With the global insurance industry hit hard by the events of 9/11 and the Argentine crisis, investors face a hardening of the private political risk insurance market, with a reduction in capacity and shorter tenors for coverage.
Meanwhile, investors that are going ahead with projects in developing countries are demanding more comprehensive insurance coverage, greater clarity in contract wording, and generally, better terms and conditions.
In this environment of changing risk perceptions and needs, there is scope for strengthening private-public partnerships in the insurance industry to help bridge the divide. This was the key finding of a symposium on political risk management organised by the Multilateral Investment Guarantee Agency (Miga), a member of the World Bank Group, and Georgetown University’s School of Foreign Service. The event, held in Washington, DC, on October 25, 2002, drew together 130 of the world’s foremost practitioners from the public and private political risk insurance (PRI) markets, investors, consultants, and academics.
The symposium examined the industry in the aftermath of 9/11, the Argentine crisis, and other events, looking at changes in capacity, tenor and contract language, claims experience, and the role of reinsurance in shaping the new PRI marketplace. Discussants also looked at issues from the viewpoints of both equity investors and lenders, focusing on topics such as breach of contract, sub-sovereign risk, devaluation coverage, and waiting periods, as well as alternative risk mitigation tools. The final panel featured the views of brokers, consultants, and academics on perceived gaps between investors’ political risk insurance needs and what insurers are currently offering, as well as possible solutions to bridge these gaps.
“These issues are particularly pertinent to tomorrow’s market. We need a new vision for our industry because many of the underlying risks have changed,” said Motomichi Ikawa, executive vice-president of Miga, kicking off the event. “Some types of political risks are becoming more associated with economic crises and less with wilful political acts of governments. Investors are questioning the effectiveness of traditional political risk insurance coverages and wanting more comprehensive products that include some portion of commercial risks.”
Facing their largest aggregate loss in history following 9/11, insurers are also being forced to re-evaluate their views of the risk associated with foreign investment. Discussants agreed that the result has been a significant reduction in the amount of insurance available to cover “risky” investments.
“We are operating in a new environment, and insurers have had to be much more precise about the perils they are actually prepared to cover,” said presenter Brian Duperreault, chairman and CEO of ACE Limited, a leading reinsurer in the market.
In particular, PRI providers are being asked to fill in the gaps left by property/casualty insurers, who are now routinely excluding terrorism and sabotage coverage from their policies. Since many lenders require this coverage as part of their loan agreements, many political risk insurers are now seeing great demand for stand-alone terrorism and sabotage policies, especially for projects in OECD countries. There were two views expressed on pricing.
While some said that prices have gone up as a result of the decrease in overall insurance capacity, others pointed out that prices need to be competitive because of fewer good transactions in the marketplace. Argentina’s economic difficulty, which highlights the changes in underlying risks, is having broad repercussions on the PRI industry. Many participants felt it would be a test of how effective PRI can be in the face of economic collapse. An interesting development has been the exemption, for Berne Union members, from the central bank approval of conversion of local currency to dollars.
But it is a complex picture and the potential for inconvertibility and expropriation claims remains. “Argentina and a number of other claims are testing the market, and the market will need to respond to those that are valid if it is to be perceived as having value by investors,” said Julie Martin, a broker with Marsh McLennan.
“The political risk market is at a crossroads,” she said, articulating the recurring notion that there is a mismatch between what investors want and what insurers are willing to provide. This is evident in a lot of areas, including coverage for currency inconvertibility, where what many investors have really wanted is a hedge against commercial risks, such as devaluation.
The Argentine crisis also brings into focus the need for greater transparency and tighter contract language. Discussants said that more specific language would help clarify what risks were being covered, but also pointed to the hazards of limiting coverage to a few specific concerns.
Some argued that insurance policies had been devised and written in a post-World War II environment and were no longer relevant, despite amendments. Prescriptions to the ills facing the political risk and insurance industry as a whole ranged from “stay the path,” to clarifying expropriation policies and providing a larger role for the public sector, to urging investors to know their insurance policies better and take on some the risks themselves.
Symposium participants pointed to an increasing role for the public sector in this environment, urging it to continue taking the lead in new product development, since it tends to have a longer-term perspective and more resources to devote to products that may not appear to be commercially viable right away. The innovation that has characterized the industry’s explosive growth in recent years is being threatened by a new cautiousness brought on by global events.
Public insurers, many agreed, could and should be at the frontier in terms of providing coverage for “riskier” countries, re-examining certain coverages, such as expropriation and inconvertibility, and rethinking the approach to complex projects, particularly in infrastructure, where sovereign performance risk is perceived to be high.
As PRI capacity and tenors are reduced in the private market, the public agencies’ role in maintaining large per-project limits and long tenors will be critical.
“A new distribution of risks among those who are best positioned to shoulder them is critical for sustaining FDI flows into developing countries,” said Ikawa. “Redistributing the risks will call for enhanced partnerships and collaboration among insurers and other risk mitigation entities.” Ikawa called on developing countries to step up their efforts to promote FDI and minimize the risks to investors.
Overall, Ikawa said, he was pleased with the sharing of knowledge and experience afforded by the event: “This symposium has played an important role in helping to broaden understanding of investors’ needs and insurers’ ability to understand and react to those needs. We now need to pursue the key points identified to begin to bridge the market gaps.”