Bond issuers will buy this type of insurance to enhance their credit rating in order to reduce the amount of interest that it needs to pay and make the bonds more attractive to potential investors.  Bond insurance protects bondholders from default by the issuer by guaranteeing repayment of principal and sometimes interest.

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What is bond insurance?

Bond insurance is a type of insurance policy that a bond issuer purchases that guarantees the repayment of the principal and all associated interest payments to the bondholders in the event of default. Bond issuers will buy this type of insurance to enhance their credit rating in order to reduce the amount of interest that it needs to pay and make the bonds more attractive to potential investors.

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Bond insurance is sometimes also known as financial guaranty insurance.

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Some key points about bond insurance:

• Bond insurance protects bondholders from default by the issuer by guaranteeing repayment of principal and sometimes interest.

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• Issuers of bonds that purchase this type of insurance can receive a higher credit rating on those bonds as a result, making them more attractive to some investors.

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• Bond insurance is most commonly seen among municipal bonds and asset-backed securities.

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Understanding Bond Insurance

The rating of a debt instrument takes into account the creditworthiness of the issuer. The riskier an issuer is deemed to be, the lower its credit rating and, thus, the higher the yield that investors expect from investing in the debt security. Such issuers are faced with a higher cost of borrowing than companies that are estimated to be stable and less risky. In order to obtain a more favorable rating and to attract more investors to a bond issue, companies may undergo a credit enhancement.

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Credit enhancement is a method taken by a borrower to improve its debt or creditworthiness so as to obtain better terms for its debt. One method that may be taken to enhance credit is bond insurance, which generally results in the rating of the insured security being the higher of the claims-paying rating of the insurer and the rating the bond would have without insurance, also known as the underlying rating.

 

Bond insurance is a type of insurance purchased by a bond issuer to guarantee the repayment of the principal and all associated scheduled interest payments to the bondholders in the event of default. The insurance company takes the risk of the issuer into account in order to determine the premium that would be paid to the insurer as compensation.