The sharp rise in country risk across a cluster of emerging markets this year is engaging minds in the political risk insurance (PRI) community in ways not seen since 2007/08, writes Kevin Godier.
As the fourth quarter of 2014 began to unroll, violence in parts of the Middle East and in Eastern Ukraine clearly dominated the global headlines, with the spread of Ebola also increasingly mentioned as a component of a heightened risk environment.
“I sense an increasing level of global political risk, led by the tensions between Ukraine and Russia, the instability in Egypt and the terror in Iraq and Syria linked to the growth of the Islamic State (IS) insurgency,” says Paul Sanders, head of credit and political risk at Aspen Insurance. Sanders underlines a wider context in which “the geopolitical predominance of the US is beginning to break down, leaving a vacuum that has yet to be filled by China”.
Similar themes are echoed by Conor Healy, senior risk management officer at the World Bank’s Multilateral Investment Guarantee Corporation (Miga), who contends that “there is much regional variation in the risk situation” across the globe. “The terrorist threat certainly dominated discussions of risk a decade ago, and still plays on the minds of investors today in certain areas. But increasingly the actions of larger powers such as China and Russia, and the status of the US and Europe shape the discussion,” he says.
“In my opinion, there is some quite major risk out there, led by Russia and Ukraine,” adds Jerome Swinscoe, head underwriter, UK, with HCC Credit Group, who also refers to the wider global evolutions. “The drivers of the global economy have quite clearly changed over the past few years. Trade between Europe, China and the US has changed, with the latter benefitting from an increase in the domestic production of hydrocarbons. Europe is facing recession again and China is slowing at a pace that may not be sustainable.”
In terms of how events are impacting the PRI market, the volume of claims incurred by the market during 2014 is “now shaping up towards a larger number than in any of the previous five years, but should not be anywhere near the levels of the 2007 or 2008 years of account that bore the brunt of the crisis,” observes Charles Berry, chairman of BPL Global. “Nothing really stands out, in terms of very sizeable claims,” he says.
Swinscoe underlines that Russia “has been a big source of income for PRI underwriters, and so has had an impact on premium revenues”, but says HCC has found new income streams from insureds that are relatively new to the PRI market. This point aligns with several recent surveys that have shown an increase in the number of executives pointing to political risk as one of the biggest threats to their business, to which the market has responded with a continuing rise in PRI and credit market cover capacity.
At Aspen, for example, credit and political risk insurance line capacity has risen from US$70mn to US$100mn, with “tenors for both contract frustration and for confiscation, expropriation and nationalisation cover pushed out to 15 years, and out to 8 years for credit risks”, points out Jeremy Shallow, senior underwriter, credit and political risks.
Reassuringly, various categories of country gradings undertaken by Export Development Canada (EDC) for the past year suggest that some forms of global political risk may not have been increasing. An “almost equal number of upgrades and downgrades” of its political violence ratings, are reported by Stuart Bergman, assistant chief economist and director of EDC’s Economic and Political Intelligence Centre. “It is no surprise, however, that the Mena region stood out as the one exception in this regard,” he stresses, in the inaugural edition of EDC’s Country Risk Quarterly publication.
Bergman comments: “Many countries continue to benefit from a build-up of foreign exchange reserves over the last number of years. With notable exceptions, this will help emerging markets, in particular, better withstand the coming correction in commodity prices than in previous cycles. In fact, we saw more than three times as many upgrades than downgrades of our transfer and conversion ratings, providing a substantial boost to our country commercial rating ceilings.”
Massive post-crisis liquidity injections have also helped many sovereigns manage debt servicing, either by boosting commodity-based revenues or lowering the cost of funds, Bergman highlights. “US tapering of QE [quantitative easing] has tested markets, but hasn’t completely wiped out appetite for sovereign bond issuances, as shown by Ecuador and Pakistan. Upgrades of sovereign probabilities of default have outnumbered downgrades by a factor of more than 2-to-1,” he notes.
In terms of the standout political risks, “Russia and Ukraine are continuing to capture our market’s attention, for obvious reasons”, emphasises Matthew Strong, a partner in the political, credit and security risk division at JLT Speciality. “Underwriters hold a lot of Russian exposure, so they are monitoring the ongoing decisions carefully and the potential impact from both a loss scenario and revenue flow implications.”
Ukraine has hosted its deadliest violence since independence from the Soviet Union in 1991, stemming from events that include the ousting of former President Yanukovych, and the annexing of Crimea by Russia. “The east of Ukraine is very different from its west, where underwriters will still look at risk, for the right price,” says Strong.
Russia has been subjected to Western sanctions imposed on individuals, banks and other major companies deemed to be having direct involvement in destabilising the situation. Moscow has in turn imposed its own sanctions upon certain food imports from Western countries.
The PRI market has “significant exposure in Russia and quite a bit in Ukraine”, Berry at BPL Global underscores. “The whole situation is on close watch. How far will it go and what the consequences will be, nobody knows.” For those insureds with Russian business that seek renewals, “cover is generally being rolled over”, he says. “But if companies have been working without insurance in Ukraine and Russia, obtaining cover is pretty difficult,” because many PRI contracts are non-cancellable, and long-term, premium is still being earned. “However, if, over time, the market aggregate drifts down, there will be a decline in income on Russian business,” he says.
“It has been a jolt to our market to see how Russia has degraded, given the level of PRI exposure to state-owned enterprises,” remarks Bernie de Haldevang, head of FINPRO International, which incorporates the credit and political risk team at Aspen Insurance. “The West’s surprise at Putin’s actions in Crimea are probably matched only by his surprise at the West threatening him with the loss of a strategic asset should Ukraine have made irreversible moves to join the EU prior to Crimea being annexed by Russia,” he observes.
“Appetite for risk in Russia, and in Ukraine, where there should have been little exposure anyway, given its failure to recover from the 2008/09 defaults, is undoubtedly down and the former is now so badly affected by sanctions preventing new risks being taken that, to all intents, we are closed,” he adds.
Inevitably, insurers are struggling to assess how their exposures will be impacted by the burgeoning sanctions. The rising risks associated with sanctions involving Russia has seen some brokers and underwriters disagreeing over the language to be used in a new standardised “sanctions clause” that has been considered for inclusion in policy wordings.
“Sanctions clauses provide an ongoing and protracted discussion, and our positions are not wholly aligned with banks on the question of where we can or cannot provide cover,” acknowledges de Haldevang. “This all revolves around the fact that the banks’ risk is different from ours as they have disbursed loans and are holding an asset; we are holding a contingent liability and need to disburse funds in a claims scenario in the light of sanctions. However, the one area where we are completely aligned is that we want to pay valid claims.”
MIDDLE EAST CHAOS
PRI market observers are also keenly tracking events in the Middle East, in particular the expansion of the militant Sunni extremist group, IS, as it spreads its presence through Iraq and northern Syria, revitalising jihadism’s regional appeal. “While IS has a huge media profile, and is having a huge political impact, a considerable degree of this has previously been factored in by our market, because IS operates in what were already high-risk territories,” says Strong. “There is not much PRI exposure to events surrounding IS,” confirms Berry.
Of more immediate concern, perhaps, is Libya, where “the political deterioration is quite rapid and serious, and a variety of companies have been forced to evacuate”, notes Swinscoe. Political instability and insecurity is unlikely to significantly improve over the next year, according to a PRI market update produced by the Gallagher London brokerage in July. “We are not doing anything in Egypt or Libya,” says Shallow. “In Iraq, we looked at a deal recently, but did not give it our stamp. Rates are likely to increase for Iraq towards the end of this year.”
Also looking ahead, Swinscoe believes that the PRI market may not have paid enough attention to the issue of the Ebola virus. “This could have a pandemic impact on countries and projects in West Africa, where there has been some PRI market expansion. If ports and airports had to be shutdown, this would hit exports. If that is the result of a government order, it is a potential trigger for PRI policies,” he explains.
JLT’s September 2014 Risk Outlook report highlighted that growth forecasts for the worst affected nations of Sierra Leone, Liberia and Guinea have already been revised downward by as much as 1% after trade and commerce has been prevented by the closure of borders and enforcement of quarantines. Shallow notes that, although there is limited PRI exposure to these countries, the credit of Sierra Leone’s iron ore producer could be endangered with the fall in that commodity price. Moreover the costs incurred by West Africa so far “would pale in comparison to those associated with a Nigerian pandemic”, stresses the JLT report.
Latin American woes include Venezuela, where “expropriation risks should be lower in 2014 than in previous years but key sectors are still likely targets”, said the Gallagher market update. Swinscoe argues that the Venezuelan government “has made a lot of very wrong decisions”, leading to “a currency that keeps crashing and a variety of exchange rates”.
He continues: “Latin America has seen a deterioration, headed by Argentina, where a recent US court ruling suggested that Argentina must pay its debt holdouts, which has triggered the prospect of a technical debt default and had a very negative impact on the country. There are issues with the currency and the decreasing transparency in the government’s economic data.”
Although underwriters remain very cautious, there has been no shift since last year in pricing or capacity, and Argentinian risk is still being placed, Strong notes.
Brazil, meanwhile, which has been a good underwriting market in areas such as soft commodities, “is not as strong or well-regarded as before”, says Swinscoe.
While PRI claims include a widespread batch of small losses, they are clearly not at the level seen six years ago. “There has been an increase in the number of war and civil disturbance (political violence) claims over the last few years and this is continuing,” observes Miga’s Healey. “This reflects current events but is aggravated, for us, by Miga’s focus on conflict-affected and fragile states, which tend to be more volatile.”
For Aspen, claims have been “relatively low to date”, says Sanders. “As far as I am aware, nobody in our market seems to be incurring big claims – even in Ukraine and Russia.” Strong concurs, adding that “it has, so far, been a relatively benign year for losses, reasonably active but not like 2008/09, although Russia and Ukraine could still change that. There is also some concern over the recovery in Europe and the impact on credit risk, however overall current loss levels are insufficient to change the current soft market dynamic.”
Caution should remain the watchword, according to EDC’s Bergman, simply because the long-term sustainability of many countries still hinges on successfully dealing with their existing debt burdens. “Governments that failed to improve debt profiles or make productivity-enhancing investments could find themselves exposed to market volatility, and may
suffer rollover pressures,” he says.