Bonds are issued by governments and other institutions like universities in order to raise capital for projects. Bond insurance is acquired by the institution as a means of making the bonds more attractive to an investor, guaranteeing that the investor receives a stated return on investment if the institution defaults or goes into bankruptcy, and improves the credit rating of the bond as assigned by credit analysis organizations.
Not all guaranty bonds are issued to governments or colleges. This type of insurance can be used by public and private cooperatives to finance a joint venture and protect the investor. This instrument is also used to protect investors in enterprises that are not based in the United States.
Prior to the “great recession”, residential mortgage-backed securities were protected by bond insurance. The high incidence of unsubstantiated loans and some illegal activities prompted government and investment entities to prevent the use of bond insurance to secure what has become a risky investment that was once thought of as a safe place to invest.
The government or other entity that uses bond insurance benefits from a reduced rate of interest on the bond that must be paid on the bond if it was not insured. The extra yield of the bond that is insured can be applied to the cost of a project and reduce the time that the payment of the debt requires. Some arrangements require that the extra yield be passed along to the investors.
The investor in insured bonds benefits by having a guaranteed return. The payment of return and interest is normally lower than one might expect from a very highly traded stock. The advantage in this type of bond is an almost guaranteed return on investment that can be received even if the government that issued the bond defaults on a project or goes into bankruptcy.
The bond insurer pays the yield for the bond and interest should an entity that issued the bond fail. The guarantee of the return on investment makes inured bond one of the safest investments according to most analysts. There have been some instances where the bond insurance company could not meet the financial obligation to the investors but the number of these occurrences is minimal compared to the numbers that paid off.
Some insurance companies only deal in bond insurance and some provide bond insurance along with many other lines of insurance products. Most reputable bond insurance companies will only underwrite a bond that has an AAA rating or at worst a BBB rating. The selectivity guarantees the investor gets the return they expect and guarantee the insurer gets the insurance payments and their return as well.
Bond insurance protects the investor by preventing any loss although returns are lower than many other investments. Bond insurance assist governments and other entities in receiving the capital they need for expansion as well as financial benefits. Any individual can acquire bonds that are protected by bond insurance but the majority of these bonds are acquired by large investment organizations to stabilize the volatility in their portfolio.