The Role of Bond Insurer in Financial Markets

Bond insurers play a crucial role in financial markets by providing credit protection to bond issuers. They essentially guarantee the timely payment of interest and principal on bonds, making them a vital component of the bond market.

This credit protection allows bond issuers to borrow money at lower interest rates, as the bond insurer takes on the risk of default. By doing so, bond insurers help to reduce the cost of borrowing for issuers.

Bond insurers also provide a layer of protection for investors, as they absorb the risk of default in the event of a bond issuer's failure to pay. This adds stability to the bond market and helps to maintain investor confidence.

By assuming this risk, bond insurers can help to facilitate the issuance of bonds, which is essential for funding various projects and activities.

An insurance bond is not the same as an insurance policy, despite being often lumped together in the insurance category. It's actually a three-party agreement between the principal, the obligee, and the insurance company.

An insurance bond is meant to provide a financial guarantee that the principal will reimburse the obligee if they default or fail to fulfill their obligations. This is its primary purpose, not to pay for claims.

In most cases, bonds are written with the expectation that loss won't occur, serving as an extra layer of protection just in case the principal is liable for not meeting the terms of any work-related agreements.

Bond insurance can be a double-edged sword. Here are the key benefits and drawbacks to consider.

A higher credit rating is one of the main advantages of obtaining bond insurance. This makes securities more marketable and less risky to investors.

The cost of obtaining bond insurance is a significant drawback. It's a major expense that may not always pay off.

If bond insurance can reduce interest rates for the borrowing municipality or corporation, it primarily adds value.

There are many types of insurance bonds available, but the most common are public official bonds, license and permit bonds, fidelity bonds, and contract bonds.

Public official bonds are designed to guarantee that you will faithfully perform the duties of your office, typically issued to persons responsible for handling money. Tax collectors, treasurers, and constables are just a few examples of public officials who may require this type of bond.

A contract bond is used to guarantee fulfillment of your construction contractual obligations. Bid bonds, performance bonds, and payment bonds are all types of contract bonds that can help ensure a job is completed on time and within budget.

License and permit bonds are required for various professions and activities, such as real estate, insurance, and auto dealers. Notary bonds and auctioneer bonds are also examples of license and permit bonds.

Fidelity bonds can be used to protect your business from fraudulent acts committed by your employees, such as employee theft or dishonesty.

Here are some examples of bonds and their uses:

Public official bonds, contract bonds, license and permit bonds, and fidelity bonds are all important types of insurance bonds that can provide financial protection and peace of mind.

Bond insurance can be a valuable tool for issuers and investors alike, but it's essential to consider the pros and cons.

One of the key benefits of obtaining bond insurance is the enhanced credit rating for the issue, which makes securities more marketable and less risky to investors.

The cost of obtaining bond insurance is a major drawback, though, and bond insurance primarily adds value if it can reduce interest rates for the borrowing municipality or corporation.

Investors purchasing or holding insured securities benefit from the additional payment source provided by the insurer in case of default, reducing the probability of a missed payment.

The value proposition of bond insurance includes the insurers' credit selection, underwriting, and surveillance of the underlying transactions, which can improve market liquidity for the insured securities.

Investors in insured bonds are also protected from rating downgrades of issuers, so long as the insurer is more highly rated than the issuer.

The bond insurance industry has saved municipal bond issuers and their taxpayers $40 billion since its inception in 1971, according to the Association of Financial Guaranty Insurers.

Most bond insurers withdrew from the residential mortgage-backed securities market after the 2008 financial crisis, but highly rated providers continue to offer insurance policies.

Assured Guaranty and National Public Finance Guarantee have kept holders of insured bonds whole in situations involving Detroit, Michigan; Jefferson County, Alabama; Harrisburg, Pennsylvania; Stockton, California, and Puerto Rico.

Insured bonds have generally exhibited significant price stability relative to comparable uninsured bonds of distressed issuers in the secondary market.

Bond insurers have a history that dates back to the 1970s. Prior to the 2008 financial crisis, they suffered few material losses.

A notable exception in the municipal sector was a 1984 loss by Ambac on its exposure to the Washington Public Power Supply System (WPPSS), which helped establish the value of bond insurance.

MBIA's loss on its exposure to Allegheny Health, Education and Research Foundation (AHERF) in 1998 was another significant exception. AHERF declared bankruptcy, resulting in a loss for MBIA.

By the late 1990s and early 2000s, about 50% of U.S. municipal bonds were insured. This high penetration of insurance in the market was a testament to the reliability and trustworthiness of bond insurers.

Here are some key milestones in the history of bond insurers:

In the 1970s, bond insurers were just starting to emerge.

Prior to the 2008 financial crisis, bond insurers suffered few material losses. One notable exception was the 1984 Ambac loss on its exposure to the Washington Public Power Supply System (WPPSS), which helped establish the value of bond insurance.

By the late 1990s, about 50% of U.S. municipal bonds were insured.

MBIA had seen only one loss by 1994, earning it the title of "an almost perfect money machine" from a BusinessWeek article.

A 1998 MBIA loss on its exposure to Allegheny Health, Education and Research Foundation (AHERF), which declared bankruptcy, was another notable exception.

The 1990s and early 2000s saw a significant increase in the use of bond insurance in the municipal bond market.

Although the penetration of insurance in the municipal bond market is far lower today, Assured Guaranty's ability to continue insuring municipal bonds is evidence that a market still exists.

The Financial Crisis of 2008 was a global economic downturn that was triggered by a housing market bubble bursting in the United States. This led to a freeze in credit markets, causing widespread job losses and a sharp decline in economic output.

The crisis was fueled by subprime mortgages, which were given to borrowers who couldn't afford them, and were then packaged into securities and sold to investors around the world. These securities were often rated as low-risk, but they turned out to be worthless when the housing market collapsed.

In 2008, the US government passed the Troubled Asset Relief Program (TARP), which provided $426 billion in bailout funds to struggling banks and other financial institutions. This was a massive effort to stabilize the financial system and prevent a complete collapse.

The financial crisis led to a significant increase in unemployment, with the US unemployment rate rising from 5% in December 2007 to 10% in October 2009. This had a devastating impact on families and communities, with many people struggling to make ends meet.

In the aftermath of the crisis, there were calls for greater regulation of the financial sector to prevent similar crises in the future. The Dodd-Frank Act was passed in 2010, which aimed to increase transparency and oversight of the financial system.