Political Risk Premiums Rising in Response to Resource Nationalism

By | November 5, 2009

Political risk insurance premiums have risen across emerging markets in the last year, fuelled by rising resource nationalism and unrest linked to the financial crisis as well as a renewed concern over risk amongst investors.

Foreign direct investors use the political risk insurance market to buy protection against nationalization, expropriation, political violence or capital controls preventing convertibility of earnings. It generates some $1.5 billion in premiums each year.

President for Surety, Credit and Political Risk at insurers Zurich Dan Riordan said the rise in premiums was due to both increased demand as well as heightened risk, particularly of government takeovers of natural resources in Latin America.

“Premiums have risen pretty much across the board in the last year,” he told Reuters. “There’s a lot more demand than there was. Wariness of risk is pretty much an all-time high, and there is a limited supply of political risk insurance.”

Generally, annual political risk premiums are 1-3 percent of the value insured, and currently were pushing towards the upper end of that. To control its exposure, Zurich will only cover $150 million per asset, with insurance coverage sold for periods of up to 15 years.

The main consumers of expropriation and nationalization coverage are resource companies increasingly nervous of a growing trend of populist governments such as that of President Hugo Chavez in Venezuela taking control of assets.

“We’re seeing more and more companies getting worried about resource nationalism,” Riordan said. “It’s been a growing trend, particularly in Latin America — Venezuela, Bolivia — and there are worries in Guinea after the change of government.”

A military junta seized power in Guinea, the world’s largest bauxite producer, in December and has since had a dispute with several foreign mining firms including UC RUSAL and Anglogold Ashanti.

The general rise in commodity prices in recent years fuelled by Chinese and other Asian demand is seen as having refocused government’s attention on their resources and the recent pullback in prices with the crisis is not seen enough to turn the trend.

Any renewed rise in commodity prices, which could be linked to a faltering dollar as much as to renewed demand, might further boost such risk.

RUSSIA ALMOST UNINSURABLE

Madagascar, Ecuador, Kyrgystan and others have also seen examples of expropriation or effectively forced renegotiation that have worried insurers. However, in some other countries — such as Brazil or South Africa — a slight rise in leftist rhetoric has had less impact on premiums.

The industry is particularly concerned over risks in Russia, where extractive projects have become almost uninsurable.

BP faced a difficult battle for control of its local joint-venture TNK-BP last year, but problems have not been limited to the oil sector and Norwegian telecom Telenor faced a similar battle this year over its stake in mobile operator Vimpelcom.

“The main difficulties seem to be in any sector you can describe as strategic,” said Elizabeth Stephens, head of credit and political risk analysis at London insurance broker Jardine Lloyd Thompson.

Buying coverage for investment in Ukraine and also become almost impossible, she said, as the country struggles with both financial and economic crisis. Ukraine’s state gas firm Naftogaz defaulted on a $500 million Eurobond last month before restructuring.

Demand for cover against political unrest has risen sharply with the crisis around the world, particularly after a string of riots in emerging economies at the beginning of the year.

Insurance firms say there has been a modest rise in claims for damage for political unrest, although usually assets have only been partially damaged rather than outright destroyed.

Risk premiums remained particularly high in the Gulf region, he said, pushed higher by ongoing worries over risk of conflict with Iran over its nuclear weapons programme.

Nevertheless, there was interest in buying political risk insurance for projects in Iraq and Afghanistan, Zurich said, although usually coverage was only sold on a one-year basis — covering a period when US troops were expected to remain.

Financial institutions with operations in emerging market countries have become increasingly worried about convertibility risk as several countries imposed capital controls during the global market crash.

Concerns over controls have risen again more recently, with several emerging countries seen imposing restrictions on foreign capital to limit hot money racing in and out.

The huge increase in Western government intervention in financial markets following the global crash had also prompted some firms to worry about the risk of expropriation in developed economies, Zurich’s Roorden said.

“We’ve had some enquiries about the United States, mainly concern over the risk of nationalisation as governments take extraordinary measures due to the crisis,” he said.

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