Funding Agreement: What it is, How it Works, Example

What Is a Funding Agreement?

A funding agreement is a type of investment that some institutional investors utilize because of the instrument's low-risk, fixed-income characteristics. The term usually refers to an agreement between two parties, with an issuer offering the investor a return on a lump sum investment. Generally, two parties may enter into a legally binding funding agreement, and the terms will typically outline the scheduled use of capital as well as the expected rate of return over time to the investor.

Understanding Funding Agreements

A funding agreement product requires a lump sum investment paid to the seller, who then provides the buyer with a fixed rate of return over a specified time period, often with the return based on LIBOR, which has become the most popular benchmark in the world for short-term interest rates.

Funding agreement products are similar to capital guarantee funds or guaranteed investment contracts, as both of these instruments also promise a fixed rate of return with little or no risk to principal. In other words, guarantee funds can typically be invested in without risk of loss and are generally considered to be risk-free. However, like certificates of deposit or annuities, funding agreements typically offer only modest rates of return.

Funding agreements and similar types of investments often have liquidity limitations and require advance notice—from either the investor or the issue—for early redemption or termination of the agreement. Therefore, the agreements are often targeted for high net worth and institutional investors with substantial capital for making long-term investments. Mutual funds and pension plans often buy funding agreements due to the safety and predictability that they offer.

Funding agreement products can be offered globally and by many types of issuers. They typically don't require registration and often have a higher rate of return than money market funds. Some products may be tied to put options allowing an investor to terminate the contract after a specified period of time. As one might expect, funding agreements are most popular with those wishing to use the products for capital preservation, rather than growth, in an investment portfolio.

Example of a Funding Agreement

Mutual of Omaha provides one platform for funding agreement products available to institutional investors. These funding agreements are marketed as conservative interest-paying products with steady income payouts, and are offered for fixed terms with fixed or variable interest. The funds that are deposited are held as part of the United of Omaha Life Insurance Company General Asset Account.

After the lump-sum investment is made, the Mutual of Omaha funding agreement allows for termination and redemption for any reason by either the issuer or the investor, but contract terms require that 30 to 90 days notice be given prior to the last day of the interest rate period by either the issuer or the investor.