Policyholder Pulse
IKEA’s Billy bookcase—so popular that one is reportedly sold every 10 seconds—recently got even cheaper, at least for Russians. IKEA is holding a fire sale as the company closes its stores and exits the Russian market. The Swedish furnituremaker’s exit from Russia is just the latest in a string of actions by over 1,000 companies—including Disney, Goldman Sachs, IBM, McDonalds and Starbucks—that are curtailing operations in the country in response to the Russia/Ukraine conflict. As of June 2022, global companies fleeing Russia have reportedly racked up more the $59 billion in losses associated with their departure. Of course, this pales in comparison to the more than 10,000 civilian casualties and $600 billion in economic losses that Ukraine has suffered since the conflict began. But even though the corporate exodus from Russia for many companies is voluntary (and has even been used by some as a positive public-relations spin), Russia has threated to confiscate Russian-based assets of companies from countries that Russia considers hostile to its interests, and U.S. and EU sanctions may practically serve to prohibit some companies from operating in Russia, all of which highlights that additional risks lie ahead.
The Ukraine conflict and other recent global events—COVID-19, climate change, supply chain disruptions potential sovereign default, and rising inflation—all suggest that the risk of political instability will likely continue to increase in the near future. This has reportedly led to an increase in demand for political risk insurance—insurance that can help protect against certain losses that result from actions by foreign governments. Meanwhile, some companies that have been forced to flee from Russia or whose Ukrainian assets have been destroyed have already begun submitting claims to their political risk insurers.
Political risk insurance began taking shape in the aftermath of World War II. To encourage investment to rebuild war-torn Europe, the Marshall Plan included investment guarantees to protect against the risk that American investors would be unable to convert foreign currency profits into dollars or that their assets would be confiscated by a foreign government without fair compensation. In 1969, as America’s desire to invest in developing countries grew, Congress created the Overseas Private Investment Corporation (OPIC), an independent agency tasked with underwriting political risk insurance. Other developed countries have formed their own public political risk insurance providers—such as Australia’s Export Finance and Insurance Corporation, China’s SINOSURE and Japan’s NEXI—as has the World Bank, with the Multilateral Investment Guarantee Agency (MIGA).
In the mid-1970s, Lloyd’s of London and AIG began offering political risk insurance, and the private political risk insurance market has since grown to include many of the largest insurance companies in the world. The menu of political risk insurance offerings has likewise expanded over time. Today, it commonly includes the following types of coverage:
- Asset deprivation: Foreign government’s refusal to allow the insured to repossess equipment or commodity (when held as collateral for a lease or loan)
- Breach of contract: Foreign government fails to pay for damages awarded to a foreign investor for breach of the terms of a project agreement
- Currency inconvertibility: Delay or inability to exchange local currency or to repatriate funds to the insured’s parent corporation
- Expropriation: Acts by the host government that interfere with fundamental ownership rights of the insured’s investment including, but not limited to, confiscation or nationalization
- Forced abandonment: Insured was forced to abandon of foreign assets because of ongoing political violence in the host country
- Forced divestiture: Legal requirement by an insured’s own government ordering it to permanently divest itself of all or part of its foreign enterprise
- War and Civil Disturbance: Physical damage to assets because of political violence such as war, armed insurrection, strikes, riots, and terrorism
In many ways, political risk insurance is a unique insurance product.
First, one typical concern with insurance is moral hazard—the fear that the availability of insurance encourages drivers to drive more recklessly and companies to take more safety shortcuts, knowing that the insurance company will be left holding the bag if casualty strikes. Political risk insurance, on the other hand, was expressly designed to promote risky behavior by encouraging investments in otherwise-risky political environments.
Second, insurance can often be used to incentivize risk-reducing behavior and decrease the number and severity of insured claims—such as by offering lower premiums when policyholders build their factories outside a flood zone, install fire-protection systems, or buy cars with collision avoidance systems. But companies selling political risk insurance typically have little influence over whether a foreign government will confiscate an insured’s property or refuse to pay damages awarded for a breach of contract claim. (Of course, when the “insurer” is a U.S. government agency or multilateral institution, there may be diplomatic or economic pressures that can be employed to remove the need to pay an insurance claim.)
Third, unlike most insurance policies that are written on pre-determined policy forms and endorsements, political risk insurance policies often include bespoke provisions that are specifically drafted to cover the specific risks of the investment, project, or transaction. Experienced insurance coverage counsel are therefore crucial for companies looking to purchase political risk insurance.
In other ways, however, political risk insurance is not that different from other commercial insurance policies a company may choose to buy. The insurer first assesses the potential risk and determines what terms and conditions it can offer and what premiums it will charge. The policyholder can choose to accept the terms offered and pay the policy premiums, or it can choose to “go bare” and invest that money in other ways. In either event, the policyholder and insurer both hope that the insured-against risks never materialize—and that no claim is ever made.
But when a claim arises, disputes over how the insurance policy applies often follow. As one OPIC official admitted, because it is impossible to predict all possible future risks, policy wording may be left intentionally vague. Although there is a dearth of judicial decisions on political risk insurance disputes (as most are subject to confidential arbitration), some public agencies do report how disputed claims were resolved. Careful scrutiny of the policy wording and proper characterization of the loss can often mean the difference between a claim that is ultimately covered and one that is denied. Early engagement of insurance coverage counsel is therefore especially important in maximizing the value of any political risk insurance claim.
The Russia/Ukraine conflict is a striking reminder of how political instability can have far-reaching global consequences. In light of current events, companies considering future investments in other potentially unstable regions likely will give increasing attention to political risk insurance as an important tool to mitigate financial risk.
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