What is a Funding Agreement?

A funding agreement is a type of investment that is offered by insurance companies and is considered to be a safe investment. This type of investment is also sometimes referred to as a guaranteed investment contract. This contract has some elements of a CD and a bond, but it is a unique type of investment that can benefit investors. Here are the basics of the funding agreement and how it works.

Funding Agreement

With a funding agreement, you agree to give an insurance company a certain amount of money as principle for the investment. You also agree to let them keep the money for a specific amount of time. The insurance company will then use that money to make other investments. At the end of the investment term, the insurance company will then give back the original investment as well as a certain amount of interest.

Paying Interest

A guaranteed investment contract is similar to a CD in the way that it pays interest. Instead of making regular coupon payments to the investor like a bond, they simply keep the interest and let it accrue. Then they pay the interest at the maturity date of the funding agreement. The interest rate on the funding agreement is typically a fixed rate. In some cases, they will make it a variable rate that is tied to a particular financial index or some other type of equity.

Guarantee

Even though this type of investment is considered to be guaranteed, there are some risks associated with it still. The insurance company is guaranteeing that they will pay you a certain amount of interest as well as return your original principal at the end of the contract. The only problem with this scenario is that the guarantee is made by an insurance company. Insurance companies have gone bankrupt in the past and they will continue to do so in the future. When you are relying on an insurance company to provide a guarantee, there is always going to be some risk.

Opportunity Cost

Another risk that you will have to take into consideration is the opportunity cost. In most cases, the interest rates on funding agreements are very modest. Since you are essentially getting a guaranteed investment, the insurance company cannot guarantee large interest rates. This means that you could potentially do better by investing in other securities. Stocks, mutual funds, and even bonds could potentially do better than the funding agreement. You only have so much money to invest and if you allocate a certain amount to the funding agreement, you are missing out on the opportunity to invest in other more profitable investments.

With the low interest rates that come with funding agreements, it is possible that you might not be able to beat the rate of inflation. This means that you could potentially be losing money even though your investment is considered to be a guaranteed one. 

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