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What is Bond Insurance?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 10 November 2016
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    2003-2016
    Conjecture Corporation
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Bond insurance is a type of coverage that guarantees that bondholders will be reimbursed in the event that a bond issue goes into default. In most instances, the provisions of the insurance plan will not only ensure the repayment of the principal amount originally invested, but also any interest that accrues up to the point that the default takes place. Bond issuers usually secure this type of insurance as a means of protecting their own interests as well as the interests of their investors.

One immediate benefit that bond issuers receive from securing bond insurance is an increase in their overall credit rating. This has the effect of reducing the degree of risk associated with the bond issue, allowing the issuer to offer a lower rate of interest while still attracting potential investors. As another benefit, the presence of bond insurance shifts the focus from the bond rating of the issuer to the credit rating of the issuer in terms of analysts evaluating the degree of risk associated with the investment opportunity. Since the insurance coverage eliminates the risk to investors, the bond issue is typically deemed a worthy investment.

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For investors, the presence of the bond insurance means that even if the bondholder goes into some type of default, there is likely to be little to no disruption in the function of the bond itself. With most plans, the insurer simply takes up where the issuer left off, making any periodic interest payments that may be due to investors, or continuing to accrue that interest for payment when the bond reaches maturity. It is not unusual for bondholders to notice no real change in the process, other than who is issuing the interest payment. Investors who prefer to deal only with investment opportunities that are considered stable and relatively safe often verify if a given bond issue is covered with insurance before making the purchase.

While bond insurance does make it possible for issuers to structure bond options with a lower rate of interest than would be possible otherwise, this does not mean the return offered is below par. In order to attract investors, bond issuers must still make sure the amount of interest offered over the life of the bond is competitive with similar bond issues. With virtually no risk remaining and an equitable return guaranteed even in the event that the issuer defaults, a bond that is covered by bond insurance is easily worth the time and consideration of any investor seeking a safe and reliable opportunity.

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