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By CYRIL TUOHY, managing editor of Risk & Insurance®

Political risk insurance, which private insurers have offered for more than 30 years, used to cover confiscation, expropriation and nationalization of assets.

Coverage for these new economically centered risks were traditionally offered by insurance programs in government-backed export credit agencies. Now they are being covered by private insurers, Ascari said in a paper published last year titled "Political Risk Insurance: An Industry in Search of a Business."

"This broadening of the spectrum of activity by private insurers brings them in to what used to be the exclusive territory of public insurers," he wrote.

It's not hard to see why. For underwriters with global breadth, there are profits aplenty to be made covering these risks, which are categorized as infrequent but very expensive for insurers when they do occur.

The good news for issuers of political risk coverage--ACE and Travelers in the United States, for example, or Lloyd's in England--is that demand for political risk coverage is going to go up as direct foreign investment in emerging markets increases.

Net foreign direct investment inflows into emerging markets has gone from less than $200 billion in 1996 to nearly $600 billion in 2008, according to data from the World Bank and the Berne Union, a group of export credit agencies and private insurers.

Buyers representing large companies doing business on foreign soil are going to need coverage for multimillion-contracts and high-stakes deals involving billions of dollars in trade.

In effect, modern-day political risk coverage is less about protecting assets factories or mines from the prying hands of an aggressive foreign government, and more about protecting income, the exchange of goods and services, and trade agreements.

"It's one thing to have assets on ground and another to get the income out," said Joseph Restoule, principal with Restoule Risk Management Ltd. and a consultant to Aegis Insurance Services.

Governments that may have once upon a time been in the habit of throwing out rules at the whim of the latest autocrat are these days more likely to simply change the rules.

That makes political risk coverage harder--indeed impossible--to price accurately, Ascari argued, and more complicated when it comes to defining the terms and conditions of the coverage.

Arbitrary exchange rates alter currency values, which affects the price of products and services, said Matthew Woollam, chief underwriting officer for trade credit and political risk with Liberty International Underwriters in London.

"The problem is that the government changes the rules, and that changes the variables in the contracts," he said.

When a government doesn't pay the subsidies for staples and basic commodities, distributors and producers lose out as they can't pass on the increase to the consumer, Woollam said.

Governments change the rules in developed countries too. To wit: The U.S. government, which was most affected by the most recent financial crisis. The rescue of the automobile and the financial services industry in 2008 sent many a corporate risk manager scrambling to fine tune, amend or renegotiate existing insurance contracts with counterparties and trading partners.

How ironic. For a string of several months more than two years ago, before the recent upheavals in the Middle East earlier this year, the countries with the greatest amount of political risk appeared to be world's most developed economies. Governments in the United States and Great Britain, coming to the rescue of crumbling institutions, were nationalizing or expropriating chunks of private companies.

The very political risk coverage that corporate risk managers would have clamored for in an emerging market to protect their employers against the hand of government intervention wasn't available in the most mature markets in the world.

"No insurer would nonetheless be prepared to cover political risk in an industrialized country," Ascari wrote. "Why is this so?"

May 1, 2011

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