Fidelity bond

A fidelity bond is a form of insurance protection that covers policyholders for losses that they incur as a result of fraudulent acts by specified individuals. It usually insures a business for losses caused by the dishonest acts of its employees.

While called bonds, these obligations to protect an employer from employee-dishonesty losses are really insurance policies.These insurance policies protect from losses of company monies, securities, and other property from employees who have a manifest intent to cause the company loss. There are also many other forms of crime-insurance policies (burglary, fire, general theft, computer theft, disappearance, fraud, forgery, etc.) to protect company assets.

By country

Australia

In Australia, this type of employer protection is called employee dishonesty insurance coverage.

United Kingdom

In the United Kingdom, this type of employee dishonesty insurance is called fidelity guarantee insurance coverage.

Trade credit insurance

Trade credit insurance, business credit insurance, export credit insurance, or credit insurance is an insurance policy and a risk management product offered by private insurance companies and governmental export credit agencies to business entities wishing to protect their balance sheet asset, accounts receivable, from loss due to credit risks such as protracted default, insolvency, bankruptcy, etc. This insurance product, commonly referred to as credit insurance, is a type of property & casualty insurance and should not be confused with such products as credit life or credit disability insurance, which the insured obtains to protect against the risk of loss of income needed to pay debts. Trade Credit Insurance can include a component of political risk insurance which is offered by the same insurers to insure the risk of non-payment by foreign buyers due to currency issues, political unrest, expropriation, etc.

This points to the major role trade credit insurance plays in facilitating international trade. Trade credit is offered by vendors to their customers as an alternative to prepayment or cash on delivery terms, providing time for the customer to generate income from sales to pay for the product or service. This requires the vendor to assume non-payment risk. In a local or domestic situation as well as in an export transaction, the risk increases when laws, customs communications and customer's reputation are not fully understood. In addition to increased risk of non-payment, international trade presents the problem of the time between product shipment and its availability for sale. The account receivable is like a loan and represents capital invested, and often borrowed, by the vendor. But this is not a secure asset until it is paid. If the customer's debt is credit insured the large, risky asset becomes more secure, like an insured building. This asset may then be viewed ascollateral by lending institutions and a loan based upon it used to defray the expenses of the transaction and to produce more product. Trade credit insurance is, therefore, a trade finance tool.

History

Trade credit insurance was born at the end of nineteenth century, but it was mostly developed in Western Europe between the first andSecond World Wars. Several companies were founded in every country, some of them also managed the political risk to export on behalf of their state.

Over the '90s, a concentration of the trade credit insurance market took place and three groups now account for over 85% of the global credit insurance market. These main players focused on Western Europe, but rapidly expanded towards Eastern Europe, Asia and the Americas.:

• Euler Hermes, merger of the two credit insurance companies of the Allianz Group. Euler Hermes is the world's number one credit insurance provider.
• Atradius. A merger between NCM and Gerling Kreditversicherung. Later renamed Atradius after it was demerged from the Gerling insurance group.
• Coface. Formerly a French government sponsored institution established in 1946, this company is now part of the Natixis group.

Many variations of trade credit insurance have evolved ranging from coverage that can be canceled or reduced at an insurers discretion, to coverage that cannot be canceled or reduced by the insurer during the policy period. Other programs may allow the policy holder to act as the underwriter.

While trade credit insurance is often mostly known for protecting foreign or export accounts receivable, there has always been a large segment of the market that uses Trade Credit Insurance for domestic accounts receivable protection as well. Domestic trade credit insurance provides companies with the protection they need as their customer base consolidates creating larger receivables to fewer customers. This further creates a larger exposure and greater risk if a customer does not pay their accounts. The addition of new insurers in this area have increased the availability of domestic cover for companies.

Many businesses found that their insurers withdrew trade credit insurance during the financial crisis of 2007–2010, forseeing large losses if they continued to underwrite sales to failing businesses. This led to accusations that the insurers were deepening and prolonging the recession, as businesses could not afford the risk of making sales without the insurance, and therefore contracted in size or had to close. Insurers countered these criticisms by claiming that they were not the cause of the crisis, but were responding to economic reality and ringing the alarm bells.

In the UK, the Government set up a £5 billion emergency fund for trade credit top-up. However, this was considered a failure as the take-up was very low.

Credit insurance providers

AIG UK Ltd Askrindo (Indonesia) Atradius AXA Assurcredit (France) AXA-Winterthur (Switzerland) BPI - MS (Philippines) CESCE (Spain) China Export & Credit Insurance Corporation CLAL (Israel) Coface COSEC (Portugal) Credit Guarantee (South Africa) Ducroire/Delcredere (Belgium) ECICS (Singapore) Equinox Global (United Kingdom) Ethniki (Greece) Euler Hermes Executive Risk Insurance Services (Canada) Export Credit Guarantee Corporation of India Export-Import Bank of the United States Garant (Austria) GCNA (Canada) Groupama Assurance-Crédit (France) HCC International (United Kingdom) ICIC (Israel) Liberty Mutual Insurance Europe Ltd (United Kingdom) Malayan Insurance (Philippines) Mapfre (Spain) Mitsui Sumitomo (Japan) Nippon Export and Investment Insurance (Japan) Oriental Assurance Corp (Philippines) Prisma (Austria) QBE Insurance (Australia, United Kingdom and The Americas) R&Q Risk Services Canada Limited SACE BT (Italy) Seoul Guarantee Insurance Company (Korea) SID First Credit (Slovenia) Sompo Japan Tokio Marine & Nichido Fire (Japan) Trade Credit Re Insurance Company Zurich Surety, Credit and Political Risk (USA) Zurich Versicherung (Germany)

Protection and indemnity insurance

Protection and indemnity insurance, commonly known as P&I, is a form of marine insurance provided by a P&I Club. A P&I Club is a mutual (i.e. co-operative) insurance association that provides cover for its members, who will typically be ship-owners, ship-operators or demise charterers. Unlike a marine insurance company, which is answerable to its shareholders, a P&I Club is the servant only of its members.

Both P&I Clubs and conventional marine insurers are governed by the provisions of the Marine Insurance Act 1906. Marine insurers provide cover for known quantifiable risks, mainly Hull & Machinery insurance for shipowners, and Cargo Insurance for cargo owners. By contrast, P&I Clubs provide insurance cover for broader indeterminate risks, such as third party liabilities that marine insurers are loath to cover. Third party risks include a carrier’s liability to a cargo-owner for damage to cargo, a ship’s liability after a collision, environmental pollution and war risk insurance; (although some marine insurers are also prepared to cover war risks).

It follows that any given cargo may be insured twice: the shipper/cargo-owner will take out conventional cover, and the carrier will have P&I cover. If the cargo is lost or damaged, the cargo-owner should first make a cargo claim against the carrier; but the latter may avoid liability because either (i) he did not cause the loss, or (ii) he has exempt under the Hague-Visby Rules. In such a case, the cargo owner will claim against his own insurer. If the cargo-owner fails to claim first against the carrier, but claims against his own insurer, the latter (having reimbursed their client) will, through subrogation, be able to pursue the claim in their own right against the carrier.

Marine insurers charge a premium, which guarantees to the assured full cover during the validity of the policy; but P&I insurance is financed not by premiums but by “calls”. Club members contribute to the club’s common pool, out of which claims are paid. If the pool is insufficient, the club members will be asked to pay a further call; but if the pool is in surplus, the Club will ask for a reduced call the following year, or may even make a refund to members. (Only ship operators with a sound reputation will be allowed to join a P&I club; and any P&I cub member who incurs reckless or avoidable losses to the club may be asked to leave)

Whereas a marine insurer will, on average, pay out £70 for every £100 received in premiums, a P&I Club seeks to run as a non-profit-making business. Curiously, the largest P&I Club, Norway’s Gard, manages to combine mutual P&I business with conventional marine insurance. Should the Rotterdam Rules come into force, third-party liabilities will increase; and this may result in conventional insurers losing more and more business to P&I Clubs.

Growth of third party liabilities

Although marine insurance dates from the Middle Ages, British shipowners did not feel the need to purchase liability insurance until the 19th century when injured crew members began to seek compensation from their employers, and the Fatal Accidents Act 1846 facilitated claims by passengers or their survivors. The likelihood of claims was greatly increased by the vast numbers of passengers who constituted the flood of emigrants to North America and Australia in the second half of the century. Shipowners were also becoming increasingly aware of the inadequacy of the available insurance cover in respect of damage caused by their ships in collisions with other ships. The usual cover for claims by other ships and their cargo for collision damage excluded altogether one fourth of such damage and, more seriously, was limited in amount. (The maximum recovery under hull policies, including both damage to the insured ship and liability for the damage it had caused, was the insured value of the ship).

The first protection association, the Shipowners' Mutual Protection Society, was formed in 1855. It was intended to cover liabilities for loss of life and personal injury and also the collision risks excluded from the current marine policies, particularly the excess above the limits in those policies. Similar associations were subsequently formed in various cities and towns within the United Kingdom, and later in Scandinavia,Japan, and the United States.

In 1874, the risk of liability for loss of or damage to cargo carried on board the insured ship was first added to the cover provided by a protection Club. The values of cargoes had risen and cargo underwriters, encouraged by the courts, had become keener on recovering their losses from shipowners. After 1874 many Clubs added an indemnity class to provide the necessary cover. Subsequently, most of these separate classes were amalgamated with the class reserved for the original protection risks, and the distinction between the two classes virtually disappeared.

Following the grounding of the Torrey Canyon in 1967, coverage for the liabilities, costs and expenses arising from oil spills became an increasingly important aspect of P&I insurance.

Coverage today

More than 90% of the World's oceangoing tonnage is insured by the mutual P&I Clubs that are members of the International Group of P&I Clubs. These organisations are the successors of the associations founded in the 19th and early 20th centuries. The 13 P&I clubs are mainly situated in the U.K. but also in USA, Japan, Sweden, Norway and the Netherlands. The Clubs vary considerably in size and currently the largest club is the Norwegian based Gard. P&I Club coverage is generally as broad as the liabilities faced by a shipowner qua shipowner. The following are the major exceptions to this rule.

Other insurance

Traditionally, one of the main reasons a claim was not covered by P&I insurance was that the managers of the Club thought it should be covered by other insurance that the shipowner should have taken out. That usually meant hull insurance, which paid collision liabilities and, in some cases, liabilities for damage to fixed and floating objects ("FFO"), or war risks insurance.

Mutuality

Another reason a claim might not be covered, or at least not covered in full, is that the shipowner had not taken certain steps to have limited his liability in order to protect the Club. The principal steps expected of shipowners were making sure that the appropriate exculpatory language was inserted in bills of lading and passenger tickets. Today the legal requirements with which shipowners are expected to comply include all the requirements of the flag state concerning marine safety and environmental protection. Another illustration of this principle is the rule that contractual liabilities (those assumed by the shipowner as a matter of contract) are not generally covered.

Moral hazard

P&I Clubs have always taken pains to point out to members that liabilities arising out of the fraudulent misdelivery of cargo, especially delivery of cargo without demanding the production of an original bill of lading, were not covered by P&I insurance. Club managers evidently thought that commerce would grind to a halt if there was a risk that shipowners would conspire with shippers to defraud receivers and their banks, so they refused to indemnify shipowners under these circumstances. This view was shared by the English courts. Sze Hai Tong Bank v. Rambler Cycle Co. [1959] A.C. 576; [1959] 2 Lloyd's Rep. 114 (P.C.)

Willful misconduct

Losses intended by the insured, or to which it "turned a blind eye" knowing they were likely to happen.

Public policy

There was a time when criminal liabilities were not covered as a matter of course. To say otherwise might even make the underwriter liable for facilitating the crime. It was understood that criminal liability was imposed only for intentional misconduct, and the requirement of fortuity generally foreclosed any question of coverage for criminal liabilities. Today, the situation is vastly more difficult. Statutes in many countries impose "criminal" liability for negligent conduct that damages the environment, under circumstances which do not even rise to the level of "willful misconduct" under the law of marine insurance. Shipowners justifiably expect their Clubs to pay the fines and penalties thus incurred.

Professional liability insurance

Professional liability insurance (PLI), also called professional indemnity insurance (PII) but more commonly known as errors & omissions (E&O) in the US, is a form of liability insurance that helps protect professional advice- and service-providing individuals and companies from bearing the full cost of defending against a negligence claim made by a client, and damages awarded in such a civil lawsuit. The coverage focuses on alleged failure to perform on the part of, financial loss caused by, and error or omission in the service or product sold by the policyholder. These are potential causes for legal action that would not be covered by a more general liability insurance policy which addresses more direct forms of harm. Professional liability coverage sometimes also provides for the defence costs, including when legal action turns out to be groundless. Coverage does not include criminal prosecution, nor a wide range of potential liabilities under civil law that are not enumerate in the policy, but which may be subject to other forms of insurance. Professional liability insurance is required by law in some areas for certain kinds of professional practice (especially medical and legal), and is also sometimes required under contract by other businesses that are the beneficiaries of the advice or service.

Professional liability insurance may take on different forms and names depending on the profession. For example, in reference to medical professions it is called malpractice insurance, while errors and omissions (E&O) insurance is used by consultants, brokers and lawyers. Other professions that commonly purchase professional liability insurance include accounting and financial services, construction and maintenance (general contractors, plumbers, etc., many of whom are also surety bonded), and transport. Some charities and othernonprofits/NGOs are also professional-liability insured.

Rationale

The primary reason for professional liability coverage is that a typical general liability insurance policy will only respond to a bodily injury, property damage, personal injury or advertising injury claim. Other forms insurance cover employers, public and product liability. But various professional services and products can give rise to legal claims without causing any of the specific types of harm covered by such policies. Common claims that professional liability insurance covers are negligence, misrepresentation, violation of good faith and fair dealing, and inaccurate advice. For example, if a software product fails to perform properly, it may not cause physical damages, or personal or advertising injuries, therefore the general liability policy would not be triggered; it may, however, directly cause financial losses which could potentially be attributed to the software developer's misrepresentation of the product capabilities.

Coverage

Professional liability insurance policies are generally set up based on a claims-made basis, meaning that the policy only covers claims made during the policy period. More specifically, a typical policy will provide indemnity to the insured against loss arising from any claim or claims made during the policy period by reason of any covered neglect, error or omission committed in the conduct of the insured's professional business during the policy period. Claims which may relate to incidents occurring before the coverage was active may not be covered, although some policies may have a retroactive date, such that claims made during the policy period but which relate to an incident after the retroactive date (where the retroactive date is earlier than the inception date of the policy) are covered.

Coverage does not include criminal prosecution, nor all forms of legal liability under civil law, only those specifically enumerated in the policy.

Some policies are more tightly worded than others and while a number of policy wordings are designed to satisfy a stated minimum approved wording, which makes them easier to compare, others differ dramatically in the coverage they provide. For example, breach of duty may be included if the incident occurred and was reported by the policy holder to the insurer during the policy period. Wordings with major legal differences can be confusingly similar to non-lawyers. Coverage for "negligent act, error or omission" indemnifies the policyholder against loss/circumstances incurred only as a result of any professional error or omission, or negligent act (i.e., the modifier "negligent" does not apply to all three categories, though any non-legal reader might assume that it did). A "negligent act, negligent error or negligent omission" clause is a much more restrictive policy, and would deny coverage in a lawsuit alleging a non-negligent error or omission.

Coverage is usually continued for as long as the policyholder provides covered services or products, plus the span of any applicable statute of limitations. Cancelling the policy before this time would in effect make it as if the insured never had coverage for any incidents, since any client could bring any case with regard to any such services or products that occurred before the statute of limitations cut-off point. A break in coverage could result in what is called a "gap in coverage," which is the loss of all prior acts.

Errors and omissions insurance

Errors and omissions (E&O) insurance, which may exclude negligent acts other than errors and omissions ("mistakes"), is most often used by consultants and brokers and agents of various sorts, including notaries public, real estate brokers, insurance agents themselves,appraisers, management consultants and information technology service providers (there are specific E&O policies for software developers,website developers, etc.), architects and engineers, attorneys, third-party business administrators, quality control specialists, nondestructive testing analysts, and many others. A mistake which causes financial harm to another can occur in almost any transaction in many professions.^[1]

Gaps in coverage for E&O Claims Made Policies

A gap in coverage, or lapse in coverage could be the result from not renewing the professionals E&O coverage the same day it expires. Several carriers who underwrite policies will not allow professionals to backdate your coverage to your expiration date with out a valid explanation (such as, but not limited to: natural disaster or personal medical issue that prevented your from renewing on time) and a signed warranty letter informing the carrier the specific professional is not aware of any pending claims; for example, an effective date may be 06/01/2010 and your coverage may expire on 06/01/2011, if the professional does not renew your coverage on or before 06/01/2011 then the professional may have to enroll with a gap in coverage, resulting in a loss of prior acts coverage, meaning the professional will have no coverage for any business placed 'prior' to their new effective date. Although some carriers may allow a 30 - 45 day grace period, it is not uncommon for them to not allow this.

Gaps in coverage are common in E&O coverage. A modest survey suggested that most professionals are not aware of what a gap in coverage really is, or its harsh consequences. Several professionals agreed that they believed since they were not writing business during specific months, they did not need to keep coverage continuous, although this is not the case and will result in a gap and loss of prior acts coverage.

A gap in coverage should not be confused with not renewing a policy due to retirement, or death as an Extended Reporting Policy may take place in this scenario. A professional will want to verify what Extended Reporting Policies (ERP) are available for their specific policy in the event of retirement, termination, death or other unspecified scenarios, as they will differ between carriers and policies. Certain provisions will limit the professional from writing new business during the ERP, since only past policies are generally covered in an ERP policie, nothing current or new.

Civil liability insurance

Some policies go further than the standard coverage. Professional liability insurance coverage usually does not include defamation (libel andslander), breach of contract, breach of warranty, intellectual property, personal injury, security,and cost of contract.Coverage can often be added to provide indemnity "for any civil liability".

Because the operative clause of a civil liability policy is so wide, there is normally a long list of exclusions so that liabilities, like employers liability and public liability, that are the subject of other forms of insurance are not covered the policy.

Directors and officers liability insurance

Directors and Officers Liability Insurance (often called D&O) is liability insurance payable to the directors and officers of a company, or to the organization(s) itself, to cover damages or defense costs in the event they suffer such losses as a result of a lawsuit for alleged wrongful acts while acting in their capacity as directors and officers for the organization. Such coverage can extend to defense costs arising out of criminal and regulatory investigations/trials as well; in fact, often civil and criminal actions are brought against directors/officers simultaneously. It has become closely associated with broader management liability insurance, which covers liabilities of the corporation as well as the personal liabilities for the directors and officers of the corporation.^[1]

Under the "traditional" D&O policy applied to "public companies" (those having securities trading under national securities exchanges), there are three (3) insuring clauses. These insuring clauses are termed: Insuring Clause 1 (Side-A); Insuring Clause 2 (Side-B); and Insuring Clause 3 (Side-C). Contemporary (competitive) D&O policies also provide for Insuring Clause 4 (Side-D), which provides for a $250,000 sublimit for investigative costs coverage related to a shareholder derivative demand.

Side-A (Insuring Clause 1) provides coverage to individual directors and officers when not indemnified by the corporation (as a result of state law or financial capability of the corporation) Side-B (Insuring Clause 2) provides coverage for the corporation when it indemnifies the directors and officers (corporate reimbursement) Side-C (Insuring Clause 3) provides coverage to the corporation itself for securities claims brought against it

Note - more extensive (broader) coverage can be obtained for individual directors and officers under a Broad Form Side-A DIC ("Difference in Conditions") policy purchased to not only provide excess Side-A coverage but also to fill the gaps in coverage under the traditional policy, respond when the traditional policy does not, protect the individual directors and officers in the face of U.S. bankruptcy courts from wrongfully deeming the D&O policy a part of the bankruptcy estate and otherwise more fully protect the personal assets of individual directors and officers.

At its roots, D&O insurance insures "behavior" in that the decisions of directors and officers are the matters which often lead to covered claims. That is, an incorrect decision often leads to shareholder discontent and, thus, a lawsuit against the directors and officers who made the decision. State law typically protects the directors and officers from liability (particularly exculpatory provisions under state law relating to directors) but this does not mean that actions are not brought by private plaintiffs (aggravated by the loss of money and seeking a quick payout from insurance proceeds). As such, even innocent errors in judgment by executives will bring D&O insurance into the forefront of the matter; especially because most "D&O" claims are settled before going to trial. The key, apparently, is the motion to dismiss stage of civil litigation (at least in the U.S.A.).

Typical sources of claims include shareholders, shareholder-derivative actions, customers, regulators (including those that would bring civil and criminal charges), and competitors (for anti-trust or unfair trade practice allegations). The extent of coverage is dramatically dictated by the fact the company is publicly traded or privately held. For instance, publicly traded companies (themselves) are only covered for securities claims.

In terms of basic state corporate law (at least in the U.S.A.), directors and officers of a corporation can be liable if they damage the corporation by breaching their duties and contracts to the corporation, mix personal and business assets, or fail to disclose conflicts of interest. In the United States, under state corporate law, corporations are often mandated to indemnify directors and officers of companies incorporated in that state in order to encourage people to take the positions. That being said, there exist extensive situations in which either the corporation is only permitted to indemnify the director or officer or the company is explicitly forbidden from indemnifying such director or officer. Liabilities which aren't indemnified by the corporation are potentially covered by certain types of D&O insurance (particularly Side-A Broad Form DIC policies).^[2] However, the policies have exclusions and must be read carefully.

D&O insurance is usually purchased by the company itself, even when it is for the sole benefit of directors and officers. Reasons for doing so are many, but commonly would assist a company in attracting and retaining directors. Where a country's legislation prevents the company from purchasing the insurance, a premium split between the directors and the company is often done, so as to demonstrate that the directors have paid a portion of the premium. Problems related to income tax liability may come into play when a corporation avoids country specific liability law in order to protect its individual directors and officers through insurance.

A common misperception of D&O insurance is that it makes directors or officers able to engage in acts they know to be wrong; this is not the case. Intentional illegal acts or any illegal gains/profits obtained by directors/officers are not covered under most D&O insurance policies; coverage would only extend to "wrongful acts" as defined under the policy, which may include certain acts, omissions, misstatements while acting as a director/officer of the organization. Exclusionary language, however, would not provide coverage for fraud, illegal profits/gains, or intentional/wanton illegal conduct by such director/officer (as examples).

The basic principle underlying the acceptance of D&O insurance is that companies (and their shareholders) are best served by knowledgeable directors and officers who take strategic risks based upon the information reasonably available to them at the time the decision is made, without the threat of personal liability. By doing so, it is believed, corporations are better able to attract qualified, intelligent, and reasonable directors and officers to manage the operations of the company. Not only would this result in better returns for shareholders but also benefit society in general (due to the increased productivity, jobs created, and advancement of products due to such calculated business decisions). Under the law of states in the U.S.A. and most capitalistic based economies, directors and officers are not "insurers" of their business decisions made in furtherance of the company they serve. This includes the advancement of not only the shareholders, but also the company itself, its customers, and the constituents of the company (such as employees, a particular town, community, charity etc.). In addition to D&O insurance (which fills the gaps), state law ensures that reasonable, calculated, and well-processed decisions (see "business judgment rule"), that are made by the executives of a company, will be made without fear of personal financial loss should their well thought-out plan not come to fruition. As practical and sound as that proposition may sound, it is still within the power of states and individual companies to deny such executives indemnification for claims that arise out of their well intended efforts. As a result, D&O insurance exists.

In contemporary times (particularly in the U.S.), directors and officers (especially those most sought out by shareholders due to their ability to produce results) are intimately concerned with a company's directors & officers liability insurance program. Under state law, their personal assets are at risk (not to mention their hard-earned reputation). Thus, companies with quality D&O insurance coverage are the most suited to attract the best directors and officers to serve the corporation. Ultimately, it is a cost/benefit analysis...you get what you pay for...

The leaders in the provision of Directors & Officers Liability Insurance include: Chartis, Chubb Corp., The Travelers Companies, ACE Limited,XL Group, Zurich Financial Services, HCC Insurance Holdings, The Hartford, and CNA Financial(among many others).

In the United Kingdom the majority of contracts are facilitated on behalf of policyholders by intermediary brokers. Leading players in this field include Marsh, Willis, Howden and the Lark Group.

Berkshire Hathaway, the holding company managed by Warren Buffett, does not purchase D&O insurance for its directors, unlike most similar companies. Warren Buffett believes that the directors should face consequences of their mistakes the way that other shareholders do.^[3]

Bond insurance

Bond insurance is a service whereby issuers of a bond can pay a premium to a third party, who will provide interest and capital repayments as specified in the bond in the event of the failure of the issuer to do so. The effect of this is to raise the rating of the bond to the rating of the insurer; accordingly, a bond insurer's credit rating must be almost perfect.

The premium requested for insurance on a bond is a measure of the perceived risk of failure of the issuer.

The economic value of bond insurance to the governmental unit, agency, or company offering bonds is a saving in interest costs reflecting the difference in yield on an insured bond from that on the same bond if uninsured. Insured securities ranged from municipal bonds andstructured finance bonds to collateralized debt obligations (CDOs) domestically and abroad.

National government bonds are almost never insured because governments can print money. In fact, for this reason, securities that are tied to or backed by government bonds are typically considered by ratings agencies to be high grade.

Municipal government bonds were insured by the so-called monolines starting in the 1970s. The financial crisis of 2008 seriously harmed their business model, to the point where their continued existence is in doubt.

Terminology

Bond insurers are also called "financial guaranty insurance companies" or "financial guarantors".

Companies whose sole line of business is to provide bond insurance services to one industry are called monoline insurers.The term 'monoline' eventually became synonymous in some literature with terms like 'financial guarantors', and 'municipal bond insurers'.

Bonds which are insured by these companies are sometimes said to be 'wrapped' by the insurer.

Municipal Bond Insurance and the Monolines

Municipal bond insurance was introduced in the US in 1971 by AMBAC, the first of the 'financial guaranty corporations'. They guaranteed the timely repayment of bond principal and interest when a municipal debt issuer defaulted.AMBAC was soon joined by MBIA (1974), FGIC(1983), and FSA (1985). These were the 'big four'. They only wrote insurance on municipal bonds, and they became known as the 'monolines'.

In the late 90s/2000s a new crop of competition came up, such as ACA Financial Guaranty Corp (1997), XL Capital (2000), and CIFG (2001)., as well as the reinsurers, such as Radian, ACE Guaranty Re, and AXA Re Finance.

The financial crisis of 2007-2010 negatively impacted the monolines to the point where their continued existence is in doubt.

Real Estate

Since public administrators often had large balance sheets of real estate assets, monolines soon started building up portfolios of bonds that had real estate assets backing them. The difficulty for analysts had always been understanding how similar are municipal assets often funded from secure tax revenues compared to private asset portfolios funded by profits from a variety of fluctuating markets. To counter criticism, bond insurers claimed they had sophisticated risk management maths and in the event of claims, paid slowly over time to match the profile of the debt issued rather than lump sums.

Business model

The benefit for governments was purported to be reduced borrowing costs. The companies, which had to be highly rated by the credit rating agencies to fulfill their role, provided a back-up guarantee to debt issued by lower rated borrowers in exchange for insurance premiums. Thus a city or regional municipal borrower rated A, by paying a premium could enjoy AAA rating. Many more kinds of investors would then buy that bond significantly reducing the interest cost of that debt.

The purported benefit for the insurers was that they had very stable profits from a market that almost never defaulted. As publicbonds.org points out, Businessweek ran an article in 1994 exclaiming that MBIA was a “an almost perfect money machine.” The Businessweek story said that up to 1994, MBIA had only one loss.

However, some have criticized the entire business model. In Confidence Game, Christine S Richard describes the questions regarding the basic assumptions that the industry was based on. A monoline's business can be seen as, basically, selling an AAA credit rating to a municipal bond issuer. However, the credit rating agencies had a separate 'rating scale' they used for municipalities vs corporations. Some argued that if the ratings agencies had rated the municipalities on the same scale they rated corporations, that the municipalities would have been rated much higher to begin with, and thus there was no real need for bond insurance. The question was debated before congress in 2008, at the House Finance Committee under Barney Frank. Richard Blumenthal, the attorney general of Connecticut, Ajit Jain of Berkshire Hathaway, Eric Dinallo of the New York State Insurance Department, and a Moody's representative were also in attendance. Moody's disputed their view.

Taxable investors benefit from the exemption of municipal bond interest from Federal income tax. In many cases local bonds are also free of state and local taxes. Taxable investors face a compelling incentive to purchase local bonds. However, an investor holding a large portfolio allocation in local bonds carries a risk of substantial loss if the local economy becomes depressed, for instance if a local industry declines or a major natural disaster strikes, and defaults ensue. On the other hand, diversifying nationally causes loss of the tax benefit. If a AAA-rated monoline insurer guarantees a municipal bond, the investor gains the benefit of owning a diversified portfolio and retains the local tax benefit. (The investor is even better off than owning a diversified national portfolio, which might suffer an occasional default: the insured bond can only default if the issuer defaults, and the insurer experiences defaults on its entire portfolio in excess of the insurer's capital).

When insuring taxable bonds, as opposed to municipals, bond insurance is a 'pure credit' business which does not take advantage of tax-induced market anomalies. The insurer seeks to insure credits with little likelihood of default, which the market will nevertheless pay a premium to insure, perhaps because of investor restrictions on the amount they can invest in non-AAA credits or other anomalies.

Monoline history

1960s - the precursor - Moral obligation bonds

In the 1960s, John N. Mitchell (of later Watergate fame), created the idea of a 'moral obligation bond', when analyzing the affordable housing problem. It enabled municipalities to issue debt without a vote of the people, based on the idea that the government would 'pledge' the 'intent' to repay the bonds if they defaulted. Moral obligation bonds were outlawed in 1976 after they were blamed in part for the New York City financial crisis of the 1970s.

1970s - 1990s

The first monoline insurer, American Municipal Bond Assurance Corporation (now AMBAC), was formed in 1971 as an insurer of municipal bonds. Municipal Bond Insurance Association (now MBIA) was formed in 1973.The companies sought to help regional public administrators get better access to cheaper funding.

By 1980, about 2.5 percent of long-term municipal bonds were insured.

As the number and size of insured bond issues grew, regulatory concern arose that bond defaults could adversely affect even a large multiline insurer's claims-paying ability. In 1975, New York City teetered on the edge of default during a steep recession.There was a high risk that people who had bought NYC municipal bonds would not get their money back, but at the last minute a deal was made with the city's labor unions that saved it.

In 1983 the Washington Public Power Supply System defaulted on $2b of revenue bonds from a troubled nuclear power project . The 30,000 bond holders lost between 60 and 90 cents on the dollar.

In 1989 New York State Article 69 prevented property/casualty insurance companies, life insurance companies, and multiline insurance companies from offering financial guaranty insurance. A cited rationale was to make the industry easier to regulate and ensure capital adequacy. The monoline industry claimed that it had the advantage over multilines of sole focus on capital markets. Thus the 'monoline' insurers, who dealt only in one line of business in theory, took over the municipal bond insurance market.

In 1995 the New York State Insurance Department enabled the monolines to write insurance on Guaranteed Investment Contracts. GICs were supposed to be 'stable' investments that insurance companies had sold, largely to pension funds from the 70s and 80s. With an insured GIC, the monoline would pay out in case the original insurer failed.

In the late 1990s, the percentage of bonds that were insured rose to about 50%.

1990s - 2000s - CDOs, derivatives, and 'structured products'

By 2002 over 40% of municipal bonds were insured, often by a procedure involving payment of a single premium at the purchase of the bond. But this was not enough for the monolines. They had been moving to diversify and grow. Municipal bond insurance was becoming a 'commodity'. See for example the 1994 Businessweek article on MBIA.

At some point the monolines started becoming involved with mortgage-based Collateralized Debt Obligations and other 'structured' financial products. The involvement especially grew in the mid 1990s. They were involved via 'Financial guarantee policies' and 'Credit default swaps', which insured parts of certain CDOs.

By the early 2000s, the CDO market (especially mortgage-backed CDOs) was growing quite large. The monolines began to become involved in more and more of these deals, typically by selling Credit Default Swap protection on the CDO tranches. This was at the same time that more and more of the CDOs were being based on subprime mortgage debt. This business became a large contributor to the monoline's growth during the period. The total outstanding amount of paper insured by monolines reached $3.3 trillion in 2006. This contingent liability was backed by approximately $34 billion of equity capital .

Bill Ackman, of Gotham (and later Pershing Square) hedge funds, grew increasingly suspicious of the viability of one monoline in particular, MBIA. He dove into their company reports and their business model, and subsequently shorted their business by purchasing credit default swaps on MBIA corporate debt. He also released reports to the public and tried to bring the problem to the attention of government regulators and other corporate executives. He was largely ignored.

2007 Subprime Crisis and Credit Crunch

Main article: 2007 subprime mortgage financial crisis

No monoline insurer had ever been downgraded or defaulted prior to 2007 .

2007 saw a crystallizing crisis in US subprime mortgage related bonds. The spillover into broader structured credit markets had a huge impact on bond insurers. The worst hit was RADIAN Group which insured mortgage-backed debt. Shares in Radian Group tumbled by over 67 per cent in the space of months. The falling share price reflected the almost ninefold rise in the cost of protecting debt against default. Bond insurers had a tiny capital base compared to the volume of debt insured. Rating agencies have come under increasing scrutiny by regulators for their methods as bond insurers lent their high credit ratings to securities issued by others in return for a fee.

When the housing market declined, defaults soared to record levels on subprime mortgages and innovative adjustable rate mortgages, such as interest-only, option-ARM, stated-income, and NINA loans (No Income No Asset) which had been issued in anticipation of continued rises in house prices. Monoline insurers posted losses as insured structured products backed by residential mortgages appeared headed for default.

On November 7, ACA, the only single-A rated insurer, reported a $1B loss, wiping out equity and resulting in negative net worth . On November 19, ACA noted in a 10-Q, that, if downgraded below A-, collateral would have to be posted to comply with standard insurance agreements, and that 'Based on current fair values, we would not have the ability to post such collateral.'  On December 13, ACA's stock was delisted from the NYSE due to low market price and negative net worth, but ACA retained its A rating . Finally, on December 19, it was downgraded to CCC by S&P.

The following month, on January 18, 2008, Ambac Financial Group Inc's rating was reduced from AAA to AA by Fitch Ratings. Due to the very nature of monoline insurance the downgrade of a major monoline triggered a simultaneous downgrade of bonds from over 100,000 municipalities and institutions totalling more than $500 billion.

Credit rating agencies placed the other monoline insurers under review . Credit default swap markets quoted rates for Monoline default protection more typical for less than investment grade credits. Structured credit issuance ceased, and many municipal bond issuers spurned bond insurance, as the market was no longer willing to pay the traditional premium for monoline-backed paper. New players such as Warren Buffett's Berkshire Hathaway Assurance entered the market. The illiquidity of the over-the-counter market in default insurance is illustrated by Berkshire taking four years (2003–06) to unwind 26,000 undesirable swap positions in calm market conditions, losing $400m in the process.

By January 2008, many municipal and institutional bonds were trading at prices as if they were uninsured, effectively discounting monoline insurance completely. The slow reaction of the ratings agencies in formalising this situation echoed their slow downgrading of sub-prime mortgage debt a year earlier.

Commentators such as investor David Einhorn  have criticized rating agencies for being slow to act, and even giving monolines undeserved ratings that allowed them to be paid to bless bonds with these ratings, even when the bonds were issued by credits superior to their own.

On June 19, 2008 Moody's also downgraded Ambac and MBIA from Aaa to Aa3 and A2 respectively.

The stock prices for the publicly traded monolines, like AMBAC and MBIA, fell dramatically. AMBAC had climbed from the teens in the early 1990s to a price of 96 in 2007. By mid 2008, it was trading at around 1 dollar, and by the end of 2010 it was trading at 10-13 cents. MBIA had a similar fate: climbing to the 60s by 2007, but by 2009 trading at about 6 dollars.

2009 and beyond

In 2009, the New York State Insurance Department introduced several new regulations regarding credit default swaps, CDOs, Monolines, and other entities involved in the financial meltdown. These regulations were described in the document entitled 'Circular Letter No. 19 (2008)'.

It is extremely important to note that Circular Letters have frequently been used by the New York Insurance Department to attempt regulatory actions. In fact, a Circular Letter is no more than an opinion of the Department, and cannot be used as the legal basis for a regulatory action. Only New York Statutes and regulations adopted following the Administrative Procedures Law of New York can be used as the basis for department enforcement actions. An attempt to use a Circular Letter as the basis for an enforcement action has been ruled a violation of the New York State Constitution by the Albany Supreme Court.

In 2010, the Wisconsin insurance commissioner took over the credit default swap contracts of Ambac, with the plan to pay about 25 cents on the dollar to the 'counterparties' that are owed.

In 2009, Berkshire Hathaway got out of the municipal bond insurance business.

On November 8, 2010, Ambac filed for Chapter 11 bankruptcy.