Funding Cover: What It Means, How It Works

What Is a Funding Cover?

Funding covers refer to insurance premiums held in an account with excess-of-loss reinsurance to pay insurance claims. They act as resource pools, with unused funds returned to policyholders or ceding insurers.

Key Takeaways

• Funding cover refers to insurance premiums held in an account with excess-of-loss reinsurance to pay insurance claims.
• In a funding cover, an insurer pays premiums into a fund to cover a finite risk, a type of alternative risk transfer (ART) transaction.
• Using a funding cover allows the insurer to earn income on funds that would otherwise be inactive, which is used to self-fund against claims.

Understanding Funding Covers

Funding covers generate investment income. When an insurance company underwrites a new policy, it indemnifies or compensates the policyholder from covered losses. In exchange, the insurer receives a premium. The premium pays claims and generates investment income. Insurance companies balance managing funding for claims with investing in premiums.

One approach is using an alternative risk transfer (ART) transaction, such as a funding cover. The insurer pays premiums into a fund to cover a finite risk, like a $50 million cover over five years. The fund invests the premiums, earning the insurer interest. If no claims are filed, the funding cover could earn the insurer a profit over 100%. The management company charges a fee for this service.

Funding covers also provide access to additional financing. For example, depositing $20 million into a funding cover grants access to $100 million in bridge financing. If no losses occur, the insurer receives the $20 million plus interest. If losses happen, the first drawn amount is $20 million, and a supplemental default policy covers any losses between $20 million and $100 million. Using a funding cover allows the insurer to earn income on inactive funds, self-funding against claims.

Funding Covers and Other Options for Insurance Float

A funding cover is a safe strategy for handling insurance float, but with low risks and potential returns. An insurance company’s success depends on how it utilizes its insurance float. Warren Buffet explains that an insurance business has value if its cost of float is less than market rates for money.

A funding cover is a safe strategy for handling insurance float, but with low risks and potential returns. An insurance company’s success depends on how it utilizes its insurance float. Warren Buffet explains that an insurance business has value if its cost of float is less than market rates for money.