Private insurance companies offer insurance protection that covers credit and wider political risks for a variety of clients, including banks, foreign investors, traders, commodities traders, and exporters and importers.
Trade credit insurance protects you against credit risks like default, insolvency, or bankruptcy.
Insurance that covers political risk protects against nonpayment due to exposure to events of political force majeure, such as acts of terror and war. It covers the possibility that payment may not be made due to foreign governments’ actions.
Trade Credit, credit and political risk insurance are all large segments of trade finance. They are in increasing demand due to the increasing number of conflicts around the world.
Trade credit is the capital provided by financiers to firms that purchase products. They do not have to pay suppliers out of their financial statements at the time of purchase. This allows the customer to have a longer repayment term, which frees up cash flow.
Credit risk is the possibility that an insured may not be able to recover the receivable because of a cause for the loss. Trade financing is an important tool for risk mitigation. Credit insurance provides insurance against non-payment by the customer for an insured event (i.e. Insolvency and contractual disputes
Similar to credit risk in that it can also prevent payment of a contract, political risk is another form of risk. It is, in its literal meaning, the risk associated with political factors, and how they might influence or prevent payment. This can include political violence, expropriation, and currency conversion.
For businesses purchasing from unstable countries, political risk insurance serves as an insurance policy. As globalization increases and other threats such as terrorism or war become more serious, it is being more popular. Investment insurance agents provide this type of protection to companies that engage in Foreign Direct Investment (FDI). These are often government-funded and coordinate with Export Credit Agencies to promote globalization. Some lenders have made it mandatory for certain countries to carry political risk insurance, due to the increased risk in the world.
Examples Of Political Risk
Discrimination And Expropriation
Governments can take companies’ shareholdings in subsidiaries or expropriate assets, either for political reasons or because they are acting quickly. Even if a government does not explicitly seize assets, it can limit a company’s ability to exercise its rights.
Sovereign states have the right to expropriate property if fair compensation has been paid. However, governments are not always willing to pay compensation. This often leaves investors and businesses powerless.
Insurance that covers political risk is designed to protect foreign businesses from the risks of arbitrarily taken actions by the government, such as:
- Nationalization, expropriation, and Confiscation
- Selective discrimination
- Forcible divestiture
- Cancellation of licences and breaching contract
Political Violence And Forced Abandonment
For different reasons, businesses choose to expand into emerging markets. Many of these countries have nascent democracies. They are looking to expand in high-growth economies or access to material resources.
These countries might be considered politically dangerous or vulnerable to regional instability. Political violence can occur in many ways. For example, companies may be forced to leave a country because of physical danger.
Political risk insurance provides broad coverage for political violence in a world that isn’t governed by rigid rules.
Inability To Convert Or Transfer Currency
For all kinds of reasons, overseas investment is risky. Sometimes, however, cash flow can be directly at risk due to government actions. In times of crisis, governments can react to internal economic or political problems by imposing exchange control.
The business unit becomes ineligible if it is unable to send funds from overseas operations back to its home country. These funds can lose value if they are not remitted to the home country within a reasonable time frame, which could potentially impact the insured’s overall profitability.
When foreign exchange restrictions prevent remittances related to:
- Payments for shareholder loans
- Intercompany payments
- Proceeds from sale