Insured U.S. Municipal Bonds
Tax-exempt municipal bonds fund public works projects, as well as private projects that serve public needs.
While the tax exempt status of municipal bonds allows state and local governments to borrow money at below-market rates and gives investors an income tax advantage, insurance makes municipal bonds an even more attractive investment because scheduled interest and principal payments are guaranteed by municipal bond insurers. The guarantee covers 100% of interest and principal for the full term of the issue, and may not be cancelled. A bond may be insured in the primary or secondary market.
Today's municipal bonds are insured by monoline insurers. This means that the insurer is in one insurance business only — the insurance of debt securities — and is not exposed to risks from any other lines of business, as are, for example, property and casualty and life insurers. Further, reinsurance allows the primary companies to cede some of the risk they incur.
Municipal bonds insured by AFGI members include general obligation bonds, tax-backed revenue bonds and issues that finance utilities, health care facilities, higher education and affordable housing.
Financial guaranty insurance companies must meet the requirements of insurance regulators in every state where they do business. They are also subject to intense scrutiny from the rating agencies, which evaluate and assign a rating to every insured transaction. To test the adequacy of the companies' capital resources, the rating agencies apply a computer-simulated stress test which measures their ability to pay claims at a level comparable to those experienced during the Great Depression.
Benefits to Issuers
Issuers often prefer to offer their bonds with insurance in order to lower borrowing costs. By raising the rating on a security, bond insurance enables the issuer to save on interest costs, since bonds with the highest rating - and thus with the greatest security - pay the least interest.
Bond insurance is cost effective for an issuer as long as the interest cost savings exceed the premium paid to the insurer. Since the inception of municipal bond insurance in 1971, municipalities have saved more than $40 billion in borrowing costs through bond insurance, saving about $2 billion annually for the past decade.
Added Benefits for Smaller Issuers
For a smaller municipal issuer, buying insurance may be simpler and less expensive than applying for a credit rating from one of the major rating agencies. When interest rates are in flux, this can be very important to the issuer.
Insurance can also increase the marketability of an issue. Small or infrequent issuers are unknown to most municipal investors, and bond insurance may improve the market's acceptance of their securities.