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Removing the bloc from joint ventures in Eastern Europe.

The changes occurring in Eastern Europe during the past few months have augured a dramatic restructuring of the economic and political systems that have existed there since the end of World War II and the advent of the Cold War. These changes present an enticing challenge and opportunity to companies investing in joint ventures in that part of the world.

The preponderance of U.S. investment in Eastern bloc countries is situated in Hungary, with six companies-Digital Equipment Corp., General Electric Co., General Motors Corp., Rank Xerox, U.S. West and American International Group-set up to do business. Japan and West Germany are running neck and neck, each with three companies making a stake in Hungary: Suzuki, Sharp and Minolta; and AEG, Allianz and Colonia, respectively. Companies from France, Italy, Korea and the United Kingdom have invested there as well. The Soviet Union, Poland and East Germany also have attracted investment, with Bulgaria attracting one investor, Japan's Arai Electric. So far, only Czechoslovakia and Romania lack investors.

The Eastern bloc represents a market of approximately 420 million people, compared with 320 million in the European Economic Community and 250 million in the United States. It is an area undergoing change and uncertainty, but with each passing day these countries lurch toward becoming democratic, free-market societies. However, due to the history of the past 40 years the long-term prospects for stability and free markets remain unclear. The desire of many multinationals based in the United States and elsewhere to invest immediately in this region creates a need to deal with several risk management issues.

For the first time since the introduction of its economic plan in the 1920s, the Soviet Union in 1987 passed a joint venture law allowing foreign equity holdings. Joint ventures are now also allowed in Hungary, Czechoslovakia, East Germany and Bulgaria. In addition, the East German government has indicated that it may allow majority foreign stakes in joint venturesan exception to a previously planned 49 percent foreign investment ceiling. The Czechoslovak joint venture law is more restrictive than the Polish or Hungarian statutes. Hungary's laws are the most liberal and have thus attracted the most investment.

The joint venture in Hungary between Raba, the state-owned truck manufacturer, and General Motors will allow GM, after an investment of $100 million, to own 67 percent of the venture's equity and appoint management. At a furious pace private companies from many countries are creating joint ventures with government-owned entities throughout the region. Aside from the problem of qualified management, skilled labor and repatriation of profits, there is tremendous risk of failure in establishing a business venture in countries changing from centrally planned to market-oriented economies. Therefore, investing companies must be concerned with the risk management aspects of protecting jointly owned assets and managing joint liabilities.

Because of the rapid changes occurring in Eastern Europe, it is difficult to specify the requirements for insuring joint ventures on a country-by-country basis. It is, however, useful to understand the insurance environment. Eastern European countries that permit investment in joint venture companies do not allow non-admitted insurance; coverage for the joint venture must be written by the state-owned insurer or insurers in that country. Also, compulsory insurance coverages do not exist in some countries, so it is up to the joint venture management to decide which exposures to insure. Therefore, the risk manager must impress upon joint venture senior managers, who may be accountable to the host ministry or company, the importance of adequately insuring assets and exposures.

In the Soviet Union, for example, property damage insurance for joint ventures is compulsory. Conversely, liability coverage is not compulsory for third parties, products or automobiles, which are only insured by approximately half the population owning cars. Property damage coverage must be insured by the state insurer, Ingosstrakh, but can be reinsured into the U.S. joint venture partner's corporate property program. Rates and policy form with Ingosstrakh are negotiable. Indeed, Ingosstrakh has created a separate department to liaise with foreign insurance companies.

Agreements are also being concluded that would allow non-compulsory coverages to be written on a co-insurance basis between the Soviet insurer and a Western insurer. The coinsured portion can be written in Western currency with premium for that portion collected and paid directly to the co-insuring company. However, Ingosstrakh must issue the policy and handle the claims. Ingosstrakh and the Chubb Group recently concluded such an agreement, under which Chubb sets the rates.

The risk manager and the joint venture partner should be greatly concerned with protecting assets because consumer protection and claims consciousness remain at Third World levels in Eastern Europe. The question of liability is critical only if the joint venture manufactures products to be sold outside the joint venture country, particularly in the West.

The approach to joint venture insurance, particularly property damage coverage, in Eastern Europe is similar to the Soviet Union. In almost all cases the forms and rating structures relate to approaches taken in West Germany and the United Kingdom in the 1950s. Similar to the Soviet Union, state-controlled insurance companies must be used to issue coverages selected or mandated for insurance. These companies will allow the joint venture partner's corporate insurer to purchase reinsurance outside the country. They will also work with that company's insurer and risk manager to achieve cover and rating that is acceptable to all parties.

Among U.S. insurance companies, AIG has had the longest relationships with Eastern European state insurers. AIG is on the verge of completing a joint venture in Hungary, and has a cooperative venture in Vienna, which includes Poland, Hungary and Romania. Another useful contact is London-based reinsurance brokers, who have for years assisted Eastern European insurers with their treaty and facultative placements in the London market. It should not be long before brokers, led by reinsurers, establish a presence in these countries.

The approach to insuring joint venture exposures will vary for each country. The risk manager should persuade his or her own management to become part of the decision-making process regarding the joint venture partner. In addition, the risk manager should recognize the need to protect his or her company's investment through political risk coverage against expropriation, deprivation and contract frustration risks. This coverage can be obtained outside the joint venture country and protects only the investing Western company. Capacity, pricing and the extent of coverage vary based on daily changes in political and economic conditions in Eastern European countries. The American risk manager should also extend corporate liability coverage to pick up the joint venture exposures on an incidental basis, particularly when the U.S. company is a minority partner without management control.

Change is also occurring in Eastern Europe within the insurance industry itself. Similar to insurance requirements, change varies on a country-to-country basis. For example, the Soviet Union prohibits joint insurance ventures, but it is the only industry in which this prohibition exists. However, cooperative agreements are being established between Ingosstrakh and national insurance supervisory bodies, such as West Germany's, or with private insurance companies from various countries, such as U.S.based AIG and Chubb. The West German insurance industry holds sway within Eastern Europe in the area of cooperative agreements in the Soviet Union and joint ventures in other countries. West German industry also leads all other countries in investment in Eastern Europe.

In Poland, foreign insurance companies may be permitted to establish operations by the end of this year. The new insurance law would allow insurers registered in Poland to engage in all aspects of business. Currently, the domestic sector is dominated by Panstwowy Zaklad Ubezpieczen, a state insurance enterprise; the foreign sector by the insurance and reinsurance company Warta. How these changes will affect Warta is not certain because most of the company's portfolio is in hard currency and reinsured or co-insured into world insurance markets. The first joint venture in the insurance industry in Hungary, between Allami Bistosito of Budapest and Assicurazioni Generali Spa of Trieste, Italy, began operation in January. Generali is a minority shareholder in the venture. As part of the economic reform program in Hungary, all state-owned insurance companies, including Allami Bistosito, will be privatized and converted into joint stock companies. Their shares will then be sold to investors abroad and in Hungary. Other joint ventures are also planned this year. Changes in East Germany, Czechoslovakia, Bulgaria and Romania are slower, but these countries will ultimately follow the lead of Poland and Hungary. Indeed, all countries are addressing the issue of insurance monopoly and its effect on joint venture companies and local requirements.

The country where change will occur the fastest is East Germany, particularly as monetary and economic union proceeds with West Germany. It will not be long before Allianz dominates the market in both East and West Germany. The only certainty about change in Eastern Europe is that nothing will remain constant in the short term. To stay abreast of changing insurance requirements for joint venture investments, it is essential for Western risk managers to monitor events on a timely basis. Hugh A. Warren is executive vice president and chief operating officer of Corroon & Black International. [TABULAR DATA OMITTED]
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Author:Warren, Hugh A.
Publication:Risk Management
Date:Jun 1, 1990
Words:1526
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