With fears roiling> the municipal bond market, one firm has begun pitching retail investors an offering the pros dumped years ago: so-called bond insurance.
This month, bond insurer Assured Guaranty Municipal began offering insurance policies on about 5,000 new and existing municipal bonds to regular investors. Brokers can purchase the policies on behalf of clients through an online trading platform called TheMuniCenter. While Assured Guaranty would not disclose costs for investors, research firm Municipal Market Advisors says such insurance typically runs 1% to more than 3% of a bond sale, including brokers' fees, depending on the quality of the bonds.
While this may be a new pitch to individuals, it's old hat to the investing pros. Before the market drubbing of 2008, municipal bond insurance which guarantees an investor's principal and interest payments was hugely popular. Muni bond issuers commonly bought policies from highly rated insurance companies to help boost the credit ratings of their new offerings (and lower their payouts to investors).
Money managers, on the other hand, snapped up policies on the secondary market to add protection to their existing holdings. But many insurers, including MBIA Insurance and Ambac Assurance, got slapped with ratings downgrades in 2008 following massive losses. After that, such policies stopped providing a ratings lift for new issues, says Stanislas Rouyer, senior vice president and team leader of Moody's Specialty Insurance team.
Meanwhile, yield-hungry investors began seeking out muni bonds with higher payouts most of which lacked insurance, say experts. Today, just 5% of municipal bonds are insured, down from 57% in 2005, according to Thomson Reuters. And the number of companies insuring new bonds has plummeted from about nine to one Assured Guaranty, says Rouyer. The other bond insurers have ceased writing new policies for bonds, and some have even stopped paying existing claims due to financial hardships, says Rouyer. "People have moved on and realized that insurance, because of all the problems it's had, may not be worth it," says Anthony Valeri, a fixed income strategist for LPL Financial.
But while professional investors and municipal bond issuers have all but abandoned the market for bond insurance, Assured Guaranty says it's betting that individual investors will increasingly demand such protection for their muni holdings. "Before the financial crisis everybody was a little more comfortable taking risk," says Sabra Purtill, managing director of investor relations for Assured Guaranty. "This is a good product to offer to the individual investor market, particularly for people who need more yield but are afraid of the risk."
Many financial advisers, however, disagree, cautioning that bond insurance makes little sense for most investors. "It may be nice fall back for people psychologically, but insurance has never really been needed," says Valeri. Indeed, Valeri and others say the credit concerns that sparked the $40 billion selloff in muni bond funds that started last November are overblown and the chance of defaults remains low.
Even in the case of a default, investors usually recover up to 80% of their investment on highly graded municipal bonds, according to MMA. Another risk is that the insurer itself may not survive the next five years or more, says Josh Gonze, a municipal bond fund manager for Thornburg Investment Management. "What if the bond insurer is not around in 10 or 20 or 30 years?" Assured Guaranty said in a statement that it has a strong track record of making scheduled payments on claims and that it avoided backing the risky securities that caused many competitors to be downgraded during the crisis.