Emerged market economies are no longer the safe havens they once were. Sofia Lotto Persio looks at the changing face of terrorism and the resurgence of nationalist parties as some of the complex political risks that insurers need to take into consideration.

The unexpected exit of the UK from the European Union (EU) and the rise of Donald Trump in American politics have been two popular topics of conversations at risk-related conferences in the past year. The growth of nationalism, surprising referendum results and a change in the dynamics of political violence and terrorism are creating unprecedented uncertainty in the business environment of western countries, renewing interest in political risk insurance for these areas

This year’s edition of the World Economic Forum’s (WEF) Global Risk Report found that the whole world is facing ever more complex, interconnected and imminent global risks. “The need for business leaders to consider the implications of these risks on their firm’s footprint, reputation and supply chain has never been more pressing,” John Drzik, president of global risk and specialities at Marsh, said at the January press conference that launched the WEF risk report.

According to James Esdaile, managing director at BPL Global, the increase in complex, interconnected global risks was aggravated by the financial crisis in the eurozone. And, because of the increased interconnectedness of global business environments, if an area is affected by crisis, the impact will be echoed across different regions. So, just as the Greek financial crisis took its toll on emerging markets, the fall in commodity prices and ensuing difficulties in the developing world are, in turn, impacting on western countries. “There is vast volatility at the moment, which drives demand for credit and political risk insurance. Indeed, no one can predict which credit committee in any bank is cast-iron certain of the creditworthiness of any obligor, whether they be emerging market or otherwise,” says Esdaile.

As the WEF report finds, the risk landscape is broader than it has ever been, with threats generating from categories as diverse as societal, environmental, geopolitical and economic. Such risks may not target business assets or affect a corporate’s credit risk directly, but they may do so indirectly. According to Sian Aspinall, managing director at BPL Global, non-payment cover remains the bread and butter of the credit and political risk insurance market, but the extent to which political factors affect payment default risk is increasing. “There are more factors that need to be brought into the risk assessment equation. Certainly, it is much more complex,” she tells GTR, and explains further “Previously, insurers would look at the balance sheet and stress-test from there, but increasingly that test criteria isn’t coming primarily from within the business sector, but externally from the wider economic and political environment – and the outcomes are increasingly unpredictable to model.”


Terror threat

Terrorism is one of the risks that are becoming increasingly difficult to predict. Political violence within a state and against a government could somehow be expected – for instance, the recent military coup in Turkey may have been surprising in its execution, but could hardly have taken corporates completely by surprise considering the heightened political tensions in the country.

On the other hand, events such as the terrorist attacks that have plagued France repeatedly over the past year and a half represent a clear example of the changed dynamic of terrorism. Attacks have hit targets as diverse as a newsroom, a Jewish supermarket, a concert hall, a national holiday celebration and a church.

These are not the usual business assets that insurers would be covering directly, but the attacks and their aftermath may still affect business operations indirectly, in terms of employees’ safety, or borders closing, slowing down logistics operations.

According to Jim Thomas, head of credit and political risk at Everest Specialty Underwriters, political violence and political risk overall is much more front of mind for corporate boards, CEOs and risk managers. “This heightened awareness and increased risk at home has led to a more interesting insurance market generally,” he tells GTR. But how to deal with this uncertainty is something that the sector is still dealing with. “At the moment, [terrorism] is almost an uninsurable risk in that sense,” says Esdaile.


Nationalism will tear us apart

In this climate, some brokers have started to consider the risk of an EU break-up. “Following the UK’s referendum, the EU is aware that it now needs to undertake significant reforms to prevent such sentiment which resulted in the ‘Leave’ result becoming contagious which, if it does, would lead to the potential break-up of the EU,” says Esdaile.

Changes may come, but possibly for the worse, as the Franco-German axis that has so far been instrumental in ensuring peace and stability in the EU is threatened on both French and German fronts. In France, political risk does not only concern political violence and terrorism, but also the rise of nationalist parties, as these represent an additional long-term risk to stability in the country and region. For instance, the Front National led by Marine LePen (the daughter of party founder and holocaust-denier Jean-Marie LePen), is currently around 28% in the polls and is expected to have a serious shot at the presidency in the national elections in 2017. The eurosceptic party and its leaders responded enthusiastically to the British public’s vote for Brexit, seeing in the result a confirmation of their own ambitions to leave the EU.

In Germany, where elections will also be held in 2017, the risk concerns prime minister Angela Merkel’s ability to stay in power. According to Thanos Papasavvas, CIO and co-founder of Equant Analytics, Merkel is one of the few strong political leaders in the EU and as such, her political capital in keeping the bloc together is essential. “The eventual departure of Merkel would challenge the status quo and give more weight to politicians and political parties at the fringes across the EU,” he says.

Experts have linked Merkel’s popularity in Germany to her handling of the refugee crisis. Particularly in ageing European countries, migration could be seen as economically positive, bringing new skills and young labour demographics, but it has been framed negatively in the political agenda by nationalist parties such as the Front National and the UK Independence Party, whose anti-immigration campaign was effectively instrumental in winning the referendum for the Leave vote.

The influx of refugees from war-torn African and Middle Eastern countries has negatively affected the free movement of people, one of the four pillars of the EU single market, with countries strengthening border controls (and in some cases building fences) in sensitive crossing points, for instance between Austria and Slovenia, Denmark and Sweden, and the English Channel.

The migrant influx may have been contained, but the nationalist parties’ popularity and the consequences of the Brexit vote will keep on testing the openness of borders in the trading bloc. “The question is: how will this impact the economy and, if that cornerstone of the EU is chipped away, how will that impact the economic area,” says Thomas, adding that he is closely following these developments: “The potential economic impact of closed borders in the EU would have an adverse impact on the economy and, therefore, an adverse impact on credit risk.”

The EU’s stability and openness is crucial to the business environment in those Mediterranean countries that have suffered most from the financial crisis. In Italy, where credit risk and payment uncertainty are traditionally high, the eurozone membership offers a safety net for investors who may not be otherwise attracted. “If Italy is part of the eurozone, it won’t fail – they cannot let it fail,” explains Esdaile. But even without instability in the EU, the country is still navigating uncertain waters, and, just like in the UK with Brexit, ambiguity is linked to a referendum. A constitutional referendum due to take place this autumn (at the time of writing, the exact date was still undecided) may make or break Italy’s precarious government stability. Prime minister Matteo Renzi has said he will resign if he loses the referendum, which was called to make profound changes to the way Italy’s political representation and policymaking work – as such, the business environment in the country stands to win or lose in more than one way from the vote.


Polarised policymaking

As the Brexit vote in the UK shows, referendum results can be surprising, but even presidential elections can bring unexpected outcomes. The risk of Donald Trump winning the Republican party nomination in the US was widely underestimated, but now that it is a reality, insurers must consider the risk of a President Trump and what that would that mean for free trade and the free movement of people, considering his adverse remarks on immigration and trade agreements. “The biggest fear is the potential for increased protectionism in the US market,” says Aspinall.

The US’ bi-party system is becoming increasingly synonymous with polarisation and policy uncertainty. Factions of the Democratic party oppose the trade agreements negotiated by the US with Asian countries and the EU, while some prominent Republicans have refused to endorse Trump’s nomination as the party’s presidential candidate.
The bitter divisions over US Exim’s reauthorisation and resulting business interruptions present an example of the damage such political polarisation can cause to the country’s trade capacity and exporters. “US Exim reauthorisation was a direct product of the polarisation of politics, the very different views on the future of free trade and the role of the government in the economy. We will continue to see very polarising issues so long as the political party system is as it is,” says Thomas.

In December, US Exim finally won a five-year long reauthorisation by Congress, so the export credit agency is safe for now, but not for good. “Everyone has been put on notice that things could change very quickly in our industry based on political calculus and policy decisions,” adds Thomas. “Anybody who’s writing credit insurance knows we need to watch very closely the impact of these policy decisions on the credit risk that we write.”

Such an increasingly complex and uncertain risk environment presents a huge opportunity for insurers to evolve and thrive. “The fact that political risk is now becoming a bigger factor on the credit assessment side actually plays to [insurers’] existing strengths as it is embedded in the origins of the CPRI market,” says Aspinall. “It’s an interesting evolution, but insurers are relatively comfortable handling the political aspect of the risk assessment in an environment more volatile than ever before.”