What Is Political Risk Insurance? — Political Risks in Overseas Investment and Trade, and Public vs. Private Cover

Companies operating abroad face risks arising from the host country itself, in addition to their customers' credit and market swings: expropriation of assets by a government, damage to facilities from war or civil unrest, restrictions on transferring foreign currency, and so on. These cannot be prevented by the company's own efforts and are not covered by ordinary fire or liability insurance. Insurance against such losses is political risk insurance.

This article sets out the risks covered and how the insurance works, based on public material from Nippon Export and Investment Insurance (NEXI) and the Ministry of Economy, Trade and Industry (METI), and explains how it differs from cover arranged in the private insurance market.

What is political risk?

In trade insurance, risks in overseas transactions are divided into two groups: commercial risk, arising from the counterparty, and political risk (in Japanese terms, "emergency risk"), not attributable to the counterparty. METI's material gives examples of commercial risk such as the counterparty's bankruptcy or non-payment for three months or more, and examples of political risk such as war, restrictions on foreign exchange transactions, and import restrictions or bans.

In overseas investment, the main risks covered are these three.

When it is considered

• You plan to set up a factory or sales subsidiary in an emerging market and recover the investment and equipment over many years
• You invest in a business that depends on host government licenses or contracts, such as resource development or infrastructure
• You plan to remit profits earned in local currency to Japan as dividends on an ongoing basis
• A lender has asked you to arrange insurance as a condition of financing an overseas project
• Exports to customers in unstable countries are growing (in this case, trade credit insurance, discussed below, is the relevant cover)

Public cover: NEXI's overseas investment insurance

In Japan, trade insurance is provided by Nippon Export and Investment Insurance (NEXI), a company wholly owned by the government. Overseas investment insurance covers Japanese companies' overseas equity investments and rights to real estate, equipment and other assets held abroad against losses from the risks above.

The main features set out in NEXI's public material are:

• Choice of risks: you can choose which of the three risks to cover: expropriation and infringement of rights, war and force majeure, and inconvertibility and transfer restriction.
• Insured percentage: claims are paid at 95% or 100% of the loss.
• Policy period: set between 2 and 30 years. Long-term cover matching the project period is possible.
• Transfer restriction trigger: covered when remittance has been impossible for two months or more.
• Business disruption triggers: for losses from war and similar events, the triggers for payment include the invested company being unable to continue business, going bankrupt, being suspended from bank transactions, or suspending business for one month or more.

* Details of the triggers and terms must be checked in NEXI's policy wording and brochures.

What is not covered

Political risk insurance does not cover every loss in an overseas business. NEXI's material also explains that losses or withdrawal due to poor business performance, and losses caused by a joint venture partner's management problems, are not covered by overseas investment insurance. Only losses caused by political events such as government action or war are covered.

The following losses need to be covered by other means:

• Losses from exchange rate movements (distinct from cases where remittance itself is impossible)
• Losses for business reasons, such as weak sales or rising costs
• Bad debt from a local customer's insolvency (covered by trade credit insurance)
• Damage to facilities from fire or ordinary natural disasters (covered by property insurance)

Events that have already occurred, or are specifically expected to occur, at the time of application are not covered. Once conditions deteriorate, underwriting may be restricted or terms tightened. It is important to consider cover at the stage of deciding to invest.

Arranging cover in the private market

In addition to public cover, political risk insurance is written by private insurers and in the Lloyd's market. Private cover generally differs from public cover as follows.

* Private cover varies greatly by insurer and case. The table shows general tendencies.

Which suits you depends on the case. Public cover often suits long-term equity investments; private cover is an option for cases that do not meet public requirements, or when you want short-term cover for specific risks only. The two can also be combined.

Note that for property and other interests located in Japan, the Insurance Business Act in principle restricts direct contracts with foreign insurers not licensed in Japan. When using overseas insurance markets, the contract must take a lawful form according to where the insured property or risk is located.

Relationship with trade credit insurance

Trade credit insurance for export transactions generally covers not only the buyer's insolvency or late payment (commercial risk) but also import restrictions, foreign exchange restrictions, war and similar events in the buyer's country (political risk). In other words, the risk that receivables cannot be collected because of conditions in the buyer's country can be covered by trade credit insurance.

The risk of losing an equity investment in an overseas subsidiary, or a factory or equipment held locally, through expropriation or war is not covered by trade credit insurance. That falls within political risk insurance such as overseas investment insurance.

Points to check

1. What to protect: identify whether the target is equity, facilities, dividend remittances or receivables. The insurance used depends on the target.
2. Which risks to cover: choose among expropriation, war and transfer restriction based on the real concerns in the host country. Narrowing the risks keeps costs down.
3. Period: check that the policy period matches the time needed to recover the investment.
4. Payment triggers: check the conditions for payment, such as "for X months or more" or "unable to continue business". It takes time from the event to receiving the claim payment.
5. Obligations after binding: check what the policyholder must do, such as notifying events, preventing or mitigating loss, and preserving rights.

Frequently asked questions

Q. Is a loss from a sharp fall in the local currency covered?
A. No. What is covered is the case where conversion into foreign currency or remittance itself becomes impossible because of restrictions. Losses from exchange rate movements are covered by other means such as forward contracts.

Q. What if a private local customer does not pay?
A. A customer's insolvency or late payment is commercial risk, not political risk. It is covered by trade credit insurance or trade insurance for export transactions.

Q. How is the premium determined?
A. It depends on the country, the range of risks covered, the sum insured and the policy period. Each case is quoted individually, so we cannot give a standard rate.

Q. Can cover be obtained for any country?
A. Availability depends on the country underwriting policy for public cover, and on each insurer's capacity for private cover. Depending on conditions, underwriting may be suspended or restricted for some countries.

How Credit Hills can help

As an insurance broker, Credit Hills advises on trade credit insurance covering commercial and political risks in export transactions, as well as on arranging political risk insurance in the private market. Where public cover is the better fit, we will tell you so. Depending on the country and the case, no insurer may be willing to write the risk.

See our political risk insurance services →　What is trade credit insurance (insight) →

References (in Japanese)

• Nippon Export and Investment Insurance (NEXI) — Overseas investment insurance brochure
• NEXI — Overseas investment insurance Q&A
• NEXI — General brochure
• METI — What is trade insurance provided by NEXI?