WHAT DOES MUNICIPAL BOND INSURANCE INSURE?

Municipal bond insurance companies guarantee that the interest and principal of a municipal bond will be paid on time if the bond issuer is unable to do so.  In the event of a default, the insurance company makes the payments to ensure that investors receive their principal and interest earnings promptly.  This guarantee generally lasts for the entire life of the bond and cannot be cancelled by the insurer.  An exception to this rule is in the case of unit investment trusts.  With unit investment trusts, the bonds can be insured either for their lives or for the life of the trust only.  Insurance companies usually insure only municipal bonds with credit ratings of BBB or higher.  Policies can also be taken out on municipal bond funds.

When a municipal bond is first issued, it may come with a condition called a sinking fund requirement.  To pay off its bond debts, a municipal bond issuer may be required to make regular cash payments to a sinking fund trustee.  This condition requires the bond issuer to pay off a certain amount of the bond debt each year by making payments to the fund's trustee.  Municipal bond insurance also covers sinking fund payments, making sure the fund is kept up to date and that no payments are missed.

Now let's look at the process by which municipal bonds become insured.