issue a counter-guarantee in favour of a bank to support the issuance of a local guarantee. However, whether a bank is willing to accept such an arrangement is another matter.

In practice, a bank may be reluctant to accept a counter-guarantee issued by an insurance company, even if its wording is similar to that of a standard bank counter-guarantee. The main concerns relate to counterparty credit risk, internal risk policies, legal enforceability, and the additional time and cost required to assess an issuer that may fall outside the bank’s established guarantee procedures.

The key considerations are as follows.

1. Internal Policies and Counterparty Acceptance

The first step is to check whether the bank’s internal policies permit it to issue a local guarantee against a counter-guarantee issued by an insurance company.

Many banks have established procedures for accepting counter-guarantees from approved banks, supported by approved counterparty limits and correspondent banking relationships. An insurance company may not fall within these established arrangements.

If the bank’s policies do not permit such an arrangement, or the insurance company is not an approved counterparty, the request may be declined without proceeding to a detailed assessment.

2. Credit Risk and Due Diligence

Even if the arrangement is permitted, the bank must assess whether the insurance company can honour its reimbursement obligations when called upon to do so.

This assessment may require a review of:

• The insurance company’s financial strength, liquidity, and claims-paying ability.
• Its credit rating, where available, and the bank’s minimum rating requirements.
• Its approved counterparty credit limit and the amount of exposure arising from the proposed transaction.
• Its legal capacity and authority to issue the counter-guarantee.

Such due diligence may involve additional work for the bank’s credit risk, legal, compliance, and operational departments. For a one-off transaction, the time and cost involved may outweigh the commercial benefits.

3. Wording and Legal Enforceability

The wording of the counter-guarantee remains important. The bank should ensure that the instrument contains a clear and enforceable undertaking to reimburse it upon presentation of a complying demand in accordance with the agreed terms.

Where appropriate, the counter-guarantee may be made subject to the Uniform Rules for Demand Guarantees (URDG 758), provided this is expressly agreed and incorporated into the instrument.

However, compliant wording alone does not eliminate the issuer’s credit risk. Even if the counter-guarantee is subject to URDG 758, the bank may still face difficulties if the insurance company fails to pay or if the undertaking proves difficult to enforce.

The bank should also consider the governing law, jurisdiction, expiry date, demand requirements, and the practical process for obtaining reimbursement.

4. A More Practical Alternative

From a practical banking perspective, the bank may prefer to require a counter-guarantee issued by a bank acceptable under its internal policies.

This approach allows the bank to rely on its established procedures for counterparty assessment, credit limits, and guarantee processing, rather than undertaking a separate assessment of an insurance company.

Of course, a bank-issued counter-guarantee is not risk-free. The issuing bank’s creditworthiness, country risk, and the enforceability of its undertaking must still be considered. Nevertheless, it may be a more practical and familiar arrangement for the receiving bank.

Conclusion

The main issue is not simply whether an insurance company can issue a counter-guarantee or whether its wording resembles that of a bank-issued instrument. The question is whether the receiving bank is willing and authorised to accept the insurance company as a counterparty and assume the associated credit and legal risks.

Unless the bank has an established policy for accepting such instruments and is prepared to conduct the necessary due diligence, the more practical approach may be to require a counter-guarantee issued by an acceptable bank.

Best regards,

Mr. Old Man