Detroit’s record bankruptcy may cost bond insurers more than $1 billion in claims. Yet the filing is also boosting the appeal of guaranteed municipal debt as the companies pledge to cover Motor City investors in full.

Insured municipals are beating the overall $3.7 trillion market for the first time since 2007, before the financial crisis stripped insurers, including Assured Guaranty Ltd. and MBIA Inc., of their top credit grades. Bank of America Merrill Lynch data show guaranteed debt lost 4.2 percent through yesterday, less than the overall market’s 5 percent drop.

Companies that back Detroit’s debt are on the hook for at least $1.9 billion of unsecured debt, and also insure most of the insolvent city’s water and sewer securities. Assured Guaranty and MBIA have said they would ensure bondholders receive full payment, reaffirming their value to individuals shaken by the nation’s biggest muni bankruptcy, said Alan Schankel at Janney Montgomery Scott LLC.

“The benefit of insurance has gotten more visible because of Detroit, so investors are valuing it more than they did six months ago or a year ago,” said Schankel, head of fixed-income research for the Philadelphia-based company. “That’s reflected in trading levels.”

Buying Detroit

Michigan’s biggest city, with about 700,000 residents, sought bankruptcy protection July 18, listing about $18 billion in debt. Investors such as Tom Metzold at Eaton Vance Management in Boston and Robert Amodeo at Western Asset Management Co. in New York have said they’re buying insured Detroit utility securities, showing confidence in pledges to repay bondholders.

The financial crisis that peaked in 2008 cost bond insurers their top ratings amid losses on subprime-mortgage-backed debt. While Build America Mutual Assurance Co. last year became the first new insurer since Warren Buffett’s Berkshire Hathaway Assurance Corp. in 2007, just 3.5 percent of local debt sold in the first half of 2013 had the protection, data compiled by Bloomberg show. Insurers once covered more than half the market.

The backing was traditionally a draw for individual investors, who own about 70 percent of municipal debt. Insurance reduces the interest issuers pay by from 0.1 percentage point to 0.15 percentage point, Schankel said. That can lower the cost of borrowing by hundreds of thousands — or even millions — of dollars as the debt is repaid over periods of decades.

Surging Yields

“If there were never any losses, no one would buy insurance,” Wilbur Ross, who controlled about 14.8 million Assured Guaranty shares, or 8.1 percent, in June, said by e- mail. “The performance of insured munis clearly demonstrates the value.”

Interest rates dropping to the lowest levels since the 1960s last year also depressed insurers’ share of the market as investors favored higher-yielding securities, including those without guarantees.

Yields on local-government debt have since surged to the highest rates since April 2011, data compiled by Bloomberg show. That makes it more economical for borrowers to pay for coverage of their bonds.

The rise in demand for insurance was on display in May when the Plum Borough School District, about 13 miles (21 kilometers) east of Pittsburgh, retained Build America Mutual to back a $70.2 million deal, the insurer’s biggest deal since it began offering the guarantees last year. The general-obligation bonds are rated A+ by Standard & Poor’s, its fifth-highest grade.

Insurance Savings

A 10-year tax-exempt portion was priced to yield 2.6 percent, data compiled by Bloomberg show. That compared with a 2.76 percent average yield during the week of the sale for an index of similarly rated debt.

Bond insurers benefit from increased demand “anytime there’s noise in the market,” said Richard Holzinger, New York- based Build America Mutual’s head of investor relations. “Insurance always does better when you have wider credit spreads,” he said by telephone.

Jay Brown, MBIA’s chief executive officer, said in an Aug. 8 conference call with investors that “muni-bond defaults have historically resulted in a greater appreciation of the value of bond insurance.”

Such defaults are rare. U.S. corporate securities rated BBB+, S&P’s third-lowest investment grade, have an average default rate of about 6 percent after 15 years, compared with about 0.2 percent for similarly rated munis, according to the New York-based rating company.

Losing Streak

The broad muni index declined for three straight months through July, the longest losing streak since January 2011, Bank of America data show. During that three-month period, insured bonds lost less compared with top-rated debt.

The extra yield investors demand to own 30-year insured general-obligation debt rather than AAAs narrowed to 0.35 percentage point July 26, the least since April 2011, and remained at that level through this month, according to data compiled by Bloomberg. The spread reached 1.07 percentage points in early May, the most since the data begin in 1993.

“Detroit and other distressed situations gave investors a certain amount of comfort in insurance guaranteeing timely payments,” said Dorian Jamison, a municipal analyst at Wells Fargo Advisors in St. Louis. “That really helped insured bonds outperform during this weakness we’ve seen this summer.”

Equity Risk

While Detroit may burnish the value of bond protection, it has raised questions about the viability of the insurers as they confront the prospect of more distressed debt, said David Litvack, head of tax-exempt fixed income research at U.S. Trust, a New York-based unit of Bank of America Corp.

Assured Guaranty still has gained 44 percent this year through yesterday, yet it has fallen 11 percent in New York trading since Detroit sought court protection. MBIA has dropped 12 percent in the same period in New York, while it is still up 54 percent for 2013. The S&P 500 Index of shares has advanced 15 percent this year, despite losing 2.6 percent since July 18.

“The municipal-bond investor may perceive bond insurance to be more valuable, but the people who want to invest in bond insurers’ stock may not perceive it so favorably,” Litvack said by telephone. “There’s greater perceived risk in the market and more potential for bond insurers to lose money.”

Still, first-time muni defaults declined to 32 this year through Aug. 12 as the recovery that began in June 2009 continues, according to Municipal Market Advisors. That compares with 54 during the same period in 2012 and 77 in 2011, research from the Concord, Massachusetts, based company shows.

Rising Receipts

State tax receipts rose 8.6 percent in the first quarter of this year compared with the same period in 2012, the 13th straight quarterly increase, the Nelson A. Rockefeller Institute of Government in Albany, New York, said this month in a report.

Top-rated local governments such as Columbus, Ohio, and Charlotte, North Carolina, are set to issue debt this week amid $4.7 billion in sales, data compiled by Bloomberg show.

The ratio of 30-year top-rated muni yields to those for comparable U.S. Treasuries is near the highest in more than a year. The proportion fell to 119 percent yesterday after reaching 125 percent Aug 9, the most since June 1, 2012. The higher the percentage, the greater the relative value of municipal securities compared with Treasuries.

Following is a pending sale:

Charelston County Airport District in Charleston, South Carolina, plans to sell about $175 million in revenue bonds as soon as today in part to finance the expansion and improvement of terminal facilities at the airfield. Interest on the debt is exempt from South Carolina and regular federal income taxes. The bonds are rated A1 with a negative outlook by Moody’s Investors Service, its fifth-highest grade, and mature as late as July 2043. Bank of America Corp.’s Merrill Lynch unit is managing the sale.

With assistance from Mary Childs in New York. Editors: Ted Bunker, Justin Blum.