Municipal bond insurance protects investors who purchase bonds issued by government agencies. Issuers buy insurance to raise bond ratings, making them more attractive to investors. The US has a developed market, while Canada guarantees municipal bonds, and Europe has experienced growth. There are two types of bonds: general and tax. Bond insurance benefits insurers with lower interest rates and investors with guaranteed interest payments. Insurance companies only insure entities with strong credit ratings and have experts who assess bond issuers’ stability and creditworthiness.
Municipal bond insurance provides protection to investors who have purchased municipal bonds, or munis, issued by state, city and government agencies. Bonds are debt instruments sold to raise the capital needed to finance various public projects, including infrastructure, schools and housing developments. Many municipal bond issuers also use many of the projects they finance to create revenue streams. Issuers buy municipal bond insurance to raise the rating of bonds, thus making them more attractive to investors.
MGIC Investment Corporation formed the first municipal bond insurance company in the United States in 1971. Until that time, government bond offerings were rarely insured. By 1975, New York City’s near-bankruptcy had brought many investors to Wall Street concerned about the consequences of the city’s default on bond payments. When a large Pacific Northwest utility, Washington Public Power Supply, was unable to meet its payments on $2 billion in outstanding bond payments in 1983, pressure on secured municipal bonds started to grow. These incidents highlighted the increased vulnerability of investing in municipal bonds.
Internationally, the municipal bond market has not developed as it has in the United States. Although Canada is the second largest issuer of municipal bonds outside America, municipal bond insurance plays a minor role as bonds issued by municipalities are guaranteed by Canadian Municipal Finance Corporations. Over the past decade, the European municipal bond market has experienced growth. Some of America’s largest municipal bond insurance companies have even opened international offices or set up joint ventures to help insure matters. However, most infrastructure projects and other public works are still financed primarily by banks specializing in municipal finance.
There are basically two types of bonds issued by government agencies and agencies: general bonds and tax bonds. General compulsory bonds are usually repaid by revenue and taxes. The assets are not used to secure general mandatory obligations. The principal and interest payments owed on the tax bonds are paid from the revenue generated by the project financed by the bond issuance, such as toll bridges and sports stadiums.
Issuers buy bond insurance in order to raise the credit rating on their municipal bond offerings to triple A. The credit rating of the issuer is not the most important factor in municipal bond rating. The benefit realized by bond insurers is the lower interest rate they generally pay bond buyers. Usually, investors will accept a lower return on their investment capital in exchange for guaranteed interest payments. Buyers also prefer the security of their capital afforded by council bond insurance.
If the issuer of the bond defaults on payments, the insurance company that issued the policy will pay interest as due. As promised, principal will be paid on the bond’s maturity date. If the municipal bonds are held in an investment fund, the insurance is good for the life of the bonds or the life of the fund. Municipal bond funds may also carry bond insurance. Typically, municipal bonds must be rated BBB or higher to qualify for municipal bond insurance.
Insurance companies will only insure entities with a strong investment grade credit rating. Most municipal bond insurance companies have a staff of municipal bond experts, including credit analysts, lawyers, and municipal bond finance professionals. These individuals are well trained in every aspect of assessing the stability and creditworthiness of bond issuers. Areas typically analyzed include revenue, expenditure, and the state of the regional economy. Experts may also consider the tax base as well as the overall financial strength of the issuer.
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