The declining insurance benefit in the municipal bond market

Abstract

Using California and New York municipal bond data 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, the insurance benefit declined from 5.1 percent of average deal values between 1996 and 2001 to 0.5 percent by 2011–2014. Second, we examine five plausible explanations for this decline: (1) changes in bond maturities, (2) issuance size value, (3) issuer’s credit risk, (4) insurer’s financial strength, and (5) the interest rate environment. The main reason is the decline in insurer’s financial strength. Third, the decline in the insurance benefit explains 34 percent of the decline in the aggregate municipal bond issuance. Our results are consistent with recent models of coordination failure and imperfect information, especially during crisis years.