What is political risk insurance?

What is political risk insurance? | Insurance Business

What is political risk insurance?

The geopolitical risk landscape is more tumultuous and diverse than it has been in decades. Potential explosions on the horizon include a true US-China trade war, international cyber conflict (particularly involving Russia), a Middle East war triggered by Iran and Saudi Arabia (or Israel), and a rise in European populism and protest movements. This volatile geopolitical environment can be threatening to global businesses’ operations, assets, and people. To manage their exposure, lots of companies look to political risk insurance.

Political risk insurance is designed to mitigate against the loss of commercial assets, income or property as a result of a political risk event. The policies can provide coverage for a wide range of risks, including political violence, expropriation, currency inconvertibility, non-payment, and contract frustration. Political risks are often very difficult – sometimes impossible – to predict, and the loss of assets and income that follows can be catastrophic.

Political risk exposures

The annual Political Risk Survey undertaken by Willis Towers Watson and Oxford Analytica recently found that 55% of global organisations with revenues exceeding US$1 billion have experienced at least one political risk loss worth over US$100 million. The most common political risk-related loss was exchange transfer, which affected almost 60% of organisations that incurred losses. This was followed by political violence (48%) and import/export embargos (40%). The key geopolitical threats highlighted by survey respondents were US sanctions policy, emerging market crises in areas like Turkey and Argentina, protectionism/trade wars, and populism/nationalism.

“It’s clear from our findings that political risk has increased significantly, now becoming a reoccurring and material cost of doing business,” said Paul Davidson, chairman and CEO of Willis Towers Watson Financial Solutions. “If these levels remain elevated, companies will fall under increasing pressure from shareholders for greater levels of transparency around the losses actually incurred. Companies will need the ability to monitor, quantify and manage these risks as well as develop strategies to mitigate them.”

Emerging markets

Emerging markets present great opportunities for multinational corporations to grow and gain dominant market share. However, they also present greater risks than developed markets. Political turbulence, foreign government actions and socioeconomic events can cause asset value to decline or, in worst case scenarios, assets can be destroyed or confiscated. Without political risk insurance, businesses might be reluctant to take advantage of developing markets.

As Starr Insurance explains: “Foreign government actions and socioeconomic events can create a business environment that is unfavourable for foreign investors, exporters, and lenders, preventing them from taking advantage of commercial opportunities in emerging markets. Political risk insurance is designed to mitigate against the loss of assets, income, or property suffered by investors, lenders, and corporations in emerging markets due to political risk events.”

Who buys political risk insurance?

Political risk insurance is typically purchased by multinational corporations, importers and exporters, project lenders, financial institutions and capital markets, foreign investors, and contractors in industries like construction and engineering. Investors in financial services are the highest users of PRI, according to a World Bank survey.

What motivates companies to buy political risk insurance?

Investors and their partners are the driving force behind the majority of political risk submissions, according to the International Risk Management Institution (IRMI). It’s often purchased to satisfy the banks, who themselves have a desire to satisfy internal credit committee lending requirements.

In an IRMI blog post about political risk insurance purchasing in Asia, Daniel Wagner, founder and CEO of Country Risk Solutions, commented: “There can be little doubt that investor/trader/lender reaction to individual political events in host countries is a prime motivating factor in the purchase of PRI for transactions in Asia. I have seen rises in submission levels following political events in the region, and indeed, globally.

“It’s quite common for political risk insurance purchasers to pursue political risk insurance only after a political or economic event has occurred. Political risk insurance is ultimately a commodity that is sensitive to supply and demand. It would therefore be wise for purchasers of political risk insurance to pursue coverage either well in advance or well after such events occur because, not only is it less likely that coverage will then be available, but the cost of coverage will undoubtedly be higher during the storm.”

The structure of the political risk insurance market?

According to Global Risk Insights, there are two types of political risk insurance providers with two different agendas. The first is the private market, dominated primarily by the London-based Lloyd’s market. Other large insurers that offer political risk insurance services include AIG, XL Catlin, Euler Hermes, Starr Insurance, and Atradius.

Then there are public, state-backed investment-guarantee firms that are motivated by that government’s foreign policy and international development goals. Global Risk Insights explains: “These include national export credit agencies (ECAs) like the US’s Overseas Private Investment Corporation (OPIC), as well as multilaterals like the World Bank’s Multilateral Investment Guarantee Agency (MIGA), the Asian Development Bank, and the African Trade Insurance Agency. As state-backed entities, national and multilateral PRI providers are able to offer longer, larger, and riskier insurance policies compared with the private market.”

How does political risk insurance differ to political violence insurance and terrorism insurance?

There’s often a grey area between what is considered “terrorism” and what is considered “political violence”. Depending on how insurers and governments distinguish between the two should inform whether companies opt for political risk insurance, political violence insurance, terrorism insurance, or some form of combo.

Evan Freely, managing director and global practice leader for Marsh’s Political Risk and Trade Credit Group, explained in a Marsh blog post: “Because rates for political violence and standalone property terrorism insurance are typically lower than those for political risk insurance, some multinational companies manage the risk of political instability and violence through a combination of the two, rather than through political risk insurance.

“But it’s important to remember that standalone terrorism insurance policies do not cover all forms of political risk. Expropriation, forced abandonment or divesture, currency inconvertibility, non-payment, and contract frustration will only be covered by a political risk insurance policy. And there may be some interpretation about whether a politically motivated act of violence would be covered by political risk, political violence insurance, or standalone terrorism insurance.”