The State of Political Risk Insurance

The Role of Political Risk Insurance

Political Risk Insurance (PRI) provides coverage for non-commercial risks or political events, including host governments’ direct and indirect actions that negatively impact investments where appropriate compensation is provided. When multilateral and large national insurers do not offer coverage, PRI can also help deter host governments’ harmful actions, help resolve investment disputes, and provide access to best practices in environmental and social standards.

The PRI industry includes many broad categories of providers, where PRI covers export or trade credit and investment insurance.

Specialized multilateral insurers are a cornerstone of the PRI market. These organizations include ICIEC, the Multilateral Investment Guarantee Agency (MIGA) that is part of the World Bank Group, the Arab Investment and Export Credit Guarantee Corporation (Dhaman), and the African Trade Insurance Agency (ATI). The World Bank, Asian Development Bank, and the Inter-American Development Bank also provide types of Political Risk Guarantees.

Next are the PRI providers of national governments. The providers are principally national export credit agencies (ECAs), bilateral development banks, and investment insurance entities. These organizations focus on cross-border trade and investment, generally for clients in their own countries. Berne Union data indicate that the stock of political risk cover from member export credit agencies increased from USD 184.7 billion in 2010 to USD 317.0 billion in 2018.

There is also a growing private market for PRI. This market includes about 20 Lloyd’s syndicates and reportedly as many as 60 private PRI insurers. The largest private insurers are based in three insurance centres— London, Bermuda, and the United States (primarily New York City), and many have regional offices in various locations, principally in Asia. In addition to traditional equity PRI, the private market covers various payment risks for businesses in developing countries, either for political perils alone or comprehensive non-payment cover. Brokers play an essential role in promoting and sourcing PRI for the private market. Broking is a dynamic market segment with players entering and exiting the PRI brokerage market.

Finally, reinsurance companies underwrite PRI-related coverage for both trade and investment and are an essential factor driving both pricing and capacity in the private market. Top reinsurers include Munich Re and Hannover Re of Germany, Swiss Re of Switzerland, and Berkshire Hathaway/General Re of the United States. ECAs and multilaterals also participate as reinsurers of PRI on a smaller scale.

Recent Trends and Developments

Demand for PRI is broadly related to foreign direct investment (FDI) flows, although the relationship is neither linear nor always easily explained. There are also contradictory forces at play. Although, as noted earlier, PRI volumes are generally growing over time, the portion of FDI that PRI covers are declining. According to data from the World Bank and Berne Union, PRI to global FDI ratio fell from about 25 percent in the early 1980s to under 10 percent in the decade after 2010.

Today, only a relatively small share of the inward FDI into developing countries is insured against political risks. A recent study for the G20 confirmed that PRI covers only a small percentage of inward FDI into developing countries globally, and most FDI investments remain uninsured[1] . The average inward FDI stock insured during 2010-18 for all developing countries was around 1%. The average annual inward FDI flows insured during the nine-year reference period for all developing countries is 5%.

Notwithstanding the small share of FDI covered by PRI, before the 2020 pandemic, investing firms and analysts perceived political risk had increased. A 2019 U.K.-based survey by Willis Towers Watson indicated that most firms surveyed thought the political risk was on the rise[2]. Respondents were concerned about political sanctions related to Russia and CIS countries, and many expressed concerns about political instability in parts of the Middle East and Africa, amongst other things.

The COVID-induced recession then hit the global economy. FDI and trade both contracted sharply in 2020; MIGA expected that the pandemic would decrease global foreign direct investment (FDI) by up to 40 percent in 2020, and the World Bank Group expected the global economy to experience the worst recession since World War II. UNCTAD data confirm that FDI did indeed collapse in 2020, falling 42% from $1.5 trillion in 2019 to an estimated $859 billion.[3] This low level was last seen in the 1990s and was more than 30% below the investment trough that followed the 2008-09 global financial crisis. COVID created a flashpoint for investment risk, and traditional areas of concern were compounded by the sharp 2020 recession and by many specific financial and political stresses.

Looking ahead, expectations are that both trade and FDI will see a positive recovery in 2022 and beyond. The WTO and the IMF expect global trade to grow by 6-8 percent in 2021 before slowing to 4 percent annually. The WTO forecasts relatively strong export growth in the Middle East (12.4%) and Africa (8.1%) in 2021, although this export recovery depends on travel expenditures picking up over the year, strengthening demand for oil and oil prices.

UNCTAD projects that FDI will recover and grow by 20 percent in 2021. In 2022 and thereafter, a return to more traditional annual FDI growth rates (i.e. 6-8 percent annually for many countries) would be a reasonable assumption.

Private political risk insurers expect currency convertibility and non-transfer will continue to be popular political risk coverages, particularly in commodity-dependent countries, but also in countries that face severe consequences from the pandemic-induced slowdown.  Political tensions are also elevated in Belarus, Ukraine and US-China relations, giving investors a sense of higher perceived political risk. Climate change and the low-emission energy transition are now underway, posing another area of potential elevated political risk that both investors and insurers are examining carefully.

When taken together, these factors point to an operating environment where demand for PRI should be relatively robust in the years ahead due to both the growth recovery in FDI and the perception of heightened political risk among investors and analysts.

Political Risk in ICIEC Member Countries

ICIEC member countries have a vast array of government systems, policies, trade and investment relationships, and national priorities that affect their relative openness and attractiveness to international trade and foreign investment, presenting various types and degrees of political risk.

As a group, Gulf states have generally taken a series of political decisions and policies designed to create a positive and attractive international trade and investment environment, notably for high-value services trade and investment in addition to extracting value from the traditional energy economy. It is reasonable to expect this supportive policy environment to continue in the future.

In comparison, countries served by ICIEC in Africa and parts of the Middle East are at many different political and policy development stages, with accompanying degrees of political risk. Political uncertainty may remain an underlying factor among many of these countries. At the same time, a more stable and supportive political environment may emerge in some countries. ICIEC members in other regions may also experience events that add to political risk perceptions.

The following table summarizes the average share of FDI stock covered by political risk insurance for selected developing countries, including some ICIEC members.[4] Note: There are substantial differences in cover and perceived risk among countries, even for countries classified in the same IBRD income category.

Table 1: Average Share of Inward FDI Stock Insured 2010 – 2018

Sources: G20 report, based on UNCTAD, OECD, Berne Union data

Regional and geopolitical developments

The vast and diverse regions served by ICIEC have experienced unexpected political developments, instability and tensions. Domestic political tensions are currently heightened in some countries, and there is an ongoing civil strife in a few other cases. The evolution of political relations within, between and among ICIEC members can affect future trade and investment relations and flows and affect the demand for PRI cover from investors and financial institutions.

At the same time, there are signs that a more favourable political environment is emerging in certain areas served by ICIEC, with efforts to strengthen bilateral, regional and multinational political relations. It is thus reasonable to expect that various regional political environments will be subject to both positive and negative forces over the coming years. For some countries, this will mean a political environment supporting increased international trade and investment and likely of greater interest to political risk insurers. For others, there may continue to be destabilizing forces, with political tensions over the medium term that would not be conducive to expanding trade and investment or fostering expanded access to PRI cover.

ICIEC’s product offering

As a specialized multilateral insurer, ICIEC provides political risk insurance for equity investments, debt finance and loan guarantees in its member countries. Its PRI covers four aspects of political risk: currency inconvertibility and transfer restrictions; expropriation; war or civil disturbance; and breach of contract. ICIEC’s reputation as a leader in the market is backed by an Aa3 credit rating from Moody’s.

In addition, ICIEC provides cover for non-honouring of sovereign financial obligations as credit enhancement tools. It offers Political Risk Insurance for equity investments and cross-border loans and covers non-honouring of financial obligations by sovereign / sub-sovereign / state-owned enterprises. ICIEC also uses innovative methods to serve its customer base, such as its website’s digital application forms for PRI. ICIEC also holds a unique role in advocacy and claims avoidance due to the Corporation’s Preferred Creditor Status (PCS) over its member countries.

The political risk insurance market continues to face constant evolution. The expected recovery in FDI in 2022 and beyond, combined with a heightened risk environment, provides the context for solid growth in PRI business going forward. ICIEC promises to remain a key driver in that growth story.