With developing economies seeking investment to transition away from fossil fuels and improve access to energy, the pandemic has highlighted the progressive role that political risk insurance can play, writes Matthew Coomer, underwriter, Financial Risk Solutions at Liberty Specialty Markets.


As news of Covid-19 first spread through the world’s media, investors in emerging economies were already feeling anxious.

A wave of social unrest throughout developing economies in 2019 had triggered a sharp market reaction – a growing sense that traditional risk measures like political stability needed to be viewed alongside measures of inequality, such as the Gini coefficient, to fully understand country risk profiles.

The tide of investment turned; money began to flow out of some of these countries.

Now, as vaccination programmes around the world take effect and the prospect of a new normality beckons, for developing countries, the need for foreign investment remains paramount. Concerns about climate change and the need for cleaner, sustainable energy sources are behind a number of solar, hydroelectric and wind projects. The capital investment required for such projects can range from US$10mn–US$2bn. Hesitancy among investors to deploy their capital in emerging markets due to the political risk environment has led to a financing gap and a reluctance among financial institutions to support energy and infrastructure projects. Forecasts of increasing political unrest as the economic effects of the pandemic unwind exacerbate the problem.


The race for cleaner energy

Low interest rates and the associated yield depression on developed market assets can make infrastructure and energy projects in emerging markets more attractive to investors – if they can mitigate political risk. Emerging economies are well suited to solar energy projects, as many experience high levels of sunshine. These projects bring affordable energy to some of the most underserved populations. Additionally, developed countries are pressing emerging economies to meet sustainability goals. A report by the World Resources Institute in 2017 noted that six of the top 10 greenhouse gas-producing nations were emerging economies.

The challenge is to make infrastructure and renewable energy projects in the developing world more attractive to investors on a risk-adjusted basis. Reducing the political risk of investment is part of the solution, which is where insurers like Liberty Specialty Markets’ Financial Risk Solutions team has a vital role to play.

Political risk insurance – protection against a loss in investment value because of government action – is key to increasing investor confidence. According to a 2018 report by the LSE-Oxford Commission on State Fragility, Growth and Development, “investors cite political risk as the single most important constraint for investing in developing countries over the medium term”.


Political risks

Currently, we provide political risk cover for around 35 live infrastructure or energy assets projects around the world. Of these, 11 are partnerships with development finance institutions or multilaterals in which one party reinsures the other. Without insurance, these major infrastructure projects might struggle to attract the investment needed.

Typical political risks affecting investor confidence include:

  • The government seizing control of assets. History is full of examples of newly elected regimes forcibly taking ownership of privately controlled assets.
  • Forced abandonment: the potential for politically motivated violence to escalate to the point at which a business has to abandon assets and repatriate staff.
  • The inability to convert or transfer earnings in a local currency: if an investment is made in US dollars, with cash flow generated in local currency, government-introduced currency controls or exchange controls could restrict an investor’s ability to repatriate currency into US dollars.
  • The inability of the off-takers to honour their contractual obligations under the power purchase agreement. Often, off-takers are state-owned enterprises whose creditworthiness has been affected by the pandemic.


Underwriting process

Assessing the political risks of a construction project can be challenging. We need to understand the investor’s level of technical expertise and their track record in emerging markets. This is followed by a deep dive into the economics of the project and a review of the insured’s due diligence, for which a non-disclosure agreement is usually required. It is helpful when the investor is willing to explain their investment strategy. Do they have the ability to work out project issues and negotiate with the local authorities? What benefits will the project provide for the country? Is there government involvement and is the project likely to receive government support?

We conduct a country risk analysis to determine the political and economic risks and develop our own assumptions of its outlook. As we may be committing to provide cover for a 15 to 20-year investment horizon, our review will be extremely granular and discussed with our underwriting team.


Post-pandemic jitters

Marsh’s 2021 Political Risk Map shows larger increases than ever before in country economic risk across all regions. According to Marsh, strains on public financing in emerging markets will result from increases in sovereign indebtedness and may create unfavourable conditions for domestic and foreign-owned businesses. The inability of governments to invest in much-needed social reform programmes is likely to result in escalating social unrest and political violence.

Our opportunity is to harness our combined 200 years of political risk underwriting experience and our data-driven approach to help mitigate the long-term effects of the pandemic on the global economy.


Clean electricity in Africa

Landlocked Burundi is one of the world’s poorest countries. Its growing population and limited infrastructure have seen this African nation struggle to meet demand for electricity. In recent years, blackouts have become common. 92% of Burundi’s population has no access to electricity.

In January 2020, a public private partnership reached financial close for Gigawatt Global Burundi: a solar photovoltaic plant capable of generating 7.5 megawatts, increasing Burundi’s power generation capacity by 15%. This is the first power plant to be built in Burundi for over 30 years.

Liberty’s Financial Risk Solutions team provided political risk insurance to an investor for the development, construction, operation and maintenance of the plant.