Taking the Risk: Protecting Your Clients with Political Risk Insurance
Over the past three decades, 80 percent of the terrorist attacks against the United States have been directed against American businesses in foreign locations. In 2001, about 400 American businesses were attacked. Compared to the thousands of American interests abroad, the percentage is low and yet the raw number is enough to make an impression. Of even greater concern to risk managers and underwriters is the inescapable conclusion that this number will increase.
Terrorists around the world boldly and repeatedly declare their intent to hit Americans wherever we are. Certainly, we are more exposed and vulnerable in foreign countries than we are at home. Despite the risk, however, Americans will continue to invest overseas. We have no choice. Globalization is an open door that allows any country to enter and play the game. If Americans drop out, we lose and the investors of the rest of the world win/rejoice.
Americans interested in foreign investment and business have long enjoyed many advantages in competing for foreign contracts and business opportunities. We have the products and the skills that the world wants. We have many disadvantages as well.
Americans are viewed by many as opportunists, profiteers and much worse. Our persons, our property and our business interests can be targeted for violence by domestic or international forces and/or financial punishment through trade or tariff discrimination, etc. in retribution for U.S. administration positions without regard to the good that an individual entrepreneur or business is doing within the foreign locale. Sixty-eight percent of American business executives reportedly believe that globalization increases risk and yet it would be a safe bet that 100 percent of them would say that there is no alternative to foreign outsourcing, investment in foreign locations and competing in foreign markets.
U.S. business, almost without regard to size of operation, cannot be content with just the domestic market when the rest of the world’s entrepreneurs will hardly forego the lucrative U.S. market. Business owners with foreign interests and assets are no longer unusual and it is essential that they understand their risks. It is an unshakeable corollary that their insurance agents and brokers must also understand those risks and how to mitigate them. The large international brokerage houses recognize this and have shored up their staffs and capabilities over the last three years.
Many of the potentially more catastrophic risks of doing business in foreign countries can be mitigated by Political Risk Insurance (PRI)—a generic term that actually includes a broad range of coverage related only inasmuch as all of the causes of loss are politically motivated. Besides protecting against loss due to sabotage, terrorism, war, etc., it also protects business owners and investors against wrongful governmental actions that deprive a business of the fruits of their investment: breach of contracts or licenses; changes after you invest that result in unfairly discriminatory treatment in regulation, taxes, tariffs and/or the ability to pass costs through to consumers; impairment or prohibition of your right to convert local currency into U.S. dollars or the right to remove currency from the country, etc.
Except for terrorism, PRI protects against the kinds of actions that Americans doing business only in the United States would never think they would have to protect themselves against.
“Politics” in the U.S. refers to the eternal push and pull between Republicans and Democrat,s but it does not mean that a change from one administration to another will lead to the government taking your property or abrogating your contracts or devaluing your currency. The unfortunate reality of much of the rest of the world, however, is that “politics” means unpredictable and potentially wrenching changes in regime, reversals of laws, revocation of contracts, crippling increases in taxes, etc.—the kinds of changes that can put you out of business. PRI is the industry’s attempt to help mitigate those risks.
While there are many permutations and virtually every contract is manuscripted, PRI has three broad categories of coverage referred to in shorthand as Expropriation, Inconvertibility and Political Violence. “Expropriation” is also referred to as CEN which stands for Confiscation, Expropriation and Nationalization. This coverage actually provides more protection than might be obvious from its label. Not only does it protect you against the outright taking of your property or investment by governmental action (sometimes referred to as gunboat expropriation) but it also protects against what is known as “creeping expropriation.” Gunboat expropriation has become very rare and unlikely. Governments are more sophisticated than that nowadays. There are more subtle ways to deprive you of your investments, contracts, markets, etc. They just change the “rules of the game” after investments have been made, e.g. revoke agreed upon investment incentives, renege on contracts, impose discriminatory tax regimes or impose confiscatory import or export duties.
Countries in the throes of political and economic uncertainty can also experience serious destabilization of their currencies. Enormous capital flows can now be so rapidly executed that it is easy to imagine a government feeling the need to impose controls in periods of crisis.
Argentina is a recent example of a country in crisis imposing controls on currency conversion and transferability resulting in a number of PRI claims. Insurance claims have been presented not only under the coverage specifically designed for currency transfer and convertibility (T&C) also known as “Inconvertibility” but also under the CEN coverage out of a belief by many investors that the forced “revaluation” of virtually every contract, loan and investment from U.S. dollars to devalued Argentine pesos amounted to a wrongful taking or “expropriation”.
The general category of coverage referred to as Political Violence (PV) includes coverage for loss to assets or business income resulting from war, civil war, insurrection, sabotage, terrorism—any politically motivated act of violence. This is far broader coverage than normally found in P/C contracts which either completely exclude perils like war or offer only very limited protection for perils like sabotage and terrorism. That is not to say that PV without limitations but coverage is certainly broader in virtually all PRI contracts and extremely broad in contracts available from the U.S. government. This is not a reference to TRIA which, of course, is not even available for non-U.S. exposures.
Compared to the number of P/C carriers offering some kind of international coverage, there are not a lot of private insurers offering Political Risk Insurance. It is specialized and customized coverage with the most notable private insurers being AIG, Zurich, Chubb, Sovereign (Bermuda) and some Lloyds syndicates. There is, however, a very significant public market for this business also. Virtually every developed country has an agency that writes PRI in order to encourage foreign investment. In the U.S. it is a federal agency known as the Overseas Private Investment Corporation (OPIC).
U.S. companies are also eligible for coverage with some international organizations—most notably the Multilateral Investment Guarantee Agency (MIGA), an arm of the World Bank. They all have their advantages and disadvantages. There can be significant differences in appetite, rates, claim handling reputation, limits, coverage, length of contract (multi-year contracts are common), etc. just as there can be in P/C. While all of the carriers will try to help investors with advice on the risks, exposures and problems with foreign governments, the public carriers (OPIC & MIGA) can apply significant pressure on offending governments in an effort to remedy things before they go too far.
Another advantage of the U.S. public market is the fact that nuclear events are covered under Political Violence contracts. In an era with the very real potential for a dirty bomb, that is not an insignificant advantage. On the other hand, the public markets can be more difficult and slower in the application and underwriting processes and they can be much less flexible in coverage approaches than the private carriers.
Political Risk is an important risk mitigant that should be considered by businesses of every size and description that intend to have property or investments in foreign countries. Clearly, however, some investments and some countries just do not present sufficient risk for all three of the general coverages. Expropriation and Inconvertibility are hardly necessary in the developed countries of Western Europe. Up until recently, you might have said the same thing about Political Violence in those countries and yet the terrorists and radicals will exempt no country from their list of potential targets and, clearly, they will not exempt U.S. businesses in any locale. Even when a U.S. business is not the target, there is the possibility that businesses will suffer collateral damage or supply chain interruption that is not adequately covered by the P/C contracts.
Agents and brokers who have the capability of offering Political Risk Coverages perform a valuable service for their clients. Offering the coverage also insulates the agent or broker of record against having their clients exposed, and potentially lost to the large brokers with PRI capabilities. Retention of business and adequate protection of your clients is too important to be left to chance.
Furthermore, PRI premiums and commissions are often not insubstantial, especially when they are attached to multi-year contracts that can have policy periods from three to 20 years. Agents and brokers can place business with PRI carriers without the need for an agency contract. Commissions are negotiated and the greater your knowledge and value, the better the commission. Developing expertise, however, is difficult and non-productive for those who have very few clients with foreign exposures. It may, therefore, be worthwhile to consider hiring a PRI consultant for individual transactions.
Rod Morris, cgsm@cox.net is a Political and International Risk consultant. He served as the vice president/department head of Political Risk Insurance for the Overseas Private Investment Corporation. Prior to that he was senior vice president for CNA Risk Management, CNA International.