Muni Bond Insurance : About as Useful to your Investment as a Kids Comfort Object

Our society has come to value insurance in the same way little tikes value their baby blankets and teddy bears. As children we loved our teddy bears because they would protect us were anything to happen through out the night that the good 'ol night light couldn't take care of. As adults we pay up for insurance because it's supposed to protect us against any unforeseen financial boogie monsters. The majority of the time insurance serves its purpose when dealing with types of insurance like life insurance and car insurance but a teddy bear (insurance company) can only protect a certain number of people (securities), if it's spread too thin, or protects someone who lives in a ghost and ghoul ridden house (junk), it's protection powers fade to nothing. Basically in the Fall of 2008, nearly every municipal bond insurance company had its ratings lowered from AAA down to at least Aa, in most cases a lot lower than that. The reason for this is that they were insuring other types of securities aside from municipal bonds such as the CDOs that we've all heard about that started our economy to tumble. Once these securities went bad, so did the insurance companies.

The difference is that while the CDOs actually were poor investments, the municipal bonds that the same insurance companies were insuring were fine. Of course the ratings were lowered on these bonds because they could not show the insurance company's AAA which in some cases is now CC but the true quality of the bonds stayed the same insurance or none.

Municipal bonds have been known as one of the safest securities you could buy for over 100 years now, bond insurance came about in the late 1980s and shortly after that nearly 75% of all munis were rated AAA. The underlying quality of munis never changed, municipal insurance companies just came up with an easy way to make a profit. Basically as investors we love to hear that our investment is insured (comes with a teddu bear) so we'll pay more for an insured security than one that doesn't have insurance (EVEN WHEN THE SECURITY IS STRONGER THAN THE INSURANCE COMPANY). Now that the insurance companies are not worthy insurance to pay for, nearly all the municipal bonds that these companies insured are doing fine without the insurance. The moral of the story is, don't pay up for a bond that has insurance.

So how do you tell a municipal bond's true quality if you can't depend on the insurance? First off, look at what is paying the bond (ask your broker) specifically who is holding your principal and how are they going to afford to pay your interest? If it makes sense to you such as, a general obligation bond (payable from property taxes) or a essential service revenue bond (water, sewer, gas, electric) which are payable from everyone's bills, then these are reliable sources of revenue to pay off your bond. You want sources of revenue that people don't have the option to pay such as taxes, bills of an essential service, and tolls. Another factor to look at is the bond's rating without insurance. Usually this will give you a good idea of the security's quality but not something you should always depend on. Most important is what is paying your bond.

While there are some types of insurance in our society that can give great comfort such as car insurance, municipal bond insurance is just not in the security blanket category. Don't fall for it.