Spike in demand for political risk cover as government reserves deplete
Infrastructure and construction sectors high risk
London-based specialty insurer Chaucer said that demand for political risk insurance is on the rise as a sharp fall in foreign exchange reserves across the globe raises the spectre of governments failing to pay foreign suppliers.
The insurer, acquired by China Re in 2018, said that 50 countries saw their foreign reserves fall by 10% or more during 2022. The UK, for example, saw a 13.7% fall in its foreign reserves over this period.
In total, 64% of 142 countries have seen their foreign exchange reserves fall in the last year, with 35% seeing their reserves fall by more than 10%, according to the study.
Foreign exchange reserves of US dollars dropped from $12.23tn to $11.16tn over the past year in the 142 countries studied.
A sharp fall in foreign exchange reserves, often caused by economic instability, can limit a country’s ability to pay debts they owe in foreign currency, and pay for imports, explained Chaucer. If governments struggle to pay their bills, corporates can find their public sector contracts are suddenly cancelled or go unpaid.
As a result, risk managers have increasingly been insuring against governments failing to pay their bills by buying political risk insurance, said Chaucer.
Jonathan Bint, senior analyst and underwriter at the insurer, explained: “When governments are short of foreign exchange then contracts with foreign suppliers can be a tempting target for cost-cutting. When the global economy stutters, cancelled government contracts and disputes over payments rise, and they are by no means limited to emerging markets.”
“In a period of rising global economic uncertainty, businesses that ignore the risk of contract cancellation, or an increase in reneging on bills, could be opening themselves up to significant financial loss,” he added.
Chaucer said that Sri Lanka’s foreign reserves dropped to unsustainable levels in 2022 as it battled rising import and debt-servicing costs. This resulted in the country defaulting on its debts, inflation rising to around 50% and widespread civil unrest.
“More than half of countries depleting their reserves over the past year is an indication of growing pressure on global economies, and suggests a rising number of countries are now less capable of managing their obligations,” said Chaucer.
Foreign reserves are usually held in US dollars or, to a lesser extent, euros, and are controlled by central banks. Some sectors are at greater risk than others of having their contracts cut by cash-strapped governments.
“Businesses in the infrastructure and construction sectors are especially at risk of suffering losses from governments reneging on bills, especially given the high value of the projects they typically undertake on behalf of national governments,” said Bint.
The underwriter said that emerging markets present big opportunities for multinational corporations to grow, but often present greater risks. Insurers are also seeing increased demand for political risk insurance in places that had previously been ‘safe’ investment destinations such as the UK and the EU, according to Chaucer.
