Political risks are generally unpredictable and often unexpected, which makes them a concern for business owners. Losses that occur as a result of political unrest are often excluded from typical property coverage, so companies must be diligent.

“These losses, when they happen, have the potential to be financially severe,” says Roger S. Schwartz, senior vice president, Political Risk Practice with Aon Risk Solutions. “They have the potential to have a very definite negative impact on the company’s well being. Executives should be aware that operating in emerging markets has its risks, but the risks can be mitigated.”

Smart Business spoke with Schwartz and David Schaake, resident sales director, Aon Risk Solutions, about why businesses should be concerned about political risks and how to protect against them.

What are some examples of political risk?

The events that transpired in the Middle East provide examples, especially for companies with exposures in countries that were targeted by the Arab Spring. An oil and gas operation in Libya, for example, would have potential for damage as a result of the revolution, as well as potential for disruption of operations. The company might not have been able to conduct drilling, so it would face a business interruption loss.

These events have the potential for ripple effects. If you are contracted to do work that depends on materials, commodities or services provided in a particular country, an interruption in your ability to provide that work can cause a break in the contract downstream for the end user. There are a variety of things that can occur, not the least of which is the potential for physical damage losses, which generally are not covered under the standard property policies.

Even terrorism coverage will take you only so far. Some property policies have brought terrorism coverage back; some organizations have to buy it separately. In the context of Tunisia, Libya, Egypt, Syria and Bahrain, all of those events were acts of political violence. They are not classified as terrorism, so losses caused by those events would not have been covered under a standard terrorism policy.

How can businesses expand their coverage to include political risks?

There is a policy sold routinely designed to insure political violence. It adds a number of components to the terrorism coverage: war, civil war, rebellion, revolution, insurrection, strikes, riots, civil commotion and malicious damage. These are extra coverages that are specifically excluded by the property policy and terrorism policy. Companies operating in emerging markets that are politically unstable should consider adding that suite of coverages.

How can companies determine whether they need to add these coverages to their risk management portfolio?

It is a function of cost versus benefit. If you or one of your key suppliers or customers are operating in an emerging market and you think there is a potential for this type of risk to occur, it is something you may want to hedge. Some companies may choose to self-insure because, as a class, political risk fits under the low-frequency/high-severity class of catastrophic losses. It’s not the sort of risk where you can point to a consistent, ongoing loss stream as you might with a property or casualty policy.

Organization leaders often say, ‘The odds are with me; perhaps I may not need to expend the premium.’ This is the same sort of calculation you make or don’t make when you think about buying an earthquake policy or a terrorism policy.

How can businesses account for political risk in their risk management planning?

It requires a corporate exercise in introspection. Companies need to take into account the line of business in which they are operating. These issues are going to be self-evident to people who give the matter consideration.

If you are a company working in an emerging market that is politically unstable, the probability is that you know the issue of political risk exists and that you have an exposure to it. The next question you should ask yourself as a business owner is, ‘Does it make sense economically or otherwise for us to mitigate that risk?’

It depends on who you are and what you are doing, but that is a decision that has to be made internally after a balanced review with risk management and the company’s insurance broker. When you are doing an enterprise risk management analysis, you’re basically looking at the shock loss to a company from a variety of different angles. Political risk is just another one of those angles.

Risk management is a function of the economics of the situation. People in manufacturing have a different viewpoint than people in service industries. Publicly traded companies have to be cognizant of the fact that there is a certain amount of shareholder scrutiny. If you look at any public company’s 10-K form, there is a section devoted to that company’s risk factors. As a matter of routine, CFOs use this section to warn investors and potential investors that the business could be impacted by political risks. <<

For more information on political risk and its potential impact for businesses, visit http://www.aon.com/2012politicalriskmap.

Roger S. Schwartz is a senior vice president, Political Risk Practice with Aon Risk Solutions. Reach him at (212) 441-1125 or roger.schwartz@aon.com. David Schaake is resident sales director with Aon Risk Solutions. Reach him at (314) 854-0821 or david.schaake@aon.com.

Published in St. Louis