Evan Freely – Taking a multi-country approach to political risk and trade credit insurance

Forecasting political and trade credit risk

At first glance, some political and trade credit risks may seem easy to spot or to predict. A significant portion of political violence today, for example, is a result of violence in Libya and Syria spilling over into other countries in Western and North Africa and the Middle East, including Mali, Lebanon, and Algeria.

As evidenced by events in Egypt during and since the Arab Spring of 2011 and in Thailand and elsewhere, political instability can develop quickly. Much like the stock market, past performance is not necessarily an indication of future results. In other words, political risk frequently emerges in countries that have historically been considered stable by risk managers, insurers, and other observers.

hide

In the years since the peak of the financial crisis in 2008, global credit risk has persisted. The European sovereign debt crisis – and the growing willingness of companies to use bankruptcy as a strategic option – has added to multinationals’ concerns about trade credit exposures, and made predicting the location of the next default difficult.

Further complicating matters are several broad macroeconomic and societal factors that have been at work for several years:

• Geography: Whereas in the past economic downturns and political turmoil would typically spread geographically, today’s increasingly interconnected global economy means that contagion risk no longer knows borders;
• Social media: The broad availability and use of social media in countries at all levels of economic development has played an important role in fueling societal and political change. At times social media has even sparked unrest by spreading misinformation;
• Emerging markets: Global economic power continues to shift to emerging markets, which inherently carry more political risk than developed markets.

A broader approach

Given this new level of unpredictability, it might seem odd that businesses would try to anticipate specific countries in which they would face the greatest political and trade credit risks and the specific nature of those risks. But for much of the last decade, this is precisely what many multinationals did as they purchased separate political risk and trade credit insurance policies to cover particular risks in specific countries. For example, a company might buy a policy to cover war risks in Kuwait and a trade credit insurance policy on one customer in China, while leaving exposures in other countries uninsured.

Many multinationals have since discovered that this country-by-country approach may leave them vulnerable to unexpected events. In recent years, many businesses have recognised the unpredictability of global risk and have increasingly turned to a broader approach to political and trade credit risk management through the purchase of multi-country insurance policies.

A multi-country policy enables businesses to take a more holistic approach to managing risk.

Instead of attempting to cover unpredictable risks through a patchwork of policies for individual nations, a multi-country policy typically covers 15 to 20 countries, but potentially more. These policies can be customised to cover a single region – for example, the Middle East and North Africa – or include countries worldwide.

Underwriters often prefer this multi-country approach as it allows them to spread their political and trade credit risks across several countries. Because of this, the terms available in such policies can often be more favourable than single-country policies. For example, policies may have higher limits available, provide coverage for countries that are typically difficult to insure, such as Egypt, and/or offer more attractive pricing.

Companies purchasing political risk insurance on foreign investments and assets are also seeking to insure a broader range of risks, rather than focusing on what they perceive to be the most likely events to occur. Some of these risks include expropriation, forced divestiture, political violence (including forced abandonment), business interruption and contingent business interruption, contract frustration, and trade disruption.

Business interruption and beyond

A strategic approach to managing political and trade credit risks, of course, extends well beyond assessing insurance needs. Organisations doing business in countries with high levels of political risk, for example, also should review their current business interruption and supply chain resiliency plans and procedures. These businesses should evaluate the immediate and long-term impact of potential political risk events on their own operations and on those of their customers and suppliers.

Among other things, businesses should ensure that they can give early warnings of any potential problems to employees, customers, and suppliers, and review crisis communication plans and procedures to ensure the safety of employees.

Business should also review their credit risks and credit control policies and procedures. Ongoing financial monitoring of customers and suppliers can identify strengths and weaknesses in their credit risk management processes, ultimately enabling businesses to avoid bad debts and improve cash flow.

Emerging markets play an increasingly important role in the global economy, and it is increasingly clear that multinationals need insurance and consulting services to help expand global sales and supply sources.