Global woes, including the demise of the equity markets, are likely to crank up the demand for private market insurance, which is available in ever-greater capacity, writes Kevin Godier.
Rising demand for the many types of political risk insurance (PRI) cover offered by private sector underwriters has been matched over recent years by a steady increase in the capacity that the market has made available for single situation trade and project risks.
Statistics produced from FirstCity trade and political risks brokerage show a thriving marketplace in which capacity has climbed back to and exceeded pre-9/11 levels. As of mid-2008, 11 mainstream underwriters and 17 Lloyd’s of London syndicates were offering a combined maximum of some US$1.25bn in CEN (confiscation, expropriation, nationalisation) cover per single project risk, according to the PRI Market Report and Market Update for July 2008.
Project lenders are ramping up their use of this CEN capacity, says Rupert Morgan, partner at FirstCity Trade and Political Risks. “As the credit crunch has effectively killed off the equity markets as a source of easy money, sponsors of projects in emerging economies are returning, cap in hand, to the project finance banks whose loan conditions are increasingly likely to include PRI. The banks buy the cover and pass on the cost to the sponsor,” he underlines.
FirstCity’s report also shows that aggregate political and commercial risk capacity for trade transactions has also climbed to over US$1bn on a per risk basis, and to some US$650mn per risk for pure commercial trade credits.
Established players such as AIG, Ace, Atradius and Zurich offer hefty chunks of cover in all of the above classes. By contrast a relative newcomer that has accelerated its capacity offering within a short timeframe is Aspen Insurance, which has hiked its maximum lines to US$60mn in all three project and trade risk classes, and recently added kidnap and ransom insurance to its product lines. “We use the $60mn limit selectively, if we really like a risk – at the moment there is more than enough business for everybody in our market,” says Aspen Insurance UK’s head of financial and political risk Bernard de Haldevang.
Elsewhere, Houston Casualty raised its maximum lines in all three classes earlier in 2008 from US$20mn to US$35mn. “Most of our demand for export credits in emerging markets right now is in Russia, Kazakhstan, Ukraine, Turkey, China and India,” says Jerome Swinscoe, senior underwriter at HCC Service Company, the London unit of Houston Casualty.
In the Lloyd’s of London market, Hiscox (Syndicate 33) has increased its maximum lines from US$10mn to US$25mn. “Business demand from banks and other clients is strong, because oil and food and other essentials have to be imported, wherever we are in the economic cycle, so trade and export financing continues,” observes Andrew Underwood, head of political risks at Hiscox.
The possibility of new business that involves obligor banks: “in emerging markets such as Mauritania, Lebanon – and a range of Sub-Saharan markets where local banks have local and more traditional sources of funds, are, at the most, moderately exposed to current liquidity issues,” is mooted by Adrian Lewers, underwriter, political and credit risks at the Beazley Group’s (Lloyd’s Syndicate 623) political and contingency risk division.
Beazley writes lines as high as US$30mn and operates via a structure, “that is unusual for Lloyd’s and more like the larger company insurers, with four underwriters, one analyst, and two claims handlers,” says Lewers.
With an underwriter also based in Singapore, Beazley is one of a number of PRI underwriters with a presence in Asia, others being AIG, Ace, Chubb, QBE, Unistrat, Zurich and the Catlin and Kiln Lloyd’s syndicates (2003 and 510).
Commenting on the manufacturing force that is the Asian market, Mark Cooper, managing director at TFC Brokerage, notes that Asia has, “the potential of driving an export-led recovery secured by insurance”. In recent months, the effect of the spreading credit crunch upon commercial banks’ risk appetite has been a key factor in an increasing level of requests received by TFC, says Cooper, adding that, “the ‘serious’ insurers still have adequate credit lines and the willingness to assist good quality trade business—in short, the cover is available at a reasonable cost. But the banks still hold the key, if working capital remains unavailable.”
Following bank appetite is also a key business thrust at the Bermuda-based Sovereign Risk Insurance, which in August 2008 set up a wholly-owned subsidiary in Dubai, in response to the raft of global banks that have relocated their MENA teams out of London or Singapore.
Credit crunch fallout
“The first half of the year was very good – we wrote significantly more business than the first half of 2007,” says Price Lowenstein, president and chief executive officer at Sovereign. Lowenstein cites current client demand for risks in Nigeria, Angola, Turkey and Russia, and stresses that commodity transactions are still going ahead, as are deals in Africa. However he acknowledges that, “it is still too early to assess the macroeconomic effects of the credit crunch on emerging economies, and how long until the banks start lending fully again”.
All underwriters and brokers agreed that demand has reduced since mid- September as the flow of new deals has been stymied by the effects of the credit crunch upon bank liquidity. However James Cunningham, head of Marsh’s political risk brokerage team in London, stresses, “it is too early to accurately predict the full impact on the insurance market”. Nonetheless one trend that he foresees is, “the insurance market playing a more prominent role in a bank’s syndication and distribution strategy.”
According to broker Ted Watson of the UK-based Watson Robinson & Associates, “the insurance and reinsurance markets are fortunate enough to be working along a line where they are not experiencing the traumas seen in the banking world.” He recalls a recent conversation with the chief executive of a major insurer, “who said to me that any insurance company dealing with credit or political risk has to walk through the equivalent of an unknown dark room if financial risk is involved.”
Danger areas
Where might claims spring up, as the smooth sailing of the past six years hits choppier waters? According to Alex Lotocki, underwriting manager for political risks at IOA (managing general agent, writing in the US market on behalf of Ark syndicate 4020 at Lloyd’s): “underwriters should adapt well to the changing economic environment on new business, yet the biggest danger lurks in existing portfolios”.
Lotocki suggests that “previously sound assumptions may be challenged by new realities”, much as they were in the 1990s when Asian power projects were abrogated as the ever lowering price of oil made them economically undesirable.
“The more experienced underwriters, having seen down cycles before, are likely to be better positioned with balance in their portfolios,” he posits.
And while no underwriter likes losses, there is an oft-forgotten upside, contends Lotocki. “It demonstrates that PRI does work, not just to the policyholder but to all buyers of PRI. And recoveries are more tangible than with sub-prime or CDO losses,” he points out.
Even before the recent intensification of the crisis, one distinguishing strand of risk mitigation at Aspen, says de Haldevang, has been to avoid underwriting risk on sovereign obligors in net oil importing emerging markets that subsidise domestic fuel costs. “As oil costs have filtered through into the wider economy, some of these entities have serious cashflow issues, leaving their international banking partners with no choice but to increase the financing or let them go under. We are not particularly looking for exposure to those companies,” he points out.
Beazley has “avoided the slightly artificial ‘trade-related’ route, which is a grey area, and has been used by a number of banks to advance working capital funds to emerging market banks, especially in Russia, Kazakhstan, Turkey and Ukraine,” says Lewers.
He continues: “These loans have no specific requirement that they should be used for identifiable trades other than a general requirement that the funds are used for trade-related purposes. Our preference is to look for specific underlying trade or revenue streams or assets directly linked to the risk.”
Tighter terms
De Haldevang emphasises the impact of the liquidity squeeze on premium costs. “Pricing across the whole book overall has increased by around 150% in the last twelve months, while on Russian risk, we have seen rises of 300% for certain counterparty risks, which could still increase further.”
Watson underlines that “the market is looking at the bottom of the price cycle,” flagging up an end to the ‘soft’ PRI and credit market of the last five or so years.
“On the PRI side, there is such underwriting diversity, so results around the world will be more volatile than on the credit side. But even if losses don’t materialise, the market will probably harden.”
In addition to increased pricing, tighter structures are sought by underwriters as part of “a more cautious approach”, adds Underwood. “In times of stress, when a commodity price has moved significantly, or an industry is under pressure, affected, counter-parties are more likely to renege on contracts. So the message at Hiscox is that we are still very much open for business, but the transactions that reach close are more likely to be straightforward, relatively vanilla transactions,” he notes.
Lewers also highlights that “structured credit deals are reverting to a more traditional shape, where debt is heavily secured or collateralised against a clearly identified commodity. We view these deals as performance more than payment risk, and will structure them to flex in the light of political, economic and pricing events.”
Plain vanilla Chinese import business has also involved Beazley – and many of its peer insurers – in covering local bank letters of credit. “Prices for this business have crept up from 30bp to around 40-60bp and will increase further still. The reason why the increase is more muted than elsewhere is that although Chinese banks have their own financial issues, the state is expected to be a strong supporter of the sector,” he explains.
Product diversity
Although product diversification is far less of an issue in present market conditions, the PRI market has been a leader in areas such as war and terrorism risks. A newer theme, announced in February 2008, saw Zurich focusing on carbon credit projects in emerging markets, where it will offer PRI to protect against risk of host government actions that might prevent an investor from receiving financial benefits associated with emission credits. “Several new projects have been completed and we are working on a variety of new prospects making available to customers our project limits of up to US$125mn per risk and up to 15 years per policy term,” concludes Daniel Riordan, executive vice-president and managing director for Zurich’s emerging markets unit.
