The Declining Insurance Benefit in the Municipal Bond Market

Bronshtein, Gila; Makridis, Christos

doi:10.17310/ntj.2020.1.04

Cited by 5 publications

(2 citation statements)

References 45 publications

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“…Moreover, if bonds are subject to heterogeneous shocks that are correlated with investor types, an equilibrium may emerge with many bond issuers obtaining bond insurance. Bronshtein and Makridis (2020) show an 80-bps lower yield for insured bonds and follow a complementary approach and find similar findings ex ante 2008 GFC. (1987); Liu and Thakor (1984) Credit ratings contain information in excess of publicly available financial and economic information…”

Section: Journal Of Policy Analysis and Managementsupporting

confidence: 65%

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Icarus of the 21st century: bond/monoline insurance

Daluwathumullagamage

2021

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Purpose The business model of monoline insurers is to guarantee payments of debt issues in case of defaults by the issuer. Although sparse attention is given to monolines in literature, they play an important role in enabling municipalities and firms in refinancing. This study aims to conduct a systematic review of 181 articles from 1990 to 2020 from 23,130 records and a case study on the key monoline insurers. Key failure, success factors and demand for future monoline insurance are identified. Finally, the study explores monolines’ potential during COVID-19 and develops a framework for monoline governance and regulation. Design/methodology/approach The study follows Briner and Denyer and Moher et al. to implement the systematic review. The methodology involves ascertaining the motivation behind the review, and formulating research questions; aggregating relevant prior literature from scientific databases, conducting quality assessment and synthesising the data; and conducting extensive analysis for framework development. Case study methodology foundation phase focuses on understanding the research philosophy. The second phase involves documenting the procedures involved. The final phase involves collecting the relevant quantitative and qualitative material. In addition, collecting empirical data from numerous sources allows triangulation. Findings The review results of 181 articles from 1990 to 2020 show that peak article counts occur in 2010 and 2013 (nine academic studies) and in 2008 and 2010 (six industry studies). Over- and under-explored domains happen to be bond pricing (86 academic studies) and bond markets (36 industry studies) and corporate bonds (19 academic studies), respectively. The study highlights failure factors such as adverse selection, premiums mispricings, inadequate capital and regulation, untimely downgrades and governance issues; and identifies success factors such as conservative underwriting, early financing, competitor business acquisitions and obtaining put-back claims. Potential during COVID-19 is discussed and a monoline governance framework is developed. Research limitations/implications Search and selection criteria distortions may lead to sample selection bias in systematic reviews. Issue is addressed by using different permutations of the search key words to refine the search criteria. Reference list of collected final sample of articles are perused to identify additional articles. It is difficult to obtain verifiable empirical data on the bond/monoline insurers or their insured products, especially for the structured finance sector. Most of the information available on data stream and firm’s quarterly financial reports for publicly traded monoline/bond insurers and credit rating reports are included to overcome this issue. Practical implications Demand for bond/monoline insurance still persists even in the USA. Although borrowing costs are low, obtaining bank loans would be challenging for municipalities and corporates with increased risks. Especially, given worldwide government stimulus on wages, most municipalities would possess reduced budgets for public finance. Monoline insurance can play a key role in financing such projects. Thus, it is important to understand their unique traditional and transformed business model and applicability during and post-COVID-19. Given the near extinction of bond/monoline insurers during the 2008 global financial crisis (GFC), an adequate framework for bond/monoline insurers as developed in this study is key for future business continuity. Social implications There is significant interest, especially, from the industry on monolines as identified in our systematic review. Monoline insurance has major effects on taxpayers, government policies and bond investors. They aid in financing public finance projects that have significant societal impact. This study contributes by filling existing gaps in the literature, especially, from a behavioural, ethical and social perspective of the monolines, regulators, other stakeholders and new entrants to the industry during COVID-19. This study links prior finance theories to the impact of bond/monoline insurer’s during the 2008 GFC and their stakeholders involved that has societal implications. Originality/value This study can be differentiated from prior research on monoline insurers as follows: The study identifies, gaps, similarities, trends between prior academic and industry literature and develop a bond/monoline governance framework; identifies key failure and success factors during the 2008 GFC crisis to develop the governance framework and identify monolines’ potential during COVID-19; as opposed to most prior literature that only focus on one (Drake and Neal, 2011 analyse MBIA) or two key bond/monoline insurers, this study focuses on five key bond/monoline insurers in detail and all other key insurers as well in the empirical analysis section.

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Section: Journal Of Policy Analysis and Managementsupporting

confidence: 65%

“…Essentially, complex products would result in distinctive ratings by rating agencies enabling issuers to shop for the highest rating. Moreover, ratings may have been a much noisier proxy for risk, which suggest bonds with same credit ratings to have different yields (Bronshtein and Makridis, 2020).…”

Section: Icarus Of the 21st Centurymentioning

confidence: 99%

Icarus of the 21st century: bond/monoline insurance

Daluwathumullagamage

2021

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The Price of Safety: The Evolution of Municipal Bond Insurance Value

2024

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Economic theory predicts that bond insurance lowers issuers’ financing costs by resolving asymmetric information and mitigating credit risk. With comprehensive data over the last 36 years, we find increasingly diminished empirical support for these models. The value of insurance in resolving asymmetric information beyond that resolved by credit ratings and other observable bond characteristics is economically minimal. The average gross value of insurance ranges from 4 to 14 bps when bond insurers offer Aaa-rated coverage. However, this gross value becomes insignificant after 2008 when Aaa-rated insurance no longer exists. Evidence suggests that the lack of insurance benefit in the postcrisis period is attributable to the deteriorated creditworthiness of insurance companies. Examining noninterest saving explanations for the continued use of insurance in the no-Aaa insurance market, we find evidence that issuers purchase insurance out of habit (with insurance value most diminished for habitual purchasers with low governance quality) and for the convenience it affords in default, but no evidence that insurance improves secondary market liquidity. This paper was accepted by Gustavo Manso, finance. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.4813 .

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