Why Insure Municipal Bonds?

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Why Insure Municipal Bonds?

A municipal bond is an obligation of debt issued by states and city and local governments to raise money for the public funding of projects and services such as schools and housing. Municipal bond insurance is an insurance policy on the bond and is underwritten by a private insurance company.

Municipal bonds have default risk

Like other bonds, municipal bonds have certain risks associated with them. A bond’s primary risk is that it could default. If a bond defaults, it means the government that issued the bond does not have the funds to make timely payments of interest and principal.

Many municipal bonds also count on the projects they finance to bring in expected revenues. The governments that issue municipal bonds often rely on these revenues to pay back the bonds they issue. Municipal bonds therefore also run the risk that these projects will fail to produce the revenue needed to pay off the bonds. Insurance provides investors with the security that no matter what happens to the finances of the government that issues the bond, the bond’s interest and principal payments covered under the insurance policy will be made.

Why some bonds have high ratings

Bonds with low default risk are given high credit ratings, which influence the market prices of the bonds. A bond that is insured will have a higher credit rating than a non-insured bond. Insured bonds receive the highest credit rating possible: AAA. The higher credit rating enables the bond issuer to pay a lower interest rate on the bonds when they are sold. There are three major agencies that provide bond credit ratings. These agencies are the following:

• Moody’s Investors Service
• Standard & Poor’s Corporation
• Fitch

Insuring a municipal bond also increases the bond’s marketability. The insurance helps smaller issuers who are unknown or do not issue bonds frequently to be taken seriously by investors.