Default Insurance/CDS Question

My initial thought is this isn't likely to work. I mean from the protection provider's viewpoint, why would I agree to insure somebody against themselves? I am basically giving them an incentive to default.

I don't see why a structure like that couldn't exist in theory, but as a practical matter, the moral hazard / adverse selection problems you'd have would drive premium rates up too high for it to be feasible.

By the way - it's "(c/sh/w)ould have", not "of".

@CorpFinHopeful: I disagree, its not an incentive. If the swap is triggered you would at best break even with your initial investment.

@Angus Macgyver: Providers sell all kinds of products that induce moral hazard. Life insurance, art insurance, home insurance. Seems to work. Why not a default insurance?

And couldn't companies buy CDS on themselves in the secondary market?

Isn't this an effective instance of "reinsurance"? Moreover, for institutions that have outstanding debt, DVA achieves a similar purpose to what you describe.

In general, other than the conflict of interest issue, I don't see why this can't be done...

Limited under Permitted Investment clauses usually.

A company buying CDS protection on itself out of the blue would no doubt set off alarms in the market....Not sure it is even legal however.

There is nothing illegal about a company (e.g. a bank) buying its own CDS.

You can insure the deal and synthetically offload your exposure to a third party.