Why is bond insurance often necessary for smaller entities?

Bond insurance is often necessary for smaller entities primarily to enhance their credit ratings and lower borrowing costs. Smaller entities typically have a more limited financial history and may not have the same level of creditworthiness as larger, well-established organizations. By obtaining bond insurance, these entities can improve their perceived credit quality in the eyes of investors.

Bond insurance essentially acts as a guarantee that the insurer will cover the bondholders' principal and interest payments if the issuer defaults. This assurance allows smaller issuers to present a more favorable risk profile, leading to potentially higher credit ratings from rating agencies. As a result, better credit ratings enable these entities to issue bonds at lower interest rates, reducing their overall borrowing costs. This is particularly crucial for smaller governments or organizations that need to finance essential projects but have less financial leverage.

On the other hand, while increasing the amount of debt they can issue, meeting legal requirements, and persuading investors are important aspects of bond issuance, the fundamental benefit of bond insurance lies in its impact on credit ratings and associated borrowing costs, making it easier for smaller entities to access funding.