Municipal Bond Insurance: What are the risks?

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Weathering
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Joined: Sun Oct 15, 2017 4:20 pm

Municipal Bond Insurance: What are the risks?

Post by Weathering »

Question about municipal bond insurance: Does municipal bond insurance insure the bond purchaser against any risk from the issuer?
What I'm getting at is, if the issuer of a municipal bond (with an insurance policy from one of the main muni insurers) does something nefarious (e.g., decides not to pay the municipal bond purchaser for no good reason), will the insurance policy still pay the bond purchaser?

The very specific example I'm interested in is Puerto Rico municipal bonds with insurance from the higher-rated municipal bond insurers. Just because Puerto Rico may decide not to pay the municipal bond purchasers, will the municipal bond insurers need to pay the bond purchasers? Could Puerto Rico and the muni bond insurers agree that the muni bond insurance is no longer in effect? Could the muni bond insurers attempt to invalidate the insurance policies because they were entered into based on false information?
typical.investor
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Re: Municipal Bond Insurance: What are the risks?

Post by typical.investor »

Weathering wrote: Thu May 12, 2022 10:25 am Question about municipal bond insurance: Does municipal bond insurance insure the bond purchaser against any risk from the issuer?
What I'm getting at is, if the issuer of a municipal bond (with an insurance policy from one of the main muni insurers) does something nefarious (e.g., decides not to pay the municipal bond purchaser for no good reason), will the insurance policy still pay the bond purchaser?

The very specific example I'm interested in is Puerto Rico municipal bonds with insurance from the higher-rated municipal bond insurers. Just because Puerto Rico may decide not to pay the municipal bond purchasers, will the municipal bond insurers need to pay the bond purchasers? Could Puerto Rico and the muni bond insurers agree that the muni bond insurance is no longer in effect? Could the muni bond insurers attempt to invalidate the insurance policies because they were entered into based on false information?
Puerto Rico municipal bonds .... seriously? If you are looking for clarity before your purchase, then I'd choose another product.

I mean has litigation about whether insurers have rights to secured revenue ended yet? What about the insurer invalidating the policy because the bond issuer filed bankruptcy which blocked the legal remedy that the insurer had to enforce payment from pledged revenue. Those insurers got majorly screwed when denied receipt of pledged revenue.

So I wouldn't be surprised if the policies get invalidated but the courts will do what the courts will do and I don't think even informed legal opinion is going to be able to tell you what that is especially since this is newish ground here.
Topic Author
Weathering
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Re: Municipal Bond Insurance: What are the risks?

Post by Weathering »

Thank you. You have answered my question. I wasn't sure if an insurance policy for a muni bond was 100% between the insurer and the bond purchaser. It sounds like the bond issuer is still in the mix.
I only purchased $4k in Puerto Rico bonds (transportation bonds insured by AGMC). It's less than 1/10th of 1 % of the portfolio, so I just bought it for personal interest in municipal finance.
Kenneth Almquist
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Re: Municipal Bond Insurance: What are the risks?

Post by Kenneth Almquist »

Weathering wrote: Thu May 12, 2022 10:25 am Question about municipal bond insurance: Does municipal bond insurance insure the bond purchaser against any risk from the issuer?
What I'm getting at is, if the issuer of a municipal bond (with an insurance policy from one of the main muni insurers) does something nefarious (e.g., decides not to pay the municipal bond purchaser for no good reason), will the insurance policy still pay the bond purchaser?
I'm not a lawyer, but I've never heard of an insurance company trying to invalidate a bond insurance policy. In a scenario you describe, I would expect the insurance company to pay the bondholders and sue the issuer to recover the money.
typical.investor wrote: Thu May 12, 2022 1:51 pm I mean has litigation about whether insurers have rights to secured revenue ended yet? What about the insurer invalidating the policy because the bond issuer filed bankruptcy which blocked the legal remedy that the insurer had to enforce payment from pledged revenue. Those insurers got majorly screwed when denied receipt of pledged revenue.
Bankruptcy is the the primary event that the insurers insured against. If insurance companies were allowed to invalidate a policy just because the event that the policy was insuring against actually occurred, insurance policies would be worthless. So if the insurance companies tried to argue that the policies should be invalidated because Puerto Rico filed for bankruptcy, they'd be laughed out of court.

The insurance companies have been heavily involved in the Puerto Rico bankruptcy proceedings, trying to get a resolution to the bankruptcy that is as favorable to them as possible. What they haven't done is to refuse to pay bondholders, or even hint that they might do that. For whatever reason, whether it is concern about reputation or concern about the legal consequences, I haven't seen bond insurers try to walk away from their obligations. They pay, or if they can't afford to pay, they file for bankruptcy.
typical.investor
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Re: Municipal Bond Insurance: What are the risks?

Post by typical.investor »

Kenneth Almquist wrote: Fri May 13, 2022 10:00 pm
Weathering wrote: Thu May 12, 2022 10:25 am Question about municipal bond insurance: Does municipal bond insurance insure the bond purchaser against any risk from the issuer?
What I'm getting at is, if the issuer of a municipal bond (with an insurance policy from one of the main muni insurers) does something nefarious (e.g., decides not to pay the municipal bond purchaser for no good reason), will the insurance policy still pay the bond purchaser?
I'm not a lawyer, but I've never heard of an insurance company trying to invalidate a bond insurance policy. In a scenario you describe, I would expect the insurance company to pay the bondholders and sue the issuer to recover the money.
typical.investor wrote: Thu May 12, 2022 1:51 pm I mean has litigation about whether insurers have rights to secured revenue ended yet? What about the insurer invalidating the policy because the bond issuer filed bankruptcy which blocked the legal remedy that the insurer had to enforce payment from pledged revenue. Those insurers got majorly screwed when denied receipt of pledged revenue.
Bankruptcy is the the primary event that the insurers insured against. If insurance companies were allowed to invalidate a policy just because the event that the policy was insuring against actually occurred, insurance policies would be worthless. So if the insurance companies tried to argue that the policies should be invalidated because Puerto Rico filed for bankruptcy, they'd be laughed out of court.
I don't think it was a laughing matter but insurer did go to court and argued that there was a “settled understanding” of the municipal bankruptcy code whereby pledged toll and other revenue would be used to make payments in a bankruptcy. Obviously the bonds were bought at a price which reflected the promise of those payments even in bankruptcy.

So what was though to be settled wasn't and insurers went to court. I think they lost but don't know the final outcome or if they went to negotiations or what the desired remedy was.
Tier1Capital
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Re: Municipal Bond Insurance: What are the risks?

Post by Tier1Capital »

Bond insurance policies are irrevocable and the policies pay for any reason as long as the insurer is solvent. What happens between the borrower and the bond insurer doesn't impact the insurance policy.
hudson
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Re: Municipal Bond Insurance: What are the risks?

Post by hudson »

Weathering wrote: Thu May 12, 2022 2:09 pm Thank you. You have answered my question. I wasn't sure if an insurance policy for a muni bond was 100% between the insurer and the bond purchaser. It sounds like the bond issuer is still in the mix.
I only purchased $4k in Puerto Rico bonds (transportation bonds insured by AGMC). It's less than 1/10th of 1 % of the portfolio, so I just bought it for personal interest in municipal finance.
Larry Swedroe in his bond book, recommends only AAA/AA rated munis.
I've always thought that buying individual munis was for the advanced investor.
I've heard that there is an invisible haircut laying in wait for beginning investors.
I looked into buying individual munis a few years back and decided that the learning curve was to high.
I decided that if I wanted munis, VWIUX or BMBIX would work for me. (The state specific muni funds for my state are all high expense ratio funds.)
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