Download the Schwab app from iTunes®Get the AppClose

6 Things Investors Should Know About Municipal Bond Insurance

Key Points
  • Owning an insured municipal bond can help ensure timely interest and principal payments in the rare instance that the issuer defaults.

  • The “cost” of municipal bond insurance usually comes in the form of a lower yield.

  • If you’re considering investing in insured munis, we believe the underlying rating—and not the insured rating—should fit your risk tolerance.

What’s the case for investing in insured municipal bonds? This isn’t a question many investors have had to ask in recent years.

The financial crisis in 2008 cut down most of the market’s insurers, so the chances of finding a newly issued insured muni have been pretty low in recent years. However, that may be changing now that the industry is showing signs of life again.

To be sure, the share of newly issued munis covered by insurance is still small—only around 6%, according to Bloomberg—but that’s up from just 3% in 2013. Before the crisis, nearly half of all newly issued munis were insured.

So although the market is still a far cry from its pre-crisis days, it is growing again. Here are six things to consider before investing:

1. Muni insurance can provide protection in the event of a missed interest payment or default.

In short, if you own an insured muni and the muni issuer fails to pay you on time (or defaults), the insurer will pay you instead – assuming the insurer has the financial resources to do so. You don't have to buy the insurance yourself. The city, school district, or local government that issues the bond buys it, and the insurance covers the bond until it matures—no matter who owns it.

Bond insurers offer a layer of protection

Source: Schwab Center for Financial Research. For illustrative purposes only.

However, it’s worth noting that defaults by muni issuers are rare. Moody’s Investor Services found that since 1970, only 99 out of the thousands of different municipalities they rate have defaulted. That’s better than some other parts of the bond market. For example, there were 102 corporate defaults in 2016 alone.1

Insurance doesn’t cover losses from price fluctuations caused by changes in credit quality, interest rates or other factors. If prices fall and you try to sell an insured muni before maturity, it’s possible you’ll receive less than you originally paid.

However, if an issuer suffers financial difficulty, its insured bonds should generally trade at a higher price than its uninsured bonds.

2. Having insurance can result in having more than one credit rating.

An insured bond’s primary credit rating is generally the higher of the issuer’s rating or the insurer’s rating. For example, if an A-rated municipality has bonds insured by Assured Guarantee Municipal, which is rated AA, you will generally see the bond listed as AA, with an underlying rating of A. If the insurer’s credit rating falls below the issuer’s rating—which happened to many insurers after the 2008 credit crisis—insurance coverage will generally not boost the bond’s rating.

3. Municipal bond insurance is only as good as the insurance company backing it.

Municipal bond insurers are corporations and, as the damage wrought by the financial crisis showed, they are subject to risks and financial pressures that can affect their ability to pay claims. Before the financial crisis, there were at least seven municipal bond insurers, all of them with the highest credit rating (AAA). Today, three insurers dominate the muni bond insurance marketplace and none have AAA ratings.2 Investors looking to evaluate the financial strength of a muni insurer can check the credit ratings assigned by agencies like S&P and Moody’s.

The muni bond insurance market is largely dominated by three insurers today

Source: Bloomberg, as of 5/1/ 2017.

Note: Ratings are from Standard & Poor's and Moody's Investors Service. Holdings for Assured" includes holdings for Assured Guaranty Corp and Assured Guaranty Municipal Corp (formerly FSA). The rating for Assured is the credit rating for Assured Guaranty Municipal Corp which is a subsidiary of Assured Guaranty Corp.

4. You will generally pay a price for the additional protection.

Insurance generally comes at a cost, of course. Insured bonds tend to have higher prices than uninsured ones, even from the same issuer, which generally means lower yields for insured-bond investors. How much lower depends in part on a bond’s underlying credit rating. If insurance coverage significantly boosts a bond’s insured credit rating above its underlying credit rating, then the insured bond will likely have a higher price/offer a lower yield because the insurance would add a layer of protection against missed principal or interest payments. However, if the underlying rating is higher or the same as the insured rating, then there might be no difference in yields between an insured and uninsured bond (perhaps because the issuer simply has a very high credit rating).

The table below shows a selection of insured and uninsured bonds from As you can see, some bonds—such as the highly rated Connecticut state GO—offer comparable yields regardless of whether they are insured. However, lower rated bonds, like the Illinois state GO, can get a big boost from insurance.

We chose these examples for illustration only. The differences in yields for the individual bonds may also be attributable to certain call features, different coupons and different dealer pricing.

Source: Schwab Bond Source, as of 5/1/ 2017.

Note: Yields for bonds listed on Schwab Bond Source include a markup of $100. The size of each individual bond was $50,000 par. For illustration purposes only and not to be considered an investment recommendation.

5. We don’t suggest insured muni bonds solely because they are insured.

If you’re considering an insured municipal bond, we believe you should pay closer attention to the underlying rating than the insured rating. The underlying rating should fit your risk tolerance before you take insurance into account. And remember that municipal bond insurance doesn’t mean that a bond cannot default and, as we saw during the 2008 credit crisis, insurance companies can go through their own financial difficulties. If an insured municipal bond defaults and the insurance company is unable  to cover all claims, an investor may be left with less than they originally expected.

6. The Puerto Rico factor

Puerto Rico has approximately $26 billion in bonds that are insured by Assured Guaranty, MBIA, and Ambac3. On May 3rd the commonwealth sought bankruptcy-like protection—the largest municipal “bankruptcy” ever. Some muni market participants question whether insurance companies have the financial resources to make good on the policies they insure. CreditSights, a third party research firm, says in a March 21, 2017, report that it is “highly confident that Assured and MBIA policyholders will be made whole”. While the research firm thinks AMBAC policyholders will be made whole, they have run scenarios where there are losses for Ambac holders.

In our view, the final impact on various bonds and borrowers of Puerto Rico’s bankruptcy-like filing is unknown. It will likely be a long and complicated process but the outcome of the Puerto Rico situation could negatively affect insurance companies’ claims paying ability for the other bonds they insure.

The cost of protection

Muni insurance can add a layer of protection, subject to the credit quality of the insurer, in rare cases when a muni issuer can’t make timely interest or principal payments. However, this protection generally means accepting a lower yield. The decision to invest in an insured bond should depend in part on how much you value such protection.

Next Steps

Talk to Us

To discuss how this article might affect your investment decisions:

-          Call a bond specialist at Schwab anytime at 877-908-1072. 
-          Talk to a Schwab Financial Consultant at your local branch.

Are You Financially Ready to Hit the Road?
What Financial Lessons Did You Learn From Your Mother?

Important Disclosures


Thumbs up / down votes are submitted voluntarily by readers and are not meant to suggest the future performance or suitability of any account type, product or service for any particular reader and may not be representative of the experience of other readers. When displayed, thumbs up / down vote counts represent whether people found the content helpful or not helpful and are not intended as a testimonial. Any written feedback or comments collected on this page will not be published. Charles Schwab & Co., Inc. may in its sole discretion re-set the vote count to zero, remove votes appearing to be generated by robots or scripts, or remove the modules used to collect feedback and votes.