What Is a Monoline Insurance Company?

A monoline insurance company is an insurance company that provides guarantees to debt issuers, often in the form of credit wraps that enhance the credit of the issuer.

These insurance companies first began providing wraps for municipal bond issues, but now provide credit enhancement for other types of bonds, such as mortgage-backed securities and collateralized debt obligations.

Key Takeaways

  • A monoline insurance company is an insurance company that is focused on providing only one specific type of insurance product.
  • Monoline insurance companies are typically associated with insurance companies that provide insurance on bonds.
  • Insurance on bonds and other debt securities is provided by guarantees in the form of credit wraps.
  • Credit wraps improve the credit rating of a debt issuance or prevent a downgrade.
  • Monoline insurance companies were heavily involved in the 2008 financial crisis as they insured and invested in many residential mortgages that eventually defaulted.

Understanding a Monoline Insurance Company

Issuers of debt securities will often go to monoline insurance companies to either boost the rating of one of their debt issues or to ensure that a debt issue does not become downgraded. The way that an insurance company can provide this boost in rating or prevention in downgrading is by providing a credit wrap.

The credit wrap provides comfort to investors as it protects against any losses in the security by agreeing to pay back a certain portion of the interest or principal on the loan or to buy back some defaulted loans in a portfolio. It is basically insurance on a debt security.

The ratings of debt issues that are protected by credit wraps often reflect the wrap provider's credit rating. Along with providing credit wraps, monoline insurance companies also provide bonds that protect against default in transactions that deal with physical goods.

As with the definition of monoline, monoline insurance companies only provide one type of service. They are not in the business of providing multiple insurance products, such as auto insurance, home insurance, and bond insurance. Focusing on one specific type of insurance product allows for expertise in that specific area of the insurance market.

As such, a monoline insurance company is any insurance company that focuses on providing one type of insurance product; however, the term is often used with insurance companies that provide protection on debt securities.

Monoline Insurance Companies and the 2008 Financial Crisis

Monoline insurance companies were deeply involved in the financial crisis of 2008, primarily due to certain business decisions.

Insurance Activities and Investments

Monoline insurers wrote bond insurance to enhance the quality of collateralized debt obligations, most notably those backed with residential mortgages. As well, some of these insurers participated as counterparties in credit default swaps, selling an assurance of payment to the buyer of a swap if the credit quality of a collateralized debt obligation deteriorated.

In addition, these monoline insurance companies sold guaranteed investment contracts to the municipal bond or structured finance security issuers in cases in which the issuer did not require all the proceeds initially.

Monoline insurance companies also invested in both municipal bonds and structured finance debt securities. Some invested heavily in bonds that they insured, including collateralized debt obligations backed by residential mortgages.

In each of these decisions, adverse selection and moral hazard tremendously aggravated the risks to these insurers. Furthermore, regulations were not adequate to monitor monoline industry operations, capital adequacy, and risk.

Risk Impact

Monoline insurers operated in relative anonymity until the financial crisis of 2008 and were among its earliest victims. Regulators and investors underestimated the increased risk that monoline insurers took on by expanding into correlated product lines. They also underestimated the effect and extent of their dependency on credit ratings.

The financial crisis of 2008 nearly ran the entire monoline insurance industry into extinction. There were nine primary monoline firms at the time: MBIA, Ambac, FSA, FGIC, SCA (quoted as XL Capital Assurance), Assured Guarantee, Radian Asset Assurance, ACA Financial Guarantee Corporation, and CIFG.

Most companies were based in and ran out of the states of New York or Wisconsin, with subsidiaries in several European countries. One-fifth of business reported on the balance sheets of these companies was international, and securities guaranteed by financial guarantors were held in portfolios around the world.

During and after the financial crisis, all of the monoline insurance companies saw a downgrade in their credit ratings and a negative financial impact on their balance sheets.