Stakes Raised For Political Risk Coverage

Political risk insurance first became viable in the early 1980s with a number of high-profile political risk events. One of the most well-known of these events was the takeover of BELCO in Peru, which triggered a $300 million claim to the company's insurer.

Long before terrorism became a hot topic, the coverage was designed to protect companies against loss of assets or income as a result of violence undertaken for political purposes or motives. These could include hostile actions taken by national or international forces, civil war, revolution, insurrection, politically-motivated strife, terrorism or sabotage.

Today, political risk insurers still offer terrorism coverage but now must charge for it. Previously it was included in political risk coverage.

Usually political risk insurance covers government actions as well as government interference–such as foreign exchange restrictions, currency inconvertibility, trade embargoes, repudiation of existing contracts, and confiscation or nationalization of assets.

One of the most blatant recent examples of a political risk event is the Russian government's dismemberment of Yukos–Russia's largest independent oil company.

Yukos was a victim of what is known as "creeping expropriation," or increased taxation. The goal is to make ownership progressively more and more unrewarding–until the owner has been divested of all benefits and abandons the property.

Creeping expropriation doesn't just affect large, multinational companies like Yukos. In fact, some of the larger, more well-known companies are not as vulnerable as smaller, independent companies or even subsidiaries of large companies.

Take the example of a U.S. investor who established a fishing venture in Somalia in the 1990s. After a military coup occurred, the new government began a series of repeated and continuous acts of harassment and interference against the U.S. investor's personnel and operations. The personnel were repeatedly threatened by military and police officials, arrested and, in one instance, deported from the country.

In addition, the government interfered with the company's operation of its aircraft, which was used to transport the fish. They ordered a military observer on all flights–displacing several hundred pounds of seafood products and adding substantially to the cost of the company's operations.

The political risk insurer–the U.S. government agency Overseas Private Investment Corp., or OPIC–found that the Somalian government had expropriated the U.S. investor's project and the investor was compensated.

Currency inconvertibility is another area where overseas exporters are vulnerable. The ability to convert profits, debt service and other investment returns from local currency into U.S. dollars can be critical.

In this case, a U.S. company made an equity investment in a subsidiary in the Philippines that processed coconuts. Sixteen years later, the subsidiary declared a dividend of more than nine million Philippine pesos payable to the U.S. parent company.

In the meantime, the Central Bank of the Philippines had adopted restrictions on foreign currency so that the subsidiary was unable to pay the dividend in dollars. The U.S. parent company filed an inconvertibility claim with its insurer, OPIC, and was compensated, since the Central Bank restrictions were not in effect when the U.S. parent company originally obtained its insurance.

The U.S. government can also interfere with overseas contracts between buyers and sellers. It can impose a freeze on trade between the United States and another country or try to balance trade between countries with quotas.

But while obviously necessary, buying political risk insurance is not all that simple. As most companies have an insurance budget to adhere to, knowing when to buy the coverage and when to let it go is extremely important.

It all comes down to balancing the risk against the reward on each overseas opportunity. Some goods and services–war materials and medical supplies, for example–will always get paid for by the customer. Other goods and services, such as consumer products, technical expertise and non-essentials, however, are vulnerable to disruption.

All insurers and reinsurers have designated limits per country that dictate what coverage can be provided to an insured party, in which countries, over an extended period of time. Once the maximum limit for a country is reached, political risk insurance for that country, by that particular insurer or reinsurer, would not be available no matter what the price.

Underwriters of terrorism insurance today follow a similar rule, using per-risk, per-city, or per-region of accumulation or aggregation of limits.

Fortunately, political risk coverage is available through a variety of both government and private companies.

Private insurers provide the widest protection in the fastest time. In and outside the United States, there are numerous large, multinational public companies with specialized departments handling political risk insurance. While it might be a little more expensive, private sector insurers are able to partner up with government agencies if the risk is very large, and vice versa.

Insurance companies and their clients usually work with banks, which often provide improved financing terms once they know a political risk policy is in place.

If opting to work a government agency–such as OPIC, the Foreign Credit Insurance Association (formed by the U.S. Export-Import Bank), and the World Bank's Multilateral Investment Guaranty Agency–it's important to determine the percentage of U.S. content versus outside content, and to allow plenty of lead time. With appropriate planning, some of these agencies can also provide financing and excellent protection, often at the best prices.

Moreover, they have tremendous political muscle. If a political risk loss is looming or can be avoided, these agencies can step in and provide invaluable assistance.

Finally, independent brokers, from both large and smaller brokerages, can be helpful in navigating this confusing collection of options. They can help clients evaluate their political risk, offer choices and alternatives, and locate the most appropriate, affordable political risk coverage on a worldwide basis.

Edward R. Santos is senior vice president of financial advisor and reinsurance intermediary Gill and Roeser Inc. in New York City.

Caption:

Long before terrorism became a hot topic, insurers covered firms against loss of assets or income as a result of violence undertaken for political purposes, including civil war, revolution and sabotage.

Quotebox, with Santos mug, if needed:

"Today, political risk insurers still offer terrorism coverage but now must charge for it. Previously it was included in the policy."

Edward R. Santos

Sidebar:

FLAG: Pricing

Head: Political Risk Basics

Rates for political risk insurance are generally between 10 cents per $100 of limits, up to 5 percent. Capacity ranges from $100 million up to $500 million, depending on the type of coverage desired. Premium is generally payable at the policy's inception. Of course, the existence of a policy is considered confidential.

Cost and availability of political risk insurance depends upon:

o The current and future economic, financial and political stability of the overseas buyer's country.

o The type of U.S.-based exporter (single country or multiple countries).

o The insurance company's current country aggregate position.

o The insurance company's current country aggregate position, both total and per reinsurer.

Flag: Checklist

Head: Political Risk Breakdown

Text:

Companies doing business in foreign countries face a number of exposures, including:

o Hostile actions taken by national or international forces.

o Civil war, revolution or insurrection.

o Politically-motivated strife, terrorism or sabotage.

o Foreign exchange restrictions or currency inconvertibility.

o Trade embargoes or repudiation of existing contracts.

o Confiscation or nationalization of assets, or "creeping expropriation" through increased taxation.