What is Bond Insurance?

Answer:
Bond insurance is insurance underwritten

by a private insurance company that guarantees that the interest and principal payments on a bond will be made when due if an issuer of a bond defaults. Because bonds have certain financial risks associated with them many investors choose to purchase bond insurance in order to protect their investments against loss.

The primary risk of a bond is that it could default. This can happen if the government has issued bonds, but does not have the funds to make timely payments on the interest and principal. The marketability of a bond increases when insured. In fact, bond insurance assists unknown or small issuers to be taken seriously by investors. Municipal bonds rely on projects they finance to bring in expected revenues. In fact, the governments that issue municipal bonds rely on the revenues to pay back the issued bonds.

An investor purchases bond insurance by paying a one time premium at the time of the bond closing. Each bond insurer has its own specific credit criteria and not all issues qualify for bond insurance. However, if it does qualify, the insurance policy may be purchased either by what is known as a “direct purchase” or by “elective bidding.” With a direct purchase, the issuer purchases the policy “directly” from an insurer. With “elective bidding” bidders choose whether or not to insure issues when the bonds are sold. Bond dealers offering bids decide if the purchase of insurance will result in a superior bid. And, if a winning bidder offers a bid which includes insurance, then the bidder pays for the bond insurance policy.