Unlike car or homeowner’s insurance, which is issued by an agency to protect property, bond insurance protects a real cash investment. Bond insurance can seem a little complicated at first. However, it’s highly advisable that you consider bond insurance when presented with an investment opportunity.
What Is a Bond?
In order to fully understand how bond insurance functions, let’s back up a bit and take a look at what a bond entails. Sometimes companies and government agencies need to raise money—they might want to improve public school infrastructure or launch new projects.Bonds are like loans, issued by a corporation (the issuer) and paid for by an investor (the bondholder). The bond holder pays a specific amount of money to the bond issuer over a set period of time, in exchange for periodic interest payments.
What Is Bond Insurance?
So, what happens if the bond issuer goes out of business? This is called event of default, and it usually occurs after a lender demands full repayment of an outstanding debt prior to when the bond issuer was expecting. Circumstances that may trigger an event of default include breech of contract, declaration of bankruptcy,and non-repayment at loan maturity.
If and when this happens, bond insurance is used as a safeguard for bond holders—it ensures that they still receive principle and interest payments despite the bond issuer’s financial status.
Benefits of Bond Insurance
Bond insurance is advisable for many reasons. Typically, when an issuer proposes a bond to potential investors, a bond rating will be assigned to the investment opportunity according to the issuer’s regular credit quality.
There are several independent rating services available to proscribe this credit quality score. Basically, it gives investors an idea of the fiscal strength backing the bond, and the company’s ability to pay back the bond principle and interest over any length of time.
When the issuer purchases bond insurance, it generally improves its credit rating, which subsequently reduces the amount of interest needed to pay on the bond. Aside from helping the company issuing the bond, it’s also a layer of protection for the investors, ensuring they will receive their principle and interest in the event that the company can’t make payments.
It’s always a smart decision to investigate any company or agency proposing bonds as investment opportunities. Like most things in life, there are always risks involved. However, businesses should know that there are ways to minimize risks, particularly when it comes to bond insurance.
If you’re presented with this kind of investment opportunity, ask about bond insurance and look at the company’s credit rating—it will help you make smart financial decisions for your future.