Bond Insurance is also called “Financial Guarantee Insurance”. It is a type of insurance in which insurance company guarantees the payment of the periodic rentals of the rent by the issuer of bond. Insurance Premium paid by the issuer of the bond to the insurance company depends upon several factors. If the issuer of the bond has good repute in the market for paying off the schedule payments and rating of bond is also good, the insurance premium will be lesser since the issuer of the bond will be in better negation position. Issuer of bonds normally contact reputed insurance companies for the insurance since the repute of the insurance company also affects the bond rating. Several kinds of securities can be insured under the category of Bond Insurance from municipal bonds, infrastructural bonds, asset backed securities; residential mortgage backed securities and collateralized debt obligations.
Benefits of Bond Insurance
There are several kinds of benefits which issuer of the bond enjoys if bonds are insured by a reputable insurance company. Some of them are listed below;
As mentioned above, the most important benefit of having bond insurance is the rating of the bond. Rating of the bonds is an important factor for investors when they decide to invest in a bond. A good insurance company boosts the confidence of investors as well as credit rating agencies.
When a reputable insurance company insures the bond, it gives more confidence to the investors. As a result of this, demand of the bond in the market increases while supply is stagnant. Even if the issuer of the bond pays lesser interest upon the bond, people will still be interested in getting this bond. So, by having bond insurance bond issuer saves the money of the interest they may have to pay otherwise.
Liquidity refers to the cash and other assets which can be readily convertible into cash. When bond issuer pays lesser interest to the public, they actually save some money and improve its liquidity condition.
Bond issuers are normally financial institutions and they offer several other kinds of services as well apart from issuing bonds. When they engage an investor by issuing bonds, there are more chances that he will contact them for other services if he needs such as credit underwriting, due diligence, negation of terms, surveillance and remediation.
Generally, bond insurers only insure securities with low bond rating. But sometimes they also have to insure the highly trusted securities like government bonds. In 1971, government bonds were insured by the insurance companies. When a government bond is insured by the insurance company, it is called Monolies. Normally government bonds are secured only in the time of credit crunch when people have more doubt about the recoverability of their investment. Otherwise, government bonds are treated to be the least risky investment in any economic literature. This is the reason, you will find that government bonds pay lesser interest even if they don’t have bond insurance.