GTR assembled a group of leading brokers and insurers in London to discuss the most topical trends and market issues in political risk insurance.
- Charles Berry, chairman, BPL Global
- Steve Capon, head of country and credit risk, ACE Global Markets
- Kevin Godier, freelance finance and energy journalist (chair)
- Peter Jenkins, underwriter political risk and credit, Beazley Syndicates
- Edward Nicholson, partner, credit political and security risk, JLT
- Ray Antes, senior vice-president, political risk, Chartis
- Stuart Ashworth, executive director, political risk, Willis
Godier: What has been the most important market trend for each of you over the past year?
David: The awareness of the use of the product. The Arab Spring has shown the value of political risk products. Some of our insureds have said that they should have made a more extended use of the product. But they have the awareness now. One can also say that with the uncertainties that we see around the planet, combined with the pricing levels, there is surely no better time to buy political risk insurance.
Maule: The Libyan revolution was a pretty fundamental event in my life this year, and I have spent a considerable amount of time working through Libyan claims that were placed 100% at Lloyds. It has been very challenging, and continues to be. We see movement in the extent that there are payments coming out from some of the events that we might have had losses on, which is positive.
Jenkins: The Arab Spring has been important for a number of reasons, not least because it shows one of the key risks that we face on the traditional side of the business in terms of fundamental transition risk, from one regime to another. From the overall portfolio viewpoint, the current or impending financial crisis is going to have a lot more impact from our political risk insurance (PRI) market viewpoint. At the end of the day, we are coverage providers, not liquidity providers. If there is no money to fund deals, there will be less business going forward. As a result of 2007 to 2008, I think the market is in a more robust position to weather most of the scenarios that are foreseeable. But that’s not to say that it might not take up quite a lot of people’s time.
Antes: I would say that the Arab Spring, without any doubt, has been the focal point in 2011, because of its sheer unpredictability. I don’t think that anyone predicted it – neither underwriters nor advisory groups. The way that it played out in Libya, with sanctions and the impact that that had on claims and claims handling, added a whole new twist to the business. Next year it will be the eurozone, and the impact that people have highlighted.
Berry: The phenomenon which is overhanging the whole world at the moment is the eurozone crisis. That has big implications for some of our traditional sources of income, and it is creating uncertainty about transaction flows.
There is also big uncertainty on the knock-on effect on the real economy, and particularly the real economy in emerging markets. Any market dislikes uncertainty, and we are no exception, although as ever, uncertainty
can provide opportunities.
Nicholson: The thing that has stood out for me this year has been the way in which the underwriting community has actually recognised the clientele, particularly the banking clients which actually make up 50%-60% of the income of our market. They have recognised those relationships and have looked to work with those clients to make sure that they can continue to finance transactions in difficult conditions.
That recognition is of fundamental importance, both in relation to this year, and the success of deals that we have all got on our desks at the moment, and to the future health and ongoing success of the market. Without that, the market runs the risk of grinding to a bit of a halt.
Davidson: The only real trend is one of continuing volatility. Whether it is the Arab Spring or the eurozone, if we had sat down last year and asked what is going to happen, I don’t think we would have written it like this. So, from a positive point of view, there cannot be many large corporate boards that do not talk about political risk at some point, in their discussions, which they may not have done five years ago.
From the insurance point of view, there is a trend of a continuing lack of transactional volume in the banking sector, for a whole raft of different reasons. In our portfolios, there can be different trends at work: some things going well, others not and maybe claims developing in a particular territory.
Capon: One trend that has been going on since 2009, and will continue into next year via the eurocrisis, is the trend in terms of the underwriters’ shrinking income stream from banking business. Banks do not have the funds to finance trade finance, but I think that the amount of cash now held by corporates is very interesting. To improve their returns on profitability, they may want to do what the Japanese did in the 80s and 90s, which is to finance trade finance themselves. And then lay off the credit risk into our market.
It is also worth noting market feedback from corporate risk managers and brokers that the corporates are increasingly switching onto the importance of the PRI product across their portfolio. Events in the Ivory Coast have made a lot of people look harder at
political violence cover.
Godier: Does anybody else see that shift coming, given the problems faced by banks?
Jenkins: There is likely to be a credit opportunity for those corporates that have cash to go down the GE Capital route and become a sort of bank themselves, because you can see a situation where whoever
has cash is king. It doesn’t necessarily change what we do, but it could change
the potential clients
David: The funding issue is mostly related to the European banks and dollar liquidity. We might of course see other banks replacing the European banks in the future.
Ashworth: I think that the focus on European banks is a very London-centric way of looking at the world. If you look at Asia, that is where all the flow will be going. Over the next 10 years, 80% of trade finance is going to go into Asia.
Capon: The other trend that has struck me this year is just the quantity of surplus capital in the insurance market. Post-9/11, the figure stood at US$250bn. At the end of Q1 this year it was US$565bn. This is quite staggering, and obviously plays through into specialist lines such as ours. In one sense it’s great news – we have been remarkably resilient, and have lots of capital. But on the other hand it means the market remains soft.
Jenkins: Within our silo, the Gallagher numbers show the capacity trends, even if you want to argue about the exact quantums. The market capacity in all three classes (CF/PR/CR) of the business has effectively doubled since pre-2007/2008 crisis. Therefore in terms of the market speed in reacting to the changing risk environment, inevitably it’s going to be slower when you have got that amount of capacity, if not over-capacity.
Nicholson: By the end of this year, there will be 40 different specialist insurers in our class offering some form of credit insurance, whether contract frustration (CF) or traditional trade credit. There is around US$1.5bn of theoretical transactional capacity programmes for CF, and about US$1.1bn for trade credit. I think there will be a big movement next year of brokers and clients thinking very carefully about who they have as their lead, and perhaps a sort of regression to how the market was 10-15 years ago, where there were only a few real market leaders.
Godier: What can we say about demand at present?
Berry: It has tailed off. But there are a lot of options where we will be pursuing new clients with our very good non-payment products. Perhaps some of the traditional banking clients are not going to be such big buyers, but there will be banks in other parts of the world that have yet to discover non-payment policies as a tool. It takes time to develop new clients, but there are opportunities there, including the traditional export clients in the capital goods arena, that I think we do not take enough advantage of as a market. There are opportunities in the traditional PRI investment insurance, and in the
property-related PRI area too.
Jenkins: Inevitably, the Arab Spring gave rise to more publicity about the products, but also produced a stable door mentality, initially, in terms of enquiries from corporates that invested five years ago and then wanted to buy cover this year. Significantly, all the talk of the last few years about south-south trade flows is now translating into opportunities.
Turkey is a big regional player in some of the contracting in the countries involved in the Arab Spring, particularly in Libya. Non-traditional players in Brazil, or various parts of Asia, also present opportunities. The issue then comes down to various regulatory complexities in these countries, which is something that we will ultimately get around.
David: I agree. There has to be an education of the insured, but also an education of the different governments in countries where we do not have too much representation at present, because of the various regulation and tax issues. They need to understand that we can also help their economy and their exporters. They have ECAs sometimes, which do a good job, but we also complement ECAs, and we need to have more market access.
Davidson: The transactional volume is definitely down, and I suspect that it will remain down, while recognising that some parts of it are going up. I agree that there is a lot of opportunity, but I don’t think we will suddenly see a big surge in volume in the next 12 months. And I am not entirely convinced that the corporate world is as healthy as some of the observations would indicate. They live in the same world as we do, and are looking at their costs as closely as everybody else.
Berry: The problem with cultivating new clients is that it takes place over a period which is much longer than the 12-month budgeting cycle that everybody is
Davidson: And that is coupled with another strong trend, the fact that transactional time has stretched. It is
now taking a very long time to get from original enquiry to date of execution.
Maule: I can certainly support that. Investments in the Arab world have been postponed for many of our German contractors.
Jenkins: On the banking side, the credit committees have been taking a lot more care over what they are signing off on
Ashworth: That’s an opportunity for the insurance market. A lot of banks are going to sell down their exposure on existing deals. In many cases, the insurance market can do it for a fraction of that price, and provide capital relief.
David: You are talking about capital relief under Basel II, but with Basel III it is not crystal clear yet whether banks will be able to use the insurance market as well and as efficiently as they wish to.
Davidson: I suspect the answer is that it will vary. The additional levels of measurement and leverage and so forth
will impact different banks differently. And some I don’t think will turn a hair, while others will struggle.
Maule: German export finance bankers are trying to quantify what the additional costs will be when they buy insurance under Basel III for the first time. A figure was raised of 0.4% additional cost, which is quite a significant additional cost when you think of what a standard ECA-backed five or 10-year credit cost would be in a reasonable country. This obviously concerns them, because they will be competing with Asian contractors and banks that won’t necessarily be under the same constraints. Although the implementation date is some way off, this is really concentrating their thoughts.
Ashworth: The nine-year horizon for Basel III can seem a long way off if we are looking at the 12-month budgeting cycle of our business, and taking into account the volatility in the market place over Portugal, Ireland, Italy, Greece and Spain.
Jenkins: It is already having an impact. Rating agencies are already asking the banks how compliant they are. That impact will ratchet up as we get closer.
Capon: If you cast your mind back to the 1990s, when the Bank of England regulated UK banks, the capital requirements in the UK were far greater than they were anywhere else. One of the banks that I worked for at the time had a 14.5% capital adequacy ratio, with much tighter liquidity requirements than anyone else. But it didn’t stop us, or the city, being competitive. Sometimes you have to take these things with a slight pinch of salt.
Godier: Let’s switch to claims. Has the market passed its major payout phase?
Berry: There was a huge wave of claims notifications prompted by the first phase of the crisis, when the global economy stopped for a month in October/November 2008. I have been looking quite closely at our 2007 and 2008 years of account that were impacted by this wave, and there is very little of that left to be resolved. Those claims have been dealt with very well, on the whole, but the period is not completely behind us yet. We still have running risks from 2007 and 2008 that have come through the first phase of the crisis.
We also have new claims that have arisen, and there will undoubtedly be others. But we have definitely returned to a more normal level of claims. Even Libya falls within the normal run of claims activity.
Maule: This is nothing like as catastrophic as the situation was arising out of 2008. There is a concern that Egypt could develop into something nastier over the next few months. We don’t know yet. There are other countries, lurking around, but I think this is what the product is here to serve. Libya is one of the purest political risk events that I have experienced.
Jenkins: Libya is a classic, traditional reason why people buy cover. With regard to the last credit crisis, I don’t think it will necessarily be significant, but there are still deals that were effectively rescheduled out of the problem, that are therefore more vulnerable to a further slowdown than one would have hoped two years ago. In the case of a further slowdown, the recovery percentages would probably also be less than some people might have hoped.
Berry: It is worth making the point though that the prospects for the recoveries from the 2007 to 2008 period, for what were mainly credit-related claims, look much better than people dared hope two years ago. And better than they hoped a year ago.
Nicholson: We did a market survey recently, and if the effect of the possible global slowdown doesn’t impact too greatly on the recovery potential of those restructured deals, we think loss ratio across CF and CR will be below 100% in the not too distant future.
Jenkins: The crisis has in most cases helped to reinforce the trust that the underwriters must have in their insureds.
A lot of the market’s core insureds have put in a major amount of work to get through their claims and recovery processes. Hopefully, going forward, those clients will get the benefit from that.
David: We have seen major differences between insureds in regard to the same single risks. It has been staggering to watch how differently the contractual relationships and negotiations processes have been managed from one insured to another.
Jenkins: Recoveries in Eastern Europe for some of BPL’s clients were faster than anybody thought, down to their own hard work. Similarly, some of David’s [Maule] clients in Libya are working very proactively through the problem, rather than walking away from it.
Maule: I think the recovery potential in Libya is excellent, in time.
Davidson: I suppose the other aspect of the claims issue, rather than looking backwards, is that we have collected some very good data on the performance of the products that we sell. We probably did not have this relevant, widespread and real hard data five years ago. That’s a hugely positive thing.
Godier: Is this collation of data a market-wide phenomenon?
Berry: The PRI market has been at the forefront of the trend to do that. It’s really healthy and very good for the clients that claims performance has in some respects become a factor of competition between practitioners in the market. In the last round of claims, people were actually competing to pay claims on time. People now know that they are being rated and scored, and so compete to perform.
Capon: This is really important. One of the things that we started doing, the moment that the 2007-08 crisis started, was to collate data on the level of what had breached covenants, what had reached default, what had been restructured and what had turned into a claim, at every stage of the process, for the STC line. It was a perfect opportunity to gather in every line, track it, test it against the model and improve the performance.
Davidson: We tracked the market’s performance by time, by underwriter, and obviously that information was fed back to the market. So eventually they understood where they were amongst their peers, and could be judged on more than just a series of isolated cases.
Godier: What general trend has pricing taken?
Capon: To me it has certainly stabilised in the last few months. We are still seeing banks attempting to squeeze a bit more out of the insurance market as their funding costs have gone up. Underwriters have generally said no, there is a floor to the risk pricing.
Your liquidity problems are not ours, and we are taking a risk, not funding you. That has been a good learning experience. Although pricing is still too low, and not reflecting the fundamental risks, it is difficult to see it increasing, given the amount of capital in the insurance market, plus the competition that exists.
Berry: The rising cost of bank funding is going to push pricing down to levels where some deals just don’t work. The reality is that the margins that the insurers say they need are just not there anymore.
Antes: The trouble that we have as underwriters when they make that argument is that we are facing Solvency 2, and a new measure for us is the return on capital.
Jenkins: There is also a hazard here. The banks have been desperate for income, and at a transactional level, bonuses are often tied to fees, not margins. So there is this temptation to get the deal away, take the fee, and not worry too much about the margin. But it’s the margin that our market is traditionally fed from. Addressing rising cost of funds should undoubtedly be the banks’ problem and we are starting to see margins being built upon cost of funds as opposed to Libor.
Nicholson: Insurance companies and underwriters generally must not lose sight of the fact that we are not banks. In the run up to the financial crisis, people would go straight to the margin when negotiating price, with absolutely no thought to the relationship or to the retention of the bank. It is going to be a key test for underwriters to be able to make sure that their models properly reflect the degree of net exposure that these banks retain. Underwriters that fail to do that will lose out. In a dynamic environment where people are investing in new syndicates, but with a depressed volume of business coming through, those who are stuck on this issue will fall by the wayside.
Jenkins: And that will also come back to the Solvency 2 issue on how people model the capital, and how the floor pricing for rates is impacted.
Capon: Remember Solvency 2 will have a different impact for different insurers.
Davidson: But the fact of the matter remains that the banks are the most significant trading partners for this market by a significant factor. We all live in the same world and have to work it through and find a solution. The time may come soon, as we move in a more professionally modelled market, when we won’t talk
about margins, but about prices. That would be a good thing.
David: I understand the focus on bank prices, because this is what much of the market must deal with, but I have seen inconsistency in price trends in the market’s different niches, particularly between single situation credits and CF.
Maule: We have got to set ourselves against the alternative providers. So we have got to talk about the ECAs. There has been no change in their costs, in fact quite the contrary. Because of the credit crisis, they have stepped up to the plate and improved their product, increasing the percentage indemnity.
I read to my horror that a turnkey prison project in Gabon was covered with a 99% guarantee by Spain’s Cesce. Germany’s ECA now offers 95% indemnity on all commercial and political risk cases, which means that our offers of 85% or 90% are now insufficient. We are going to be benchmarked against ECAs, and will have to step up to the plate.
Godier: How much of a threat to your business are the ECAs?
Maule: A significant threat. We have also seen a trend started by the smaller ECAs of improved flexibility. The issue of national content has been replaced by a looser criterion of national interest from smaller players, which is an extremely flexible concept. The bigger ECAs are also being more flexible in their understanding of national content, so there is less business around for the private market.
Jenkins: There is a big drive among the ECAs to support their national champions on the export side, because they are desperate for economic transactions and growth. Sometimes we work in co-operation with the ECAs, and at other times we do not. Pressure on us increases when they become more competitive.
David: They do what they are supposed to, and do it well. Every government wants to help support exports, to maintain the cash flow for their economies. But sometimes governments and regulators lack awareness that there is an alternative way of handling their risks and supporting their exports. Perhaps we should try and keep them better informed.
Godier: Is PRI distribution into under-served geographical regions such as Asia and Latin America improving?
Antes: There is a positive trend in the south-south trade flows, and in some other regions.
Certainly in Asia there is a big development among the brokers that are beginning to open up independent operations. We have put an underwriter there, and Singapore is becoming a kind of new hub for political risk insurance. Meanwhile Latin American Underwriters (LAU) is focusing not only on Latin American risk but trying to garner clients from that region.
Ashworth: There is going to be a slowdown in Western Europe, so the natural progression would in any case be the increased business coming out of Asia. The underwriting companies and brokers are moving out there, to capitalise on the growth and the money flowing in.
David: It is probably the future but regulators are often not ready for us to be completely active. Singapore is fine, but China is not easy.
Nicholson: I agree that people are revising their position on China. It is not the great hope that it was. It held out hopes after the 2008 financial crisis, but where it is going now is certainly a moot point. You only have to look at what the Americans are doing in terms of increased tariffs for imported goods.
Ashworth: China is only one of the markets out there that we deal with. A lot of the business is coming from Singapore, the Philippines and Indonesia. I don’t even think China has traditionally produced much of the income coming into the political risk market.
Jenkins: Everyone wants to cover the south-south trade flows, so long as the regulatory hurdles can be overcome, but there are short-term ways around it by reinsurance of local entities who perhaps understand the risks better than we do or who can add value regarding recovery or mitigation. Brazil is a classic case of how these things take time.
Realistically it may take five to 10 years, but that new spread of business has to be the future, to obviate a situation where a catastrophic European slowdown significantly cuts back our business.
Capon: We’ve certainly been encouraged by the split coming out of Singapore between trade credit, STC and PRI. There has been much more balance.
Jenkins: The weakness in the Singapore market is that, to a degree, the insured names are actually still the same. The real opportunity with Asia is that it is a lot of different small markets, but it will take time for us to get the expertise on the broking side to really penetrate into those regional corporates.
Ashworth: It’s a relatively young marketplace, and so it takes a long time to get new corporate clients on board, and to get comfortable with board meetings, and minutes, and all the rest of it. It is usually a two to three-year process, and I guess the market will go for the low hanging fruit by focusing on the existing banking clients in Singapore until this next step.
Davidson: I think Singapore will be a good platform to expand the Asian business over time. As a hub, it does work quite well, for what is an enormous piece of territory. I don’t think it’s quite so obvious in other parts of the world. We are focusing on Brazil, but Latin America is a whole raft of different countries, with different regulatory environments, and different stages up the curve.
Godier: How are reinsurers looking at your industry?
David: It’s definitely a good time at the moment. They are very supportive. There is lots of capacity. The price is right.
Davidson: The reinsurance market has no great concerns with our business. By and large there is more capacity available if it’s needed, although there may be some pushing on aggregates.
Capon: You have had seven new players over the past two years. They are now banging on everyone’s doors, trying to get on treaties. This has clearly contributed to the soft market.
Berry: Capacity is the least of our concerns at the moment. There are no real problems on the supply side. This has got quite a lot to do with the conditions in the general insurance industry. Over-supply of capital, a soft market, and very little sign of that ending.
David: From the reinsurers’ point of view, the crisis showed that we could supply a better quality of information than five years ago. This improved their confidence levels. It is in all of our interests to keep this confidence level as high as possible. You don’t want volatility in their appetite for our industry. We need reinsurance support on a consistent basis.
Maule: Does anybody see a trend towards more primary insurers retaining more risk?
Antes: We have always had a strong appetite for risk, and it is increasing. We have always taken large nets, it’s always been our approach. But we are also always afraid of that catastrophic event. You have to draw the line somewhere.
Godier: What are the prospects for the investment insurance market?
Capon: The cake does not look likely to get any bigger. GDP may finish up globally at 2%. FDI flows will be down for another two or three years, as corporates sit on their cash. But that doesn’t mean we can’t expand our share of the existing cake. Based upon talks with clients in the last two to three months, there are some real opportunities to look at multi-country programmes in areas such as political violence and stocks, and maybe adjusting the equity product to be more responsive to the market.
Nicholson: We have certainly seen clients historically who resisted the idea of buying insurance cover for their investment portfolio on a global basis. The events of the Arab Spring, particularly, have been a point of real focus in this respect. We see that as a growing opportunity.
Ashworth: It is a growth area, but it does depend on corporates having disposable income. Investment insurance has always tended to be looked at once other lines of insurance are paid for.
Capon: There is a whole host of corporates out there that we can approach. Really enormous multinationals can swallow some losses, but lesser-sized entities with assets in difficult countries are waking up to the ability of PRI to cover them in really difficult situations, such as when sanctions are applied to the host country.
Davidson: It does require the market to provide the right product. And I’m not persuaded that we are there yet. That could explain why the market is under-penetrated.
Berry: There is a big opportunity in this area flowing from the experience in Thailand and with the Arab Spring. The standalone terrorism insurance product has – not surprisingly – proved to be simply irrelevant in the face of this sort of civil unrest. Buyers of terrorism insurance are therefore switching towards broader political violence covers. This is an opportunity for the PRI market, because these broader political violence products are really PRI products
at the end of the day.
Davidson: If you are talking about a sophisticated, complex investment, and you look at some of the standard expropriation coverage that is available, I don’t think that is up to the job. It is not an off-the-shelf commodity product, and shouldn’t be regarded by any of the market as such.
Jenkins: For the last four years, since Israel-Lebanon, the TO/PV market has been pushing the notion of a broader cover, yet the amount of terrorism market clients that are still buying T3 on exposures outside of Europe and the US is still surprising and disappointing. That traditional standalone terrorism cover provided by T3 just isn’t suitable for vast swathes of the world.
Maule: If you have got somebody who is used to paying 0.5% per annum for a T3, and full coverage is 0.8% per annum, it is sometimes a tough sell.
Berry: There ought to be a more commoditised, property-related PRI product that would compete. One of the issues here is which team within the broker sells the product.
Godier: What is the outlook upon resource nationalism perils?
Maule: I am hoping that some of the countries, particularly Peru, where we might fear a resurgence of this, could be learning from what has happened in Venezuela and Bolivia. There is a lot of rhetoric in Peru, but the local populace has actually been against the nationalisation trend in some instances that we have seen.
Ashworth: Resource nationalism is going to be an increasingly big issue.
Nicholson: It’s worth looking at the ways in which the different insureds act. In Ecuador recently, an American company took an action to resist a decision against them.
They were in partnership with a French oil exploration company which took a far more pragmatic approach with regard to the government attempts to increase percentage shares and so on. While it has lost a little of its profitability, the French company has emerged relatively intact, whereas their American counterpart is looking at an unsuccessful action through the courts.
The lesson is that the insurance market, while being hungry for this sort of business, must take a very careful view on the corporate governance and guidance within the companies making these investments. GTR