Political risk: Converting mystery into opportunity

By Kathleen S. Ellis

The stars are aligning for a growing demand for political risk insurance. Changes in the landscape have created fresh opportunities for producers to increase retention and grow their customer base by offering political risk insurance protection to middle-market clients.

Skeptical? Consider the factors influencing demand. Foreign direct investment rose 34 percent in 2006, according to the United Nations Conference on Trade and Development (UNCTAD). Global supply chains, a weakened dollar, and emerging market consumers with rising disposable income beckon businesses as they seek lower production costs and new customers.

With the “stars” being more aligned for international expansion, even mid-market customers are going global more often. Whether large or small, these customers face typical property and liability risks, but insurance for those risks only goes so far to protect against exposures presented by local political climates.

Consider the following scenarios:

• A company’s license to operate in an emerging market is revoked by the local government.

• Local civil unrest causes significant property damage to an overseas production plant.

• A company cannot convert revenue earned in a foreign market to hard currency and transfer it out of the country.

Typical property and liability insurance policies do not respond to such circumstances. That’s where political risk insurance comes in.

There has also been a shift on the supply side. Private political risk insurance carriers are playing a bigger role in the market, which is marked by new entrants and innovative offerings. In addition, many government-sponsored insurers, such as Overseas Private Investment Corporation (OPIC) and the Multilateral Investment Guarantee Agency (MIGA), have narrowed their focus in response to changing market conditions.

These trends spell clear opportunities for producers, and the benefits of selling political risk insurance are compelling. Producers can use political risk insurance as a tool to proactively protect accounts or seek new ones. Perhaps most important, offering political risk insurance solutions can be a means of differentiation.

Few mainstream agents offer political risk insurance, perceiving it and the segment to be cloaked in mystery or to fall squarely within the realm of the largest multinationals and their insurance providers.

The reality, though, is that mid-market companies have become much more adventurous in their international expansion as they solidify their presence in more developed countries. These potential clients need service and consultation on a vast array of international products and services to protect their operations and exposures around the globe.

The complexities of political risk insurance, while very real, can be navigated with an experienced global carrier.

Political risk solutions

Broadly speaking, political risk insurance helps protect against losses caused by an event or series of events triggered by governmental action. Losses arising from expropriation or an embargo — and even political violence or war — are not covered under typical property insurance policies. Yet these exposures create significant financial risk to a global company.

The benefits of political risk insurance extend beyond reducing financial uncertainty. By transferring the political risk exposure to an insurer, companies may be looked on more favorably by lenders and investors. In addition, the balance sheet protection afforded by this type of insurance may fuel additional investment in overseas operations.

Political risk insurance solutions include the following:

• Confiscation, expropriation and nationalization. The most frequently purchased type of political risk insurance, confiscation, expropriation and nationalization, protects companies against government actions that would deprive them of the use or benefit of their assets. It also responds to losses triggered by terrorism, sabotage, civil war, insurrection, rebellions and coups d’etat.

• Structured trade credit. This type of insurance is very similar to confiscation, expropriation and nationalization, but is written for those that extend credit for imports and exports of assets.

• Currency inconvertibility. This insurance helps protect companies against restrictions or controls that prevent conversion of local currency into hard currency and the transfer of funds out of the host country.

• Contract frustration. This type of insurance helps protect against the risk that a government-owned entity will fail to live up to the terms of its contract with the insured.

• Political violence. This insurance responds to property damage caused by violence directed against the sitting government.

• Wrongful calling of guarantees. This type of insurance helps protect companies when a government arbitrarily calls its bonds or contracting parties are forced to call guarantees due to events driven by local political or societal conditions.

Targeting the right prospects

Who makes a good candidate for political risk insurance? Policyholders that are based in one country and have exposures in the form of investments or trade contracts in another. Companies that cannot afford to write off all, or a large part, of their foreign operating base, likely need the protection of political risk insurance.

To explore whether their clients need political risk insurance, producers should ask their clients whether they have operations outside the United States, Canada and Western Europe with the following:

• Manufacturing plants;

• Substantial locations owned or operated under a long-term lease or joint ventures;

• Substantial inventory or mobile equipment ;

• Infrastructure or energy-related projects; or

• Contracts to provide foreign governments or companies with goods, services, or both.

When it comes to determining which countries have the most significant political risk exposures, the answer is not as simple as it might seem. Economic, political, security and other issues can quickly change the tenor of a country’s business environment. It was not long ago, for instance, that Venezuela had a reputation as an attractive investment destination. But in the course of months, the government expanded its control of the oil industry, and threatened to nationalize the country’s telecommunications, electricity and cement companies.

Such examples illustrate a critical point: It can be tempting to delay investigating political risk insurance when an emerging country seems relatively stable. However, once a country’s political climate becomes more volatile, the availability of political risk insurance capacity across the marketplace can be significantly reduced. Just when companies seek political risk insurance protection, it may elude them or become too costly to justify in the budget.

To avoid this potential issue, companies are advised to purchase political risk insurance early for extended periods. Political risk policies are non-cancelable and typically have tenures ranging from five to 15 years.

Consider the example of Venezuela: A company that had the foresight to purchase a 15 year political risk policy for its Venezuelan operations in 1995 would have three years left on its policy even though the risk in that country has escalated dramatically. Unfortunately, many other companies that postponed the purchase are now unable to afford or find capacity in the Venezuelan market.

Choosing the right carrier

When selecting an insurer, look for one with a strong global reputation, a network of offices and a strong underwriting and claims specialty in this segment. An insurance company with a far-reaching network will have a first-hand understanding of local laws and regulations and a firm grasp of the political and economic climate. Financial strength is another key consideration. Because the terms of political risk contracts can run as long as 15 years, producers and their clients will want peace of mind that the insurer can pay claims into the future.

It is also important to select an insurer with expertise in handling political risk claims and one that can offer loss prevention services as well. An insurer can often provide crucial advice to help an insured in its negotiations with a government and hopefully resolve a problem amicably before it turns into a full-fledged loss.

Expansion into emerging market countries involves inherent risk as political structures and legal systems continue to mature. But international trade continues to grow as companies pursue the benefits of an increasingly global economy. By purchasing political risk insurance, companies can more confidently expand into new countries, knowing they are taking an important step to address the risks of such a move.

Topics Carriers Property