RIDERS ON THE STORM
Does insuring against political risk make sense? It may, if your company has millions invested in a volatile market - and can afford the hefty premiums.
By Lynne Curry

When Gordon Wu talks about the risks of doing business in a foreign country, he's speaking from experience. A very painful experience, at that.

Sitting in his expansive office atop Hopewell Centre in Hong Kong, the chairman of Hopewell Holdings ponders the fate of his half-completed, multi-billion dollar elevated road and rail project in Bangkok. Begun amid great fanfare in 1992, the project looked to be on track during the first few years of development. Final design and work plans were approved in 1993. Pilings were put down in 1995. A year later, substructure concrete was poured. But suddenly in early 1998, with the regional currency crisis worsening, the Thai government informed Wu it was canceling Hopewell's contract for the train system, citing delays and cost overruns.

Frustrated, the Hopewell chairman has been negotiating with Thai authorities ever since. In an attempt to recoup some of the company's investment, Wu says Hopewell has offered to help complete the stalled venture. Barring that, he's asking for some type of compensation. But so far, Thai officials don't seem eager to take him up on either suggestion, and negotiations continue to drag on. "The Thais can't finish it on their own," the short-sleeved, casually dressed Wu insists. "We have the material, the data, the documents. Would you put a structure on to something that looks like Stonehenge?"

At a time when financial certainty and government stability have just about hit rock-bottom in Asia, more CFOs, risk managers and corporate treasurers are asking themselves if it's finally time to purchase political risk insurance. While the premiums for these policies are pricey, it's often small potatoes compared to losses that can occur when things turn very ugly in a foreign market. In general, political risk insurance covers an array of unforeseen events, from popular unrest to civil war, from currency controls to bans on profit repatriation, from revoking business licenses to outright nationalization.

Banks, which suffered serious losses in the Asian financial crisis, have actually begun to require that some clients purchase political risk policies. "We're seeing more requests for political risk insurance coverage in Malaysia, Indonesia, Korea and the Philippines than we did before the Indonesia crisis occurred," says Christophe Bellinger, chief underwriter at the Multilateral Investment Guarantee Agency (MIGA), a World Bank institution that offers export credit and investment insurance. "A large number of companies in the business community have said, 'We can't get insurance or loans since the collapse of the Indonesian government.'"

What's more, with governments in the region keen to privatize state-owned enterprises, foreign investors are being ushered into boardrooms that were previously off limits. "It's a very, very new phenomenon for governments to allow foreigners to operate power plants and telecommunication networks," MIGA's Bellinger says. Wu's power plants and infrastructure projects are part of that trend. The problem is, these sorts of high-profile infrastructure projects often make inviting targets for jingoistic journalists and militant ministers. Overnight, an electric power plant can turn into a political lightning rod, with ten-year business plans scuttled by a flash flood of anti-foreigner sentiment.

Fearful of stirring up trouble - and eager to maintain a low profile - few finance managers will disclose if their companies are, in fact, carrying any political risk policies. Indeed, most finance executives contacted for this story by CFO Asia flat out refused to talk on the record about political risk insurance. Some have no choice: many private insurers have clauses stipulating that their clients will not advertise they are carrying political risk insurance. "If a company tells the government it is insuring against confiscation, it might adversely influence the government to act against you," explains Andrew Miller, a director at London-based insurance brokerage Berry, Palmer, & Lyle. "Just the knowledge of its existence might precipitate a loss."

Of course, not all political risks are front-page news. Sometimes, more mundane concerns - such as haggling over contract details - can bring a multi-million dollar project to a grinding halt. Wu's dispute with the Thais, for instance, stems from a disagreement on the development of land rights along the route. "In Thailand, we worked for seven years, and the Thais didn't spend a single baht," Wu claims.

Not surprisingly, the Hopewell chairman's experience in Thailand has made him more receptive to taking out political risk insurance elsewhere. "I had no political risk insurance in Thailand. But if I did, I would have taken the whole indemnity." While Wu says Hopewell has operated successfully in China, the Philippines and Australia, he is currently working with Indonesian authorities to resolve problems surrounding the suspension of the company's power project in that country. "Political risk insurance is worth having, depending on the country," Wu notes. "If I went to India or Pakistan, for instance, I'd take out strong insurance. The question to ask is: how do they treat cross-border investors?"

Utility Futility

In Indonesia, not too well. Or at least, that seems to be the answer some corporate managers have arrived at. Newbridge Capital, for one, bought political risk insurance for one of its projects on the archipelago. Newbridge, a private equity fund, recently paid US$100 million for ownership of Advanced Microtronics Technology, a semiconductor technology assembly and production business in Batam, an Indonesian island not far from Singapore. "For most investments we don't purchase political risk insurance, but Indonesia is an exception and continues to remain so," notes Emerson Yip, vice-president of Newbridge Capital in Singapore. "The political situation hasn't stabilized and there is a danger of internal strife."

Yip says Newbridge bought the policy through insurance brokers. The policy insures the company against political violence, including war, confiscation and expropriation. Yip points out that Newbridge also wanted coverage for currency inconvertibility in Indonesia, but was unable to purchase it. "Given what has happened in Indonesia, it was very difficult to obtain insurance for capital controls," Yip explains. "We couldn't find any underwriter who would offer it at any price."

Still, he says Newbridge did obtain coverage, not only for the company's assets, but for its investment costs. "Not only is our own investment covered, but the amount we borrowed as well," Yip says. "[After all] we will continue to owe the banks loans if something happens."

Newbridge's policy underscores the fact that Indonesia, with its continuing political unrest and economic uncertainty, remains one of the riskiest places to do business in Asia - if not the world. Take the recent travails of two dozen or so independent foreign power producers in Indonesia. The companies initially invested in energy projects during the heyday of the Suharto regime, when the economy was booming, and when doing business meant dealing with family members or associates of the Indonesian president. "The former president was pushing deals that were very lucrative for business interests," says a Western lawyer familiar with the deals in Jakarta, "and the Indonesian economy was growing at 7 percent a year before the crisis."

But following Suharto's ouster in May 1998, the rules of the game changed dramatically. All of a sudden, officials at the state-owned Indonesian utility, PT Perusalaan Listrik Negara (PLN), questioned the terms of contracts signed during the Suharto era, claiming electricity tariffs were too high. With the collapse of the rupiah, officials at PLN announced that the utility couldn't pay for the power and postponed further development of the plants.

At the time of the pronouncement, the foreign power projects were in various stages of completion, from signed memorandums of understanding to fully operational plants. With officials at the PLN saying the power company didn't have the money - and didn't need the power - the foreign companies were stuck. "This is a huge problem," says the lawyer familiar with the industry. "Construction costs are between US$70 million and US$2.4 billion per project. There are no easy answers."

Paper Beats Rock

Against such an uncertain backdrop, political risk insurance does not provide an automatic guarantee of protection. The problems faced by foreign power providers in Indonesia show that political risks involve more than physical violence: changes in a new government's policy can often be just as harmful to a company's interests. "We're not talking about stone throwing by students," says Miller of Berry, Palmer, & Lyle. "Far more damage is done by pieces of paper the government has issued."

Consider the cases of Edison Mission Energy, a division of US-based Edison International, and MidAmerican Energy Holdings, a US company formerly known as CalEnergy Co. Despite having purchased political risk policies, both companies have struggled to win compensation for their Indonesian business losses. Managers at Edison Mission, a partner in a consortium that owns and operates the US$2.5 billion Paiton plant in eastern Java, has lodged a notice of dispute against PLN. But in October, the government agency filed suit to nullify the power purchase agreement. Edison Mission carries partial political risk insurance on the Paiton plant through the Overseas Private Investment Corporation (OPIC), a US government agency, as well as the Export/Import banks of the US and Japan. But a source close to the project says Edison Mission's policy may not be adequate to cover the situation. Officials at Edison Mission declined to comment.

Meanwhile, executives at MidAmerican claim that PLN failed to pay for power supplies from one geothermal power plant, and then suspended work on a second geothermal project. A UN-supervised international arbitration panel ordered PLN to pay the two MidAmerican subsidiaries a total of US$572 million for breach of contract. So far, the PLN has not paid.

MidAmerican carries political risk insurance on its investment in the two subsidiaries through OPIC, as well as other private market insurers. The insurance covers expropriation of its investment and breaches of the sales contract by PLN and by the Indonesian government of its performance undertakings. MidAmerican has filed what is believed to be a US$400 million claim with OPIC, which is currently evaluating the case.

In addition, a Jakarta-based lawyer knowledgeable about the Indonesian power industry says MidAmerican is now thought to be seeking a "comfort" letter, a document that states the government doesn't object to liability as a guarantor of PLN, for the suspension of one of its plants. A company official declined to comment on any aspects of the case, however, saying the matter was too sensitive.

Policy Makers

MidAmerican is lucky. At least it has political risk insurance. "A huge retailer had its stores gutted by looters who stole the products and burned the place last year," notes Bruce Wimmer, regional general manager of Pinkerton Consulting Services, a security and intelligence agency. "It didn't have political risk insurance and ate the loss. The company now says its needs insurance and needs to be proactive."

To avoid such unpleasantries, Texas Instruments (TI), a US-based, global semiconductor and electronics manufacturer, does purchase political risk insurance on a case-by-case basis from OPIC. Mostly, the policies cover the seizure of plants and equipment and withholding of funds. "The dollar amount of exposure and location are the drivers" in the decision about whether to purchase political risk, explains Tom Henderson, TI's corporate risk manager in Dallas, Texas. TI also has worldwide marine insurance to cover goods that could be seized while in transit. Henderson says senior executives examine a number of issues before deciding to purchase political risk insurance. Key among those are the company's "financial strength and position - can you do it?" he asked. "Can it potentially affect shareholder value? Can it protect materially and not affect profitability?" The terms of this kind of coverage depend on the nature of the insured assets, whether they are moveable or fixed, their location and whether they are trade related.

Indeed, experts say policies for political risk need to be tailor-made for different countries, industries, types of assets, as well as a company's aversion to risk. Boiler plate policies, most insurers say, simply won't cut it.

Until recently, the only way to line up any kind of political risk policy was to appeal to government agencies. Typically, political risk coverage was provided by government export credit agencies in Organization for Economic Cooperation and Development countries to assist trade by their exporters. Governments tied investment programs to exports from their own country and didn't provide insurance coverage if their nations' companies were not involved in a particular project. That practice still exists today. Some of the larger government agencies are OPIC, Japan's Export Insurance Division of the Ministry of International and Trade Industry (MITI), Germany's Hermes and France's Compagnie Francaise D'Assurances Pour Le Commerce Exterieur (Coface).

But with the growing demand for more customized policies, private insurers have rushed into the political risk market. The private insurers can be divided into several groups. First are the large US-based brokers - AON Risk Services and J&H Marsh & McLennan - which dominate the market. The second category includes 20 to 30 niche players, including London-based brokers like Berry, Palmer, & Lyle, which help companies access the Lloyd's underwriting syndicate. Most of these are located in continental Europe and North America, as well as London. In addition, there are about 50 to 70 underwriters that provide political risk insurance. Some of them include carriers like US-based AIG Global Trade and Political Risk Insurance Company, Bermuda-based Sovereign Political Risk, and Zurich-American Political Risk, which is located in Washington, D.C.

Although government agencies and private insurers often cooperate closely, the two groups offer different products and services. Until the mid-1990s, when private insurers and brokers entered the market, government agencies offered longer term coverage than the commercial vendors. AIG was one of the first to sell seven-year political risk coverage. Now, although government agencies still provide some longer term coverage, private companies and government agencies frequently co-insure large projects for ten to 20 years. Government agencies offer troubleshooting services to customers, as well. They also carry some serious clout. Says Julie Martin, vice-president for insurance at OPIC, in Washington: "We bring to bear the weight of the US government."

And its values. Export credit agencies like OPIC and MIGA are often constrained by the policy requirements of their governments. Depending on the country, eligibility for government-backed insurance is based on meeting certain criteria, such as environmental standards, workers rights, and, for MIGA, poverty reduction. Export credit agencies are also subject to the politics and sanctions of their own governments. Since the Tiananmen Square massacre in Beijing in 1989, for example, OPIC has not operated in China. Some governments stop coverage when a country is experiencing financial difficulties. "Loans get rescheduled and countries shut down investment programs," MIGA's Bellinger said. "If a country can't pay its bills, then the lending country doesn't want to continue to underwrite the risk."

Premium Premiums

If vendors of political risk insurance are divided neatly into two camps, so, too, are opinions on the value of their policies. A cultural rift appears to have emerged in Asia over the value of carrying this kind of insurance. Multinational corporations tend to purchase political risk coverage, while local companies, with rare exceptions, do not. "Most Asian companies are not insured to any degree," explains Pinkerton's Wimmer. "They believe, 'What if nothing happens? Why should I pay all of that money? What if there is no fire? Then I've wasted all of my money.'"

Conversely, CFOs at many multinationals with operations in Asia don't see transferring risk as a waste of money. "They see locations in this part of the world as more volatile and ones that potentially could damage their business interests," notes Chris Charman, managing director of the risk management group at insurer Commercial General Union, in Singapore.. "The smaller businesses think they don't need it."

In defending the decision not to purchase political risk insurance, finance managers cite various reasons, including concerns about being able to cover the true risk, and cultural differences. Many CFOs question whether the coverage is worth the price of the premium. Managers at AES Orient, a subsidiary of AES Corporation, one of the largest independent power producers in the US, decided the price was too high. "It's a lot more expensive than commercial insurance," explains Stanley Chau, CFO at AES Orient in Hong Kong. "Such expensive insurance may hurt the bottom line."

Getting a fix on just how much a political risk insurance policy actually costs is not easy. But Chau says a policy could cost between 1 and 2 percent of the value of a project. With expected 15 percent returns for a project in China, he says his company is not willing to pay that amount. Another CFO from a Hong Kong property developer with projects in China says he had "never found an insurable risk that justified the price. It's very expensive coverage." He also points out that the insurable risk might not be the real risk the company needs to insure. "For example, a company could insure against confiscation, when it should really be more concerned about paralysis in the business environment," which leads to sluggish demand.

Western Digital, a US-based computer disc drive manufacturer, did consider political risk insurance for its factory in Kuala Lumpur. At the time, demonstrations had erupted in Malaysia with the trial of former deputy prime minister Anwar Ibrahim. "Our plant is close to a number of Malay squatter areas," notes Soon Wing Chong, finance director at Western Digital. "As a precautionary measure, we looked into it, because we were afraid riots might spill over."

The company hired outside consultants to conduct an economic survey of conditions in Malaysia, then faxed the results back to the California headquarters. Based upon the consultant's recommendations - and an improving economic climate - managers at Western Digital opted not to buy the coverage. The multinational does have global commercial insurance, which covers natural disasters, but not man-made ones such as government intervention.

Just Say No

Thus, Western Digital had no coverage last year when the Malaysian government abruptly slapped restrictions on the distribution of corporate dividends. These regulations were enacted in November, the same time Prime Minister Mahatir imposed capital controls on the securities market (see "The Great Currency Clampdown," December issue). "A lot of companies are appealing this act," says Soon. "But it's highly unlikely that we could insure against this."

Other managers rule out political risk insurance because they insist they understand the host country's culture and any accompanying dangers, and therefore, don't need the insurance. "We have good enough connections," argues Benny Chang, vice-president of the financial division at Formosa Plastics, a Taiwanese chemical and plastic resin manufacturer, which has a large plant on the Chinese mainland. "Most Taiwan people understand the mainland. We feel more comfortable there than other nationalities do."

David Uhazie, CFO for the Greater Asia region of Eastman Kodak, says his company pretty much knows what the risks are before it sets up shop in a new market. But he does note that the company is reevaluating whether it should start hedging some of its currency risks on foreign exchange markets. "Hedging may cost more, but it produces more predictable results," Uhazie explains. "That's a key factor in the value of the [company's] stock price."

Still, several finance managers believe the best form of political risk insurance is to cooperate closely with local governments, particularly if the company is in a highly regulated industry. "It is so hard to get policies for our business that the best way to cover your risks is to partner with the government," says Hong Kong-based Mark Keithley, assistant vice-president, regional finance, at Global One, a telecommunications service provider. "With martial law, devaluation and turnovers in parliaments ... I haven't found a hedge that covers the complete risks - and that isn't cost prohibitive."

Of course, some CFOs say the cheapest - and most effective - way to avoid a political disaster is to just say no to risky cross-border forays. Certainly, good due diligence can avert a world of pain. "We carefully make investments," says Eastman Kodak's Uhazie. "When the risks are too extreme, we decline the investment opportunity."

Lynne Curry, contributing editor at CFO Asia, writes frequently about finance and risk management.