Co-insurance Effect

DEFINITION of 'Co-insurance Effect'

A theory on corporate debt that posits that the likelihood of default decreases when two firms' assets and liabilities are combined through a merger or acquisition compared to the likelihood of default in the individual companies. The co-insurance effect relates to the concept of diversification, as risky debt is spread across the new firm's operations.

BREAKING DOWN 'Co-insurance Effect'

If the co-insurance effect is true, firms that merge may experience financial synergies through combining operations. Furthermore, the combined debt should be safer than before, which should reduce the yield investors demand from the corporation's bonds. This can reduce the cost of issuing new debt for the company, making it cheaper to raise additional funds.

RELATED TERMS
  1. Coinsurer

    One of the parties that provides additional insurance to the ...
  2. Coinsurance Formula

    The homeowners insurance formula that determines the amount of ...
  3. Default Probability

    The degree of likelihood that the borrower of a loan or debt ...
  4. Waiver Of Coinsurance Clause

    Language in an insurance policy that says the insurance company ...
  5. Temporary Default

    A bond rating that suggests the issuer might not make all of ...
  6. Debt Load

    The amount of debt or leverage that a company is carrying on ...
Related Articles
  1. Insurance

    Understanding Co-Insurance

    Co-insurance is a cost-sharing agreement between an insurer and an insured party.
  2. Retirement

    Medicare Part D Is Changing How You Pay for Drugs

    As the price of prescription medication rises and the population ages, insurers are looking for ways to cut costs. That's where coinsurance comes in.
  3. Economics

    Understanding Default Risk

    Default risk is the chance that companies or individuals will be unable to pay their debts.
  4. Options & Futures

    Mergers and Acquisitions: Definition

    The Main Idea One plus one makes three: this equation is the special alchemy of a merger or an acquisition. The key principle behind buying a company is to create shareholder value over and ...
  5. Options & Futures

    Financial Statements: Long-Term Liabilities

    By David Harper (Contact David)Long-term liabilities are company obligations that extend beyond the current year, or alternately, beyond the current operating cycle. Most commonly, these include ...
  6. Investing Basics

    Understanding Leverage Ratios

    Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios - including the debt, ...
  7. Professionals

    Majormedical Insurance and Benefits

    Majormedical Insurance and Benefits
  8. Professionals

    Capital Structure

    This is an important concept in valuing a company.
  9. Bonds & Fixed Income

    Evaluating A Company's Capital Structure

    Learn to use the composition of debt and equity to evaluate balance sheet strength.
  10. Investing Basics

    Will Corporate Debt Drag Your Stock Down?

    Borrowed funds can mean a leg up for companies or the boot for investors. Find out how to tell the difference.
RELATED FAQS
  1. In what types of financial situations would credit spread risk be applied instead ...

    Find out when credit risk is realized as spread risk and when it is realized as default risk, and learn why market participants ... Read Answer >>
  2. What is the difference between a merger and a takeover?

    In a general sense, mergers and takeovers (or acquisitions) are very similar corporate actions - they combine two previously ... Read Answer >>
  3. What are the main benchmarks that track the forest products sector?

    Learn how the net debt to EBITDA ratio, EBITDA to interest ratio and debt to capital ratio financial benchmarks are used ... Read Answer >>
  4. What factors are taken into account to quantify credit risk?

    Learn how probability of default, or PD; loss given default, or LGD; and exposure at default, or EAD, are used to help quantify ... Read Answer >>
  5. Why would you look at a company's net debt rather than its gross debt?

    Learn the difference between net debt and gross debt, how to calculate debt using a company's financial statements and why ... Read Answer >>
  6. What is a good debt ratio, and what is a bad debt ratio?

    Learn about the factors that influence how investors and lenders evaluate the debt ratio for a company and why the answer ... Read Answer >>
Hot Definitions
  1. Yield Curve

    A line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity ...
  2. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  3. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  4. Society for Worldwide Interbank Financial Telecommunications ...

    A member-owned cooperative that provides safe and secure financial transactions for its members. Established in 1973, the ...
  5. Generally Accepted Accounting Principles - GAAP

    The common set of accounting principles, standards and procedures that companies use to compile their financial statements. ...
  6. DuPont Analysis

    A method of performance measurement that was started by the DuPont Corporation in the 1920s. With this method, assets are ...
Trading Center