Leading political risk insurance (PRI) practitioners insist that their market has rarely faced such a complex mix of global perils, writes Kevin Godier.
Discussion participants
- James Brache, Zurich
- Jamie Cleary, Amlin
- Navaid Farooq, Catlin
- Kevin Godier (chair)
- Louis Habib-Deloncle, AIDA
- Peter Jenkins, BRIT
- Maggie Nicol, AIG
- Paul Sanders, Aspen
- James Steele-Perkins, Nexus CIFS
Plunging oil prices, the fallout from hostilities in Ukraine and the political violence in the Middle East were among the subjects highlighted by underwriters gathered in London on January 21, at a roundtable event. The scene was set by Paul Sanders, head of Aspen’s credit and political risk insurance team, who underlined that competition among insurers will be “intense” in 2015, particularly if fewer deals feed through from trade and increasingly liquid banking markets seeking to make a return in a low commodity price environment.
“Given that Russia is pretty much closed from a new business perspective, we are seeing more business from Africa, Kazakhstan and Azerbaijan, which bring their own challenges as banks try to diversify,” he said. James Steele-Perkins, divisional head, trade credit and political risk at Nexus CIFS, noted that risk appetite among banks is gravitating towards smaller and more unfamiliar counterparties. “We are also seeing more developed market risk, and many commodity traders acting in the capacity of banks with pre-payment deals.”
These market shifts are hardly surprising, given the massive instability in several emerging regions that were former PRI market bedrocks. “We are in a very unique stage in the PRI market,” stressed Jamie Cleary, lead underwriter, political risk, war and terrorism at Amlin. “We are looking at multiple situations of volatility: in Libya, Syria, Yemen and Ukraine, among other countries.”
In light of the falling oil price, requests for PRI have inevitably spiralled for risks involving oil producing countries. “We have seen a huge uptick in demand involving all oil exporting countries, because the risk factor is increasing,” said Maggie Nicol, political risk underwriter at AIG.
Going forward, low oil prices will be a key risk factor, observed James Brache, London head of Zurich’s credit and political risk team. “It seems inevitable that governments whose budgets depend on US$80 or US$100 per barrel oil will be stressed. How are they going to meet those challenges – and to what extent does that lead to sovereign or sub-sovereign defaults?” he asked.
“Oil extraction costs remain way below the present price, and so, in terms of producing and selling oil, it should not be an issue,” added Louis Habib-Deloncle, ex-chief executive of Garant, and chair of the credit and surety working party at the International Insurance Law Association (AIDA). Oil prices become a systemic issue “if they stay low, say for 12 to 18 months”, contended Peter Jenkins, class underwriter at BRIT Syndicate at Lloyds. “The big risks for our market in that eventuality are undoubtedly the sovereigns that have oil – Angola, Algeria, Russia and so on – which historically the market has taken large positions on. But some oil-rich sovereigns have significant sovereign wealth funds put aside for rainy days, so there are risk mitigants,” he said.
Key watch points should concern oil-dependent countries with elections looming, according to Navaid Farooq, Catlin’s deputy head of political risks and credit. “Countries like Ghana and Nigeria are going to be interesting to watch, in terms of how they manage their budgets under election pressures,” he suggested.
Sanctions focus
Farooq underscored that Russia probably trumps low oil price on his list of immediate concerns, noting that a pocket of PRI appetite exists “for some of the more benign Russian risks”. Steele-Perkins said the market is all but closed for Russia. “We are still seeing requests from banks that are still considering it on a very short-term basis, but I don’t believe our market is supportive.” In terms of business already written, all the underwriters concurred that pre-export financings were unlikely to cause direct losses due to the inherent flexibility of such deals.
Ukraine, and what happens next was Sanders’ key concern. “In the absence of a further deterioration in Ukraine and a deepening of the sanctions regime, Russia can manage a low oil price environment.
The logical and rationale argument says the situation should improve. But is the Russian government still in control of events on the ground?”
Habib-Deloncle attributed a contraction in PRI demand for Russian risk during the last quarter of 2014 to spreading sanctions fears. “A lot of people were freezing projects, unsure if they were breaching sanctions. But there has been a major overreaction. Some banks have refused a transfer from Russian banks which were not sanctioned, for a supplier which was not sanctioned. Sanctions could become a threat to the PRI market business model, if they become a regular tool of crisis management.”
The core problem is “US extra-territoriality”, Jenkins remarked. “That aspect of the sanctions process is probably the key reason to hire lawyers for the current word drafting. The ability to pay a claim to a non-Russian entity usually won’t be a problem, if you go through the appropriate process. If we are not allowed to pay by law, then other mechanisms – such as whether claims can be paid into escrow – may be able to come into play.”
Farooq cited mandatory compliance and legal procedures – and a consequent slowing of deal processing – as the key PRI market impact. “Even where sanctions are drafted in a way that allows us to pay a claim, the process has become more complicated.” Brokers have equal responsibility when complying with sanctions, Cleary argued. “Some submissions show little evidence of this consideration, leaving underwriters to undertake the diligence.”
Several areas require clarification, commented Habib-Deloncle. “If reinsurers try and impose sanction exclusion clauses, what impact will that exert on insurance wordings? And if you have to indemnify a policyholder for contract frustration due to new sanctions, how can we exercise subrogation?
Do we have recourse against our own national or regional authorities? Several German exporters are suing their government for compensation after dual-use exports were prohibited due to sanctions. If that fails, if our business model can no longer expect recoveries, then we have to increase prices, to a level where we are no longer competitive for clients.” He complained further that “export credit agencies can still pay claims in cases where sanctions are involved”.
Sanders noted that PRI underwriters “have always run the risk of limited recourse against acts of their own government in the event of embargo or licence cancellation. This is not a new development,” while Farooq accentuated that events in Iraq and Libya have added to PRI market precedents able to guide sanctions guidance for underwriters.
Market complexity
In terms of risk, the PRI market is probably as complex as it has been in 15 to 16 years, said Jenkins. “In addition to Russia/Ukraine tensions, low oil
price and significant currency volatility, we have European Union uncertainties, China wobbles, likely interest rate increases and still a residual
amount of uncertainty over bank solvency.” Nicol pointed out that deal structures have become more complex. “There are more moving parts to some transactions, which carries the risk, if things go wrong, of being difficult to manage, restructure and obtain recoveries.”
Further complications are attached to the large volume of PRI business covering feedstock sales into the global refinery market, said Steele-Perkins. “To what extent will the oil slump and the declining global demand affect refining margins?” he queried. Sanders said another area of complexity is the number and variety of claims notifications being submitted to PRI underwriters. “Market talk indicates a lot of PRI claims, mostly political violence cover, across a number of countries. In terms of the number of claims, it is being suggested by many that this is up there with 2008-09.”
Farooq claimed that “a complete segmentation of the market” adds to the complexity. “It used to be that when a big loss happened, you knew who held the exposure. Now there is far less clarity, and we are reaching the point where underwriters are very discerning when choosing the portfoliothey write. This means that the significant claims in the market are not hitting it uniformly.”
Increased market intricacy can be countered to some extent by good risk selection, said Habib-Deloncle. “At the end of the day, we can choose insureds that have a better chance of finding a solution than others if they are in difficulty. Working like that is more important today for the market than in the quiet periods.”
Another positive, said Sanders, is the backdrop of “a very liquid bank market, where most of our clients are in much better shape than in 2008-09 to work with their borrowers to roll over or restructure debt and keep them afloat. This should further limit claims activity.”
Middle East risk
Inevitably, the spread of the Islamic State (IS) movement in Iraq and Syria attracted comment.
“I think that IS caught some observers by surprise,” said Brache. “It seemed to become such a force, relatively quickly, before the western military intervened.” Cleary added that “the rise of IS has triggered a lot of physical damage to infrastructure, and a significant loss of life in northern Iraq”.
Jenkins said that whereas Syrian PRI business was scarce before the country imploded, Iraq’s “quite robust political and ethnic divides” have consistently driven a core pocket of single risk underwriting. “I’m not advocating writing a 15-year credit on somebody you’ve never heard of, but it does give a paradigm within which to underwrite.” Libya, by contrast, is virtually uninsurable, Jenkins remarked. “There are so many variables that I can’t see how you could do a new deal there at present.”
Trade flows from Lebanon and Jordan to Syria are still working, observed Habib-Deloncle. “However predicting the certainty of Arab regimes is difficult these days, and you wonder whether IS or Al-Qaeda could destabilise other countries in the region. And what impact will there be on Gulf countries? And will Egypt receive enough financial support from the international community, for the present regime to relaunch the economy and cut support to the Muslim Brotherhood? We also have to try and assess the impact of decisions by the main global powers on the local situation.”
Brache acknowledged his concern over a potential ‘contagion’ effect from the early January terrorist events in Paris. “That particular situation would not have been a covered event under most PRI policies because there was no physical damage to assets. But you could have another situation in which terrorists hit a large building or infrastructure project, in the western world.”
Pricing quandaries
This brought the comment from Nicol that PRI pricing may be insufficient, given the heightened global dangers. “There is increased risk, but can we charge the full rate for that perception, if we are asked to cover it?” Brache agreed that “PRI is often under-priced”, and that traditional supply and demand forces rarely bring this into balance.
Jenkins predicted that Ukraine’s increasing conflict may go on to demonstrate that PRI is priced too cheaply. “Generally speaking, civil war causes far more damage than a traditional cross-border conflict. Ongoing CIS events might generate political risk (PR) losses that would be severe enough to swing risk portfolios back towards more credit risk (CR) underwriting, the perception of which suffered from 2007-08 financial market events. There is still a view in some parts, given historic loss ratios, especially among some reinsurers, that contract frustration (CF) and PR are ‘good’ and that CR is ‘bad’ despite many in the market underwriting CR risks much more intelligently post-2008. The sooner we get away from some underwriters apparently writing most PR deals they see at any price in order to justify their CR exposures, which is where much of the market enquiry flow and growth has come from, the better all around.”
Sanders noted that market growth in terms of premium during the last five to 10 years, has been on the contract non-payment frustration side for banks. However the question of whether big PRI programmes will continue to be rolled over annually, if prices harden, was raised by Nicol. “If insureds have Russia, Ukraine, or any other difficult country in the portfolio, underwriters will not be prepared to roll it over at the same price, for obvious reasons. As these policies reach the end of their natural life, there could be a period of brinkmanship, where insureds wait and hope that the market comes back.”
Pure political risk provides increased recovery scenarios, Farooq asserted. “We are still making recoveries on political risks that date back to the late 1990s, which could not have happened on CR. As long as government exists, we will get some money back, although it takes a bit longer.”
Looking ahead, future PRI market shocks may pivot around exposures to surprises involving foreign policy and central banks. “Not that many of us would have been focused on the Swiss franc, or its recent de-pegging against the euro. It may be the fallout from those types of events, that we are not expecting, which hits our market the hardest,” Farooq said.
