Triple-A ratings, the key to the municipal bond insurers' franchise, overstate the strength of the industry, a report released last week says.

"The bottom line is that investors should not assume that bond insurance is fail-safe, [that] this protection reduces but does not eliminate default risk," said Fred S. Cohen, municipal credit research analyst at Sanford Bernstein & Co. and author of the report. "There is a possibility, albeit small, that a severe future recession could create an abnormally high level of defaults. Under those conditions, the insurance safety net would be likely to fail," Cohen said.

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