Bond insurance is when an insurance company guarantees scheduled payments of interest and principal on a bond in the event of a payment default by the issuer
Now that you’re up to date on bond valuation, let’s look at what bond insurance is and how it works.
What is Bond Insurance?
Bond insurance is a kind of policy that, in the event of default, guarantees the repayment of the principal and all associated interest payments to the bondholders. Once purchased, the issuer's bond rating is no longer applicable. Instead, the bond insurer's credit rating will be applied to the bond.
How does Bond Insurance work?
With bond insurance, the insurer should automatically take up the liability and make any principal and interest payments owed on the issue. This means that bondholders shouldn’t encounter much disruption if the issuer happens to default. As compensation for its insurance, the insurer is paid a premium.
Bond insurance is really a form of credit enhancement. The premium is a measure of the perceived risk of failure of the issuer. A majority of insured securities are municipal bonds issued by states and local governments in the U.S.
There’s a lot to know here. To learn more about bonds, check out our Investing in Different Markets course!