HOW TO PROTECT YOURSELF WITH POLITICAL RISK INSURANCE
If you’re stressed out over whether you should buy political risk insurance for your exports and where you’re going to get it, there’s no reason to sweat. Political risk coverage is readily available from carriers that provide trade credit insurance, often as a rider to the main policy.
The circumstances dictating the need for political risk insurance are fairly cut and dry. And, like trade credit insurance, you may be required to buy this coverage by your lender.
More complicated is the consideration of which political risks you should cover, since this type of insurance is a good deal more expensive than trade credit coverage. Trade credit insurance typically goes for a tenth to half of 1 percent of the revenues being insured, depending upon sales volumes and the destinations of the exports. Political risk insurance policies, on the other hand, generally command a premium of 1 to 2 percent of the value being covered—that’s double to 20 times the price of trade credit insurance.
However, political risk policies can be tailored to specific circumstances, so it’s probably wise to consider which you actually need, instead of buying some product off the shelf.
Trade credit insurance covers nonpayment due to commercial risk situations, such as the protracted default or insolvency of a commercial buyer. Political risk policies extend coverage to governmental actions, or inactions, which can influence nonpayment by buyers, including customers that are governmental entities.
So, if you’re exporting products that are being bought by a government or a governmental agency or a state-owned enterprise, political risk insurance will cover non-payment by those entities. Political risk insurance can also cover against non-payment by commercial buyers due to government actions such as revocation of import licenses, nationalization of industries or intervention in currency markets that make payment impossible. Beyond that, political coverage can also insure against non-payment due to war, strikes, civil strife or mayhem which are excluded from trade credit coverage.
“We insure payment by a sovereign buyer in conjunction with other contract risks called contract frustration,” says Roger Schwartz, senior vice president at Aon Risk Solutions. “It insures the contract and the potential financial loses that can occur if there is a risk by the behavior of a government counterparty. The risk of non-payment due to the action of a government party is fundamentally a political risk. Credit insurance only covers commercial non-payment.”
“Political risk insurance usually applies when you are exporting to developing markets,” says Vic Sandy, managing partner at Global Commercial Credit. “Currency transfer restrictions, war and government seizures all fall under political risk. Lenders sometimes require exporters to developing or emerging markets to carry comprehensive coverage, including both trade credit and political risk insurance, in order to lend against their receivables.”
Sometimes a transaction doesn’t really have a trade credit component but does have a political risk component, Sandy notes, as when you’re selling to a government agency in Iraq. “And if you’re selling to commercial buyers in developed markets like Europe, Japan and Australia,” he adds, “you should be able to forego the expense of political risk coverage.”
“The political risk endorsement is marketed on a case-by-case basis,” says Abdo Radi, regional manager at the Lebanese Credit Insurer. “It is directly related to each policy and to the countries of export. The political risk endorsement is never given to domestic receivables, so that if the policy is issued in Lebanon, the political risk cannot cover Lebanon.
“Policyholders have good opportunities to trade with buyers in politically risky countries,” Radi adds. “The political risk endorsement can be considered similar to a safety net, which will in turn facilitate the trade. Policyholders are getting more interested in this type of coverage, especially in the Middle East and Africa because of the current political instability in the region.”
Political risk coverage typically covers four fundamental areas. It will cover losses suffered due to war, civil war, civil disturbances, civil commotion, foreign occupation of the buyer’s country and revolutions. But war between five major powers—Russia, France, the UK, China and the U.S.—as well as nuclear attacks, are not covered.
“Transfer risk” refers to non-payment due to the lack of foreign currency in the buyer’s country or restrictions on money transferring due to the buyer’s country laws and regulations. This refers specifically to a public buyer when the contract was cancelled arbitrarily by that buyer.
Losses resulting from prohibited delivery of the products in the export or import countries because of the lack of import, export or exchange licenses—in case both parties failed to obtain the necessary licenses—are also covered under political risk. Finally, unilateral cancellation of the contract by the buyer’s country is also covered.
While trade credit coverage tends to be standard, political risk policies are generally customized to the needs of the insured, notes Smita Bhargava, vice president of Special Programs at Clements Worldwide, an insurance broker and managing agent for Lloyd’s of London. “The policies are tailored depending on what the risk is and what you want to cover,” she explains. “Some customers want or need to cover the risk of terrorism for goods in transit and others only want coverage for the goods in country. Some exporters to Africa are concerned about strikes, civil commotion and terrorism, and not so much about war, but in Iraq and Afghanistan they will be purchasing full war coverage.”
Many political risk policies will cover forced abandonment in high risk countries where government action or inaction spurs companies to lose assets. “These policies can be structured according to their individual needs,” says Bhargava. “Exporters can look over the list of things that can be covered and pay for those risks they want to cover and not the rest.”
Be Prepared or Be Left Behind