Muni Bond Insurance Is Changing
QUESTION: Ever since municipal bond issuers started offering insurance on some new issues, I have become a pretty active bond investor. The insurance is important to me. Now I hear talk that I may be able to buy insured bonds on the secondary market as well. Is that true? And if so, where do I sign up?--P. L.
ANSWER: Such insurance does indeed exist. But it has only been available for about a year. Because not all of the bugs have been worked out of the system yet, the product isn’t yet widely offered.
When insurance for bonds that have already been traded at least once before--hence the name, secondary market--first appeared on the scene, it was available only if the new owner was willing to keep the insurance as long as he kept the bond. In other words, once insurance was attached to a bond, it became a permanent part of the bond regardless of how many times the security subsequently changed hands before maturity.
As you might guess, this created an enormous headache for the insurer and the brokers who had to keep track of which part of a bond issue was insured and which wasn’t. The distinction is important to them, because investors who want insurance have to pay for it, in the form of a higher bond price. So in effect, the insurers created two classes of the same bond. And for the system to work, a tracking system had to be devised to distinguish between the two.
What insurers came up with was a system for assigning new identification numbers to bonds they were asked to insure. And so they wouldn’t have to spend an inordinate amount of time tracking these bonds every time they changed hands, they designed the system so the bonds are always kept on deposit with a financial institution or other trustee--meaning that investors never actively take possession of them.
Insurers, brokers and investors consider all of this a less-than-perfect system. It involves a lot of paper work, and investors don’t have the option of changing their minds about the insurance once they buy the bonds.
So, insurance companies have been working on a second generation of insurance for the bonds. About three months ago, Ambac Indemnity Corp., a New York bond insurer, introduced a product that makes the insurance provision optional after the first two years. The owner of the bond actually takes possession of the instrument--an attractive feature for investors who don’t quite trust an investment they can’t put their hands on. Plus, the premium on the insurance policy is renewable every year after the first two years, so the investor has the right to drop it if he so chooses.
This insurance is available for between $2 and $9 per year per bond, depending on the bond rating. The bondholder pays this premium directly to the insurance company, so there is no need to incorporate the cost into the price of the bond.
If you’re interested in buying such bonds, check with your broker. Or, if you are interested in the new Ambac product, called Portfolio Insurance for Municipal Bonds, call Ambac directly through its servicing agent, Securities Services Co., in Washington.
One word of caution. Ambac says its insured bonds currently are intended for institutional investors. So depending on how much you intend to invest, you may encounter some difficulty in finding these bonds in blocks small enough to suit your wallet.
