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Q: Generating Float ( Answered,   2 Comments )
Subject: Generating Float
Category: Business and Money > Finance
Asked by: nonbers-ga
List Price: $200.00
Posted: 03 May 2006 08:03 PDT
Expires: 02 Jun 2006 08:03 PDT
Question ID: 725078
From "Float is the concept that as insurance premiums are
collected up front, and claims paid over time (sometimes up to periods
of 10 years or more), the insurance companies are able to collect
investment income on the money they have reserved for claims that have
not occurred yet, or have not yet been paid."

Which business models, like insurance, generate *large* amounts of
*long-term* float?

A great answer would include at least 3 business models with *simple*
operating characteristics.

Request for Question Clarification by eiffel-ga on 04 May 2006 04:29 PDT
Hi nonbers-ga,

When you ask for business models that generate "long-term" float, how
"long-term" does it need to be?

Would one month (or three months) be OK, or does it need to be years?


Clarification of Question by nonbers-ga on 05 May 2006 07:14 PDT
Hi eiffel-ga,

Since the objective is "to collect investment income", less than two
or three years would really not suffice.

Request for Question Clarification by pafalafa-ga on 27 May 2006 06:46 PDT

Can you clarify for me what you're after, here, and what,
specifically, you consider 'long term'.

I need clarification because, even in the insurance industry, float is
typically a year or least, as I understand things.

That is, premiums are paid on an annual basis, and the policy-holder
is insured for events that may happen only during that year.

Of course, if the policy-holder continues paying up every year, then
the coverage continues over many years.  But still, the actual float
is generally regarded as being only for a year.

Of course, the insurance company retains the funds, so I suppose you
can say the money is still 'floating'.  But I just wanted to check
with you to clarify what you had in mind.

By the way, the other industries that come to mind that involve
longer-term floats (longer, say, than credit cards) are gift cards (a
fair number of which are never even redeemed) and re-insurance (which
isn't too different from plain old insurance, I suppose).

Again, let me know a bit more about your criteria for long-term, and
I'll see what I can do.


Subject: Re: Generating Float
Answered By: leapinglizard-ga on 30 May 2006 20:47 PDT
Dear nonbers,

Let me begin by observing that the term "float" has three different
financial meanings. Anyone who has operated a cash register is familiar
with the notion of a cash float, which is the sum of money added at the
beginning of a shift for change-making purposes and subtracted at the
end of the shift.

    The cash box (or petty cash box) acts as a temporary bank
    account. The float is the amount of cash placed in the box at
    the start of the day. [...]

    There is no formula for working out how much float you need,
    but one half of the day's typical cash receipts is a good
    starting point.

ZDNet: Quicken tutorial: Running a Cash Box or Cash Register

Another familiar type of float is check float, which is incurred by the
delay between the cashing of a check at the payee's bank and the honoring
of the check at the payer's bank.

    Float occurs when there is a delay in the clearing of payments
    between banks. It is most obvious in the time delay between
    when you write a check and when the funds to cover that check
    are deducted from your account.

    Once the holder of your check deposits it in his account, his bank
    immediately credits (increases) his account, assuming that your
    bank will ultimately send the funds to cover the check. Until
    your bank actually sends the funds, both you and the holder of
    the check have the "same" money in both of your accounts.

    Once his bank notifies your bank (usually by presenting the
    check you wrote and he endorsed), the "duplicate" funds are
    removed from your account and the check is considered to have
    "cleared" your bank.

Wikipedia: Float (money supply)

Then there is the long-term floating of funds, where an up-front payment
is used by a company to generate returns before any money is returned to
the client. This kind of float is essentially a loan made by the client
to the company. The Wikipedia article on insurance, which is the original
source of your quotation, makes explicit mention of this aspect.

    Although insurers traditionally depended upon underwriting profit
    to provide them with operating profit, market forces now require
    that insurers earn the bulk of their profit on investment income
    on premiums held pending claims occurrence. This is a form of
    financial leveraging.

Wikipedia: Insurance: How an insurance company makes money

Leverage is just a recondite way of saying that money is borrowed to
support an undertaking or a transaction. In the sense of borrowing
money against future returns, the purest kind of float is found in
the bond business. In this model, a company sells bonds to investors
with the guarantee that it will buy them back for a fixed price after a
certain period has elapsed. Although bonds can be resold and revalued,
resulting in a bond market that resembles the stock market, bonds are
fundamentally different from stocks in that a bond does not represent a
stake in the issuing company, only a promise that the price of the bond
will be returned with interest in the future. Note that the action of
issuing bonds is called "floating" a bond.

    If a company decides to offer, or float, bonds, the procedure
    is in some ways similar to that for issuing stock. But bonds
    are fundamentally different from stocks as a means of raising
    capital since the investor becomes a creditor of the company,
    not an owner. And the company is taking a loan, not selling
    ownership. That makes the process of floating and purchasing
    bonds different from issuing and buying stock in key ways.

Path to Investing: Issuing bonds

A business model that more closely resembles insurance in the way it
accrues float is the retirement fund. Here, as with insurance, regular
payments from the client are kept by the company and invested, thereby
gaining interest before eventual disbursement some years down the line.

    In a defined contribution plan, contributions are paid into
    an individual account for each member. The contributions are
    invested, for example in the stock market, and the returns on the
    investment (which may be positive or negative) are credited to
    the individual's account. On retirement, the member's account is
    used to provide retirement benefits, often through the purchase
    of an annuity which provides a regular income.

Wikipedia: Retirement plan

Another business that collects large quantities of float is the typical
American state lottery, because the announced jackpot is paid out
in annual installments over a period of 10 years or more. The lottery
winner may opt for a single payment, but only at a significant discount
from the announced jackpot. Thus, the money collected from the sale of
tickets is a long-term float that the lottery can invest and profit from
over several years before disbursing the full amount of the jackpot.

    In certain countries, such as the USA, the winner gets to choose
    between an annuity payment and a one-time payment. The one-time
    payment is much smaller, indeed often only half, of the advertised
    lottery jackpot, even before applying any withholding tax to
    which the prize may be subject. The annuity option provides
    regular payments over a period that may range from 10 to 40 years.

    In some online lotteries, the annual payments can be as little
    as $25,000 over 40 years, with a balloon payment in the final
    year. This type of installment payment is often made through
    investment in government-backed securities.

Wikipedia: Lottery: Payment of prizes

In some jurisdictions, notably the UK, funeral homes accumulate large
amounts of float from funeral prepayment plans. Here, the float is
simply the amount collected at the time of prepayment and subsequently
invested so as to generate returns that will cover the inflated cost of
the funeral when the time comes. Funeral prepayment is also common in
some parts of the USA.

    A funeral prepayment may be made in full or only part. Once
    prepayment is made, the State of Michigan tells the funeral home
    what they can do with the funeral prearrangement money. There are
    two methods which include funeral insurance or a trust account.
    The funeral insurance company used must be approved and regulated
    by the State of Michigan. The second method, a trust account,
    is set-up between the State of Michigan and the funeral home.
    Your money is then put into this trust account. The professional
    who helps you with your funeral prearrangement will direct you
    to the form of prepayment that is best for you. 
    In both cases, the funeral home guarantees that you will have
    the funeral you have selected and paid for. In all cases, the
    money will earn interest. The interest remains in the fund and
    accumulates over time. The intent is for the interest to keep
    up with the cost of inflation.

The Senior Corner: Funeral Preplanning

It has been an interesting challenge to work on your question. If you
have any concerns about the accuracy or completeness of my research,
please advise me through a Clarification Request and allow me the
opportunity to fully meet your needs before you rate this answer. 

Search strategy:

cash register float

check float

insurance float

bond float 

retirement fund plan
Subject: Re: Generating Float
From: myoarin-ga on 16 May 2006 13:20 PDT
Traveler's checks and cash cards issued by banks/companies generate
float, as do similar cards issued for specific use:  prepaid cell
phone cards and in some countires, cards for use in pay phones;
prepaid transit system tickets, such as for the Metro in DC and London
Public Transport.
The individual amounts may be short term, but for an ongoing
operation, the float may be a constant and significant amount.

Hope this helps a bit, maybe suggests better examples to someone else.
Subject: Re: Generating Float
From: nperkins-ga on 26 Jun 2006 12:39 PDT
Another great example is of course PayPal, which, like with checks,
has a period of time before the money can clear. For example,
transfering money to your bank account takes five days, over which the
money is still within PayPal's possession.

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