Course 210: Municipal Bond Insurance
Why Insure Municipal Bonds?

A municipal bond is an obligation of debt issued by states and city and local governments to raise money for the public funding of projects and services such as schools and housing. Municipal bond insurance is an insurance policy on the bond and is underwritten by a private insurance company.

Insurance provides investors with the security that no matter what happens to the finances of the government that issues the bond, the bond's interest and principal payments will be made.

Like other bonds, municipal bonds have certain risks associated with them. A bond's primary risk is that it could default. If a bond defaults, it means the government that issued the bond does not have the funds to make timely payments of interest and principal.

Municipal bonds also count on the projects they finance to bring in expected revenues. The governments that issue municipal bonds often rely on these revenues to pay back the bonds they issue. Municipal bonds therefore also run the risk that these projects will fail to produce the revenue needed to pay off the bonds. Insurance provides investors with the security that no matter what happens to the finances of the government that issues the bond, the bond's interest and principal payments will be made.

Bonds with low default risk are given high credit ratings, which influence the market prices of the bonds. A bond that is insured will have a higher credit rating than a non-insured bond. Insured bonds receive the highest credit rating possible: AAA. The higher credit rating enables the bond issuer to pay a lower interest rate on the bonds when they are sold. There are four major agencies that provide bond credit ratings. These agencies are the following:

  • Moody's Investors Service
  • Standard & Poor's Corporation
  • Fitch IBCA, Inc. 
  • Duff & Phelps Credit Rating Co.

Insuring a municipal bond also increases the bond's marketability. The insurance helps smaller issuers who are unknown or do not issue bonds frequently to be taken seriously by investors.

[subsection What Does Municipal Bond Insurance Cover?

In this course
1 Introduction
2 Why Insure Municipal Bonds?

A municipal bond is an obligation of debt issued by states and city and local governments to raise money for the public funding of projects and services such as schools and housing. Municipal bond insurance is an insurance policy on the bond and is underwritten by a private insurance company.

Insurance provides investors with the security that no matter what happens to the finances of the government that issues the bond, the bond's interest and principal payments will be made.

Like other bonds, municipal bonds have certain risks associated with them. A bond's primary risk is that it could default. If a bond defaults, it means the government that issued the bond does not have the funds to make timely payments of interest and principal.

Municipal bonds also count on the projects they finance to bring in expected revenues. The governments that issue municipal bonds often rely on these revenues to pay back the bonds they issue. Municipal bonds therefore also run the risk that these projects will fail to produce the revenue needed to pay off the bonds. Insurance provides investors with the security that no matter what happens to the finances of the government that issues the bond, the bond's interest and principal payments will be made.

Bonds with low default risk are given high credit ratings, which influence the market prices of the bonds. A bond that is insured will have a higher credit rating than a non-insured bond. Insured bonds receive the highest credit rating possible: AAA. The higher credit rating enables the bond issuer to pay a lower interest rate on the bonds when they are sold. There are four major agencies that provide bond credit ratings. These agencies are the following:

  • Moody's Investors Service
  • Standard & Poor's Corporation
  • Fitch IBCA, Inc. 
  • Duff & Phelps Credit Rating Co.

Insuring a municipal bond also increases the bond's marketability. The insurance helps smaller issuers who are unknown or do not issue bonds frequently to be taken seriously by investors.

[subsection What Does Municipal Bond Insurance Cover?

3 What Does Municipal Bond Insurance Cover?
4 How Municipal Bonds Are Insured?
5 Drawbacks of Insuring Municipal Bonds
6 Municipal Bond Insurers
7 Should You Buy Insurance?

Municipal bond insurance companies guarantee that the interest and principal of a municipal bond will be paid on time if the bond issuer is unable to do so. In the event of a default, the insurance company makes the payments to ensure that investors receive their principal and interest earnings promptly. This guarantee generally lasts for the entire life of the bond and cannot be canceled by the insurer. An exception to this rule is in the case of unit investment trusts. With unit investment trusts, the bonds can be insured either for their lives or for the life of the trust only. Insurance companies usually insure only municipal bonds with credit ratings of BBB or higher. Policies can also be taken out on municipal bond funds.

When a municipal bond is first issued, it may come with a condition called a sinking fund requirement. To pay off its bond debts, a municipal bond issuer may be required to make regular cash payments to a sinking fund trustee. This condition requires the bond issuer to pay off a certain amount of the bond debt each year by making payments to the fund's trustee. Municipal bond insurance also covers sinking fund payments, making sure the fund is kept up to date and that no payments are missed.

Next: What Does Municipal Bond Insurance Cover? >>


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