A Fragile World
The headlines seem to roll out a daily drumbeat of bad news: a refugee crisis in Europe; ISIS terror attacks; failing economies in Greece, Venezuela and elsewhere; political turmoil in Turkey and Brazil; eternal tensions in the Middle East.
The so-called emerging market is being hit hard by falling prices for commodities such as oil and copper, increasing the chances that interventionist governments renege on agreements with foreign investors. In the West, countries that previously could be counted on for crisis management are turning inward and doing little to ease the situation. For investors, the economic consequences could be disastrous: a disruption or even loss of global capital flow resulting from terror attacks, interventionist sanctions and regulations, and even expropriation.
In this environment, says Chris Beck, president of Clements Worldwide, political risk insurance is piquing investors’ interest.
“Since the Arab Spring there has been fairly consistent conflict across multiple regions, resulting in a global refugee crisis,” Beck says. “This consistency of political risk has created broad awareness of the potential impact on business, resulting in increased demand. The sustained consistence of events has maintained this demand, making it a potentially high-reward opportunity for investors.”
Increased Capacity Won’t Always Mean Soft Pricing
Details about most political risk policies and claims are kept secret for good reason. But recent examples of claims highlight how the policies work.
After a slowdown in the global economy, and with double-digit inflation in 2011, Argentina imposed strict currency controls to keep foreign capital from leaving the country, a move that created hardship for companies operating in Argentina with dollar-denominated debt. In one case, a large commercial bank in Argentina was unable to honor its dollar-denominated obligations, subjecting the bank to possible punitive action from its counterparties. The bank, however, had political risk insurance and triggered a claim under the policy’s currency inconvertibility coverage.
A second recent example involved a large European commodity trading firm that had a deal with Sonara, a state-owned oil refinery in Cameroon. In this case, the claim was triggered when Sonara, facing financial difficulties, defaulted on six months’ worth of crude oil shipments under a term contract. This default was covered by the political risk insurance, under the payment default provision, and the insured was indemnified following a waiting period (typically 180 days) to see if any remedies were possible.
Against that backdrop, more investment capital players are coming to the political risk market.
Broadly speaking, political risk insurance provides cover for losses stemming from four main categories: expropriation; breach of contract; inconvertibility and transfer; and political violence. An estimated 50 private carriers globally offer the coverage. A public market includes organizations such as the U.S. Overseas Private Investment Council; Italian export credit agency SACE; French export credit agency COFACE; the World Bank’s Multilateral Investment Guarantee Agency; African Trade Insurance Agency; and the Asian Development Bank.
“One of the things that is contradictory is that there have been some sizable claims, but there have been a lot of new entrants into the market,” says Roger Schwartz, leader of Aon Risk Solutions’ political risk practice. “Essentially you find yourself in a position where there is a lot of money chasing a lot of business, and as a result people are getting a lot of good pricing on this stuff. Now that obviously comes with limitations because getting coverage in crappy markets is not going to be any easier in a soft market than any other time.”
“The defining feature that sets the political risk market against aviation or property, for example, is that just because there is an increase in capacity doesn’t necessarily mean a decrease in insurance rates,” says Harriet Karwatowska, a London-based credit and political risk product specialist for Miller Insurance Services.
“It’s dependent on what country you are talking about,” says Dave Anderson, executive vice president and managing director of Zurich Credit & Political Risk. “The number of countries that you can comfortably write business in these days has come down. For the remaining countries that are considered low risk there may be excess capacity, which would drive down rates in those countries. But in a lot of countries that we could write before the commodities price drop we now have to be extremely selective in what we write. By and large, there are some countries where it’s very hard to find coverage.”
Beck says Clements Worldwide, which covers government contractors, government-funded entities, humanitarian organizations, and schools in volatile areas around the globe, takes a “consultive approach” to its coverage, “starting with defining triggers beyond terrorism, which in many countries is blurred with civil war and insurrection.”
“But defining civil strikes and riots, disaster, and epidemics, and ensuring policies cover all these events, is critical. We generally encourage our clients in the highest-risk markets—Afghanistan, Iraq, Syria, South Sudan, Somalia, Mali, Democratic Republic of Congo and Yemen but expanding to include places like Egypt and Turkey—to have broad coverage, as there is an unpredictability around events that even protective security measures cannot counteract.”
Post–World War II Evolution
The original political risk policies were written by Lloyd’s more than 200 years ago to protect shippers from pirates and government interventions away from home, but it wasn’t until the years immediately after World War II that political risk became attractive on a larger scale. The cover was used to entice U.S. investment back into post-war Europe.
Rashmi Nehra, the practice leader for political risk at Starr Companies, says the initial buyers were essentially corporate entities such as the major multinational businesses that have exposures overseas.
Today the market has evolved to include companies such as power plant developers and energy companies building infrastructure projects that are subject to local government control. Nehra says these companies buy political risk insurance because typically they are investing in strategic sectors where there is potential for government interference.
Nehra says the market has evolved from one that consisted mainly of Western corporations buying insurance in emerging markets. “What has changed over the years is you now have sort of a South to South,” she says. “You have companies in Brazil that are investing in Portuguese-speaking Africa and buying coverage for their political risk exposures. Similarly, you have Asian companies that are investing in Latin America. It’s in some sense broadened the universe of entities that buy this coverage.”
Dante Disparte, who founded both the Business Council for American Security and the risk management firm Risk Cooperative, says product offerings are also becoming more sophisticated.
“The product category is coming of age,” he says. “There are more pioneering approaches. For instance, looking at insurance as part of an investment portfolio. Instead of underwriting one country at a time and one industry at a time, we have helped a number of portfolio investors insure a region or their entire asset class of cross-border investments. That’s been a game-changer that we think will help spur a lot more global investment.
“A big company like Walmart, for example, has a big global footprint and is increasingly putting that footprint in the south of the Mediterranean, in Latin America, in sub-Saharan Africa. Instead of Walmart carving out this type of insurance for its highest-risk investments, we’re able to have a conversation with Walmart around a global strategy that would encompass these political risks across the scope of these types of countries. I think that is a very big break from the old way of doing this business, which was project-specific, country-specific.”
Brokers Must Look Ahead
Brokers, therefore, must make sure their clients understand the risks and are prepared. “Terrorism, war, government actions, they are all random,” says Conal Duffy, vice president of Alliant Emerging Markets. “What could have been a safe place to invest yesterday, or maybe tomorrow, may not be going forward. That’s really where you want to take things. You want to talk to people who think they need this cover. You walk them through the various scenarios that could present themselves: what kinds of losses might they incur; how big a loss; what’s the likelihood; what are they doing to mitigate those risks.
“These are low-frequency, high-loss kinds of scenarios. There are no actuarial tables out there to tell how much this will happen. Then you take that to the insurers and talk to them about how the insured party has done their due diligence and what actions they are taking to mitigate risk. What prudent acts they will be taking going forward to reduce the chances of being the target of some government action. In so doing, we’ve been successful in getting folks into various markets around the world that they wouldn’t have otherwise been able to.”
For example, Duffy says, he’s been able to convince a carrier to underwrite infrastructure projects in sub-Saharan Africa that previously might not have been possible.
Joe Gleason, AHT Insurance’s director of risk management, says his firm tries to instill in its clients a “duty of care” in protecting employees and assets.
“It really is about taking reasonable measures to address foreseeable risk,” Gleason says. “It’s a broad, holistic sort of risk management concept. As a legal construct it’s been around for quite some time, but we’re seeing it more and more as an approach to international risk management. It really connects the old siloed security, insurance, general counsel and HR people. The concept spans all of those traditional categories to provide a broader holistic approach to risk management.”
Gleason says he asks clients to take a three-pronged approach:
- Assess and identify the risk.
- Prepare the appropriate plans and procedures to mitigate the risk.
- Determine how to respond when something happens.
“Our view is to take a multi-stage approach, starting with assessing and identifying the risk, based on what you do, how you do it and where you do it,” Gleason says. “Every organization has a different risk profile, even if they are operating in the same environments. It depends on what they are doing, where they are doing it and who is doing it on their behalf.
“The second part is communicating and educating people on the organizational risk; building the day-to-day plans and procedures and aligning resources. That can be anything from how you move around and security screening at a venue to how you are tracking your travelers globally. And then lastly, putting systems in place to respond when something happens, because it is really a when, not an if, in today’s global environment.”
Beck says Clements maintains ongoing communication with clients operating in areas that might suddenly turn risky.
“We monitor both public and private risk analysis databases for potential coming trends or changes,” he says. “Should a situation arise, we contact our clients in the affected location and offer advice, as needed, regarding coverage changes or other risk mitigation approaches. A change in risk profile for a country or region almost never occurs overnight. However, there can be rapid changes that require consultation. For example, the risk profile for Turkey changed rather rapidly over the past several months. Finally, we work very closely with underwriters and insurers that understand the high-risk marketplace and share our philosophy of a steady hand benefits all involved rather than a knee-jerk reaction to either bad or good news.”
According to the Eurasia Group, a leading global political risk-consulting firm founded by political scientist Ian Bremmer, global investors should be wary of several political trends and stress points. These include weakening relationships between the United States and European nations; pressure in Europe brought about by inequalities between European nations and other factors; China’s impact on the global economy; continued terror attacks from ISIS; and political instability in places such as Brazil and Turkey. And, finally, falling commodity prices and insufficient infrastructure in Africa threaten many countries there.
“There are places where people just aren’t making investments today,” says Duffy, citing south Sudan, Venezuela, Somalia and Yemen. “But in other places that you’d think are the worst places, people are actually going in there and doing business—Pakistan, Iraq, Thailand. Argentina is coming out of a recession, and banks are lending money again. Nigeria is a place where a lot of people are hesitant about doing business, but there is also a lot of foreign investment going in there.”
Clements advises its clients to obtain political and emergency evacuation coverage in case an organization must evacuate its entire staff.
“We have seen this policy triggered in south Sudan, which has been extremely risky for several years, but an eruption of violence was a tipping point that made it unsafe for even organizations most experienced in high-risk markets,” Beck says. “There are several markets where our customers operate that are in this same balancing act, and having the right protection is critical.”
He says a forced-abandonment clause, which protects assets left behind in an evacuation, is difficult to get in high-risk markets but often critical depending on a client’s level of assets in the affected area. It is these policies that are a bit more complicated than typical political violence coverage, Beck says.
Clements also offers salary continuation coverage in cases when business is interrupted. “Many organizations are bound by contract to continue paying staff even if political violence interrupts operations,” Beck says. “Having protection for this expense is an important part of ensuring viability for organizations, both nonprofits and for-profits.”
Arnaud Froideval, a Paris-based credit and political risk product specialist for Miller Insurance Services, says falling prices for commodities such as oil and copper threaten several countries that rely on that income. That can cause a destabilization of governments and increase the possibility of government action that would jeopardize foreign investors.
“From a macro standpoint, the various economies around the world are more fragile than they were in 2008,” Froideval says. “We are seeing a number of economies suffering more and more. I think the fall of pricing of raw materials hurts a lot of economies. When we see a country such as Saudi Arabia issuing bonds, which has never been the case before, that is an illustration. There is a trend clearly driven toward more war across the board, and that could start at any time.”
Froideval is wary of several hotspots.
“Brazil has been entering a very troublesome period with a lot of economic problems to sort out,” says Froideval. “Africa is a problem. The leading economy in that area, Nigeria, is suffering from a lot of economic problems. Add to that countries such as Angola and Ivory Coast, where the growth is reaching nearly double digits at the same time there are some local violence problems, which can affect rates.
“I could draw a very long list of countries in the Middle East, among them Yemen and Bahrain. Everyone is anticipating some difficulties in those countries. Russia is also affected by the fall of oil prices and some political instability related to the situation in Ukraine. It’s quite an unstable world,” he says.
Anderson says with more than 55 underwriters in the political risk arena, one should never say never when considering what projects can be covered, Still, there are some areas like Venezuela where it is virtually impossible to find cover.
“Venezuela is not a very high-exposure country in the market anymore because it has been considered too high risk for most underwriters for several years,” Anderson says.
“Venezuela is a very sad state of affairs,” Disparte adds. “Venezuela marks one of the first countries to fail by not having diversified its economy sufficiently from oil. Persistently low oil prices, combined with really bad management at the political level in Venezuela, has created a perfect storm, and the economy has collapsed. The process of coming out of this mess is going to be at least a decade long.”
Nehra says that, while most current political risk insurance losses result from political violence and terrorism, she expects that to change. “It comes in cycles,” she says. “We are going to start seeing losses resulting from lowering commodity prices where governments are putting capital controls in place or they are not able to meet their obligations because they don’t have the revenue to do so. Nigeria is a prime example. Its state-owned oil companies have had to restructure a lot of their payment obligations. I wouldn’t say that there is a ton of outright expropriation, but there continues to be some level of government interference.”
Most analysts say it is too early to know what impact the United Kingdom’s decision to leave the European Union will have on the political risk market, if any.
“I don’t know that we have something that we have to worry about right away,” Aon’s Schwartz says. “From a political risk standpoint, I don’t think that we expect the government of the United Kingdom to start embarking on a program of expropriations, repudiating contracts or otherwise closing themselves off from the rest of the world.”
“It’s a distinct negative for world trade and for world investment when a leading economy decides not to go along with others,” Duffy says. “The West has been working for years on free trade and helping governments understand the benefits of treating foreign investors fairly, and as a result we’ve expanded our exports to developing countries. Something like Brexit really puts a lot of added risk in terms of sending signals of protectionism or perhaps they are not wanted. There’s still plenty of time left in the game to figure out what Brexit means. For the present time, it just sends a pretty awful message in respect of trade and investment.”