The Declining Insurance Benefit in the Municipal Bond Market

Using data on municipal bonds issued in California and New York between 1996 and 2014, this paper documents a decline in the benefit of municipal bond insurance, explores its underlying determinants, and quantifies its aggregate effect. First, we find that the insurance benefit declined remarkably from approximately 5.1% of the overall deal value between 1996 and 2001 to 0.5% by 2011-2014. Second, we examine five plausible explanations: changes in bond maturities, issuance size value, issuers’ credit risk, insurers’ credit risk and interest rate environment. Our results indicate that the main reason is a decline in the insurer’s credit strength, specifically the market’s perception, for two reasons: (a) higher yields due to lower insurer credit ratings, and (b) an appearance of a market premium for insurance. Third, through a back-of-the-envelope calculation, the decline in the insurance benefit explains 34% of the decline in the aggregate insurance market.