Liquidity providers act as syndates, supplying insurance collateral in exchange for policyholder premiums. Depending on the policy design, the collateral amount is typically much less than the coverage capacity that it supports, resulting in a high earning ratio.
To ensure that sold policies have backup capital in the event of a default, withdrawing liquidity has a lockup term that is longer than the policy's maximum length. The exact withdrawal waiting term will be mentioned on the collateral contract in each pool. During the withdrawal period, liquidity providers might still earn premiums and face capital losses if a payout happens.
The capital loss is proportional to the entire asset value in the collateral pool. For example, if Bob's deposit is 10% of the overall collateral pool and 100 USDC are used for payout, his loss is 100 x 10% = 10 USDC.