BOND INSURANCE

A type of insurance policy that a bond issuer purchases that guarantees the repayment of the principal and all associated interest payments to the bondholders in the event of default. Bond issuers buy insurance to enhance their credit rating to 'AAA' in order to reduce the amount of interest that it needs to pay.

Once bond insurance has been purchased, the issuer's bond rating will no longer be applicable and instead, the bond insurer's credit rating will be applied to the bond instead. By design, bondholders should not encounter too much disruption if the issuer of a bond in their portfolio goes into default. The insurer should automatically take up the liability and make any principal and interest payments owed on the issue going forward.