Whether it’s a high speed train, a wind farm or a sports stadium, infrastructure investment is a hot topic right now. However, the success of such projects can be in jeopardy by exposure to a wide range of political risks.
Opportunity or risk?
Infrastructure demand is at its greatest in emerging markets, where more than one billion people lack access to roads, sanitation and/or safe drinking water, and where many times more have no reliable source of energy and are without modern communication services.
The potential rewards for foreign investors and companies in emerging markets can be significant, but then so are the risks, according to Julian Macey-Dare, International Leader of Marsh’s Political Risk and Structured Trade Credit Practice.
“Governments change and are unpredictable. When a change of government occurs, foreign investors are vulnerable, and it is not just bricks and mortar that is at risk, the value of contracts can also be affected, ” he says.
The extent of the threat from political instability has been brought into sharp relief by the recent events in the Middle East and North Africa. Investors’ and lenders’ perceptions of political risk have been changing, and many are now building political risk assessments into their project decision-making processes, says Macey-Dare.
Demand for political risk cover for infrastructure investments has also been increasing, in particular, from banks, according to Macey-Dare. “We see more and more financial institutions use the insurance product because it reduces the amount of regulatory capital they need to hold, ” he says.
In response to higher demand from banks, insurers have adapted policies to be more attractive to banks by limiting the conditionality of wordings.
Political risk insurance protects investors and companies from non-payment by a government or private company for political reasons. However, there are many other political risks that affect the success of an infrastructure project.
Political risk is proving more complex and more connected, says Charles Berry, chairman of Berry Palmer & Lyle. “It starts at the low end of the spectrum with riots and civil unrest, but can quickly move to an uprising and civil war, which can eventually lead to expropriation and the cancellation of contracts after a change of regime, ” he explains.
Berry believes that investors often underestimate the effects of war and revolution. “The main risks are not damage to property but are of confiscation and abandonment, ” he says.
Investors once only considered terrorism but many now look at the broader spectrum of political risk. “Investment related political risk and political violence are two separate classes of insurance, but they should be considered together under one investment approach, ” Berry suggests.
Insurers have been looking at ways by which they can meet the needs of investors, in particular with regard to regulatory risk, says Macey-Dare. For example, debt burdened countries in Europe, like Spain, have altered tariff regimes for renewable energy projects, reducing the benefits to investors.
“There have been discussions on regulatory and political risk issues and we are trying to stretch the boundaries and engineer products for the future, ” he says.
Marsh has also been working with underwriters to meet demand from investors for political risk insurance for Eastern European countries. “These countries are often stable but there is potential for governments to change and investors take a more cautious view as a result, ” says Macey-Dare.
Non-payment cover is now also much broader and includes many of the new variants of political risk that would once have fallen between the cracks, says Mike Holley, Chief Executive of Equinox Global, a trade credit insurance provider backed by Lloyd’s syndicates.
Equinox, like some other Lloyd’s insurers, offers non-payment due to political risk cover as standard with its trade credit insurance, a practice that was once uncommon in the credit insurance market. “Clients now acknowledge that political risk is a real threat that can occur anywhere, ” says Holley.