What is political risk and how to protect against it? 

In today’s increasingly interconnected world, “just-in-time” supply chains, global internet connection and smartphones give SMEs the ability to conduct business in a global arena that was once the exclusive province of big multinationals. This means the possibility for great opportunities, but also that every business is just a few steps away from political risk.

Pierre Lamourelle, Deputy Global Head of Specialty Credit within Allianz Trade for Multinationals – our team dedicated to multinationals – answers the question “What is political risk?” and provides information about political risk management, explaining how political risk insurance can help protect your company.

Political risk is the possibility that your business could suffer because of instability or political changes in a country: conflicts and unrest, changes in regime or government, changes in international policies or relations between countries, as well as changes that occur in a country's policies, business laws or investment regulations.

Other influential factors contributing to political risk include any other situation which may have an influence on a country’s economy, such as commodity price volatility, liquidity crises and sectoral downturns. Think of conflicts in the Middle East, the Arab Spring recurrent coups, confiscation of assets by local governments, and disputes over natural resources among nations. These may sound like unique political risks to international business, but they can still affect your local business and you may not see them coming.

“When it comes to political risk, we say it could be defined to a certain extent by its unpredictability,” says Pierre Lamourelle, Deputy Global Head of Specialty Credit within Allianz Trade for Multinationals and a 25-year veteran of political risk assessment and management. “Contrary to most other types of insurance, it’s not always possible to model this type of risk based on historic data.”

Jurisdictional risk is also a major political risk in international business, whether your company is an SME looking to expand or a global multi-billion-dollar company. “Jurisdiction” refers to the laws that will govern the agreement you sign with your partner. When that partner is in another country, difficulties can arise should the terms of the contract begin to unravel.

For instance, a European company contracting with an African company under local law would not be exposed to the same legal framework as it would under English or French law or if the contract is subject to international arbitration for the resolution of disputes between the parties. “If you chose the local law, you could be exposed to unexpected changes in the local law regulation or difficulty to enforce a decision made by a local tribunal,” Pierre points out. “The choice of the law governing the commercial contract is often the responsibility of the insured and is not an insurable risk as such. However, it is worth mentioning that non-respect of an international arbitration award can be included as a cause of loss, and therefore could be covered under certain political risk insurance policies.”

Having the knowledge of how to deal with the complexity of the local legal environment can make a big difference in your ability to withstand and manage political risks. International risk insurers such as Allianz Trade have people on the ground in more than 40 countries dealing with political risks of all types: check out our political risk map.

“What has changed in the 25 years since I started in this business is that we are living in a more connected world today,” says Pierre. On the upside, that means business is easier to conduct on a global scale. Almost everybody now has the ability to reach out to emerging countries or to conclude a contract and to secure a sale in a foreign country.

On the downside, this means that when something goes wrong in one part of the world, you can feel the impact halfway around the globe – directly, if you are dealing with the country in question, or indirectly because of your diverse supply chain. Remember when the 20,000-tonne container ship “Ever Given” got stuck in the Suez Canal in March 2021, shutting down international trade for a week?

Another good example is when your own government decides to ban sending people on the ground to the country where you are executing your contract. “You would have to stop the performance of your contract,” says Pierre, “and you would be exposed to additional expenses and not be able to keep on performing or to keep invoicing and receiving payment from the customer in that specific country. This ban would clearly translate into a loss for the contractor.” 

As a last illustration, let’s take a change of law or a regulation that is super-selective and targets only foreign companies. “That could be seen as a soft discriminatory measure and could be covered as a political risk,” says Pierre. “But only if it’s a discriminatory measure. Any governmental decision that would impact all the companies located in a country is not captured by a political risk insurance policy. These are risks that all business owners are facing when running a business.”

Political risk management is essential in these situations in order to assess the risks and define actions to protect your company.

Some risks may be worth taking for the exposure to new markets at opportune moments. But it is always important to keep your eyes and ears open because political risks in international business aren't always well-identified. Sometimes the risks may be just rumours – events that one could deem as not material with little or no substance behind them.

Some of the early signs of political risk are political, economic and social instability:

• The political situation in the country: how is the country behaving with its neighbours? You want to be prepared if there’s an escalation of tensions or a war.
• The economic conditions: what are the macro-economic imbalances? How stable is the economy? What is the ability of the country to honour its payment obligations or debt over the period of your project? 
• The social conditions: is youth unemployment or underemployment high (think: Arab Spring, Sudan, Algeria etc.)? Are social tensions erupting into violence? Riots can also impact trade transactions or performance of commercial contracts. For example, there is a strong correlation in countries whose economies are heavily dependent on natural resources such as oil and gas. “You know that in these countries if the price goes below a certain threshold, there are going to be fewer resources to finance social programs and that can lead to some social instability or even the inability to honour debt obligations,” Pierre points out. 

Political risk insurance is not a “mandatory” insurance product. It is a niche market, originally used by large exporters, international contractors or banks facing the risk of contract interruption, or the risk of non-payment or non-repayment of a loan. However, political risk is no longer the exclusive domain of emerging countries. It can directly impact all businesses due to the increased interconnection of economies. Political risk insurance, targeted to your specific engagements by an insurer with a global reach, can secure your economic and business interests. 

“For companies, political risk insurance can cover, for example, non-payment of a cargo or the non-performance of a contract,” explains Pierre. “When it comes to banks, we cover their full spectrum of transactions from export finance to trade finance, to infrastructure finance, asset-based finance and structure-trade finance. So, it’s a highly-customised solution.”

What about recovery? “The destruction of an asset… there’s no recovery potential for that,” says Pierre, “but if you insure against non-payment or non-reimbursement by a state or local government entity, you have the ability to make a claim against the government and get recoveries.” Or the debt may be rescheduled.

Trade credit and political risk insurance (or structured trade credit insurance) are not mutually exclusive, they are compatible. Trade credit insurance covers risks to your company’s short-term portfolio of receivables. Structured trade credit or political risk insurance covers a specific transaction, with risk horizons that can vary from very short-term risks to long-term ones. Trade credit and political risk insurance, therefore, go hand-in-hand to secure your business transactions.

“We design the political risk insurance policy transaction by transaction, for a specific loan for a specific contract,” explains Pierre. “Discuss with your insurer or specialised broker and check where you are really exposed and whether there is a need for political risk cover.”

As a conclusion, Pierre reflects on his 25 years in risk management and points out: “You can have a very strong transaction in a very complicated and sensitive country, but you could also have a very bad transaction – if it’s not well structured – in a developed country. I’ve seen lots of transactions performing very well in emerging economies, and conversely claims that have been made on supposedly strong counterparties."