Bond Insurers
From FXPedia
A bond insurer offers investors the opportunity to protect themselves against potential losses on their bond holdings by purchasing insurance. The bond insurer agrees to underwrite the bond by assuming responsibility for interest payments and the full principal at maturity should the bond issuer be unable to meet its obligations. This enables investors to hedge potential losses on their investments.
Monoline insurers are bond insurers that provide service to a single industry. In the early 1970s, Ambac Financial Group Inc. became the first monoline insurer providing insurance on municipal bonds exclusively but several other monolines now exist. The larger ones, in addition to Ambac, include ACA Financial, FGIC, and MBIA Insurance Corporation.
The basics of bond insurance are much like any traditional form of insurance; the policy holder pays premiums to the insurance provider, who in turn, provides payment to the policy holder should specific events occur as detailed in the policy contract. Like other types of insurance, there are several factors that determine the amount of premium the insurance purchaser will be required to pay.
When taking out a life insurance policy for example, factors including age and general health affect the rate you pay. Most policies require that you take a physical and have a doctor provide a report. Premiums for bond insurance also rely on a “health check” which is expressed as a rating.
Ratings assess the quality of the bond, with the highest ratings referred to as investment grade, while the lowest ratings are considered junk status. The higher the rating, the “healthier” the investment so the lower the premium will be for the buyer.
To ensure an unbiased rating assessment for tradable securities, independent third-party organizations known as rating agencies perform this function. Standard and Poor’s (S&P) and Moody’s are two of the larger rating agencies. Both firms also rate other securities as well as the investment quality of publically-traded companies.
Update – Feb 6, 2008
Bond insurers are front and center in the news these days as the bond insurance crisis deepens. This crisis can be traced directly to the subprime mortgage issues and is a result of several of the large monoline insurers underwriting collateralized debt obligations (CDOs) containing subprime mortgages. As the number of defaulting mortgages increase, the CDOs lose value, thus triggering insurance claims for far more than the monoline insurers anticipated.
