The global economy means the world is getting smaller. But, some things never change. In some developing areas of the world and in some cultures revolution, regime change and social unrest present real risks to business. Political risk insurance is a business insurance product designed to limit that risk.
What is Political Risk Insurance?
Political risk insurance (PRI) is business insurance that reimburses losses caused by social or political disruption in a country. It is also a product that can serve as a loss control or mitigation tool in order to encourage investment in a project. As such a tool, even small companies may be required to insure overseas investment with some form of PRI.
For example, take the case of a small importer here in the United States. The importer would like to set up a small shipping facility in order to lower shipping costs and to take advantage of local labor. The problem is that the importer cannot secure financing for the project. Not because of credit or the lack of potential profit, but because the area is subject to frequent coups and social unrest. The last coup resulted in the seizure of all foreign owned businesses.
The importer could purchase PRI for the project. The insurance would pay off if the property was damaged, taken or destroyed by political upheaval. This would eliminate the primary risk to investors and encourage investment. PRI is both a business insurance and a mitigation of risk tool that will allow foreign investment.
What Does Political Risk Insurance Cover?
PRI is not like other business insurance. Each policy and company may cover different events. Most policies may be scripted or written for a specific type of project. However, there are three risks that are generally covered by most policies:
- Expropriation - This is the taking or conversion of private property or investments by the host government. Think of Castro's nationalization of all private business in 1966.
- Political Violence- This coverage protect the business from damage of assets during political upheaval. Think of the most recent violent protests and street battles in Iran.
- Currency Inconvertibility- This is business insurance to insure against the risk of the local currency being impossible to convert to hard currency and currency devaluations.
Where Can You Purchase Political Risk Insurance?
Again, this is not ordinary business insurance and cannot be purchased from the local agent. PRI is often sold as part of a private-public partnership with the host country encouraging investment by offering some measure of PRI or trade credit protection. So each country is different. The World Bank posts an excellent list of brokers and intermediaries with specific expertise in this area. Zurich North America's political risk product web page is also very good.
Before making an overseas investment it is always a good idea to look at the current political, social and economic situation. Overseas trade can benefit both countries and the businesses involved. However, the world's GDP is set to contract by nearly 2% this year, resulting in more poverty, hunger and lack of opportunity. These conditions are always the breeding ground of unrest. PRI is a type of business insurance that can mitigate the risk, but it cannot solve the underlying problems -- unfortunately.