“There are too many unknown unknowns.”
Those are the words used by former US Secretary of Defense Donald Rumsfeld in 2002 to describe the lack of evidence linking the Iraqi government with the supply of weapons of mass destruction. They’re also the words used by a country risk management expert to describe the risks geopolitics pose to businesses in 2018.
As a result, the political risk insurance market is booming, with risk managers increasingly turning to credit and political risk insurance (CPRI) to manage hard-to-predict geopolitical threats to business. Over the past three years, capacity in the CPRI market has grown by 30%, according to a report just released by CPRI specialist broker BPL Global. “Appetite for the CPRI class is on an upwards trajectory – both in terms of capacity and tenors,” says Sian Aspinall, managing director, BPL Global.
The growth in capacity reflects increasing demand for coverage. A whopping 89% of companies included in a recent survey by Willis Towers Watson and Oxford Analytica believe that levels of political risk have increased over the past five years. Sixty-three percent of the companies – most representing the Forbes Global 500 – recently experienced a financial loss caused by political risk.
What’s driving the demand?
A perfect storm of geopolitical uncertainty is currently turning risk managers’ attention to CPRI. “The political climate in any given year is always going to have some flashpoints,” says Daniel Wagner, CEO of Country Risk Solutions and a former corporate risk manager at GE. “I don’t view that as too unusual. What I do view as unusual is the degree of disruption economically and politically on so many fronts at one time. That, more than anything else, is driving the demand for political risk insurance.”
Here are a few notable factors:
US sanctions on Russia and the Crimean conflict in Ukraine
The biggest geopolitical concern cited by companies in Willis Towers Watson and Oxford Analytica’s survey? Russia sanctions. Those fears are warranted, as some of the biggest recent claims have come from organisations doing business in Russia and Ukraine. Instability from repercussions of the global financial crisis, compounded by the ongoing conflict in Crimea led Ukraine to top the BPL’s charts in terms of claims for both frequency (57) and value (US$509m). Russia came in second, with the destabilising effects of US sanctions playing a major role in the 31 claims totalling US$195m. Banks were especially exposed to various projects in the two countries, says Laura Hobern, consulting actuary at Milliman.
Brexit has brought political risk to the forefront of risk management agendas in regions not traditionally bothered by the threat. “Now, even if you’re trading between the UK and Germany, there is political risk because of Brexit,” says Derek Newton, principal, consulting actuary at Milliman.
The retreat of US leadership from the world stage has created chaos in the form of a power vacuum. International relations and norms have been upended as President Donald Trump’s “America First” motto has translated to vast geopolitical uncertainty, especially as it relates to trade. Supply-chain risk, much of which is covered by PRI, has been exacerbated by protectionist trends.
What’s CPRI good for?
Political risk insurance is designed to fill gaps in conventional policies. “It’s effectively a bundle of different covers,” says Newton. “What that bundle looks like depends very much on what the nature of the cover is.” Policies are tailored on a case-by-case basis. “There isn’t that much in the way of a standard policy,” he says. “Things are very much bespoke and put together to meet the actual needs of the particular insured.”
Coverage is often one-off and is commonly purchased for specific projects, like major construction or engineering projects that can last anywhere from a few months to several years. Critically, political risk insurance is often a requirement for businesses looking to secure financing from banks. “A lot of times, cross-border traders and investors cannot get financing if they don’t have PRI in place,” says Wagner.
Political risk insurance is akin to natural catastrophe cover in that claims frequency is low and claims values are high. Acquisition prices can be high, but the current market is competitive enough that it remains a feasible option for many companies. “The marketplace accommodates billion-dollar transactions now,” says Wagner. “That will cover almost anything companies want to do.”
Larger companies have more options when it comes to managing political risk. “The biggest companies can effectively self-insure,” says Newton. That could be done through either using a captive, or by simply carrying the risk on your own balance sheet and relying on alternative mitigation measures. BP, for example, relies on diversifying exposure to geopolitical events and developing relationships with governments and stakeholders in each country and region where it operates as part of its political risk management, according to its latest annual report.
Other times, a company may need to consider whether the risk needs to be avoided completely. “It’s effectively a question of risk management,” says Newton. “But certainly, if you’re a small business doing something in a foreign country, you would probably want to take out insurance, because the risk to you is so much greater.”
“Political risk insurance is an important option, but it’s certainly not the only option,” says Wagner, who as a corporate risk manager at GE, helped invest billions of dollars into global energy projects, with a portfolio totalling over US$20bn of assets in 20 countries. “In addition to PRI, there are a host of other things people can be doing – from educating their staff, to traveling to the countries where they’re doing business and making the kinds of relationships that will make their entry into these marketplaces as well as their time there much better.”