Political Risk Insurance: Options in the Commercial Market October 5, 2006 Thomas E. Birsic www.klng.com
Overview Analysis of the expanding commercial market for political risk insurance (PRI) and some of its prominent players New developments in private PRI are eroding some of the perceived disadvantages of commercial coverage Key differences between commercial PRI and traditional MIGA coverage 1
I. Focus on the Expanding Commercial Market A. Basic Market Corporations are becoming increasingly aware of the effect various political risk issues can have on the success and stability of increased globalization . Where interest is high, the market usually follows , and PRI is no exception. In the last several years the PRI market has seen a renewed expansion in commercial underwriting , along with an intense focus by brokers and other professionals in the arena. According to the 2/20/2006 of Business Insurance Magazine this increased capacity ha[s] created a buyer s market for the political risk insurance market - particularly for standard coverage against nationalization and expropriation. 2
B. Scope of Coverage Basic Coverage Mirrors MIGA: All of the types of risks covered by government-backed insurance will be found available in some form in the private marketplace. Confiscation and Expropriation Currency Incontrovertibility Political Violence Contract Frustration Potentially Broader Opportunities than MIGA : The private market purports to offer a broader range and flexibility of cover than government programs. Cover of certain political risks is unique to the private market, such as loss with respect to the personal property of employees, kidnap/ransom/extortion ( KRE ) coverage, and the cancellation of export licenses by authorities in project procurement source countries. Further, the private market has the freedom and willingness to customize coverage to deal flexibly with novel risks. 3
C. Significant Participants Some Major Underwriters Include : Lloyd s of London AIG Chubb Zurich Sovereign Brokers : major brokerage entities have dedicated extensive resources to position themselves as expert advisors regarding PRI coverage, such as: Aon Marsh For Example : Aon maintains an extensive Political and Economic Risk Map , monitoring the various political risks throughout the world, available at http://www.aon.com/about/publications/pdf/issues/2006_P&E_Risk_M ap.pdf 4
II. Traditional Disadvantages of Private PRI are Eroding New developments in the world of private PRI have addressed many of the commonly cited drawbacks of commercial coverage. 5
A. Cost of Private Coverage Perceived Drawback: Private PRI has historically been more expensive than MIGA coverage. Developing Solution: As discussed earlier, on 2/20/2006, Business Insurance Magazine reported that developments in the market have created a soft buyer s market for private PRI, greatly reducing the cost. Thus, an investor can now likely find rates which are more competitive with those from MIGA. Note : Cover may still be more expensive in those areas where there is no competition from public programs, like MIGA, or in countries where risk is particularly high and private PRI supply has remained low. 6
B. Duration of Coverage Perceived Drawback: Until recent years, private PRI had traditionally focused on coverage limited to renewable 3 year periods, unlike the MIGA s 15 (and in some cases 20) years of coverage offered. Developing Solution: In recent years private providers, such as AIG and Sovereign, have begun to offer coverage of up to 15 years. 7
C. Extent of Financial Coverage Perceived Drawback: Private PRI may provide more limited financial coverage. Developing Solution: MIGA is still able to offer more extensive financial coverage than private providers, such as the $313 million in PRI covering the development of the Kupol Mine in the Russian Federation; however, over the last few years private providers have begun to offer increasingly larger levels of financial coverage. For example : Zurich recently increased its limit for PRI to $80 million and Sovereign underwrites individual political risks on a stand alone basis with limits of up to $125 million on a 15 year term. 8
III. Some Significant Differences Between Private PRI and MIGA A. MI GA s country-related requirem ents typically not applicable to private PRI No nationality requirement : The private company will not have a nationality requirement other than that the insured not be a citizen of the host country. No socio-economic requirements : Private PRI providers insure without regard to such factors as the host country s level of economic development, or the investment s economic effects upon the investor s home country. 9
B. Private PRI covers new and existing investments New and Existing Investments : The private insurer commonly will insure existing as well as new investments, whereas the government insurance companies, like MIGA, will usually only insure new projects, or the expansion of an existing project. Why the Difference? : This is because the underlying rationale of coverage like MIGA is the promotion of foreign investment. 10
C. Private PRI adds flexibility and an opportunity to negotiate Flexibility : With a private company, often there is more flexibility and opportunity to negotiate the provisions of the policy . The government companies are usually not willing to alter the provisions of their standard form of policy. 11
D. MIGA coverage centers on public consultation and disclosure, while private PRI takes a more confidential approach Disclosure Differences : Under MIGA, the host government is informed of the coverage. Private sector policies often prohibit the investor from disclosing the fact of the coverage. In fact, disclosure can nullify the policy. Why the Difference? : The government companies feel that a foreign government will be less likely to take expropriatory action if they know it will lead to a direct claim by, and potential conflict, with the other government. 12
E. Private PRI can respond to a potential custom er s needs w ith great speed The Speed : The speed with which private market brokers and underwriters can respond to a potential customer for political risk insurance can be a major advantage. Typically, a broker can obtain a quote from an underwriter in the London or American market in a matter of days for risks that are not extraordinary in size or character . The Advantage of Speed : Such speed may not be a major factor in the planning of an equity investment, but it can make a big difference to a supplier of goods or services that needs such information in order to price and pursue a contract . 13
Concluding Remarks: Although private PRI has traditionally been less attractive than MIGA because of its historically higher cost and more limited coverage options, developments in the market have eroded many of these differences. Due to these changes, commercial PRI is a more attractive alternative for foreign investors. 14
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