Why political risk insurance is critical to the global economy
Political Risk Insurance (PRI) began as a niche product but has become a “critical tool in the expansion of the global economy,” OPIC Director Mark Stuckart, wrote in the magazine of the Association for Financial Professionals. Stuckart, director for Political Risk Insurance and Product Development, explains the key role OPIC has played in developing insurance to protect investors in developing markets and developing new PRI products for an evolving market and creating more opportunities for investment.
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Political Risk Insurance: Securing private business to lead the way in global development
Recent years have seen a growing appetite for international investment and a realization that the world’s consumer base is on the rise outside of more traditional developed markets. The opportunity of frontier market investment is appealing to be sure, but what about prohibitive risk profiles in emerging market sectors like power, water, agriculture, and infrastructure?
Enter political risk insurance (PRI) coverage as a key instrument to help mitigate those risks.
OPIC and the Emerging Role of Political Risk Insurance
What began as a niche product for which the Overseas Private Investment Corporation (OPIC) – the U.S. government’s development finance institution (DFI) – was a pioneer, PRI is now a critical tool to the expansion of the global economy. PRI provides intrepid investors and companies perched on the leading edge of frontier markets with a targeted risk mitigation instrument necessary to deploy significant amounts of private capital into sectors and regions that once would have been perceived as prohibitively risky.
Today, a now-mature global PRI industry has insured private capital flows at levels in the trillions of dollars. This, in turn, has catalyzed hundreds of billions of additional dollars of new foreign direct investment (FDI) and loans in such emerging market sectors as energy, infrastructure, clean water, healthcare and agriculture. The result: more inclusive economic development led by the world’s private sector investors.
In the spring of 2015, OPIC informally surveyed top PRI insurance brokers and PRI clients and found that approximately 90 public and private institutions now underwrite PRI globally. These include the 50 members of the Berne Union (the global organization of public and private investment insurance and export credit insurers), as well as 27 separate individual syndicates of Lloyds of London, and approximately 20 private sector PRI providers (including AIG, Ace, Sovereign, Zurich, Starr, FCIA, and others.)
OPIC has been a lead actor in this expansion. Since OPIC first began issuing PRI in the 1970s, annual publication of its PRI underwriting portfolio and its ongoing public posting of each claims determination have provided private sector insurance companies the necessary foundation to enable those private companies to consider adding PRI to its insurance offerings. As part of its mandate to leverage private U.S. businesses to address major world development challenges, OPIC continues to work to cooperate with the private sector PRI industry and building its reinsurance capabilities. The PRI industry has greatly facilitated US foreign investment – key to development and increasing global economic growth – by providing protection to investors against certain sovereign risks like the failure to honor international arbitration awards, confiscatory changes in law, currency convertibility and transfer restrictions.
Adapting Political Risk Insurance Products to a Changing Market
A quick review reveals that there now exists a fully functioning, competitive private PRI market that did not exist when public-sector OPIC helped spearhead the product. While there is no single source for full industry data, estimates are that the PRI industry now writes $1.5 billion or more in annual insurance premiums.
But more important than this scale is the dramatic reinvention of the global PRI industry in the past 15 years. Insured debt investments have grown substantially, while traditional equity insurance has grown but at a slower pace. In the aftermath of the early 21st century’s East Asia Crisis and default problems in Argentina, many banks realized that traditional PRI did not adequately cover all the risks those banks faced in making loans to governments, ministries, and state-owned corporations. As a result, banks realized that they needed comprehensive, non-payment protection that fully covered risks of contract frustration and also qualified for Basel II risk-based capital considerations.
The Advent of Non-Honoring Sovereign Guaranty Coverage
In the early 2000s, OPIC responded with an industry-changing new product, the Non-Honoring of a Sovereign Guaranty (NHSG). NHSG fully covered the failure of a government to “honor” its guaranty contract on bank loans and capital markets bond issues. OPIC’s pioneering first utilization of this coverage was in 2003, provided on the Philippine Government’s sovereign guaranty of debt issued by the government-owned electric power utility, NAPOCOR, in a 144A, Reg. S. bond offering, which was rated “AAA” by S&P. Another compelling aspect of the NAPOCOR NHSG transaction is that OPIC reinsured $100 million of that first issue to Zurich and Sovereign.
To date, OPIC has cumulatively underwritten $1.2 billion of this NHSG coverage in five major transactions, and also provided coverage on interest rate and currency swaps backed by the sovereign in some of those deals. These transactions provided the foundation for the private market and other political risk insurers to develop NHSG-type coverage that met a huge market demand.
In fact, private sector insurers quickly began writing billions of this new debt coverage. It is now estimated that the global PRI industry has underwritten an estimated $70 billion of NHSG-type coverage to date. The World Bank’s Multilateral Investment Guaranty Agency (“MIGA”) embraced the product several years ago and now issues coverage through a product called “Non-Honoring of Sovereign Financial Obligations.” Quietly, revolutionary advances in the PRI industry have led to robust coverage of sovereign financial obligations, which results in access to financing for critically-needed infrastructure improvements in the developing world.
Innovative Political Risk Insurance for Debt
Traditional equity PRI coverage continues to be underwritten, primarily by private insurers. The most telling growth of the PRI industry has been on the debt side, specifically with insurance contracts for bank loans. Again as it has done with the NHSG product, OPIC continues its key role as an innovative force in the industry. Specifically, OPIC has adapted its long-standing Breach of Contract/Arbitral Award Default coverage by extending it to insuring debt instruments in Capital Markets and Bank Syndicates to mobilize private financing for upgrading a country’s physical infrastructure.
Under this coverage, the insured investor is required to secure a favorable arbitral award against the host government obligor. Key facets of this coverage also include “fast-track” arbitration on the debt agreement and a requirement that arbitration is binary in its assessment, essentially based on payment or nonpayment on the debt. These combined coverages enables ratings agencies to rate the combined package of risk mitigation coverages at a higher investment-grade rating level.
The Way Forward: Opportunities for the Private PRI Market Working with OPIC
The global banking industry has weathered a tough worldwide recession over the past six years and now faces new, stronger risk-based Basel III capital requirements. At this critical juncture, OPIC’s new Breach of Contract Insurance for Capital Markets and Bank Syndicates (BOC) is an important new vehicle to help mobilize US investors with long-tenor loans via rated private placement bonds and/or bank syndicates.
Moreover, non-bank debt investors can also join loan syndicates and can take risk off of the balance sheets of banks, reducing bank capital requirements but still allowing banks to serve their customers. OPIC’s well-earned reputation for paying legitimate claims, coupled with its excellent track record of recoveries on expropriation claims paid (over a 90% recovery rate), allows OPIC to accept risks prudently and to enable U.S. investors and lenders to pursue commercially attractive opportunities involving global debt markets and the developing world.
OPIC uses its unique role to enable the private PRI market to expand. OPIC is mandated by statute to cooperate with the private sector PRI industry, which OPIC itself helped to create. The PRI industry capacity has now grown to approximately $2 billion per individual risk, double what it was five years ago. There is a large, well-functioning market with insurance syndicates, co-insurance, reinsurance networks, and knowledgeable PRI specialist insurance brokers.
The ongoing challenge, however, remains tenor and capacity for large infrastructure projects beyond ten years in term, as many private sector insurers generally do not want to commit over seven or ten years for large dollar amounts. Here again with the NHSG and BOC products, OPIC and other large DFIs can open doors and continue to be market catalyzers, particularly in facilitating and mobilizing private sector insurers and investors to participate in long-tenor transactions. With OPIC and other DFIs taking the long-tenor risk, the private sector insurers can accommodate the shorter portions of a financing.
As the PRI industry continues to evolve, OPIC will continue to play an important pioneering role in new risk mitigation products, particularly with long-tenor public-private partnership infrastructure projects. This new innovative partnership with the private sector will enable larger infrastructure deals, and greater development in frontier markets and critical areas such as the power, ports, pipelines, water, and other essential sectors.