Funding agreement backed notes are fixed-income securities issued by a special purpose vehicle whose only asset is a funding agreement purchased from a life insurance company. The notes pass through the insurer’s scheduled interest and principal payments to investors, and because the underlying funding agreement ranks alongside policyholder claims in an insolvency, the notes typically price and rate better than the same insurer’s senior unsecured bonds. The market is institutional only, and issuance reached roughly $80 billion in 2025 across more than two dozen active issuers.
The Funding Agreement at the Center
A funding agreement is a contract issued by a life insurer that behaves like a large institutional deposit. The insurer takes a lump sum and promises to return it with interest at a guaranteed fixed or floating rate over a set term. Nothing about the payment depends on mortality or life expectancy, which separates it from annuities and life policies. State insurance codes still classify funding agreements as insurance products, even though they function as investment contracts.
State law restricts who can purchase these contracts directly. Eligible purchasers are generally limited to institutional buyers, including accredited investors, government entities, and organizations with assets exceeding $25 million.1State of Texas. Texas Insurance Code Chapter 1154 – Funding Agreements, Guaranteed Investment Contracts, and Synthetic Guaranteed Investment Contracts The insurer’s obligation under the funding agreement is a direct liability of its general account, so holders stand alongside other policyholders if the insurer becomes insolvent. That policyholder-level priority is the single most important feature driving the entire FABN structure.
How the SPV Turns One Contract Into Tradable Notes
The architecture depends on legal separation between the insurer and the notes. A Special Purpose Vehicle, almost always a Delaware statutory trust, buys the funding agreement from the insurer using the proceeds raised from issuing notes to investors. From that point on, the SPV owns the funding agreement, its only income is what the insurer pays under that contract, and its only obligation is to forward those payments to note holders.
The transfer from insurer to SPV has to qualify as a true sale rather than a secured loan. If a court later recharacterized it, the funding agreement could be pulled back into the insurer’s estate in a rehabilitation proceeding and note holders would lose their structural protection. Legal counsel issues a formal true-sale opinion, and rating agencies review it closely before assigning ratings.
The SPV’s organizational documents lock it into a narrow set of permitted activities through what practitioners call separateness covenants. It cannot take on additional debt, hire employees, merge with other entities, or do any business beyond holding the funding agreement and servicing the notes. These restrictions keep the SPV from accumulating liabilities of its own.
The Payment Waterfall
Cash moves to note holders through a contractual priority built into the trust indenture. When the insurer makes a scheduled payment, the trustee pays trustee fees and administrative expenses first, then interest to note holders, then principal, with any residual returning to the insurer or its designee. Strict priority lets note holders see exactly where they stand in every distribution.
The Indenture Trustee
An indenture trustee, usually a major bank’s corporate trust division, runs the operational side. The trustee monitors compliance with the trust documents, acts as paying agent, maintains the note holder register, and handles filings and tax reporting. If the insurer misses a payment under the funding agreement, the trustee is the entity that enforces remedies on behalf of note holders.
Who Can Buy FABNs and How They Are Structured
FABNs are sold almost exclusively through private placements. The standard route is an offering under SEC Rule 144A, which permits resale of privately placed securities to Qualified Institutional Buyers. A QIB must own and invest on a discretionary basis at least $100 million in securities of unaffiliated issuers.2eCFR. 17 CFR 230.144A – Private Resales of Securities to Institutions That threshold limits the buyer pool to pension funds, insurance companies, large asset managers, and comparable institutions. Issuers often add a Regulation S component to reach non-U.S. investors, so between the two exemptions the insurer can tap domestic and international institutional capital without full SEC registration. FABNs are not available to retail investors or to smaller institutions that fall below the QIB threshold.
The notes themselves are flexible. Issuers can structure them with fixed or floating interest rates, and maturities typically range from two to thirty years. The NAIC describes the typical FABN as a “term certain liability with very predictable cash flows based on known terms, crediting rates, etc. and not exposed to policyholder behavior or other actuarial risks,”3NAIC. Funding Agreement Backed Notes/Securities – Macroprudential Working Group Analysis which is part of why they appeal to investors managing long-duration portfolios.
Credit Quality and Policyholder Priority
Credit analysis on a FABN has two layers. The first is the insurer: its claims-paying ability, regulatory capital position, and investment portfolio quality determine whether cash actually arrives. The second is the structure around the SPV.
The structural layer is where FABNs separate themselves from ordinary corporate bonds. Because the funding agreement sits in the insurer’s general account and carries policyholder priority, note holders effectively step into the shoes of policyholders if the insurer is placed into state-supervised rehabilitation or liquidation. Policyholder claims rank ahead of general creditors in every state insurance insolvency framework. Combined with the SPV’s bankruptcy remoteness, that elevated priority often lifts a FABN’s rating one or more notches above the insurer’s own senior unsecured debt.
One boundary matters here. The notes issued by the SPV are non-recourse to the insurer itself. If the insurer fails to perform under the funding agreement, note holders can look only to the SPV’s assets, which consist of the funding agreement and whatever remedies the trustee can enforce.3NAIC. Funding Agreement Backed Notes/Securities – Macroprudential Working Group Analysis The policyholder-level claim is the real credit enhancement; there is no parent guarantee behind it.
The Risks That Remain
Insurer Credit Risk
Every FABN depends on one counterparty. If the issuing life insurer’s financial condition deteriorates, the notes lose value regardless of how carefully the SPV was built. A state insurance regulator can place a troubled insurer into rehabilitation, which may alter or delay the payment schedule under the funding agreement. Policyholder priority helps in that scenario but does not guarantee full or timely recovery.
Duration Mismatch
Insurers invest FABN proceeds in long-duration assets like corporate bonds and mortgage loans. If asset maturities do not align with note maturities, interest rate movements can create losses. The NAIC has flagged duration mismatch specifically, noting that short-maturity funding vehicles “can create a duration mismatch” between the proceeds received and the assets purchased.4NAIC. Statutory Accounting Principles Working Group Meeting Materials – March 23, 2026 Longer-dated FABNs mitigate the risk because the insurer can better match asset and liability durations, but floating-rate notes still expose both sides to rate volatility.
Liquidity Risk
FABNs trade over-the-counter among institutional investors, and the market is far less liquid than investment-grade corporate bonds. The Rule 144A restriction keeps the buyer universe to QIBs, which naturally thins secondary trading. FABNs are typically not puttable, so investors cannot demand their principal back before maturity. That protects the insurer from a run-like scenario, but an investor who needs to sell early depends entirely on finding a willing buyer at an acceptable price.
The Regulatory Framework
FABNs sit at the intersection of two regulatory systems that rarely overlap elsewhere. The funding agreement is an insurance product governed by state insurance regulators; the notes sold to investors are securities subject to federal oversight.
State Insurance Regulation
State insurance departments regulate the terms and issuance of funding agreements. State codes specify who may purchase them, which insurers can issue them, and how they are accounted for on the insurer’s financial statements.5New York State Senate. New York Insurance Law 3222 – Funding Agreements Amounts credited under the agreement must reflect reasonable assumptions about investment income and expenses, so the insurer cannot promise rates it cannot sustain. Regulators also monitor overall capital adequacy, including liabilities created by outstanding funding agreements.
Federal Securities Regulation
Once the SPV issues notes, the transaction enters SEC territory. The Rule 144A exemption permits sale without full registration provided buyers are QIBs.2eCFR. 17 CFR 230.144A – Private Resales of Securities to Institutions The SPV typically prepares an offering memorandum describing the structure, the insurer’s financials, risk factors, and note terms. It is not a registration statement, but it gives institutional investors enough to run diligence.
NAIC Designations
When insurance companies buy FABNs for their own portfolios, those holdings get reported on statutory financial statements. The NAIC’s Securities Valuation Office assigns each bond a designation from 1 (highest quality) through 6 (in or near default).6NAIC. Purposes and Procedures Manual of the NAIC Investment Analysis Office The designation feeds directly into risk-based capital calculations, so a FABN rated NAIC 1 requires far less capital than one rated NAIC 3. The favorable credit profile driven by policyholder priority means most FABNs land in the NAIC 1 or 2 categories.
Tax Treatment
Most FABN SPVs are organized as pass-through entities, typically grantor trusts. The SPV pays no income tax; interest income flows through to note holders and is taxable as ordinary income in the year it is received or credited.7Internal Revenue Service. Topic No. 403 – Interest Received For domestic institutional investors like pension funds and insurance companies, the reporting is straightforward.
Foreign government investors may qualify for an exemption under Section 892 of the Internal Revenue Code, which excludes certain investment income earned by foreign sovereigns from U.S. tax when the income is not derived from commercial activity. The IRS finalized updated regulations on this exemption effective for tax years beginning on or after December 15, 2025, broadening the definition of qualifying financial instruments.8Internal Revenue Service. Internal Revenue Bulletin No. 2026-3 Foreign private investors without sovereign status generally owe U.S. withholding tax on interest income unless a treaty reduces the rate.
Why Insurers Issue Them
The economics favor FABNs over traditional corporate debt. Because the notes carry policyholder priority through the funding agreement, they price tighter than the insurer’s senior unsecured bonds, and that spread advantage translates into a lower cost of capital. FABN spreads also tend to move less and more slowly than unsecured spreads from the same issuer, which makes the funding source more stable during market stress.
FABNs let insurers manage their balance sheets with more precision too. A life insurer with long-duration liabilities, such as pension risk transfer obligations, can issue a FABN with a matching maturity and buy assets aligned with that duration. The structure creates a cleaner asset-liability match than a general corporate bond issuance, where proceeds enter the general account without a direct link to specific liabilities. Record 2025 issuance reflects that fit: growth has been driven in part by increased demand for pension risk transfer and spread-based products at life insurers, which generate exactly the long-duration liabilities FABNs are well suited to fund.