25/06/2010

By Lynn Strongin Dodds

While political risk has always been a major concern for multinational corporations (MNCs), it has risen to the top of the agenda in recent years. The financial crisis, coupled with increased activity in emerging markets, has prompted companies to review their political risk coverage. The type
of policies available vary, and firms are also encouraged to take preventive action to better protect their operations and employees.
Jonathan Wood, senior global issues analyst at Control Risks, an international business risk consultancy says: “I think companies are certainly widening their view and looking at political risks in a more holistic way. In addition, certain risks such as terrorism, which used to be perceived as niche risks, have become mainstream. The insurance industry is responsive to these changes in the marketplace. There is a better understanding of the threats being posed and the operators are refining their approach.”
In broad terms political risk is defined as the disruption of a company’s operations by forces or events which occur in either the host or home countries, or changes from the international environment. This could translate into a breach of contract by governments, restrictions on currency transfer and convertibility, expropriation, and political violence such as war, civil disturbance and terrorism. It could also mean a government failing to honour its guarantees, adverse regulatory changes, and restrictions on foreign direct outflows.
The insurance industry employs a narrower definition though, that focuses on actions taking place within host countries only. This is divided into currency convertibility and transfer, expropriation, political violence, breach of contract by a host government, and the non-honouring of sovereign financial obligations. Political risk insurance (PRI) is also more bespoke in nature. As Dr Elizabeth Stephens, head of credit and political risk analysis at broker Jardine Lloyd Thompson puts it: “There is no off-the-shelf coverage, because it depends on the type of risk, the country and type of transaction. The one common factor though is that there needs to be a cross-border element. A British company, operating in Britain, cannot get political risk insurance against the actions of the British government.”

Risk league tables
Although risks vary from country to country, one common perception is that conducting business in emerging markets is more dangerous than in the developed world. These sentiments are echoed in the latest World Investment and Political Risk report published by the Multilateral Investment Guarantee Agency (MIGA) of the World Bank Group. It revealed that for MNCs operating in emerging markets, political risk has risen to head their top three concerns, followed by macroeconomic instability and access to finance.
The MIGA report also noted that while the overall risk appetite leading up to the financial crisis appeared to be increasing, against the background of flattening risk premiums, political risks had been deteriorating in several areas. These risks include potential expropriation and breach of contract in the extractive industries such as mining, due to a resurgence of resource nationalism. In addition, decentralisation to sub-sovereign entities led to increased fears over their inability to meet contractual and financial obligations, particularly in infrastructure projects.
A separate study, the 2010 Political Risk Map produced by Aon Risk Services in partnership with international consulting firm Oxford Analytica, puts the following countries at the top of its risk league tables:
Algeria, Argentina, El Salvador, Equatorial Guinea, Ghana, Honduras, Kazakhstan, Latvia, Madagascar, Mauritania, the Philippines, Puerto Rico, Seychelles, Sudan, United Arab Emirates, Ukraine, Venezuela and Yemen
“Some places are more dangerous than others, but many times it also comes down to the origin of the investment,” adds JLT’s Dr Stephens. “For example, a Chinese company doing business in Africa may be seen more benignly than a Western company. This is because it does not carry the same legacy of colonialism and doesn’t mention good governance and human rights.”
In terms of PRI policies, although there are variations on a theme and nuances in terminology that an insurer will employ, there are also basic concepts. For example, expropriation insurance typically protects a company against losses due to host government actions that may reduce
or eliminate ownership or control. It covers outright confiscations, expropriations and nationalisations. Currency inconvertibility and transfer restrictions insurance, on the other hand, protects against losses arising from an investor’s inability to convert local currency into foreign exchange and transfer it out of the host country. Generally, this coverage applies to the interruption of interest payments, repatriation of capital or dividends due to currency restrictions. It also includes excessive delays in acquiring foreign exchange, but does not cover devaluation risk.

Self-protection
Protection against political violence is also high on the radar screen, as witnessed by recent civil disturbances in Thailand and Greece. Coverage comprises civil war, vandalism, sabotage, civil disturbance, strikes and riots and also includes damage to tangible assets or business interruption caused by war, insurrection, rebellion and revolution. As for terrorism, certain insurers offer this coverage on a stand-alone basis to supplement property insurance policies, which have largely excluded terrorism as a threat since 9/11.
Wood of Control Risks notes: “We are starting to see the components of terrorism being broken down, with policies covering specific threats such as nuclear, chemical, radiological and biological attacks, which traditionally have not been included in terrorism policies. Insurers are also distinguishing between the initial impact and the long-term effect, such as the demolition of a building that might have to take place sometime after the attack.”
There is also a rising demand for kidnap and ransom (K&R) policies, which protect individuals and corporations in high-risk areas worldwide, reports Philip Skinner, marketing executive at Exclusive Analysis, a specialist intelligence company that forecasts commercially relevant political and violent risks worldwide. K&R risk not only covers the ransom, but also the response consultants who are involved in the negotiations as well as loss of hire. This is the loss of income as a result of a vessel being out of operation, due to damage or the inability by a physical obstruction from leaving a port.
Although official estimates are not available, insurance brokers reckon annual sales of so-called marine K&R insurance have soared to about $100m since 2008, when there was an upsurge of vessel seizures and ransom demands by Somali gangs. Rates have since dropped as more players have entered the marketplace.
Philip Turner, who heads up the specie practice at broker Marsh, says: “The outlook for standard K&R, excluding piracy, is stable as the world is becoming a calmer place in many respects. However, piracy off Somalia and the associated kidnap risk shows no signs of abating.
“Ship owners can mitigate the risk of a piracy attack by installing better physical protection for their vessels such as razor wire around the deck rail, which so far has proved effective. Some vessels sail with the protection of armed guards on board, but this can raise liability issues if shots are fired in anger and the crew are injured or worse. The only way to avoid the risk is to avoid the area, but taking alternative routes costs time and money."
Turner also notes that the Obama administration has recently passed a directive stating that no ransoms should be paid to Somali pirates while the European Union has also put a similar measure in place. However, these moves have done little to temper demand for piracy insurance – companies still want to have this level of protection in place.
Overall, though, insurers are working more closely with companies to better look after their employees in high-risk areas and sectors such as mining and energy. As Stephens puts it: “If a company sends people into a hazardous environment, they have to teach them how to protect themselves. This means living in a secure compound, varying their patterns of behaviour so they do not always leave and arrive at the same time as well as travelling in a convoy. However, companies also have to realise that they are responsible for creating some of that risk. For example, if they set up a mine in a village where there are two tribes they have to ensure that they take a balanced approach and employ people from both tribes. If they don’t, they risk creating resentment amongst the local community and against the project.”

Lynn Strongin Dodds is a freelance contributor to Risk Management Professional