Political risk can be a major source of financial loss for business. The chance always exist that political and social forces out of your control can disrupt or destroy your operations, whether it be in the form of political violence or government expropriation of your company. Typically, this kind of risk is thought of as something that international businesses only need to deal with in dangerous, undeveloped countries. However, the reality is somewhat more complicated, with political risk as a continuum being present in most, if not all countries around the world in one way or another. In order to better understand this, and determine whether political risk is something you need to worry about, it’s necessary to have a better understanding of what political risk actually is.
At a basic level, political risk can be divided into macro and micro risk. Macro-level risks, which apply broadly to all companies in a region, include major disruptive events like war, while micro risks, which apply to individual companies or industries, are more typically the result of targeted events, such as selective treatment by government officials. These definitions indicate that macro risks are present even in developed regions like the European Union (and even more so in countries like the United Kingdom and Spain) due to the risks and potential fallout of secession movements. Likewise, actions by the United States government in moderating debt restructuring after the recent financial crisis could be seen as micro risks for those in the financial sector.
Take Argentina as another example. Despite being a country rich in natural resources and with a highly educated population, it is still considered one of the riskiest countries in the world to do business in. The former president of the country, Cristina Kirchener, implemented severe currency restrictions in 2011, making it exceedingly difficult to take money out and hampering the ability of international businesses to operate. This transient difficulty in doing business is further complicated by the fact that Argentina has a history of dramatic recessions, not to mention consistent and continuous government appropriation of businesses, particularly in the petroleum sector. Of course, the recent election of Mauricio Macri brings with it a government that is lifting currency controls and seeks to decrease government involvement in the economy; that being said, the general unpredictability of the Argentine economy, coupled with the fact that the Argentine Congress is still controlled by supporters of the former president, makes it unclear what the business prospects will be in the country in the coming years.
With all this being said, it shouldn’t come as a surprise that quantifying the extent of risk in a given country is not an exact science, given that doing so involves not only many variables and an understanding of economics, politics, and history, but also a good deal of guesswork. Nonetheless, there are many organizations that analyze countries for their potential for political risk, including A.M. Best, the Eurasia Group, and the Economist Intelligence Unit; also refer to the Aon Political Risk Map, an especially useful resource for quick reference. When deciding to enter or change the extent of investment in a market, it’s a good idea to take advantage of analyses offered by these organization or others. This is especially important given that your own personal analysis, or even the analysis of a local or expatriate working for you in the country, may not be complete or entirely unbiased.
As always, insurance is a potentially important element of managing risk. It doesn’t help much to talk about a “typical” political risk policy; such policies are non-standard and highly variable, in part due to the difficulty of quantifying such risk, as discussed above, and also given the unique needs of clients depending on their industry and the location where they are operating. However, in general, these policies provide very broad protection, given the broad nature of the risk, and can cover many different kinds of claims, including losses due to expropriation, political violence and forced abandonment, import/export controls, and currency controls. Interestingly, these policies frequently cover terrorism risks, which, as we have discussed previously, may not always be covered in typical General Liability policies. Additionally, note that these policies generally don’t provide coverage if claims are the result of illegal action on the part of the insured; this can actually be a complication in countries where corruption is expected as part of routine business practices and where such practices on the part of the insured are used as an excuse as part of some broader political action.
Political risk is an extremely complicated topic that requires consideration whenever you engage in business. It would be impossible for us to address all of the factors to consider when weighing political risk in this blog post, though that fact in itself should provide an indication for how complex the topic is and how important it is to take such dangers seriously.
