S&P - Public Finance Criteria (2007). - The Global Clearinghouse

Other CriteriaBond InsuranceThe dramatic growth and acceptance of the useof bond insurance has been one of the mostinfluential developments of the past 35 years forcapital markets. From its modest beginnings in1971, when Ambac Assurance Corp. wrote its firstpolicy in the U.S. municipal bond market, the useof financial guaranty insurance has become notonly a significant mainstay of government infrastructurefinance in the U.S. but also a major forcein asset-backed, structured finance, and projectfinance transactions around the world. Accordingto the financial guaranty industry’s trade organization,the Association of Financial GuarantyInsurers, insurance in force (principal and interest)at the end of 2005 totaled nearly $2.9 trillion. In2005, bond insurers wrote coverage on more than$540 billion in par value of obligations.The success of bond insurance as a productreflects the fact that it provides a tool that issuersuse to lower their financing costs and to broadenthe investor base for their securities. Additional factorsthat have supported this success include theattractiveness of bond insurance to retail investorswho are risk-averse, the higher proportion of morecomplex transactions, periodic flights to quality,and greater numbers of issues eligible for insurance.Insurance penetration in the various marketsserved varies, based largely on the length of time thebond insurers have been active in the particularmarket, the extent to which a robust capital markethas developed in a segment or region, and the existenceof viable competitors or alternate issuancestructures that do not require bond insurance. Theinsurers’ highest penetration is in the U.S. municipalmarket, where more than 50% of the new issuancehas been insured in recent years. Penetration islower in the U.S. structured finance market, reflectingthe availability of alternate issuance structuresthat do not require insurance. Outside the U.S., penetrationis less developed, reflecting a combinationof less-developed capital markets, significant competition,and the fact that insurers have been active inthese markets for shorter periods of time.A bond insurance policy represents a financialguaranty company’s unconditional and irrevocablepledge to pay principal and interest in a timely fashionshould the issuer of the debt be unable to do so.The Standard & Poor’s Ratings Services financialstrength rating is a current opinion of the financialsecurity characteristics of an insurance organizationwith respect to its ability to pay under its insurancepolicies and contracts in accordance with theirterms. In addition to their financial strength ratings,the monoline companies also carry a companionfinancial enhancement rating. This rating providesinvestors with a specific opinion regarding an insurancecompany’s willingness to pay financial guarantyclaims on a timely basis.By regulation, since 1986, an insurer wanting toconduct bond insurance business in the U.S. had tobe operated as a monoline company—that is, a separatelystructured and capitalized entity operatingsolely as an insurer of third-party debt. The mostprevalent business model for a primary insurer, interms of numbers of active companies and evenmore so in terms of debt insured, is to be ‘AAA’rated. All the major monoline insurers have ‘AAA’ratings and are engaged in the guaranty of publicfinance debt—the older, more established segmentof the business that dates back to 1971—as well astaxable structured financings, which is a segment ofthe business that began in 1986. All the major‘AAA’ rated monoline primaries also insure transactionsoutside the U.S., either directly or throughsupported affiliates. There are two niche primaryinsurers, one ‘AA’ rated and one rated ‘A’, that participatein several of the same sectors as do the‘AAA’ primaries but seek out certain niches, eitherbased on lower credit quality or limited ‘AAA’monoline involvement, where they can competeeffectively. Many non-U.S.-based multiline insurers(insurers that participate in several product lines)still participate in the financial guaranty businessoutside the U.S. and as reinsurers of the U.S.-basedmonoline insurers.Rating MethodologyStandard & Poor’s rating methodology for monolinebond insurers addresses many of the same factorsinvolved in any insurance company’s financialstrength rating. However, the criteria developed forbond insurers have been tailored to the uniqueaspects of the financial guaranty business and differin important respects.One critical difference compared with other insuranceproducts is the expectation that only minimal294 Standard & Poor’s Public Finance Criteria 2007