Bond Insurance: Introducing a Better Business Model

Today’s bond insurance industry has lost the ability to create value for the great majority of municipal bond issuers. Despite an environment of wide credit spreads, the weakened state of the active bond insurers has virtually eliminated their ability to improve pricing for issuers at or above the single-A credit grade. The underlying problem is that the bond insurers and the credit rating agencies embrace a business model for the sector that presumes an ability to accumulate resources in the future, after the onset of stress. The presumption causes the bond insurers to hold too few existing resources in relation to their insured risks and undercuts both their credit quality and the pricing effect of their guarantees. The solution is an alternative business model that entails a much higher level of existing claims-paying resources in relation to the insured risks. Contingent capital securities provide a cost-effective vehicle for accumulating such resources. Combined with certain operating rules and continuous quantitative testing of credit quality, the new business model can create a truly strong, stable, and transparent bond insurer.