Bond Insurance is when an insurance provider will guarantee the principal and interest payments on a bond against defaulted payments by the issuer. Generally speaking, you should always consult with an expert commercial insurance agent before buying a bond insurance policy as they can offer you direct guidance and expertise that is tailored to your individual needs and demands.
Here, we outline the key points you need to know before buying bond insurance for your business.
What is a Bond Insurance Policy?
When you buy a bond insurance policy, it means that in the event of a default occurring, the repayment is guaranteed to the bondholders. Once you purchase a bond insurance policy, the bond rating of the issuer will no longer be applicable. Instead, the credit rating of the insurer is applied to the bond. Bond insurance is often referred to as financial guarantee insurance.
How exactly does a Bond Insurance policy work?
The insurer will take up any liability, and will make any payments covering both the principal and interest. To a bondholder, this means they will not encounter a significant disruption if there is a default by the issuer, and the insurer is paid a premium in return for providing this service.
It is essentially a type of credit enhancement, and the cost of the premiums that are paid directly relates to the potential risk of a failure by the issuer. Bond insurance premiums can either be paid monthly or as a lump sum. Bonding serves as a benefit for a contractor, and it performs similarly to insurance for the contractor’s clients.
A bond insurance provider is classified as a monoline, which means they will not sell other types of insurance policies, such as property, life or health insurance. Unlike municipal bonds, bond insurance companies can operate in more than one securities market.
The cost of borrowing is typically lower for issuers of insured bonds. This is usually because an investor will typically be prepared to take a lower interest rate in return for the credit enhancement they receive from the insurance. Any savings in interest will generally be split between the insurer (as the insurance premium), and the issuer (as the incentive to use insurance). Because the issuer can sell its securities with or without insurance, it is normally only ever used when the end-result demonstrates a clear cost-saving benefit.
Non-municipal insurance premiums are generally paid in installments, and municipal bond insurance premiums will be paid as a lump sum.
For an investor who either holds or buys insured bonds will benefit from having an extra payment source that is provided by the insurance in the event the issuer defaults on their payment. This also makes the likelihood of a missed payment occurring much less too.
A bond insurance company will also work directly with issuers to help them avoid defaults, and they can also help by guiding any debt restructuring process as well. Should an event occur, then any litigations involved in the recovery will always fall down to the insurance company to handle, and not the investor.
An investor with insured bonds will also receive additional protection from a downgrade of an issuer’s rating; this is as long as the insurer is rated more highly than the issuer.
Buying financial guarantee insurance is something that should be discussed in detail with an expert bond insurance agent. They can offer guidance and give you a clear indication of the best companies to buy a bond insurance policy from.