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Deficits in auditory emotion recognition (AER) are a core feature of schizophrenia and a key component of social cognitive impairment. AER deficits are tied behaviorally to impaired ability to interpret tonal (“prosodic”) features of speech that normally convey emotion, such as modulations in base pitch (F0M) and pitch variability (F0SD). These modulations can be recreated using synthetic frequency modulated (FM) tones that mimic the prosodic contours of specific emotional stimuli. The present study investigates neural mechanisms underlying impaired AER using a combined event-related potential/resting-state functional connectivity (rsfMRI) approach in 84 schizophrenia/schizoaffective disorder patients and 66 healthy comparison subjects. Mismatch negativity (MMN) to FM tones was assessed in 43 patients/36 controls. rsfMRI between auditory cortex and medial temporal (insula) regions was assessed in 55 patients/51 controls. The relationship between AER, MMN to FM tones, and rsfMRI was assessed in the subset who performed all assessments (14 patients, 21 controls). As predicted, patients showed robust reductions in MMN across FM stimulus type (p= 0.005), particularly to modulations in F0M, along with impairments in AER and FM tone discrimination. MMN source analysis indicated dipoles in both auditory cortex and anterior insula, whereas rsfMRI analyses showed reduced auditory-insula connectivity. MMN to FM tones and functional connectivity together accounted for ∼50% of the variance in AER performance across individuals. These findings demonstrate that impaired preattentive processing of tonal information and reduced auditory-insula connectivity are critical determinants of social cognitive dysfunction in schizophrenia, and thus represent key targets for future research and clinical intervention.SIGNIFICANCE STATEMENTSchizophrenia patients show deficits in the ability to infer emotion based upon tone of voice [auditory emotion recognition (AER)] that drive impairments in social cognition and global functional outcome. This study evaluated neural substrates of impaired AER in schizophrenia using a combined event-related potential/resting-state fMRI approach. Patients showed impaired mismatch negativity response to emotionally relevant frequency modulated tones along with impaired functional connectivity between auditory and medial temporal (anterior insula) cortex. These deficits contributed in parallel to impaired AER and accounted for ∼50% of variance in AER performance. Overall, these findings demonstrate the importance of both auditory-level dysfunction and impaired auditory/insula connectivity in the pathophysiology of social cognitive dysfunction in schizophrenia.