Risky business: political risks still abound for foreign companies in Latin America, and insurers are there to profit.
Despite a wholesale move to democratic capitalism across the region, political crises in Venezuela, Bolivia, and Ecuador are creating untold hazards that may well lead to significant business losses.
Expropriation, foreign exchange moratoriums, political violence--the list goes on. According to the Multilateral Investment Guarantee Agency (MIGA), a foreign-investment insurance agency run by the World Bank, political risk concerns helped cut the flow of investments in the developing world by 23% to US$135 billion in 2003, compared with just two years earlier. While economies gained steam in 2004, political-risk premiums remained high, as companies stayed on the sidelines as opposed to investing abroad, according to MIGA.
U.S. insurance giant Aon says the number of large-scale confiscations of private properties from governments has tapered off dramatically in the last 20 years, but instability still exists.
To mitigate potential losses, companies are turning to political risk insurance. MD International, a mid-size medical products exporter in Doral, Florida, recently purchased a policy because the company's lender required it before financing a transaction in Latin America. "We would not have been able to do the transaction without it," says Maggie Morales-Perez, chief financial officer of MD International, without giving details. "It's not something we could finance ourselves,"
In countries where MD International has not been able to get political risk insurance "we are out of the picture," Morales-P6rez says. As a result the company has not been able to compete in Argentina, Ecuador and Venezuela. "We have had to pass on some of the deals because we can't get insurance, which is affecting our competitiveness," she says.
Some companies are finding that turmoil, whether political or economic, reduces the availability of risk insurance. "In the difficult markets, coverage is being written on a selected basis" says Matt Handwork, a partner in the Columbus, Ohio office of IRC North America, a specialty broker of political risk and trade insurance that helped MD International get its policy. "Often, many small transactions are difficult to provide coverage for because on the political risk side, if they are too small to generate enough premiums, then the insurers are not interested."
While numerous factors, such as the amount of exposure and type of coverage, play a role in pricing, premiums normally range from 0.5% up to 3% a year on exposed limits. For example, the cost on a $100 investment would run from $0.45 to $2.70, based on insuring 90% of the transaction. However, rates have been known to go as high as 5% in regions where volatility is greater. Of Latin America's major economies, only Chile is considered to be a low-risk country, according to Aon, a U.S. insurance giant. Venezuela, Colombia and Ecuador are considered to be high-risk countries while Peru, Bolivia, Uruguay, Paraguay and Argentina are considered medium-high risk countries.
Despite the region's volatility, insurance companies and brokers say that demand is high. "We had significant growth last year," says Dan Riordan, executive vice president and managing director at Zurich North America. "There is enough going on in the emerging markets to keep us busy for some time to come. Large multinationals that have operations throughout the world are coming back into the market rather than self-insure."
Zurich North America writes up to $75 million per risk covering up to 15 years. "We cover large and we cover long," Riordan says. "Our industry doesn't have a high frequency of loss, but it does have a high severity. That's how we look at price risk."
Political risks can shift rapidly, disrupting business and leading to unexpected losses. Different businesses can react in different ways, and that's why underwriters first look closely at a company seeking risk insurance and at its experience in a particular region. "We look at the project specifics, how well that project has been vetted, structured and organized," says Riordan.
Insurers also look at how a company will deal with problems should they arise. Will a change in government affect its industry? Does it have a strong joint venture partner? Does it have dispute resolution agreements built into contracts? "If that's not been addressed, then those are risks we would not consider," Riordan says.
Availability also depends on a company's industry. For example, general manufacturing plants are considered less risky than companies extracting more politically sensitive products such as oil, gas or silver.
Bolivia is a prime example, says V. Manuel Rocha, former United States Ambassador to Bolivia and managing director of Globis Group, a Miami global business development company. "Bolivians feel gas and oil should be developed by a public, national company, not a private company. So when private companies move into those areas, they become vulnerable," says Rocha.
Creeping. Political risks such as property expropriation and war are typically associated with the military governments of the past, and not of the more democratic administrations of today. "Expropriation drives away other foreign investment; therefore most governments don't consider it because they would only be shooting themselves in the foot," says Rocha. But that doesn't mean expropriation is dead. Today, it tends to be subtle and has come to be known as "creeping expropriation," such as when a government regulatory body changes the rules in the middle of the transaction, resulting in losses for a company.
"It's not uncommon. From one administration to the next there will be changes," says Francisco Cerezo, a partner who handles international and corporate matters for Tew Cardenas, a law firm in Miami. "There is concern that one administration might enter into an agreement and then fast-forward to a few years later and there is another administration and they feel they can renege." This can happen through the raising of taxes or fees charged, or the tightening of regulations, Cerezo says.
Insurance firms track such policies closely. Each year, Aon releases a political and economic risk map. It outlines not only areas of high risk but also specifies the risks companies face. "Our client base is looking at what political risk means before going to the market. We are seeing more awareness," says Bryan Squibb, head of Aon's trade-credit practice in the United States.
However, with a constantly changing political climate, industry trends can shift at a moment's notice. A few years ago the insurance industry was nervous prior to the election of Brazilian President Luiz Inacio Lula da Silva, and political risk insurance for that country became very expensive, if it was available at all, says Sam Moore, a partner in the Columbus, Ohio office of IBC North America.
"Anything longer than one year was difficult to place," says Moore. "People were uncertain what the policies of this so-called 'people's president' would do to the economy. But here we are in the third year after the election and things are looking as good, or better, than they ever have in Brazil." The perception of risk is lower, rates have come down, and the availability of insurance has improved, he says.
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|Comment:||Risky business: political risks still abound for foreign companies in Latin America, and insurers are there to profit.(INSURANCE)|
|Date:||Aug 1, 2005|
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