REGIONAL BOND INSURANCE
Local bond owners can buy insurance for them. Despite the fact that municipal bonds are considered very safe, some investors are easier to sleep if they know that their investments are also protected against losses. A competent investor should understand the mechanisms of insuring municipal bonds, knowing their advantages and disadvantages, to get the right choice: to buy municipal bond insurance or not.
Why Do You Need Municipal Bond Insurance
Municipal bonds are debts incurred by states, municipalities or municipalities to provide financing for public projects and services, such as schools, hospitals and housing. Regional bond insurance is an insurance policy, the subject of insurance is a bond, and the insurance company (the person selling the policy) is a private insurance company.
Like other bonds, municipal bonds have certain risks. The main risk is the risk of default - the issuer's refusal to pay. The default means that municipal governments that issue bonds do not have enough funds to ensure timely payment of all bond payments.
When issuing regional bonds, future project revenue that finance the issuance of bonds can also be used as collateral. Thus, the added risk of such bonds is the possibility that this particular project will not work and can not provide sufficient revenue streams for timely payment of bonds. Insurance gives investors confidence that no matter what happens, interest and principal debt on the bonds will be paid in full and on time.
If a bond has a low risk of failure, then it is given a high credit rating, which positively affects its market price. In addition, a higher credit rating will receive bonds, where there is insurance. As a rule, the insured bonds get the highest possible credit rating: AAA. A higher credit rating allows the local government to issue lower interest on the bond when issuing it.
There are four major institutions that assign credit ratings to bonds:
- Moody's Investors Service
- Standard & Poor's Corporation
- Fitch IBCA, Inc.
- Duff & Phelps Credit Rating Co.
Regional bond insurers also increase their market appeal. In addition, insurance helps investors to seriously look at small municipal issuers that are unknown to the market or do not issue bonds quite often.
What is Covered in Municipal Bond Insurance?
The guarantor company guarantees investors in local bonds that the interest and principal payments on the bonds will be paid in full and on time, if the issuer can not do so. In the event of a failure, the insurer makes all necessary payments to ensure that the investor receives all such amounts due to them. This warranty usually applies to all periods of the circulation of the bond and can not be canceled by the insurance company. Exceptions to this rule apply only to investment trust. In the case of investment trusts, bonds can be insured for the entire period of their circulation or for the life of the trust itself. Insurance companies usually insure local government bonds with only BBB or higher rating. Insurance policies can be written off to municipal bond funds.
On the initial placement of the local bonds, there may be a condition known as "demand for depreciation funds". To settle the bonds payable, the local government must make regular payments to the holders of special depreciation funds. Regional bond insurers also include these depreciation deductions, ensuring that the funds remain up to date and no payments are missed.
How are Municipal Bonds Insured?
Before issuing insurance to municipal bonds and offering them to investors, the bonds are bought by an underwriter, who in turn collects insurance and sells it to investors. Underwriting is the process of assessing the risks associated with bonds made by insurance companies. In the underwriting process, the insurance company decides whether to provide insurance for the issuance of these bonds and on what terms. Most of the companies that include local bonds are mono-food companies. This means that the company only issues insurance only on debt instruments, thus eliminating risks arising when insuring other products or services. This insurance company gets a careful analysis by the same rating agency that gives credit ratings on the bond itself.
Once the bonds are insured, their indicators are carefully monitored by the insurance company. This process is known as "observation". Under scrutiny, the insurance company carefully examines the bond issuer's financial statements and tries to ensure that the issuer's credit worthiness will be considered stable.
After underwriting, which takes about a month, the bonds are rated new. They are also given a special identification number, known as CUSIP. CUSIP is used to identify security when traded on the market or paid off.
Lack of Local Bond Insurance
Issuers of regional bonds must pay insurance premiums for insurance companies to issue insurance on their bonds. Despite the fact that investors do not pay these premiums directly, the fact that investment companies and issuers pay them, means these fees are transferred to investors. Transfer mechanisms usually lower the interest rate on bonds. Issuers are reducing interest rates, taking advantage of the fact that insured bonds now have AAA ratings. As you know, for the bond with the highest rating, the interest rate is slightly lower than the bond with the lower rank. The higher the risk of bonds, the lower the credit rating, the more investors who want to take this risk when buying this bond. In order for the insurance process to make sense for the issuer of this bond, the amount of savings from the interest rate reduction should be higher than the amount of insurance premium paid to the insurance company.
Insurance from municipal bonds does not in any way guarantee that bond market prices will reach current or future levels, because even insured bonds remain exposed to the effect of changes in interest rates on the market. Thus, the bonds sold before redemption may be worth less than the purchase price or the value.
Regional Bond Insurance Company
Most municipal bonds are insured by several large insurance companies. The largest insurer of government bonds in the world is the Association of Municipal Bond Insurance (MBIA). MBIA provides financial guarantees, provides investment management services and a host of other financial services to the population, private and nonprofit organizations.
The other major players in this market are the American Corporation for the Insurance of Municipal Bonds (AMBAC). AMBAC guarantees local government bonds and structured debt products. He is also the legal successor of the oldest government bond insurer, which first insured the first problem in 1971. AMBAC became a subsidiary of Citibank in 1985 and made an initial public offering in 1991. In 1995, AMBAC and MBIA established an international joint venture called MBIA-AMBAC International.
Since 1984, the Financial Guarantee Insurance Company (FGIC) has issued insurance for more than 13,500 local government bonds. The FGIC also provides the necessary public authorities of financial services, such as provision of credit resources and direct investment in projects. Municipalities can also ensure their bonds in a number of small insurance companies specializing in this market.
Should You Buy Insurance?
Insured country's bonds have a higher credit rating. They are one of the most reliable investments. If the issuer of the bonds defaults, the main debt under the payment of bonds and interest will be given by the insurer. However, this insurance has a price - lower interest payments. The decision to buy or not guarantee municipal bonds depends on your risk appetite - are you ready to forgo future profits in exchange for additional coverage? If so, then you should definitely consider buying exactly the insured municipal bonds.
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