Junk Bonds

Corporate bonds with credit ratings of BB/Ba or less. They pay a higher yield than investment grade bonds because issuers have a higher perceived risk of default. Borrowers purchase these bonds when they have little other option because of poor credit. Such bonds involve market risk that could force investors, including insurers, to sell the bonds when their value is low.

Most states place limits on insurers’ investments in these bonds. In general, because property/casualty insurers can be called upon to provide huge sums of money immediately after a disaster, their investments must be liquid. Less than 2 percent are in real estate and a similarly small percentage are in junk bonds.

Junk bonds are broken down into two categories:

Fallen Angels are bonds that were once high investment grade but, because of a company's poor credit status, have become junk bonds.

Rising Stars, reverse to Fallen Angels, are bonds whose rates have increased due to a company's rising credit status. They are on their way to a higher investment grade.

Why purchase junk bonds? Intensely high risk, there is a great chance purchasers will not get their money returned on the investment in a junk bond. Most entities purchasing junk bonds are large institutional investors with great analytic knowledge in credit. But the rewards of buying junk bonds, for those who have enough to invest, are a high yield and a diversified investment of their assets -- typically 4% to 6% above U.S. Treasuries.