Political risk: Insights for your firm

Today, as many businesses wonder how to thrive amid political uncertainty, companies with experience in emerging markets can offer insights to help with the changing business environment. One common solution chosen by companies operating in emerging markets is political risk insurance. Political risk insurance both helps protect businesses against the risk of losing investments and helps companies secure funds for new ventures at more favourable interest rates.

Changing governments
There are many types of political risk, from expropriation to political violence. One risk in emerging markets is regime change. Emerging markets may not have the same underpinning of civil societies or government institutions as do more developed countries, so the impact of regime change can be greater. The legislative and judicial systems may be underdeveloped, and existing laws are not always consistently applied. There is more potential for negative effects on foreign investors because they cannot count on ‘the system’ to protect their interests.

When government policies change, the company’s business plan might have to change quickly as well. A contract made with the government might be invalidated, or a subsidy might be taken away. A new administration may have won an election on a platform of cleaning up past real or perceived corruption: contracts put in place by the previous government may be reviewed, amended unilaterally, or even cancelled.

An area where we have seen this happen more frequently is in the natural resources sector. There is often a lot of local passion around natural resources because agricultural, oil, gas and mining projects have a strong impact on the local community. So there may be a lot of pressure on politicians to respond to those local concerns.

In some instances countries have nationalised the oil and gas industries in the name of protecting the national interest. In these cases, operations owned and run by foreign companies have been expropriated, and these companies have had to leave their assets (and future profits) behind. Many countries’ constitutions allow for expropriation, albeit often with compensation, though the level of compensation might be inadequate.

On another note, when anti-foreign investment sentiment rises, the government might increase regulatory involvement in industry sectors with high levels of foreign participation; this may lead to higher operating costs or perhaps restrictions on certain activities. One example of a sector that may be impacted is utility companies, where there may be a cap imposed on prices charged to local customers.

Another significant risk is change in the economic situation of the country. Whether there is a change in government or not, a weakening economy could lead a government to decide that it is no longer in the public interest to provide subsidies, say, for clean energy. So the government may want, or need, to revisit those contracts. That has happened in a number of countries: Spain a few years ago would be one example.

How does political risk insurance help?
There are many opportunities that political risk insurance (PRI) can help open up for companies. Not only can political risk insurance help protect against loss of the company’s assets, but it also can help companies finance new opportunities. When a company is looking to expand overseas, generally speaking, that can make its lenders a little nervous. PRI can mitigate some of the risks.

A political risk insurance policy can be provided to the investor or to its financial institution: coverage can apply to the equity and/or the commercial loan. This can help make banks more open to helping their clients make investments in new markets.
PRI is not just for large investments like infrastructure or manufacturing. We have a number of clients that insure their mobile assets – for example, drilling rigs, high-value electronic equipment, or inventories.

PRI is helpful for companies with mobile equipment because it enables them to take advantage of business opportunities, wherever they’re available. For companies with distribution facilities in various regions of the world, PRI helps keep them close to their customers while minimising the risk to their assets.

PRI is structured differently to other lines in global programmes because coverage is provided to the parent company rather than to the local operation. If a political event occurs in the foreign country, a claim payment would be made to the parent rather than to the foreign subsidiary which is experiencing the turmoil.

PRI policies are admitted in the home country of the parent, so there is no master underlyer structure, but instead we can provide multi-country policies wherein a company’s investments around the world can be covered under a single policy, with named insured locations.

Political risk insurance is often under the radar and awareness of the product can be limited, even on the part of large multinational companies. Particularly outside of specialist broker markets such as London, New York, and Singapore, there is a need to raise awareness of the product and to explain its benefits and how it can help with finance, investments and risk management.

Contributed by Alison Ramsay, vice-president, global credit lines, AIG