What is Bond Insurance?
Bond Insurance (or financial guaranty insurance), is an insurance policy that is purchased by the bond issuer that guarantees that the Principal and accompanying interest is repaid to the bondholders if the bond’s issuer defaults. They generally do this to boost the credit rating, so that the interest that they pay will be lower, due to the bond’s rating being enhanced and more valuable than it would have been if not for the insurance.
Generally, this type of insurance is purchased when a new municipal security is issued. It can also be used with new Infrastructure bonds, to facilitate the issuing of asset-backed securities, utilities not regulated by the U. S., and financing private/public partnerships. These are usually issued by local governments, states and of the various agencies in the U.S. and some other countries.
The insurers of these bonds usually only insure securities that are deemed to be investment grade and whose ratings without this credit boost are already from BBB to AAA. the Debt instrument’s rating is reflective of the issuer’s creditworthiness. After the insurance has been purchased, the bond rating for the issuer will no longer apply, but rather the bond issuer’s credit rating will now be applied to the bond.
This type of insurance is valuable to the issuers of the bonds because it lowers the borrowing costs to the government agencies and others who issue these bonds, because of the investor confidence being raised and the gain in credit enhancement, even though they generally accept an interest rate that is typically lower. As far as interest savings, it’s pretty much shared between the issuer and the insurer. The issuer realizes and incentive to purchase the insurance and the insurer will receive the insurance premium. The investor also can look forward to being paid by the insurer in the event of the issuer not paying the principal and internet on time.
The two main types of bond insurance are known as surety and fidelity, each offering different protections. The surety bond guarantees that a company will abide by all of the promises outlined in the contract, as well as to guarantee that they will meet the financial responsibility and performance specifications to finish the job. The fidelity bond insures against loss resulting from fraudulent and dishonest acts by individuals, usually employees.