The most common use of the term funding agreement in the United States is as an alternative phrase for a guaranteed investment contract, which is also known as a deposit-funds contract. It's a form of investment in which people give cash to an insurance company and then receive regular interest payments before getting their cash back at a fixed date. The term funding agreement also has other uses, most notably in litigation in countries such as the United Kingdom and Australia.
A funding agreement is usually seen as a relatively safe investment,as it offers a fixed rate of return and comes from an insurance company, which is considered relatively trustworthy. The investment in a funding agreement is not put at risk by the performance of the stock market or other financial fluctuations. Because of this, a funding agreement usually pays a fairly low rate of interest.
Although a funding agreement is a safe investment in terms of the fixed rate of return, investors are still effectively taking a gamble in the overall picture of their investment. This is because a funding agreement may pay less than they could have made through a different investment. For example, if the overall stock market performs very well during the period of the funding agreement, then putting the money into shares might have worked out better. In periods of high inflation, a funding agreement can effectively lose money if the interest rate is lower than the rise in prices. Both these risks are enhanced by the fact that funding agreements often have high fees.
Some people argue that funding agreement is a much more accurate term than guaranteed investment contract. That's because the only guarantee is from the insurance company itself. The money investors put into them is not guaranteed by the government in the same way as buying Treasury securities such as bonds. They are also not protected by a government scheme in the same way as cash deposited into a bank.
In the United Kingdom and Australia, the phrase funding agreement can also be used for situations where people want to take civil legal action but do not have enough money to pay for it. Firms will offer to take on the case in return for taking a commission of any money the client receives from the court, for example in compensation. Such deals are often marketed as being on a “no-win, no-fee” basis. However, in some situations, the client is required to take out an insurance policy against the possibility of losing the case. The client will pay the premiums, but the legal firm will receive the payout if they lose the case.