For political risk, insurance isn’t all

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. ECGC in India had virtual monopoly to issue political risk insurance cover for credit risks. Things have
potentially changed after insurance sector liberalisation.

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.

Sophisticated managers address political risk by employing tailored risk mitigation strategies that reflect the specific factors affecting a company’s risk profile. Insurers may therefore determine the proper scope and price more accurately and efficiently by assessing the fitness of a given political risk mitigation strategy.

Investors contemplating entry into countries with “opaque” governance, e.g., China, Russia, Indonesia, Turkey, South Korea, Romania and the Czech Republic face the equivalent of a 33-46% increase in corporate income taxes, relative to the cost of entering a country with stronger governance, e.g., the United States or Chile.

India is in still in the club of knotty risks, neither here nor there. Similarly, bondholders in countries with opaque governance demand premiums of 9-13%. While these aggregate statistics are compelling, they mask the underlying company and project-level heterogeneity. There lies the underwriting skill of the insurers in a detariff regime.

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.

Treaty rights are derived from treaties entered into between countries, either bilaterally or multilaterally, to foster investment in the contracting states. India has had a programme of entering into such treaties for many years.

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 five or so years 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 realise 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 organisation 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 publicise 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.

(The writer is director, National Insurance Academy, Pune)