Political risk insurance was first actively written in Lloyd’s in the 1980s, with policies inevitably designed to respond to the risks of the time, such as US oil companies being expropriated by the Peruvian government. However, with many profound changes over the last 40 years, it begs the question; are political risk policies still capable of responding to the perils facing foreign direct investors today?
Considering how they reacted to recent risks facing investors in Africa, Asia and now central Europe, the answer appears to be that they are. Nowadays while the risk of government expropriation still exists (and in that regard we should be aware of the recent election of some extreme left-wing leaders in previously “solid” capitalist countries), perhaps the more pressing concerns to foreign investors are war, insurrection, political violence, forced abandonment and forced divestiture –clearly a not unthinkable risk in the context of Russia today.
Looking back over the past eighteen months our market has been tested to a degree not experienced for a decade or more. I am thinking of the Chilean riots; the coups in Myanmar, Burkina Faso and Mali; the withdrawal from Afghanistan; the Battle of Palma in Mozambique; the civil war in Ethiopia; the civil disorder in Kazakhstan and of course the Russian “special military operation” in Ukraine. Each of these led to claims being paid, often for abandonment or physical damage due to war or political violence. Beyond the headlines, we have also seen difficult situations arise in other countries where the government decided to pursue hostile legal activities against foreign organisations which had fallen foul of the authorities in order to force them out of the country. Fines, malicious prosecution, discrimination; the tools at a government’s disposal are numerous but the “Selective Discrimination” clauses found in most Political Risk policies provide effective protection against such actions.
One thing that these losses had in common was their unpredictability. For example, the war in Ethiopia, which few expected would spill out from the Tigray region to the other parts of the country, let alone almost engulf the capital. The Myanmar coup, the Battle of Palma, the Chilean riots, the Russian invasion – none of these were predicted by any serious mainstream analysts. Another common feature is the degree to which losses also arose from Forced Abandonment as opposed to physical loss or damage. Political Risk policies cover the risk of abandonment (i.e., where there has not been physical damage, but where it is too perilous to hang around). In this regard the product is superior compared with other types of insurance cover.
Whether we will see claims being submitted for Forced Divestiture in Russia is an open question. Political Risk policies cover the scenario where the government of the insured’s country orders the investor to divest from businesses they may own in the Host Country. The cover responds only when the investor has no choice in the matter – it is forced into divestiture by order of its government. However, most of the companies that have divested from or ceased operations in Russia have done so voluntarily, perhaps mindful of reputational risk, and so the potential for claims arising from divestiture is uncertain. Perhaps there is some thinking to be done on product development in this area.
Another area where our clients obtain real value from the political risk product involves Non-Transfer and Currency Inconvertibility risk. This protects an Insured against the risk that it cannot convert and transfer money out of the Host Country to remit profits, pay dividends or repay debt. Where the Host Country becomes a pariah state, hit with sanctions, and the economy implodes, the ability to transfer money back to the parent organisation in, for example, the US becomes increasingly difficult.
The political risk market offers a robust and responsive product, which over the past 24 months has demonstrated its value and efficacy. It is an almost unrecognisable product, in terms of its breadth and scope, compared to the early prototype policies on the early 1980’s. But where does it go from here? What lessons can we learn from the Russian invasion of Ukraine?
- Lesson One: (for Insureds). Ensure you buy the correct level of cover. Anecdotal stories are circulating across the market that some companies are heavily under-insured.
- Lesson Two: The next round of product improvement should accelerate the initiatives we have seen by some underwriters in recent years to offer external Crisis Management Support (from the likes of Control Risk) in order to help an Insured manage a deteriorating situation so as to avoid financial loss and more importantly protect the safety of its local staff. Optio’s PRISM policy is one of the few policies on the market that provides this service. Often insureds will be in urgent need of immediate guidance and assistance if they find they are suddenly in an Ethiopia-like situation, in which a civil war threatens to engulf their entire operations and the government has started to round up foreign workers.
- Lesson Three: There is some thinking to be done by the market regarding the efficacy of the Forced Divestiture element of the product. More on that in future blogs…
Find out more about the author, Nick Hedley