DEFINITION of 'Bond Insurance'

Bond 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. Bond issuers buy insurance to enhance their credit rating in order to reduce the amount of interest that it needs to pay.

Bond insurance is also known as financial guaranty insurance.

BREAKING DOWN 'Bond Insurance'

The rating of a debt instrument takes into account the creditworthiness of the issuer. The more risky an issuer is deemed to be, the lower its credit rating and, thus, the higher the yield that investors expect from investing in the debt security. Such issuers are faced with a higher cost of borrowing than companies that are estimated to be stable and less risky. In order to obtain a more favorable rating and to attract more investors to a bond issue, companies may undergo a credit enhancement.

Credit enhancement is a method taken by a borrower to improve its debt or creditworthiness so as to obtain better terms for its debt. One method that may be taken to enhance credit is bond insurance, which 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 the bond would have without insurance, also known as the underlying rating. Bond insurance is a type of insurance purchased by a bond issuer to guarantee the repayment of the principal and all associated scheduled interest payments to the bondholders in the event of default. The insurance company takes the risk of the issuer into account in order to determine the premium that would be paid to the insurer as compensation.

Bond insurers generally insure only securities that have underlying ratings in the investment grade category, with unenhanced credit ratings ranging from BBB to AAA. 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.

Bond insurance typically is acquired in conjunction with a new issue of municipal securities. In addition, bond insurance can be applied to infrastructure bonds, such as those issued to finance public-private partnerships, non-U.S. regulated utilities, and asset-backed securities (ABS).

RELATED TERMS
  1. American Municipal Bond Assurance ...

    The American Municipal Bond Assurance Corporation offers insurance ...
  2. Insured Bond

    A bond with interest and principle payments insured by a third ...
  3. Secured Bond

    A secured bond is secured by the issuer's pledge of a specific ...
  4. Bond Rating Agencies

    Bond rating agencies are companies that assess the creditworthiness ...
  5. Income Bond

    An income bond is a type of debt security in which only the face ...
  6. Call Provision

    A call provision is a provision on a bond or other fixed-income ...
Related Articles
  1. Investing

    Why Bond Prices Fall When Interest Rates Rise

    Never invest in something you don’t understand. Bonds are no exception.
  2. Investing

    The Basics Of Municipal Bonds

    Investing in municipal bonds may offer a tax-free income stream, but such bonds are not without risks. Check out types of bonds and the risk factors of muni-bond.
  3. Investing

    A Guide to High Yield Corporate Bonds

    The universe of corporate high yield bonds encompasses multiple different types and structures.
  4. Investing

    How To Choose The Right Bond For You

    Bond investing is a stable and low-risk way to diversify a portfolio. However, knowing which types of bonds are right for you is not always easy.
  5. Investing

    Corporate Bond Basics: Learn to Invest

    Understand the basics of corporate bonds to increase your chances of positive returns.
RELATED FAQS
  1. What are the risks of investing in a bond?

    Are you thinking of investing in bond market? Learn more about bond market investment risk, including interest rate risk, ... Read Answer >>
  2. Are high-yield bonds better investments than low-yield bonds?

    It depends on the amount of default risk you as an investor want to be exposed to. More yield goes hand-in-hand with more ... Read Answer >>
Hot Definitions
  1. Socially Responsible Investment - SRI

    Socially responsible investing looks for investments that are considered socially conscious because of the nature of the ...
  2. Business Cycle

    The business cycle describes the rise and fall in production output of goods and services in an economy. Business cycles ...
  3. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  4. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  5. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  6. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
Trading Center