Why risk managers are turning to political risk insurance

What happened?

Foreign exchange reserves are falling globally, with 64% of countries showing a drop in the last 12 months.

In fact, 35% of countries have seen their foreign exchange reserves fall by more than 10%, new research compiled by Chaucer has revealed.

Across the 142 countries covered by the research, foreign exchange reserves of USD dropped from $12.23tn to $11.16tn collectively.

Bolivia, New Zealand, and the Republic of Congo saw their reserves fall the fastest in the past year, with Bolivia seeing a drop of more than half (51.7%) or $881m.

However, falls were not limited to emerging markets - Even the UK saw reserves fall sharply by 13.7%.

What does it mean for risk managers?

When foreign exchange reserves plummet, often as a result of economic instability, it can limit a country’s ability to pay debts that they owe in foreign currency and for imports.

Ultimately this increases the risk that corporates will find their public sector contracts suddenly cancelled or going unpaid.

Understandably, businesses are concerned and are looking for ways to insure against any fallout from contracts with affected countries.

”When the global economy stutters, cancelled government contracts and disputes over payments rise”

This has prompted a spike in the number of corporates seeking out political risk insurance (PRI), which can insure against governments failing to pay their bills.

Jonathan Bint, Senior Analyst & Underwriter at Chaucer explains: “When governments are short of foreign exchange then contracts with foreign suppliers can be a tempting target for cost-cutting. When the global economy stutters, cancelled government contracts and disputes over payments rise and they are by no means limited to emerging markets.”

What next?

In a period of rising global economic uncertainty, businesses that ignore the risk of contract cancellation, or an increase in reneging on bills, could be opening themselves up to a significant financial loss.

Sri Lanka’s foreign reserves dropped to unsustainable levels in 2022 as it battled rising import and debt servicing costs. This resulted in the country defaulting on its debts, inflation rising to around 50% and widespread civil unrest.

”Insurance firms are also seeing increased demand for political risk insurance in places that had previously been ‘safe’ investment destinations such as the UK and the EU.”

More than half of countries depleting their reserves over the past year is an indication of growing pressure on global economies and suggests a rising number of countries are now less capable of managing their obligations.

Some sectors are at greater risk than others of having their contracts cut by cash-strapped governments.

Bint added: “Businesses in the infrastructure and construction sectors are especially at risk of suffering losses from governments reneging on bills especially given the high value of the projects they typically undertake on behalf of national governments.”

“Whilst emerging markets present great opportunities for multinational corporations to grow, they often present greater risks. However, insurance firms are also seeing increased demand for political risk insurance in places that had previously been ‘safe’ investment destinations such as the UK and the EU.”