Who Is the Bond Insurer?

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Written By SmarterrMoney.org

The latest in personal finance to help you make smarter money choices. 

DEFINITION:Bond insurers provide insurance to guarantee the payment of principal and interest on a bond if the issuing municipality defaults. Municipal bond insurance reduces interest costs for issuers.

In the case of municipalities, bond insurance increases marketability and improves yield.

With bond insurance, the bond rating is based on the insurer’s credit instead of the underlying issuer’s credit. Both the major bond insurers — Assured Guaranty and Build America Mutual — have an “AA” rating from Standard & Poor’s (S&P), one of the largest credit rating agencies. Thus, issuers with a rating of “A” or lower could benefit from bond insurance.

Issuers with weaker credit profiles buy bond insurance to boost their marketability. Bond insurance can benefit the issuer by expanding its buyer base.

A second benefit to bond insurance is an improved (lowered) bond yield for the issuer. 

The actual savings will depend mainly on the credit quality of the issuer. Both major bond insurers have “AA” ratings; thus, any issuer with a rating below AA (i.e., A or lower) may benefit from bond insurance.

In determining whether bond insurance is worth it, the issuer must find out whether the interest savings will be greater than the insurance premium. If the upfront premium or annual premiums are greater than the interest cost savings over the life of the issue, it likely won’t make sense to purchase bond insurance. 

Direct purchase or elective bidding are the two ways to purchase bond insurance. With direct purchase, the issuer buys a policy directly from the insurer. The insurer assesses the feasibility, comparing the interest cost difference for insured versus uninsured bonds.

Only some bond issues qualify for bond insurance. Each insurer has its own requirements. Insurers also offer coverage for issues on the secondary market — such as bonds previously sold without insurance. Fee-wise, insurers may charge a fee upfront or an annual fee for the life of the bonds.  

EXAMPLE: Assured Guaranty and Build America Mutual insured $38.7 billion in bonds across 2,151 deals during 2021 — the highest amount since 2009. Assured Guaranty wrapped $23.1 billion in bonds across 1,078 deals, and Build America Mutual insured $15.6 billion across 1,073 deals. Bond insurance was used for 8.7% of all new issues last year.

What’s important here?

The purpose of bond insurance is to increase a bond’s rating. Effectively, bond insurance boosts a municipality’s credit rating to AA for a bond issuance — which also increases the bond’s liquidity. 

Bond insurance helps to save an issuer’s interest. With it, the yield on the bond should be lower. Note that in 2007, there were seven triple-A-rated bond insurers, whereas today, there are none. 

Municipal bond insurance peaked in 2007 when nearly half of the $2.5 trillion in municipal bond issues was insured — up from just 5% in 1980. However, following the financial crisis, bond insurance demand fell sharply. 

There were $18.3 billion in municipal bond issues, including insurance, during the first half of 2022. While that number went down from $20.8 billion during the first half of 2021, the rate of issues wrapped in insurance rose to 8.8% for 1H 2022 versus 8.4% for 1H 2021.