Bonds Insurance
Bonds insurance (also known as “financial guarantee insurance”) is a type of insurance policy that a bond issuer purchases that guarantees the repayment of the principal and all associated interest payments to the bondholders in the event of default. As compensation for its insurance, the insurer is paid a premium (as a lump sum or in installments) by the issuer or owner of the security to be insured.
Bond insurance is a form of “credit enhancement” that generally results in the rating of the insured security being the higher of the claims-paying rating of the insurer and the rating the bond would have without insurance.
How Does Bond Insurance Work?
Once bond insurance has been purchased, the issuer’s bond rating will no longer be applicable and instead, the bond insurer’s credit rating will be applied to the bond instead. By design, bondholders should not encounter too much disruption if the issuer of a bond in their portfolio goes into default. The insurer should automatically take up the liability and make any principal and interest payments owed on the issue going forward.