Bond Insurance

Bond Insurance guarantees expected payments of interest as well as principal on a bond.   This occurs in the event of a non-payment by the issuer of the bond or security.

As compensation for its insurance, the insurer is paid a premium (as a lump sum or in instalments) by the issuer or owner of the security to be insured.

Bond insurance is a form of “credit enhancement”.   This generally results in the rating of the insured security being the higher of:-

(i) the claims-paying rating of the insurer and

(ii) the rating of the bond would absent insurance (also known as the “underlying” or “shadow” rating.

The premium asked for insurance on a bond is a measure of the understood risk of failure of the issuer.

Insured securities range from municipal bonds and infrastructure bonds to asset-backed securities (ABS).  (CDO is a type of structured asset-back security (ABS).  Originally developed for the corporate debt markets, over time CDOs evolved to encompass the mortgage and mortgage-backed security (MBS) markets).  domestically and abroad.

The economic value of bond insurance to the government unit, agency, or other issuer offering bonds or other securities is a saving in interest costs.

The economic value of bond insurance to the investor purchasing or holding insured securities is based upon:-

the additional payment source provided by the insurer if the issuer fails to pay principal or interest when due (which reduces the probability of a missed payment to the joint probability that both the issuer and insurer default).

improved liquidity and

services provided by the insurer such as credit underwriting, due diligence, negotiation of terms, surveillance and remediation.

Bond insurers generally insure only securities that have underlying or shadow ratings in the investment grade category, with unenhanced ratings ranging from “Triple-B” to “Triple-A”.

 The global financial crisis of 2008 seriously harmed their business model, to the point where the continued operation of a number of bond insurers is in doubt.

Not that the insurance term monoline” means only that these companies do not have other insurance lines, such as life or property/casualty.


Bond insurance of residential mortgage-backed securities (RMBS) (RMBS is a reference to the general package of financial agreements that typically represents cash yields that are paid to investors and that are supported by cash payments received from homeowners who pay interest and principal according to terms agreed to with their lenders) commenced in the 1980s.   This expanded at an accelerated pace in the 2000s, leading up to the 2008 financial crisis.

As the housing bubble grew in the mid-2000s, bond insurers generally increased the collateral protection required for RMBS. However, both the bond insurers and the rating agencies that evaluated their credit did not anticipate the collapse of the real estate market.

In addition, following the crisis, the bond insurers became aware that many RMBS they had insured included large percentages of loans that were ineligible for securitisation. They were subject to repurchase obligations by the RMBS sponsors who originated the securitisations based upon certain representations and warranties made by the sponsors of such loans.

Unlike mortgage insurance bond insurance generally provides for unconditional payment of claims.   The insurers reserve the right to pursue contractual or other available remedies. As a result, the bond insurers were faced with billions of dollars of claims to insured security holders associated with their exposure to RMBS following the financial crisis.