The political risk insurance industry is a $2 trillion industry. What does it do, who are the major players, and how is the industry responding to a looming global economic slowdown?
In 2010, Venezuela’s then-President Hugo Chavez attempted to nationalize eleven oil rigs owned by the American energy exploration company Helmerich & Payne. The move was part of a series of state seizures of private property as the late president nationalized much of Venezuela’s economy throughout the 2000s. Helmerich & Payne claimed the value of seized assets was approximately $43 million, but their suit against the Venezuelan government remains in arbitration until today.
This scenario, uncommon in the developed world, is a factor that investors must take into account when doing business in developing countries. Weak or unstable regimes, corrupt leaders, state-led violence, and civil disturbances can all lead to significant losses for international investors. These are the types of losses for which the political risk insurance (PRI) industry offers protection.
What is PRI?
PRI, like other types of insurance, is a form of risk-management that protects policyholders from financial losses. But doing business in developing and conflict-affected countries poses a unique set of problems compared with investment in the developed world. PRI providers offer protection against risk from political events that negatively impact investments.
The types of political events that PRI policies typically protect against include:
- Expropriation; when a host government limits or eliminates investor control over assets through confiscations and nationalizations.
- Capital controls; when an investor is unable to convert local currency into foreign exchange or transfer capital out of the country.
- Political violence; losses to business assets or activities due to war, terrorism, or civil disturbance.
- Breach of contract; when a host government fails to honor the terms of a contract or after an arbitration process awards the investor damages that the host government fails to pay.
- Failure of sovereign financial obligations; when a government fails to meet an unconditional financial obligation or guarantee.
Investors who use PRI are typically (a) industrial companies with assets or investments in developing countries, such as international oil companies; (b) traders who buy and sell to emerging markets, such as merchants who export capital equipment that is paid for over a long period; and (c) the financial services institutions that lend money to companies, traders, and emerging market economies. Investors in financial services are the highest users of PRI, according to a World Bank survey.
Structure of the PRI Industry
There are two different types of PRI provider with two different agendas. The first is private, profit-seeking firms that are similar to (and often subsidiary businesses of) traditional insurance companies. The second type are public, state-backed investment-guarantee firms that are motivated by that government’s foreign policy and international development goals.
The private PRI market is dominated by the London-based Lloyds Market, an umbrella brand that brings together insurance policy holders with more than 150 brokers, coverholders, and agents. Other large private insurance companies offering PRI services include AIG, Euler Hermes, XL Catlin, and Atradius. Together, the private PRI industry offered about $2 billion in project risk coverage as of 2015.
Public PRI organizations are either state-run or multinational corporations. These include national export credit agencies (ECAs) like the US’s Overseas Private Investment Corporation (OPIC), as well as multilaterals like the World Bank’s Multilateral Investment Guarantee Agency (MIGA), the Asian Development Bank, and the African Trade Insurance Agency. As state-backed entities, national and multilateral PRI providers are able to offer longer, larger, and riskier insurance policies compared with the private market.
Like the rest of the global economy, PRI providers fared poorly during the 2008 financial crisis. Total coverage offered by members of the Berne Union, an investment insurance association that includes the major industry players, dropped 6% in 2009. But PRI coverage grew 7.7% the following year, reflecting the general recovery of FDI following the crisis. About two-thirds of the PRI portfolio in 2010 was held by public providers like ECAs and multilaterals.
Today, world FDI appears to be declining due to worries about slower Chinese growth and a general aversion to emerging market investments. Net world FDI fell from over $2 trillion in 2011 to just over $1.5 trillion in 2014, according to the World Bank. Investment insurance capacity remained relatively stable, remaining between 12% and 17% of total FDI to lower- and middle-income countries, according to data from the Berne Union.
PRI lowers the costs of investing in uncertain and unstable nations, enabling greater trade and development for both the investor and the host country. But for the world’s riskiest countries, such as those categorized as conflict-affected or fragile (CAF) states, PRI availability is limited. Paradoxically, this does not appear to represent a significant barrier to investment in these countries. According to data from the World Bank and the PRS Group, net FDI to high-risk countries remained relatively stable, averaging about $550 billion from 2010 to 2014 (see above).
One explanation may be that there doesn’t appear to be high demand for PRI in the riskiest countries. In a 2010 survey by the World Bank, 90% of investors in CAF nations said that the availability of PRI was not a major factor in their investment decisions. This may be related to the nature of these investments, such as smaller sizes and faster payback times, or due to the relatively high risk-tolerance of the investors involved.