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 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, the 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, it enhances the security’s marketability. It also helps 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?
If a municipality is unable to pay principal and interest because of a specific event and all covenants between the insurer and the municipality are met, the insurance will cover timely principal and interest payment 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 service projects 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 it is not already insured in the primary marketplace at issuance. There are exceptions to this point if you are trying to insure a very sizable block of bonds.
- Bond insurance went through 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 (BAM, AGM, AGC) are monoline insurers with ratings of AA from Standard and Poor’s.
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 my experience, municipal investors want 45% of their investable assets in this asset class; therefore, it is an important topic to cover with an experienced investment advisor.
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, it is best to consult your fixed income advisor for a more detailed understanding and risk assessment.
