Business risks during unpeaceful transitions of power
In recent years, foreign businesses operating abroad have faced risks rarely seen when democratic governments transfer power.
The January 20th inauguration of President Joe Biden ushered in a new era of politics in the U.S. But the event also had a profound symbolism that dates back over 200 years: The peaceful transition of power is a hallmark of American democracy.
In the U.S. and many other democratic countries around the globe, the transfer of authority from one publicly elected official to another typically results in little disturbance to business markets or the economy.
But what happens when a government goes through a hostile regime change? How are businesses affected, and how does insurance respond to these situations?
“It’s important to draw a distinction between an orderly change of government, following an undisputed election, and a violent or disputed change of government. Where there is an orderly change in power, you wouldn’t generally expect to see severe consequences for foreign investors or foreign creditors,” says Nick Hedley, head of political risk at Optio, an insurance collective offering products, underwriting and broking services. “After a democratic change of power, it is, of course, possible to have a government with a new and more hostile approach and a new attitude toward foreign investors and foreign creditors. We’ve seen that situation happen in the past. Generally, it is an uncomfortable period for two or three years, but they usually come back into the fold eventually.
“The more worrying risk is when you have a situation where the change of government is not orderly and not part of a democratic process, which can lead to a sharp change of attitude towards foreign businesses,” he adds.
Business in the crosshairs
There have been several attempted coups in recent years, including one in Turkey in 2016, when a faction within the Turkish Armed Forces attempted to seize control of several cities but failed after they were defeated by forces loyal to the state.
Two years ago in Ethiopia, an attempted coup resulted in the deaths of several officials. Most recently in 2020, the country entered into an outright war between the Tigray Regional Government led by the Tigray People’s Liberation Front (TPLF) and forces supporting Ethiopian Prime Minister Abiy Ahmed. That conflict is ongoing.
Although these events may seem worlds away, they pose real threats to Western companies seeking to expand into new, emerging markets. For example, Ethiopia, with its growing middle class and a government that favors overseas investments, has been an attractive location for foreign companies.
For Western companies investing in regions prone to hostile regime changes, being aware of the associated risks can help prevent significant losses and ensure adequate insurance coverage to protect business exposures.
“With an undemocratic change of government, you have great potential for civil unrest, disorder, and civil war,” Hedley says, “I think that’s the real threat to foreigners working in an overseas country.”
In these situations, businesses may face the loss of assets and staff, property damage and supply chain disruptions. A worst-case scenario is they’re forced to entirely abandon operations in the affected areas. Additionally, business owners may find themselves aligning with one side of dueling political factions. This, according to Hedley, is the more worrisome risk associated with political instability — even when a business is a neutral party.
“What we’ve seen is that when the coup is eventually suppressed, the government starts to look around to see who may have been complicit, and the attention generally lands on the business community,” he says. “We saw this in Turkey after the failed coup; they were rounding up thousands of businesses, and many are still awaiting trial.”
The possibility of government persecution
Often, unstable governments act unlawfully toward foreign businesses and investors as a way to shore up domestic political popularity, increase government revenue, or exert control over a critical economic sector, as stated by Securitas Global. Should a foreign government confiscates a business’s assets, or acts in another manner that prevents a business from operating, then political risk insurance may come into play.
According to Stuart Barrowcliff, vice president and senior underwriter at AXA XL, expropriation/nationalization/confiscation coverage would respond to the seizure of assets by any governmental authority, but not in cases involving criminal actions.
“To the extent that a company’s behavior, such as a failure to comply with local laws and regulations, causes a government to takes steps against the company to enforce local laws/regulations, that is not covered,” Barrowcliff says. “Also, political risk insurance does not cover losses resulting from illegal acts, fraud or corruption on the part of the insured company, and it does not provide coverage to individual principals.”
In any event, if an insured business finds itself amidst political turmoil on foreign land, taking steps to prevent and minimize loss should be the first course of action, Barrowcliff suggests. Although measures will most likely focus on maintaining the physical security of operations, insureds should expect to have few insurance and risk management options overall, he cautions.
“The purpose of our policies is to indemnify the insured for losses suffered due to specific acts taken by a government, such as expropriation or physical damage caused by specified political violence acts (riots, strikes, civil war, terrorism, and the like),” Barrowcliff explains. “A change in the operating environment, while it may be less friendly than when the company first made its investment, is not in and of itself something that these policies cover. There has to be a loss due to a specified event.”
Evolution of political risk coverage
Modern political risk insurance first emerged after World War II, when the Marshall Plan promoted economic recovery programs in Western European nations, according to the National Association of Insurance Commissioners (NAIC). In the decades since, the coverage has evolved into a robust market offering bespoke cover against the expropriation of property, political violence, inconvertibility of currency, forced abandonment or forced divestiture, consequential financial loss, non-repossession assets, and trading risks.
Despite years of advancement, most political risk policies written today are still based on policy development from over 30 years ago, says Hedley, beckoning a need for more sophisticated coverage to respond to 21st-century risks.
“The insurance product needs to evolve and is evolving. It increasingly provides a mix of crisis management through firms that are on the policies to help the insured manage these situations and potentially assist in emergency evacuations if you have to get staff out of a county when there is a civil war-type situation, like in Ethiopia at the moment,” Hedley explains. “I think that is where the product is going — not just reimbursing companies for losses but providing support, risk management, and outsourced help to preserve the safety of employees during these sort of conflicts.”
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