Political Risk Insurance Industry Leaders Take Stock
November 5, 2010
What a difference two years make. When industry leaders gathered for the 2008 MIGA-Georgetown Symposium on International Political Risk Management, the global financial crisis was just unfolding. At this year’s biannual conference, held on October 28, 2010, practitioners pondered the impact of the crisis on the political risk insurance (PRI) industry—but were also able to chart a way forward that presumes a fledgling recovery is taking root.
In her opening remarks, MIGA’s Executive Vice President Izumi Kobayashi reflected on the 2008 conference: “At that time, only two months had passed since the collapse of Lehman Brothers, yet we had already witnessed the beginning of a steep decline in foreign direct investment flows, not only to developing countries, but all over the world.” She noted that, while FDI is beginning to recover, the economic landscape is vastly different than it was a few years ago.
The event’s opening panel honed in on this very topic. Panelist James Bond of MIGA reeled off some of the more notorious events of the last two years—among them: the near collapse of Greece’s economy, an IMF bailout of Eurozone countries, Britain’s unprecedented austerity measure under a coalition government, quantitative easing by the Federal Reserve, and the continued long-term unemployment in the United States. Moreover, he noted that in this “upside-down” world, the developing world has become the engine of the world’s growth. Developing world economies are expected to grow overall by a robust 6.2 percent this year. So how has the PRI industry responded and where does it need to go?
A representative of a Lloyd’s syndicate offered his perspective stating that “the last two years provided the biggest challenge since industry inception.” Nevertheless, he noted the market withstood the stress. “Some situations were beyond salvation, but where insurers were willing to work with their clients, obligor default claims were minimized.” In the end, the Lloyds market paid out $500 million in claims over the last two years, primarily in the banking sector in Eastern Europe and Central Asia, to cover sovereign obligor default.
Panelists also noted a substantial shift in the nature of claims when compared to the last major loss event—the Argentine debt crisis of 2001-2002. Most of the claims in the Argentine crisis were related to investment losses, whereas in 2009-2010 obligor default products, primarily trade credit, accounted for nearly 90 percent of the losses. Private insurers indicated the that new demand for investment/asset insurance was very limited during this period with the exception of coverage for shareholder loans provided by foreign-owned banks to their emerging market subsidiaries. This observation coincides with MIGA’s experience during the crisis: many of the infrastructure and extractive industries investments the agency considered covering were shelved, while over $1.2 billion in guarantees went to the financial sector.
Despite the strong performance of the industry during the financial crisis, most panelists indicated that PRI seems to be a discretionary purchase, with obligor default products (contract frustration and trade credit) dominating the private market. The demand for obligor default products is also largely driven by Basel II and the ability for banks to enjoy capital relief through their use. This leads to a large segment of PRI consumers that are more focused on satisfying credit committees than paying a lot of attention to their actual insurance policy. Although the impact of Basel III is unknown, a representative from the banking industry urged collaboration so that suitable PRI products could be developed going forward.
For public insurers, the landscape is somewhat different. A public insurer participating in the event noted that most of the potential claims brought forward by investors over the years were concentrated in energy and natural resources investments. While private insurers are generally more price-competitive on transactions such as export credit insurance, public insurers are generally better placed for long-term deals in risky markets. As one public insurer noted, “We are selling our partnership in addition to a product.”
Despite an extensive agenda that ranged from a macro industry view to detailed discussions on bilateral investment treaties, a few conclusions were drawn: the industry has lots of capacity—even with the exit of Chubb earlier this year. Insurers need to listen to investors and be proactive in developing new products. In addition, the emergence of more South-based investors creates new challenges and opportunities for the PRI industry. Lastly, the collaboration between public and private insurers must continue and intensify—particularly in providing capacity to investors in risky markets.
Given the rapidly changing global dynamic, insurers are likely to face unforeseen scenarios before the next gathering in two years. But given the industry’s recent experience in weathering the global financial crisis, the mood was upbeat.