• Bond insurance ensures the repayment of principle and, in some cases, interest in the event of an issuer default.
• Bonds issued by companies that purchase this form of insurance may have a higher credit rating, making them more appealing to investors.
• In municipal bonds and asset-backed securities, bond insurance is the most popular kind.

Understanding Bond Insurance

The issuer’s creditworthiness is taken into account when assigning a debt instrument a rating. The lower an issuer’s credit rating, and hence the higher the return investors expect from investing in debt securities, the more risky it is perceived to be. Borrowing costs are therefore higher for these issuers than for corporations that are considered more stable and less hazardous in their estimations. Companies may undertake a credit enhancement in order to improve their credit rating and attract more investors to a bond offering.

Borrowers use credit enhancement to increase their debt or creditworthiness in order to get better terms on their debts. With bond insurance, the higher the claims-paying rating of an insurer and the underlying rating of the bond, known as “underlying rating,” can be used to boost creditworthiness of an insured asset.

Other Considerations

In general, bond insurers only cover securities with unenhanced credit ratings ranging from BBB to AAA that have investment-grade underlying ratings. When you buy bond insurance, the bond rating of the issuer is no longer relevant; instead, the credit rating of the bond insurer is applied to the bond, notching it higher.

Bondholders, by design, should not be adversely affected if the issuer of a bond in their portfolio fails to pay its obligations. From this point on, all future principal and interest payments should be handled by your insurance provider.

In most cases, bond insurance is purchased in conjunction with a new municipal bond issue. Infrastructure bonds such as those financed by public-private partnerships, non-regulated utilities, and asset-backed securities can also benefit from bond insurance (ABS).

When a bond issuer purchases bond insurance, they are guaranteeing that the bondholders will get their money back in the case of a default. When calculating the premium to be paid to the insurer as compensation, the insurance company takes the issuer’s risk into consideration.