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Risk Management and Insurance: Perspectives in a Global Economy
17. Political Risk Management
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Information
Points to Ponder
Modes of foreign market entry
Nature of political risk
Risk analysis
Risk control
Financing the political risk exposure
The importance of monitoring
Political considerations in emerging markets
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Modes of Foreign Market Entry
Exporting
Use of a domestic intermediary
Foreign direct investment (FDI)
Joint venture
Wholly-owned subsidiary
Branch
Differences in the level of political risk
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Political Risk
Any governmental action that diminishes the value of a firm
operating within the political boundaries or influence of that
government
Elements (selected)
Nationalization (taking of property w/ compensation)
Confiscation (taking of property w/o compensation for criminal
activity)
Expropriation (taking of property w/o compensation in eminent
domain)
Contract repudiation
Currency inconvertibility
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Political Risk Management
Identification/measurement of loss exposure
Political/legal environment
Socio/ethnical environment
Economic/financial environment
Regional/international environment
Use of external data/analysis
Internal analysis
Frequency and severity of an adverse event
Changes in firm value
Benefit-cost analysis
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Public Information Sources (Table 17.1)
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The World at Risk – April 2, 2007
Brazil
President Bush and President Lula da Silva agreed to foster a
regional market for ethanol production, but the U.S. tariff on imports of
Brazilian ethanol was left untouched.
Egypt
Parliament is expected to pass 34 constitutional amendments
consolidating President Hosni Mubarak's power, which will probably
fan street protests and lead to a short period of instability.
Not in the Text –
Check Fortune
International for
updates.
Fortune International (2007)
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The World at Risk – April 2, 2007
China
An unusually large increase of 18% in the military budget shows
Beijing's determination to move ahead with military modernization,
even after its January anti-satellite weapons test drew an outcry from
the international community.
Thailand
The appointment of former World Bank economist Chalongphob
Sussangkarn as Finance Minister may convince investors that
policymaking will be business-friendly, but confidence will be slow to
return.
Fortune International (2007)
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Risk Ratings by Economic Intelligence Unit
Ecuador
Sovereign
Currency B
Banking sector
Political
Econ structure
CCC
CCC
C
CCC
Sudan
Sovereign
Currency CCC
Banking sector
Political
Econ structure
CC
CCC
C
CC
Not in the Text –
Check Economic
Intelligence Unit of the
Economist for
updates.
Economic Intelligence Unit (Feb 2007)
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Risk Ratings by Economic Intelligence Unit
Azerbaijan
Sovereign
Currency BB
Banking sector
Political
Econ structure
BB
B
CCC
CCC
Iran
Sovereign
Currency BB
Banking sector
Political
Econ structure
B
CCC
CC
BB
Economic Intelligence Unit (Feb 2007)
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Political Risk Control Techniques
Integrative strategies
Discourage the host government from interfering with the operation of
the firm
Managerial approaches
Increase in communication and tighter relationships (e.g., use of
local resources including personnel)
Financial approaches
FDI through joint venture
Fair, accurate and open financial reporting
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Political Risk Control Techniques
Defensive strategies
The cost of interference > the cost of letting the firm stay
Managerial approaches
Joint venture partner from outside the host country
Minimum use of host country nationals
Use and enforcement of intellectual property rights
Financial approaches
Source equity/debt financing from within the host country
Minimize retained earnings locally
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Financing the Political Risk Exposure
Financing the Political Risk Exposure
Retention
Insurance
Intergovernmental agencies
Governmental agencies
Private companies
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Multilateral Export Credit Agencies (Table 17.2)
The correct name for
the Arab is “Inter-Arab
Investment Guarantee
Corporation.”
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The Multilateral Investment Guarantee Agency
Created in 1988 as a World Bank Group member
Promote FDI in emerging economies
Offer political risk insurance (guarantees)
Over $2 billion in capital paid by 163 World Bank member
countries
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The Inter-Arab Investment Guarantee Corporation
Established in 1975 to foster inter-Arab investment flows
Provide coverage for inter-Arab investments and export
credits against non-commercial risks
$83 million capital in 2002
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Overseas Private Insurance Corporation (U.S.)
Established in 1971 to help US business investments
overseas, foster economic development in emerging
markets, and complement the private sector in managing the
risks associated with FDI
Up to $250 million per project against:
Currency inconvertibility, expropriation or political violence
Protection of up to 20 years of equity life or maturity
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The Export-Import Bank of the U.S.
Finance the export of U.S. goods and services
Does not compete with private sector lenders
Pre-export financing
Commonly one-year transaction-specific or revolving loan
Small Business Multi-Buyer Export Credit Insurance
Commercial losses due to insolvency, bankruptcy and default (up to
95% coverage)
Political losses due to war, revolution, cancellation of an import or
export license, currency inconvertibility (up to 100% coverage)
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Other Risk Insurance Providers
Export-Import banks around the
world
Africa (African Export-Import
Bank)
Japan (Export Import Bank of
Japan)
India (the Export Import Bank
of India)
…
Private insurance firms
American International Group
The Chubb Group
Zurich (North America)
Lloyd’s
…
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In Your Countries?
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Differences between Public and Private Insurance
Public insurers must consider their governments’ policy
objectives
Private insurers are in the business to make a profit while
avoiding undue risk.
These providers are perceived as being more flexible.
Their coverages can be more expensive.
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Differences between Public and Private Insurance
In general, public-sector insurers rely more on published rate
schedules than do private insurers
Government policy toward a particular country or region heavily
influences pricing and coverage availability.
Traditional actuarial methods based on probabilities are less
applicable. Hence, private insurers use portfolio
management and diversification to assure spread of risks,
both in terms of coverage provided and geographic area.
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The Importance of Monitoring
MNCs should carefully monitor the effectiveness of their
political risk management programs, including the
environment in the country of operation.
Circumstances that create political risk in one country may
create it in another.
Marketing practices that are effective in a developed country
may provoke suspicion and controversy in a developing
country.
Managerial practices that are effective in the home country
may precipitate labor unrest in a host country.
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Political Considerations in Emerging Markets
Eastern Europe
Asia
Latin America
Middle East
Africa
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Case Study: Iran
Not in the Text.
Background
Persia until 1935
Became an Islamic republic in 1979
Religious scholars as political leaders
1980-1988 war with Iraq
Designated as a state sponsor of terrorism
Nuclear development
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People
Population of 67 million
Median age
24.8
15~64
69%
Life expectancy
Infant mortality of 40.3 per 1,000
lives at birth
Life expectancy of 68.8 (male)
and 71.17 (female)
Ethnicity
Persian (51%), Azeri (24), …
Religion
Muslin (98%)  Shi’a (89%) and
Sunni (9%)
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Economy
Central planning with large
enterprises
47% services and 42% industry
Per capital GDP (purchasing power
parity) of $8,900
GDP real growth of 5%
Exports – gas, carpets
Imports – raw materials, capital
goods, technical services
15.8% inflation (2003*)
15% unemployment (2002*)
40% below poverty line
Single exchange rate system since
2002
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Iran – International Disputes
Fitch Credit Rating (December 2003)
B+ (long-term rating)
B (short-term rating)
Outlook – stable
S&P
Do not rate
Moody’s
Withdrew rating action in June
2002
US government concerns
that the rating was
“inconsistent” with U.S.
sanctions
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Insurance in Iran
The history
Initially serviced by foreign insurers
1935 – First, state-owned insurance firm established
1979 – The industry (with 12 foreign firms) nationalized, leaving only
state insurers: Iran Insurance Company, Asia Insurance Company,
and Alborz Insurance Company
The regulator
Bimeh Markazi (Central Insurance, www.centinsur.ir) of Iran
established in 1971
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Insurance in Iran
The market
The market is closed to the private sector and foreign firms
Third party motor liability insurance is compulsory
Related activities
Social Security Organization (SSO) for workers’ compensation type of
coverage
Medical Service Organization (MSO) for medical insurance to anyone
who selects not to be insured by Iranian commercial insurer or SSO
Export Guaranty Fund of Iran (ECGD)
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Discussion Questions
Discussion Question 1
With increasing internationalization of national economies,
would you expect political risk exposures to grow or diminish
in importance? Justify your answer.
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Discussion Question 2
Could political risk exposures of MNCs might be hedged in
the capital market? Speculate as to how this might be
accomplished.
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Discussion Question 3
An entire national economy can be exposed to political risks
in the sense that the actions of other governments can
diminish its collective “value.” How should governments
apply sound risk management principles to such exposures?
Do government considerations in this respect differ
fundamentally from those of firms?
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Discussion Question 4
Can governmental political risk exposures justify the
creation, maintenance and protection of a domestically
owned insurance industry? Justify your response.
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Discussion Question 5
We discussed two strategies for political risk management:
an integrative strategy and a defensive strategy. Pick a
country (or a political environment) for which an MNC might
use an integrative strategy. Pick another country (or an
environment) for which an MNC might use an integrative
strategy. Support your choice for each with logical
explanation. Would your choices of countries, tactics or both
change depending on the nature of business?
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