Numerous conflicts all over the world are dominating the headlines – the US-China trade issue, protests in Hong Kong, Chile, Lebanon, and other countries, and the risk of a blockade in the Strait of Hormuz – making political risk one of the top concerns businesses must address today.
But first, what is political risk?
According to Michael Lum (pictured), head of surety, trade credit and political risk insurance for Asia-Pacific at Swiss Re Corporate Solutions, political risk encompasses a plethora of risks arising from the action (or inaction) of a government of a foreign country. These range from changes in the tax, fiscal or operating environment of a foreign country to more specific acts such as:
- Confiscation, nationalization, expropriation and deprivation of assets;
- Cancellation of necessary operation licences;
- Imposition of an export or import embargo;
- Forced divestiture of interests;
- Imposition of restrictions on currency exchange and transfer;
- Property damage and potential abandonment of assets as a result of political violence (e.g. war, civil war, strike, riots, civil commotion or acts of terrorism);
- Breach of contract or the failure to honor those valid and enforceable by arbitral award by a government of a foreign country.
“These risks can cause business owners to lose the investments that they’ve made into a foreign country,” Lum said. “In the same manner, if a lender has made a loan to a company to fund its operations in a foreign country, the lender is also vulnerable to being unable to obtain repayment of its loan as a result of these same risks.”
These major actions can have a huge effect on businesses’ operations, and may inflict massive financial losses or outright dissolution of operations. However, according to Lum, many companies are not aware that there are solutions available for them to cover political violence and, more broadly, political risks.
“There is a standalone political violence insurance market that caters to covering property damage and business interruption caused by political violence,” he said. “In some cases, the covers have evolved to cover losses where there is no property damage, such as, for example, loss of attraction and denial of access.”
Lum said that, in addition, there is a broader political risk insurance market. While the term ‘political risk’ could be taken to refer to a broad range of situations, he said that political risk insurance itself is specific, and typically protects against illegal, arbitrary and discriminatory acts of a foreign government, such as the specific acts mentioned above.
“A political risk insurance policy will not protect an insured against the commercial risks that are part and parcel of any corporation’s decision to invest in a foreign country,” he said. “For example, these can include changes in the fiscal and tax environments or currency fluctuations.
“When making investment decisions in foreign countries, risk managers should be assessing their companies’ exposure to political risks and exploring covers for this exposure. These political risk solutions are available to both business owners and lenders.”
Lum believes that insurers and specialist brokers must do more to raise awareness among their clients of the various solutions that are available for political risk.
One specific example of political risk that Lum cited is the tension at the Strait of Hormuz, which is the only ocean route leading into the Persian Gulf, making it one of the most strategically important points in the world.
“The Strait of Hormuz is an important channel for the supply of oil and gas from the Middle East to the rest of the world,” he said. “With lingering risks of a blockade in the Strait of Hormuz, oil and gas companies are vulnerable to supply chain disruption. As such, there is a subset of political risk insurance that we call trade disruption insurance. This pays out when a company’s supply chain is disrupted. This is in addition to the political risk insurance solutions available to both business owners and lenders mentioned above.”
In Asia, Lum noted the emergence of Singapore as a hub for political risk insurance. Demand for political risk insurance enters Singapore from around the region, including Australia, South Korea, Malaysia and Hong Kong.
“We are seeing an increase in demand for political risk insurance in the region as a result of recent global trends and a greater awareness through the efforts of specialist brokers and insurers,” he said.
“As Asia emerges as the next economic growth engine, an increasing number of home-grown enterprises are expanding both regionally and internationally and are asking about political risk insurance,” Lum added. “This is perhaps a reversal of the previous trend, which saw Western companies seek insurance coverage when heading east and into Africa. Conversely, strong and established companies in the East are now investing in markets such as Africa and Latin America, creating greater demand in political risk insurance in the region.”