There are few areas in insurance broking that demand more specialist and professional claims handling than political and credit risk. Obtaining cover to fully protect against unforeseen circumstances is becoming a much harder task as the global political and economic environment is constantly changing, bringing new and evolving risks to investors’ capital.
Rapid growth in emerging and frontier markets and stagnation in economies of the developed markets often leads to changes in a country’s politics and civil society. These changes can cause problems as competing constituents and interest groups vie for resources and influence. Such tensions manifest themselves to foreign investors and financiers as political risks.
Political and credit risk (PCR) insurance is a risk management strategy designed to protect investors against the failure of public or private counterparties to pay debts pursuant to contract or against an adverse political environment in a country that may prejudice the value of an investor’s assets. PCR insurance covers the initial equity investment of an asset and pays out in the event that the policy is triggered. These events being war, confiscation, currency inconvertibility, government breach of contract and other political risk perils.
“Many political and economic events are often difficult to anticipate and only fully understood in retrospect,” says Tom Stansfield, Associate Director, Political Risk and Credit Risk Solutions, Howden.
He explains that recent events such as the Arab Spring, European sovereign debt and Ukraine crises have shown that political and credit risks combine to be real and tangible issues for financiers and investors in the current interconnected and volatile world.
As a result specialist insurance products are required to mitigate these exposures which can enable the confident pursuit of high-return opportunities in frontier and emerging markets such as Africa, the Middle East, Asia and Latin America, and even in more traditional developed markets.
Market Cover
In total, there are 50 insurers writing PCR insurance, with eight new entrants offering Credit and Political Risk products, in particular, within the last 18 months. With a plethora of insurers operating in the sector, capacity is not an issue. Stansfield explains that policies can be arranged to protect against loss arising from all manner of finance transactions ranging from £5 million to £1.5 billion.
Cover is generally provided on a three-to-five-year timeframe, though policies have been written for larger projects that require insurance for up to ten, even 15 years. Typically equity investments would be covered on a two- to three-year basis, with policies being re-appraised upon expiry.
Policy coverage is worldwide but there are restrictions in place. Stansfield notes these exceptions are sanctioned countries, such as Iran, North Korea and North Sudan. “I am sometimes surprised at what the market will cover as we have seen policies in southern Iraq and Kurdistan recently,” he observes.
A critical element of coverage is contractual certainty when policies are triggered. It is vitally important that clients understand and know what they are buying. Brokers need to ensure that specific concerns are allayed and they have drafted the wording appropriately. “These are pretty bespoke contracts and not simple cookie-cut insurance products,” he says.
In recent years, there has been an increasing uptake of political risk policies from financiers outside of the large international banks who along with energy or mining firms were the traditional buyers of such policies.
Stansfield says this is being driven by businesses and investors looking for opportunities to grow and create shareholder value in emerging markets where there is greater potential for growth and better returns in investment.
Family Office Demand
Increased exposure to political and credit risk has become a significant reality for family offices looking to invest overseas. The trend of disintermediation and lending restrictions placed on banks has led to gaps in funding.
This has resulted in private equity and family offices stepping in to fulfill funding needs by co-investing in projects. However, a recent trend of many going it alone and becoming the major investor in projects means that family offices need to be fully aware of all the risks inherent in transacting in emerging of frontier markets.
“Family offices are increasingly financing projects in many different and potentially risky areas of the world to obtain a higher return than they would by investing in G20 countries. This brings with it considerations of risk and reward as the higher return in places like Angola would be mitigating political risk events and government exposure,” says Stansfield.
Family offices using the insurance market as a tool to preserve and protect capital and assets is the principle function of service that we, as a broker, can provide and PCR cover is an extremely good example of this, says Edward Brennan, Howden’s Director of Business Development.
“The product allows family offices to go and invest in these places with greater confidence they may not have had previously, as they have the comfort of an insurance policy in place. In many cases, it could be the first investment that many family offices have made in emerging markets,” says Stansfield.
Evolving Risks
Investors face the difficulty of assessing how and where risks will develop. Over the past ten years, the political risk map has changed dramatically (see chart). “It will be
interesting to see in which geographies the claims have risen in five years’ time,” he says.
“The danger hot spots can change rapidly, as seen in Crimea last year, and conversely countries that are flagged as risky now may not be in the future.”
The nature of the risks have also changed and become subtler, says Stansfield, with many political risk exposures becoming more intangible, as governments become more sophisticated when acting against the interests of foreign investors. These can range from discriminatory tax provisions that governments can place on foreign investors vis-à-vis their domestic rivals to non-transfer and inconvertibility of funds outside the jurisdiction of investment.
“Expropriation and nationalisation of assets is creeping into the fore for many international investors. It is not blatant action by host governments, but a much subtler approach is now taken in undermining the value of the investor’s asset than say 20 years ago,” he says. “There is no huge physical loss or damage, but what they are doing is playing with contracts, an example being the energy sector, where governments often renege on power purchase agreements.”
Governments have a mixed track record when it comes to repaying contracts and are some of the worst credit risks going, he says. “Family offices would have little leverage in negotiating with governments successfully and so would benefit from additional guarantees covering their investments,” adds Stansfield.
