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Tuesday 17 July 2018

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Written by Jon Guy
August 2010

The global economic crisis has had a significant impact on political risk insurance. Jon Guy considers recent developments

The impact of the financial crisis has been far reaching, with market turmoil, the credit crunch and rising unemployment dominating headlines globally, as the complex causes of what some term the Great Depression II are pulled apart. The impact on the insurance sector has been no less significant as underwriters discover former ‘safe bet’ nations are now a serious cause for concern, politically as well as economically.

The threat of civil disorder, strike, riot or political upheaval have long been the driving forces behind the take-up of political risk cover. More recently, however, the financial crisis has contributed to a considerable change in the dynamics of this line of business.
While emerging markets, such as China and Brazil, for instance, have seen a strong recovery in the past 12 months, the Eurozone has been hit hard by the credit crunch, giving rise to growing demand from firms for insurance products to protect against contract defaults and non-payments.

Pepe Egger, head of western Europe forecasting at Exclusive Analysis, says there remains a real concern over certain western European economies as the effects of the financial crisis continue to be felt.

“Three years ago, if we had been asked about the risk of the collapse of the Euro we would have described it as remote,” he explains. “We had identified problems with Iceland a year before it became public because of their investment exposures, but two years ago the threat to European economies would have not been seen as high.”
However, it is the likes of Portugal, Spain, Italy, Ireland and Greece which are particularly at risk now. Egger believes the European economies have learned a lesson or two from Greece, and have cut their cloth accordingly.

“The Spanish government had been saying for some time that it would not look to cut back on spending to deal with the crisis, but the issues that we saw in Greece and the steps that the Greek government had to take to deal with the threat to their financial system has seen many European countries embarking on significant spending cuts as they look to deal with the crisis.”
While there is a view that the worst is over in the political risk sense, there remains a degree of concern, he adds. “What we have not seen yet is the emergence in any of the economies of a figure or political party putting forth a radical plan to solve the crisis, which would involve a fundamental change in political direction.

“Over the next two to three years there is a chance that we will see the emergence of a group or individual which will put forward a solution to a country’s financial problems and the resultant instability.”

Egger says as individual governments look to curb spending in areas such as welfare and transport infrastructure, the threat of civil and industrial disturbance will increase.
As governments look to control spending, the risk of a negative backlash is high, as people react to being made to foot the bill for governments bailing out the banks which caused the crisis in the first place.

“The situation varies a great deal from country to country,” Egger adds. The Eurozone has been hit hard but some economies are showing signs of recovery – most noticeably Brazil and China.”

DISCRETIONARY PURCHASE

Peter Merton, deputy marine and specialty risk underwriter on Kiln’s Syndicate 510 and a political risk specialist, says the market has seen greater interest in recent times, and that appetite and capacity is keeping pace in the underwriting community.
“Political risk is a discretionary purchase and as such it always tends to be one of those products that sees a rise in demand when the barn is already on fire, so to speak,” he adds. “It has been a fairly torrid time on the financial and trade credit side of the market, for obvious reasons. We have certainly seen an increase in enquiries and while underwriters will offer cover in most cases, they are certainly being a little more cautious.

The civil disorder which took place in the Thai capital of Bangkok earlier this year resulted in losses in the political risk market, he comments, though since the Thai insurance office declared events as acts of terrorism, much of these costs will be assumed by the insurance market.

Merton believes that the financial crisis has led underwriters to take a much longer term view in the prospects for political risk.

“It would be foolish to think that it is all rosy now. Very often you see a political risk issue start in one country then spread across a whole region.”

Merton adds there is still capacity for the more traditional political risk products to cover government nationalisation and civil disruption.

NAVIGATING THE CRISIS

Director of political risk for Aon Risk Solutions in Madrid, Mariano Viale Guerrero, says there has been a sharp rise in interest in political risk products among some financial institutions as they seek to find ways to mitigate investment risks.

The fear for those economies which have been hit hardest by the financial crisis is the ongoing potential for problems. “With the downturn, the threat of key triggers for political risk such as restricted access to welfare services and food supplies, increases,” explains Guerrero. “Though there is capacity in the market, underwriters are taking a more careful and thoughtful approach to risks.”

TOUGH TIMES

Political risk underwriter at Talbot and deputy chairman of the Lloyd’s Market Association’s Political Risk panel, James Banford, says the trade credit side of the market remains tough with underwriting capacity tight in countries where there are high aggregations of risk.

“Towards the end of last year, we started to see an increase in the volumes of trade and therefore the demand for capacity as the financial markets started to recover from the events of 2008. This was helped by a rise in commodity prices which has encouraged the flow of trade.”

Banford explains that this prompted the demand for cover as banks became reluctant to lend. “The financial climate has changed quite significantly in terms of the way deals have been constructed,” says Banford. “They are now less complex, often for shorter tenures and with tighter controls in place.”

He says underwriters are now examining the level of the risk they will place in certain countries which are seen as having a high risk of further economic problems.
“Aggregation is an issue and if there is a high aggregation of risk then underwriters will charge higher rates for the capacity they are willing to provide,” he adds.


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