Bonds

Issuers that meet certain credit criteria can purchase municipal bond insurance policies from private companies. The insurance guarantees the payment of principal and interest on a bond issue if the issuer defaults. Bond ratings are based on the credit of the insurer rather than the underlying credit of the issuer. Both issuers and bondholders can carry this insurance, though a bondholder would need to have a large stake to get the coverage.

Municipal Bond insurance protects investors in two ways. Occasionally cities and states that issue debt securities get into financial difficulties. When that happens they may not be able to pay interest and debt as scheduled. Even if the issuer doesn't default the rating agencies may lower the ratings on issuers securities if it's financial condition deteriorates, causing the market value of its securities to decline.