Political Risk Insurance in Asia: Who Purchases It, Where, and Why
July 2002
Daniel Wagner examines how in Asia it is the
banks and their lending requirements that are the real driving force behind
the majority of political risk insurance (PRI) purchases.
by Daniel
Wagner
AIG
The question of what motivates companies to purchase political risk insurance
(PRI) has long been a subject of debate in the PRI industry. Some practitioners
believe that purchasing PRI is purely a risk management function—that a company's
risk management philosophy drives the decision. Under this view, companies purchase
PRI when they have concerns about the political risks associated with specific
transactions in accordance with their corporate guidelines governing political
risk management.
Others maintain that banks drive the purchase of PRI. Many banks will not
lend money to projects without PRI, either because of their own internal risk
management concerns or because they have reached their lending limits for a
given country. Still others believe that purchasing PRI is a reaction to specific
country or regional events, making it a reactive rather than proactive response.
Having compiled detailed statistics on PRI submissions in Asia for 2 years,
I believe that a combination of factors ultimately motivate companies to purchase
PRI. While the perceived political risks associated with country-specific events
are unquestionably a motivating factor in the decision to purchase PRI, and
while individual corporate risk management philosophies clearly impact the decision,
in Asia it is the banks and their lending requirements that are the real driving
force behind the majority of PRI purchases.
Host Countries with Highest Demand
Let us first examine where organizations have been most concerned about political
risk in Asia over the past 2 years. During the last 6 months of 2000, 40 percent
of all submissions for coverage that I received were for Indonesia. This may
come as no surprise, particularly given Indonesia's political and economic situation,
the fact that Indonesia is the largest economy in Southeast Asia, and that I
am physically based in Singapore. However, 40 percent is statistically a very
significant number, particularly when one considers that of the dozen countries
in Southeast Asia, many are rarely the subject of PRI coverage requests. The
Philippines took second place with 10 percent, followed by Vietnam and Thailand
with 7 percent each, and China with 5 percent. As we will see, it is no accident
that the Philippines assumed second place during this period.
The China figure is at first glance surprising. Given that 80 percent of
Asia's Foreign Direct Investment is soaked up by China, and given the omnipresence
of China economically and politically in the region, one would think, logically,
that China would account for a significant percentage of the total number of
submissions.
Political
Risk Insurance Submission Graph #1
I believe that there are two reasons why China accounts for such a relatively
small percentage: first, investors' perceived risk of doing business in China
appears to be lower than in other countries in the region; second, there are
vast indigenous sources of financing available in China which do not require
cross-border capital flows.
By the first 6 months of 2001, things began to change. Only 27 percent of
submissions received were for Indonesia, a drop of one-third. Meanwhile, in
the Philippines, submission levels rose from 10 percent, to 13 percent; also
a one-third rise. There was a point, between June and August 2001, when Indonesia
and the Philippines were virtually equally weighted, with the Philippines at
22 percent and Indonesia at 25 percent.
Political
Risk Insurance Submissions Graph #2
This is interesting because the numbers indicate that investors and traders
responded favorably to the ouster of President Wahid and ascension of Megawati
Sukarnoputri in Indonesia. At the same time, investors and traders did not appear
to respond with confidence to the ouster of President Estrada and ascension
of Gloria Macapagal-Arroyo.
My interpretation is that few investors and traders had confidence in President
Wahid, while in the Philippines it wasn't so much that they lacked confidence
in President Arroyo, but that they were uncertain about how events would play
out. Since the summer of 2001, the international investment community has by
and large given the Arroyo Government a vote of confidence.
Regarding the other countries listed for the period, I don't attribute much
importance to the appearance of a substantial number of submissions for Sri
Lanka and Pakistan, as they did not appear as countries of top demand during
any other semi-annual period in the 2-year time frame, and it is quite common
for countries to appear in one statistical period but not another.
Political
Risk Insurance Submission Graph #3
As the statistics for the last half of 2001 show, the Philippine situation
stabilized, with submission levels settling at 14 percent, with Indonesia hovering
around the 25 percent level. China picked up some steam, rising to 12 percent,
followed by Vietnam and South Korea. Statistics for the first half of 2002 show
that the Indonesia/Philippines submission levels stabilized with Indonesia at
around 30 percent, and the Philippines in the mid-teens. China and Vietnam remained
in the third spot. What was notable for this period was that Singapore was tied
for fourth place with South Korea. I attribute this to the attention Singapore
received after it arrested 13 suspected terrorists in January. That Singapore
can go from virtually no previous political risk submissions to assume one of
the top spots so quickly appears to support the notion that investors/traders
react to news events when deciding to purchase PRI. Interestingly, Singapore
disappeared from the radar screens just as quickly as it appeared.
Political
Risk Insurance Submissions Graph #4
The conclusions to be drawn from these statistics are two: (1) Indonesia
and the Philippines are likely to remain number one and two in terms of investor/trader
demand for PRI in the region for the foreseeable future; (2) China and Vietnam
are likely to remain third or fourth, and any number of other Asian countries
will fill the secondary ranks. Since political risks exist in every country
in the world, my view is, the fact that traders and investors seek PRI in a
given country is more of an indication that they are eager or willing to do
business in a country than that they are overly concerned about the existence
of political risks. If investors and traders are overly concerned about the
political risks in a specific host country, I do not believe they will be doing
business there in the first place.
Trade and Investment Flows
Statistics regarding trade and investment flows are worth discussing because
I believe they are a fairly accurate gauge of investor/trader sentiment. During
the last 6 months of 2000, requests for trade-related PRI coverage (such as
contract frustration, wrongful calling of on-demand guarantees, and non-honoring
of letter of credit coverage) were roughly 2:1 over investment-related coverage
(such as expropriation, currency inconvertibility/non-transfer, political violence
and breach of contract). However, the situation changed dramatically during
the first half of 2001. Requests for investment coverage outpaced trade coverage
by a 3:1 ratio.
I believe that this change is attributable to the initial optimism that investors
felt for the prospect of an improved investment climate in the region in 2001.
In the 12 months between June 2001 and May 2002, requests for investment coverage
continued to outstrip requests for trade coverage by roughly a 2:1 margin. By
the middle of last year, it was evident that the economic gains and relative
political stability that had characterized 2000 were not going to persist. I
therefore believe that the statistics for this past 12-month period are indicative
of a general trend toward caution about investing in Asia, even before the terrorist
attacks of September 11 occurred.
Indeed, the project finance business in Asia has been slow since 1997—a result
of the Asian financial crisis, of banks having generally reduced their lending
levels in Asia, and of many infrastructure-related problems materializing in
the 5-year period since the crisis began. This remains fresh in the minds of
lenders and equity investors. As a result, relatively few projects are reaching
the financial close stage, margins remain tight for banks, and many banks are
chasing the same transactions. In fact, it is not uncommon for me to see requests
for coverage for the same transaction from five or six different sources.
Conclusion: What Motivates Companies To Purchase PRI in Asia?
The conclusion to be reached is that investors and their partners are the
driving force behind the majority of PRI submissions. Most of these submissions
have been generated because of banks' desire to satisfy internal credit committee
lending requirements. This, in turn, is linked to the banks' own risk management
guidelines as well as a desire to reduce capital allocation costs and/or satisfy
home office central bank lending guidelines. The pursuit of risk management
techniques that remove the need to provision for cross-border exposure while
simultaneously reducing capital allocation costs will continue to be a prime
motivating factor behind bank lending guidelines.
Although it is less common for equity investors to pursue PRI without the
involvement of a bank, investors' own risk management guidelines often require
that PRI be utilized to remove political risk from their balance sheets. Investors'
risk management guidelines generally fall into three categories: (1) purchase
PRI for each overseas exposure; (2) do not purchase PRI for any such exposure;
or (3) purchase it only for those transactions that exceed the company's tolerance
for political risk exposure. The most common approach appears to be the last
one, with most investors pursuing coverage only for those exposures that are
of particular concern. This creates a tendency for PRI providers to receive
only adversely selected transactions from equity investors.
There can be little doubt that investor/trader/lender reaction to individual
political events in host countries is a prime motivating factor in the purchase
of PRI for transactions in Asia. The example of the dramatic jump in submissions
for Singapore earlier this year is a good indication of this. I have seen similar
rises in submission levels following other political events in the region, and
indeed, globally. However, the interest levels tend to dissipate as quickly
as they arose once the event in question subsides.
It is quite common for PRI purchasers to pursue PRI only after a political
or economic event has occurred. PRI is ultimately a commodity that is sensitive
to supply and demand. It would therefore be wise for purchasers of PRI to pursue
coverage either well in advance or well after such events occur because, not
only is it less likely that coverage will then be available, but the cost of
coverage will undoubtedly be higher during the storm.
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