Municipal bond insurance called unneeded, a waste

Top insurers make huge profits selling policies with few claims

October 07, 2006|By Bloomberg News

DALLAS -- In a desolate field of tall grass in Texas, 20-foot-high concrete pillars stand in a line. Crows fly above, and old cattle gates sway in a warm breeze. The pillars were built 25 years ago to hold a Disneyland-style type of monorail in a 12,000-acre business park and residential development that was never completed.

The unfinished community, named Las Colinas, was financed by $311 million in municipal bonds. When the Dallas County Utility and Reclamation District issued most of the bonds, it paid extra for insurance against the risk of default. The district has paid one insurer, MBIA Inc., at least $11 million in premiums to date.

Even though Las Colinas hasn't been able to generate enough revenue to pay bondholders, it's never turned to MBIA to collect on the insurance policy. Instead, it has taken money from school districts to pay bondholders. "They bought insurance," says J.C. Morris, who works in Las Colinas. "Why not use it?"

That's a question people are starting to ask as states and cities spend about $2.5 billion a year on something they don't need or use: municipal bond insurance, which didn't exist until the 1970s.

Insurers in the $2.26 trillion municipal bond market almost never pay out anything because fewer than a handful of the $1.24 trillion in insured municipal bonds ever default. States don't allow municipal bonds to collapse; they almost always cover wavering public debt to protect their own credit ratings, says David Schultz, a professor in the Graduate School of Management at Hamline University in St. Paul, Minn.

"I can't really see a need for insurance if a bond is already guaranteed by a state," Schultz says. "Insurance is a new parasitic type of industry in the municipal bond market. It's not a good deal for anyone but the insurance companies."

Because they rarely pay out, bond insurance companies have some of the largest after-tax profit margins in any industry. In 2005, the four largest bond insurers, which account for 98 percent of all municipal bond insurance, had margins ranging from 30.9 percent to 44.2 percent, according to company filings.

MBIA, of Armonk, N.Y., the largest bond insurer by volume of policies, and Ambac Financial Group Inc., of New York, the second largest, are two of the 20 most-profitable public U.S. companies when ranked by net income per worker, according to data compiled by Bloomberg.

Among publicly held insurance companies, MBIA, which had a profit margin of 30.9 percent in 2005, and Ambac, which had a 44.2 percent margin last year, are two of the top four in profit as a percentage of revenue.

If there were ever a glaring example of a state needing to cash in on its bond insurance, it's Louisiana, which was devastated in August 2005 by Hurricane Katrina. Nearly half of the people and companies that paid taxes in the New Orleans area were forced to remain out of that city for almost a year because of damage to buildings and the lack of utilities.

The state had $9.1 billion in debt in the areas pummeled by the hurricane. Of that, $6.4 billion was insured, mostly by MBIA and Financial Guaranty Insurance Co., or FGIC, of Stamford, Conn.

Six weeks after the storm, Louisiana Treasurer John Neely Kennedy wrote Gov. Kathleen Babineaux Blanco a letter saying the state couldn't let any of its borrowers default and wouldn't take money from insurers. Allowing either to happen could lower the state's credit rating, he wrote.

"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 in 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 state Sen. 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 E. 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.

Sean W. McCarthy, chairman of the Association of Financial Guarantee Issuers, the bond insurance trade group based in Albany, N.Y., 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.

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