Insurance coverage has an important place in daily life: Americans insure homes, cars, lives, and businesses against unforeseen accidents or disruptions, yet many are unaware it is possible to have similar protection for specific investments.
Such is the case for investing in municipal bonds. Municipal bond insurance protects a bondholder against unexpected principal and interest payment interruptions due to delinquencies or defaults. While defaults on investment-grade municipal bonds are not commonplace, insurance provides added security and peace of mind regarding principal and interest protection.
When an issuer (municipality) wants to borrow money in the financial markets, their goal is to get that loan at the lowest interest cost possible. At the time of the initial underwriting, if an issuer decides to purchase municipal bond insurance, they not only enhance the security’s marketability but, more importantly, help the issuer keep that loan rate low. The insured rating is often higher than the underlying rating of the municipality, thus resulting in a lower net interest cost to the issuer.
So how does the insurance work?
Suppose a municipality cannot pay principal and interest on their bond issue because of a specific event, and all covenants between the insurer and the municipality have been met. In that case, the insurance will cover the timely principal and interest payments until the issuer’s financial matter is rectified.
What do I need to know about buying Muni bonds with insurance?
- Not all bond insurance companies are the same. Each insurance company has its own risk-assessment model and claims-paying ability (CPA). For example, some will only insure essential serviceprojects such as utilities, airports, and schools.
- Each insurance company carries a rating based on S&P Global Rating Service evaluations of CPA risk and how extended the insurance company is in its portfolio of like-insured obligations.
- Muni bonds come to market with and without bond insurance. Not all Munis are insurable.
- You cannot purchase bond insurance on a Muni if the issue has not already been insured at issuance. There are exceptions to this point if you are trying to insure a very sizeable block of bonds.
- Bonds insurance underwent a restructuring period following the 2008- 2009 financial crisis when legacy insurance companies overextended their coverage into riskier investments.
- New bond insurance companies in today’s market, like BAM and AGM, are monoline insurers with ratings of AA from Standard and Poor’s.
- Municipal bond insurance has no association with FDIC or SIPC.
As you can see, there are some complexities regarding municipal bond insurance and how to know which insurance-wrapped bonds are better than others.
In general, municipal bond insurance can offer added protection and peace of mind if you’re investing in municipal bonds. As always, and for any investment, knowledge is power. Knowing more about the Muni marketplace’s functioning is advantageous and essential to achieving your investment objectives. Discussing these issues with your fixed-income advisor is always time well spent.
At The DRL Group, we specialize in helping high-net-worth investors maximize their tax-free returns by proactively maintaining their custom bond portfolios through all market conditions. For more information on how we can help, please visit us at Yield-Day.com or contact one of our specialists at 281-398-8600.
The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.