POLITICAL RISK INSURANCE IN INDIA – DIRE NEED IN THE GLOBAL CONTEXT

prologue: The Indian financial market witnessed exciting twists and turns throughout 2019 due to events from all fronts, political, economical, social and corporate, both global and domestic. Indian market started the year with high hopes then saw really miserable levels in middle of the year as economic growth fell to new lows. But at the same time in the current results season, in Q3FY2019-20, on consolidated basis, the key growth came from the export-driven industries such as information technology, pharmaceuticals, automobiles and metals. A growing global presence brings the danger of a greater exposure to political risk. Precisely that aspect prompted me to come forward to start a discussion on various facets of Political risks.

WHAT IS POLITICAL RISK?

Basically the political risks are the inherent, intangible risks being faced by the firms who are doing business internationally, arising from the action(s), or inaction(s), of: –

1. The Insured’s Government; or,

2. A foreign Government or Government entity; or,

3. A third party country which deprive a company of all or part of its assets; or prevent or restrict                                          the performance of any contract.

War, riots, coups, embargoes—the sort of political upheaval that once occupied statesmen, mercenaries and spies is these days also the concern of less swashbuckling figures in the world of finance. A band of corporate-risk officers, export managers and international bankers are looking to insurers to shield them from the financial consequences of political turmoil around the world. Political risk cover would once have appealed only to the most intrepid enterprises: oil firms prospecting in the Niger Delta, or mining operations in dodgy corners of central Asia. But as companies push their business into ever more remote localities, so they have sought protection against more exotic risks. The dangers of politics now hang over companies as diverse as fruit growers in Latin America, film producers in Fiji and bankers in Dubai, London or New York.

WHAT IS POLITICAL RISK INSURANCE?

Political Risk Insurance (PRI) is a tool for the Multi National companies / enterprises, equity investors, financers, contractors, importers & exporters to mitigate and manage risks arising from adverse government actions, confiscation of assets, breach of contract or war and civil strife. PRI helps, as a risk mitigation tool, to provide a more stable environment for the various investments into developing countries, and to unlock better access to finance. The multinational enterprises – either as direct investors or exporters, use this PRI to enhance their confidence in the markets perceived to be riskier than home markets. PRI allows investors to concentrate on the commercial aspects of investments, with the comfort that someone else – PRI providers – will help them avoid potential losses, or reimburse them in case of a covered loss related to political causes. Political risk insurance is a type of insurance that can be taken out by the businesses, of any size, against political turmoil — the risk that war, invasion, act of foreign enemy, hostilities or war like operations (whether war be declared or not), civil war, mutiny, civil commotion assuming the proportions of or amounting to a popular rising, military rising, rebellion, revolution, insurrection or military or usurped power or other political conditions that will result in a loss. Political risk insurance is available covering several types of political risk, including:

• Political violence, such as revolution, insurrection, civil unrest, terrorism or war;
• Governmental expropriation or confiscation of assets;
• Governmental frustration or repudiation of contracts;
• Wrongful calling of letters of credit or similar on-demand guarantees; and
• Inconvertibility of foreign currency or the inability to repatriate funds.

As with any insurance, the precise scope of coverage is governed by the terms of the insurance policy. Big and multinational companies are drawn to expand into international markets, mainly in search of lower costs, considering the new opportunities and easier acess to potential resources. When they arrive, however, they often find that the policies of foreign environments add a risk and complexity to their business performance. A question for companies operating internationally thus becomes how best to manage the political risks. Not only do political changes pose direct risks to firms / organizations, but politics is also a component of other external risks. Moreover, political risk is often perceived to be outside of management’s control, making it difficult to define or predict. Given to the complexity of these issues, it is no wonder that corporate risk officers, export managers and international bankers will be looking for this cover simply because the Political Risk Insurance (PRI) protects an insured in case a foreign country confiscates its goods or equipment or if it interferes with the fulfilment of a contract to be complied by the organization. Now-a-days the Political Risk Insurance cover becomes the dire need to be covered by the MNCs or the companies who are engaged abroad mainly because:

1. The politics of foreign environments adds risk and complexity to business performance.
2. PRI helps provide a more stable environment for investments into developing countries.
3. India’s PRI Market is still miniscule by global standards.
4. But India’s investment in developing countries like South East Asia, Africa etc., will drive defiinite growth of PRI in future.

The underwriting of political risk insurance is a dynamic & growing business. As globalisation increases, there are more corporations doing more business in various places around the world with each passing year. Some of the changes occurring in the business are high growth, new product offerings, and a greater role for private capital. While political risk insurance policies are sometimes manuscripted for specific situations, the major political risk insurers have standard forms for the coverages that they issue.

Political risk insurance is available for political violence such as revolution, insurrection, civil unrest, terrorism or war; governmental expropriation or confiscation of assets; governmental frustration or repudiation of contracts; wrongful calling of demand guaranties; and inconvertibility of foreign currency or the inability to repatriate funds. Export Credit Guaranty Corporation (ECGC) in India had virtual monopoly to issue political risk insurance cover for credit risks. Things have potentially changed after insurance sector liberalization.

Companies are drawn to expand into international markets in search of lower costs, new opportunities and access to resources. When they arrive, however, they often find that the policies of foreign environments add risk and complexity to their business performance. The question for all such companies operating internationally thus becomes how best to manage political risk. Not only political changes pose direct risks to such firms, but politics is also a component of other external risks. Moreover, political risk is often perceived to be outside of management’s control, making it difficult to define or predict. North-based Industries in the global market are in the opinion that the Southern Hemisphere is not conducive for investment. The reason is involvement of risks such as localized-small intensity conflicts, political violence such as civil unrest, revolution, uprising, terrorism, insurgency and sectarian violence, which are mushrooming mostly in Asia, Africa and Latin America. This fragile-unstable governance situation creates hurdle in the process of ‘business as usual’ for the mandarins of market economy and globalizations. To avoid the loss of investment, the private companies seek pre-cautionary approaches in terms of commercial and political risk insurance and export credit guarantee.

POLITICAL RISK INSURANCE POLICY:

The forced exit of GMR Infrastructure from Maldives earlier has caused a huge loss to the Indian company. But GMR, which has claimed a compensation of $800 million from the Maldives government, could have easily cut its losses had it purchased a political risk cover.

It is an insurance policy bought by companies to cover losses arising out of adverse political developments in foreign countries where they have their projects or businesses. Such policies cover losses caused by political violence, such as revolutions, civil unrest, terrorism or war; confiscation of assets by governments abroad; wrongful calling of letters of credit; and business interruption. Such policies have a standard risk coverage format, though they can be modified to suit the requirements of the client.

A decision to buy such covers depends upon a company’s own assessment of risk, its concerns about political risks associated with its specific investments abroad. Sometimes, banks drive the purchase of political risk covers. Many banks do not lend to projects without this insurance, either because of their own internal risk management concerns or because they have reached their lending limits for a given country.

Export Credit Guarantee Corporation, a government enterprise, provides this insurance in India. Any company investing outside India can buy a risk cover from ECGC or the Multilateral Investment Guarantee Agency, a member of World Bank Group. ECGC bears 85% of the loss, which is part of a comprehensive cover. ECGC, however, cannot provide cover to overseas companies investing in India as it cannot cover sovereign risk, which is generally bought through a broker. The premium varies from country to country. Underwriting of political risk insurance is a dynamic process and depends on the situation in that particular country. The size of a political risk insurance policy is generally equal to the investment made by the company abroad.

Political Risk Insurance can be specially tailored to cover many different risks but can be boiled down to two basic aspects. Firstly, it protects an insured in case a foreign entity confiscates its goods or equipments, and secondly, it protects an insured in case a foreign government refuses to pay a contract or interferes with the fulfillment of a contract.

PRI protects foreign investments against:-

1. Forced Abandonment: It is like complete abandonment of a foreign investment as a direct consequence of political violence or permanent divestiture of the insured’s investment at the direction of the insured’s government. For example we may consider the Enron’s Dabhol project in Maharashtra a $3 billion, 10-year liquefied natural gas power plant development project that began in 1992, the single largest FDI in India’s history. But there arose endless disputes over the prices and terms of the deal along with mounting protests from India’s public created many stumbling blocks. By mid-1995, under new political direction, a letter to Dabhol Power Co. called for a cessation of construction and abandoning the project because the cost for building the plant and generating the electricity was too high. So Enron & its U.S. partners, Bechtel and GE, have filled claims with OPIC, the political risk insurer agency of the U.S. Government, to collect $200 million in compensation for the losses suffered in that Dabhol Project.
2. Confiscation, Expropriation, Nationalization, Deprivation – These risks may result in partial or total loss of investments or assets. Examples of outright expropriation include the nationalization of entities owing debts to foreigners or having outstanding contractual relations with them, the direct annulment of debts or claims, measures denying the foreign owner access to its funds and profits. In recent years we have seen a number of cases that have involved the issue of expropriation.
3. Import or export restriction as & when being imposed on trade.
4. Breach of Government Undertaking – The largest political risk insurance claims in history were made in the wake of the financial crisis that struck Argentina in 2002 as national and state governments broke contracts and restricted the capital transactions of foreign firms.
5. Political Violence – Basically these are the politically motivated acts of violence, including war and civil war, which result in physical damage to property.
6. Currency Inconvertibility or Non-Transfer – It is arising out of Government controls that prevent the purchase or transfer of hard currency for dividend payments, loan repayment or other remittances.
7. Business Interruption – This may be due to loss of projected net profit resulting from an act of confiscation or political violence.

Political Risk Insurance protects the Contracts against the risk of:

1. Non-payment by buyers;
2. Unfair calling of ‘On demand bid’ or contract bonds;
3. Non-honouring of Letters of Credit;
4. Import or Export restrictions;
5. Non-delivery of pre-paid goods;
6. War, Civil War, civil strife, rebellion, revolution, insurrection, military or usurped power or destruction by or under the order of the insured’s government (which are always appearing as exclusion of all general insurance policies under the heading ‘War & warlike perils’);
7. Currency Inconvertibility;
8. Contract Repudiation by buyers.

As with any insurance, the precise scope of coverage is governed by the terms of the insurance policy. Perils coverage, pricing, tenor, terms & conditions and eligibility vary widely – by Political Risk Insurance provider, depending on the host country (i.e. destination of the investment), and sector or type of the investment.

Political risk policies may offer insurance for transactions with terms of up to 10-15 years rather than the normal one year in case of other policies. Before agreeing to provide political risk insurance, insurers will most likely consider a number of factors regarding the prospective client. The insurer may want to know whether the prospective client has experience selling to the specific country and whether the client has leverage in that country to help resolve any problems. But the most important factor is the client’s specific past loss history in this field.

Insurers treat political risk as a country-specific phenomenon. But individual companies confront different sources of policy uncertainty and political influence depending on factors such as their size, nationality, familiarity with the local environment, partner status, technological leadership and network of global stakeholders.

Political risk insurance provides cover to an insured for risks such as expropriation by a foreign State or currency risk. But in recent years, attention has become more focused on other, more direct, rights under international investment treaties, which may be available to investors against political interference. Where there is a treaty in place, the rights available under it may be wider, more effective and, since no premium is payable, cheaper than political risk insurance. The scope of the protections is very wide and overlapping. Since the definition of investor is also pretty wide, these protections can often be wielded to good effect. It is only in the last ten years or so, that bilateral treaties have been put to any significant use. It is a fast developing area of international law and practice as investors begin to realize the full extent of the potential protection. In certain fields, it is beginning to lead to forum shopping where potential investors seek to channel their investment through entities in countries, which benefit from the treaty rights. One of the most vaunted aspects of such treaty rights is that arbitrations are often administered via the International Centre for Settlement of Investment Disputes, an autonomous organization within the World Bank Group in Washington. No treaty claim has ever remained outstanding. So, treaty protection can be more comprehensive and effective than political risk insurance cover. Treaties can also give an investor a very long period of ‘cover’ beyond that available in the commercial political risk insurance market since treaties often contain very long sunset clauses of up to 20 years. There are such powerful rights under treaty available for free, but still, companies bother with political risk insurance.

This question is especially acute since political risk insurers will no doubt have a provision preventing an insured investor from taking any step such as reaching a negotiated resolution with the country, which might affect its treaty rights. It is incumbent on the ministry of commerce to publicize a public document stating all the treaty advantages for Indians and where a political insurance cover is advisable. Otherwise there will be high incidence of mis-selling or under-selling of such policies to unsuspecting Indians.

INDIA’S POLITICAL RISK INSURANCE SCENARIO:

ECGC is supporting the globalization efforts of Indian exporters with all the associated three broad aspects of International Trade viz, Exports: short term, medium and long term including Goods, Services and Construction / Turnkey; Credit-trade credit and bank credit including Supplier credit, Buyer Credit and Line of Credit; Risk-pre shipment and post shipment including assessment, monitoring and managing/ mitigating. The risks broadly covered by ECGC are political risk and commercial risk. ECGC is associated with various risks in export trade with reference to advance payment, confirmed letters of credit, letters of credit, various documents against payment, documents against acceptance and straight delivery.

ECGC uses the following 7 weighted parameters to classify risks in various countries spread world-wide:

*Scores are then totaled and countries divided into 4 risk categories: A (safest), B (moderately safe), C (risky) and D (riskiest).

ECGC has revised this model several times since it was developed in 1995 to respond to evolving investor needs, host country realities and ECGC capabilities. In calculating ‘economic risk’, ECGC included exchange rate fluctuations, and GDP, inflation, and export growth rates. In calculating ‘political risk’, it has considered the type of government (that is, democracy or dictatorship, coalition versus single party, etc.). ECGC does the other country’s evaluation on the basis of weighted averages of scores on various parameters (like economic risk, political risk, their experience on that country, economic & political relations with India, experience with other credit insurers and Forecast). When evaluating its own country experience, it now considers all ECGC local exposure, its claim-premium ratio, and the incidence of commercial and political claims. It has now also begun to examine other Berne Union members’ experience with the country, particularly the number / percentage of transfer delays. Extra weight is given to ‘Focus Programme’ countries with which the Indian Government wants to bolster political ties’.

ECGC graduated a number of countries into lower-risk categories and separated some island groups (including the French Pacific Islands and the French West Isles) into a collection of self-standing countries, each with its own risk rating. However, ECGC is consistently & continuously examining how it might quantify client and project risk, over and above country risk. Currently, ECGC relies completely on banks to assess these factors, by only covering those investments being financed by a recognized bank.

Developing robust client and project risk assessment parameters will also be a pre-requisite to bringing new investment and political risk insurance products to market. At the same time, ECGC will have to start incorporating environment and corruption risk into its assessment parameters, as is now common practice internationally. ECGC has only had to pay out one claim in its entire history – of US$0.3 million to Usha Martin, a steel wire rope manufacturing company, for an investment in the former Yugoslavia. While ECGC obtains some re-insurance from India’s only re-insurer- the Government run GIC Re, it is finding it increasingly difficult to raise additional medium and long-term re-insurance from the international market.

Partly to address this problem, the Government has set up the National Export Insurance Account to insure long and medium term exporters against commercial and political risk. The account is being operated by ECGC, and in addition to exports it will also specialize in large construction and similar projects, particularly in countries of political interest to India.

Although India’s hitherto government-controlled insurance market was opened to Indian and international companies during 1999-2000, no private political risk insurance player has that way emerged out. As a result, ECGC has a completely open field – and has not yet felt the need to rethink or re-price its existing political risk insurance offering. Currently, ECGC’s only competition is corporate ‘self-insurance’. However, ECGC may have to expand the scope of risks it covers to keep with international PRI industry changes.

HOW IS INDIA’S PRI MARKET LIKELY TO DEVELOP?

Even as ECGC girds itself to cater to India’s new breed of outward investors, other PRI players will begin to emerge in the Indian market over the next few years. A combination of demand and supply-side factors will drive this development, as explained below. Risk now on India’s corporate governance agenda – tightening Indian corporate governance laws have placed the systematic measurement, minimization, and reporting of risk firmly on India’s agenda. In 2006, the Securities and Exchange Board of India (SEBI) – India’s corporate regulator – ruled that all publicly listed Indian companies are to establish in-house risk assessment teams and process. These must be regularly reviewed by the respective Company Board Meetings. More stringent risk evaluation will combine with corporate globalization plans to place political risk and risk mitigation instruments, including a stronger demand for political risk insurance, at the forefront.

Investors’ growing developing country focus – while India’s current wave of investment has focused on industrialized countries, the next wave – which has already begun – is concentrating on South East Asia, the Middle East, China and Central Asia. Indian companies are now also beginning to look seriously at Africa and Latin America. Not only are the banks financing these investments likely to require political risk insurance, companies themselves might feel more secure investing in it after availing the PRI Cover.

Most importantly, the entry of global re-insurance firms into India will dramatically boost the Indian insurance industry’s ability to underwrite political overseas investment insurance risk. Lloyd’s has established their representative office in our country and other re-insurers are actively studying the market.  These developments had reinforced (rather compelled) Indian Government to raise the foreign equity cap in insurance companies from 26% to 49%. Since most of India’s investors are not yet availing of political risk insurance, this market is still miniscule by global standards. Recently the private insurance companies have also made their foray into this line of insurance. While India’s current wave of investment has focused on industrialized countries, the next wave is concentrating on South East Asia, the Middle East, china and Central Asia. Indian companies are now also beginning to look seriously at Africa and Latin America. Not only are the banks financing these investments likely to require political risk insurance, companies themselves might feel secured investing in it.  A combination of demand and supply-side factors will drive the development of PRI in India. Also, the entry of global re-insurance firms in India will dramatically boost the Indian insurance industry’s ability to underwrite political overseas investment insurance risk.

CONCLUSION: The author has expressed here the technicalities of PRI and how it is being used as a tool to mitigate political risks which are basically dynamic in nature. Political Risk Insurance (PRI) has become an essential but indispensable proposition to deal with the definite & likely losses in the overseas market, in this era of globalization. In simple terms, PRI compensates companies for lost assets when operating outside their own countries – providing protection against risks that are absolutely beyond their control. PRI in India is now being considered as a tool to protect assets which when required to be surrendered to the local people may be by the order of the local government or due to some other contingent situation prevailing in that country of operation. The significant role of PRI in securing financial support for large project (like mining, IT initiatives, installation of on-shore or off-shore platforms/stations etc.) abroad despite their serious social and environmental consequences for the communities have now been emerged due to political instability world over.

Authored By:

Anabil Bhattacharya
B.M.E. (Honours), F.I.I.I., Risk Inspecting Engineer & Insurance Counselor,

Retired Chief Manager, H.O.,

National Insurance Co. Ltd., Kolkata.