More and more U.S. companies are doing business on an international stage. Though a lucrative option for businesses able to capture share in emerging markets, doing business in other countries brings with it different laws, unfamiliar risks and potential political unrest unlike anything most U.S. companies have experienced.
“In my experience as an account executive, I found that just about every client company that I have that is doing business internationally, whether it’s a multinational enterprise with many operations overseas or just exporting or importing, is going to have some type of exposure to political risk,” says John Hertzer, vice president at Aon Risk Services, Inc.
Smart Business spoke to Hertzer about how companies can protect themselves when doing business abroad.
Why should companies obtain political risk insurance?
A simple and short definition of political risk is the action or omission of a foreign government to either deprive the corporation of all or part of its assets or prevent or restrict the performance of a contract. Companies doing business overseas are usually exposed to that in some way or another.
You’ll tend to find that the attention and the need for political risk insurance are greater in the emerging market countries rather than the developed countries although, that’s not always true. The predominance of this coverage is sold to companies who are working outside of places like Western Europe, Australia, New Zealand or Japan.
Has the need for this insurance grown proportionate to the increase of global business?
The need certainly has. I think the question of whether the companies have taken up the requirement as much as we think they should is another story. And there’s a reason for that. Corporations spend millions of dollars on basic property casualty coverage. Political risk and its cousin, trade credit insurance, are discretionary purchases. So you have to ask yourself whether buying catastrophic coverage such as this makes economic sense. Sometimes you guess right, and sometimes you don’t.
Again, how much of this risk takes place in an emerging market? Some companies are in 20 or 30 countries, and only three or four of those are considered emerging markets, so the company has to quantify its risk first and then explore where it is going to transfer risk by purchasing insurance.
We normally suggest that clients buy insurance to cover all of their property/casualty risks and not just the ones that will cause some sort of loss. Political risk insurance tends to be a little different in that regard. Companies use what an underwriter would call adverse selection process wherein companies select the areas where they are most exposed and usually insure those for political risk. Also in this economic downturn a lot of companies that would consider political risk insurance view it as a discretionary or nonessential expense.
Do all companies doing business internationally need political risk insurance?
If you’re an extractive-industries type of company such as mining or oil and gas and you’re working in Africa or parts of the Middle East, you may have invested a lot of money into a project and that project may or may not be impacted by a government action. If you have investors and shareholders and boards of directors, you can experience a big balance sheet hit. And if you aren’t covered, then you’ve just taken a huge uninsured loss.
Publicly traded companies tend to take a more conservative view; privately held ones may have a completely different outlook. There are companies out there that are used to taking risks.
Can you pick and choose which projects you want to have covered?
You can get coverage for individual projects and, theoretically, you can get it for as long as you want. There are some top-end limitations; in other words, you can’t get it for 100 years. But policies will traditionally go out for five, 10 or 20 years. Again, it depends on how long it takes to complete the project. If you’re buying coverage for your company’s ongoing operations and not a specific project, that can also be done on a multiyear basis with annual extensions.
What else should businesses know about political risk?
There are a couple of real life examples where political risk insurance has proven to be helpful. Let’s say you’re a lender and a client wants to borrow money to build a plant in South Africa. The bank may like the project and business plan but may be concerned about the political climate in South Africa. So the bank may take a policy out to protect its loan and/or the parent company may take out the policy and assign it to the bank as an alternative.
Or, say you have an operation and a bank account in Venezuela containing millions of dollars. If President Hugo Chaves decides he’s going to nationalize your company, then the money in your bank account could get swept up with the rest of it. That happened recently when Chavez decided a U.S.-held company was charging too much for its product and causing prices in the country to inflate.
John Hertzer is vice president at Aon Risk Services, Inc. Reach him at (412) 594-7603 or John_Hertzer@ars.aon.com.