The Insurance Charade

Full Faith and Credit

``Wholesale defaults on debt of this size, or even a portion of it, would destroy the credit ratings of our local governments, the state of Louisiana and the bond insurers themselves,'' Kennedy wrote.

In July, Louisiana sold $400 million of bonds -- with insurance from CIFG Assurance North America -- to raise money to make payments to holders of bonds in areas hit by Katrina.

``If you're putting the full faith and credit of the state behind it, why is the insurance even needed?'' asks Louisiana Senator Joe McPherson, a Democrat from Woodworth who's a member of the Louisiana Bond Commission. ``I think it's an unwise use of taxpayer dollars.''

Lawrence Harris, a finance professor at the Marshall School of Business at the University of Southern California in Los Angeles, says the Louisiana situation shows that municipal bond insurance is a waste of taxpayer money.

``If the insurance is so great, then why is the state making sure the bonds got paid?'' asks Harris, 49, who was chief economist at the Securities and Exchange Commission from 2002 to 2004.

An Economic Decision

Sean McCarthy, chairman of the Albany, New York-based Association of Financial Guarantee Issuers, the bond insurance trade group, says it's up to each municipality to decide whether buying insurance is worth the price.

``First, no issuer is forced to buy insurance,'' he says. When a city buys insurance, it, in essence, buys a triple-A credit rating, the highest available, since the bonds automatically get the same rating as the insurer.

``It is an economic decision based on a simple mathematical calculation of whether the borrowing cost is lowered by raising the rating to triple A,'' says McCarthy, who's president of New York-based Financial Security Assurance Holdings Ltd., or FSA, the third-largest bond insurer. Ambac, FGIC and MBIA say McCarthy is speaking on their behalf.

McCarthy also says bond insurance makes it easier for issuers to sell bonds to investors.

`Whole and Perfect'

``How does an institution or an individual get whole and perfect information about the issuer?'' he asks. ``The bond insurance industry provides that because we analyze the issuer in depth and guarantee our assessment.''

The industry's claims that insurance helps investors don't add up, says James Lebenthal, co-author of ``Confessions of a Municipal Bond Salesman'' (John Wiley & Sons, 226 pages, $24.95). Lebenthal says investors should feel just as comfortable buying uninsured municipal bonds, since those securities almost never default. He says insurance is used for marketing and not for protection of issuers or investors.

``In reality, there is little difference in the credit quality or ability to pay in top-rated bonds,'' says Lebenthal, 78, founder of New York-based Lebenthal & Co., which popularized municipal bonds for investors. Merrill Lynch & Co. bought Lebenthal's former company in 2005. Lebenthal has also served on the board of MBIA.

No One Knows

In 2005, municipal governments saved $2.3 billion because bond insurance allowed them to get better interest rates, the insurance trade group wrote in a May report. It's impossible to know whether these figures are meaningful because the industry doesn't release details on specific premiums, says Richard Green, a finance professor at Carnegie Mellon University in Pittsburgh, who has tried to analyze bond insurance pricing.

``No one knows what issuers are paying for insurance,'' Green says. ``The insurers treat this information as though it is proprietary.''

The industry doesn't break down how much of its premiums come from municipal bonds. Green says he questions the trade group numbers, especially because the associations' report doesn't give any actual dollar amounts for fees. Bond insurance, on average, costs about one half of a percentage point of the principal and interest of a bond, according to Standard & Poor's. That would work out to about $2.5 billion last year.

Most municipal bonds are priced low because they're safe investments -- second only to U.S. Treasury debt --not because they have bond insurance, says Mark Robbins, an associate professor of public policy at the University of Connecticut in West Hartford.

Hard to Dig

``It's hard to dig in and look and see if they are really saving any money,'' Robbins says.

Moody's Investors Service said in a June report that it's reconsidering the way it rates most municipal bonds. It wrote that if it were to evaluate municipal bonds in the same way it rates corporate bonds, it would give triple-A ratings to almost all public finance. Such ratings would effectively give issuers the same value they get from bond insurance.

``Since 1970, defaults of municipal bonds have been rare,'' Moody's wrote. ``Even the riskiest municipal sectors have extremely low default rates for investment- grade credits --lower on average than triple-A-rated corporate bonds.''

Standard & Poor's Sept. 26 raised the ratings on what it says were tens of billions of municipal bonds backed by sales taxes, income taxes and highway-user fees, after re- evaluating the risks of the debt. The strength of the revenue backing the bonds, even during recessions, convinced the company the debt deserved higher ratings.

Reported Claims

One result of states' covering shaky bond issues is a profit windfall for bond insurers. Profits from 2001 through 2005 totaled $8.93 billion, or 91 percent of premium revenue during that period, according to the trade association. Bond insurers reported net income of $2.08 billion on $3.76 billion of premium revenue in 2005.

In 2005, MBIA reported claims it paid or expected to pay on insurance of $203.5 million on premiums of $735.5 million, with claims representing 27.7 percent of premiums, according to regulatory filings. Ambac paid claims of $67.3 million on premiums of $770.1 million, with claims representing 8.7 percent of premiums.

FSA paid claims of $4.3 million on premiums of $254.4 million, with claims representing 1.7 percent of premiums. And FGIC paid claims of $20.4 million on premiums of $183.3 million, with claims representing 11.1 percent of premiums. The claims were from both corporate and municipal policies; the companies didn't specify how much came from public finance.

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