The Impact of Political Change and How To Protect Your

Business Against It
Political risk insurance cannot be a panacea for every conceivable
political risk that can confront an international trader or investor. But in a
world filled with political change, obtaining political risk insurance can
make the difference between operating a profitable business and making a
costly mistake.

Almost any event can trigger political change. An unexpected

resignation, a terrorist act, or a currency collapse can completely transform
the political and economic landscape. Politics and economics are forever
entwined, as was dramatically demonstrated with the collapse of the Thai
Baht in 1997. The collapse of the Thai currency set off a chain of events that
ultimately led to the economic meltdown of many of Asia’s economies and
impacted most of the rest of the world. It took Asia and the world 18 months
to recover from that crisis, and much of Asia has yet to fully recover. It
could be argued that one of the disadvantages of globalization is that the
impact of political change is felt instantaneously.

There is less time to react, as someone else has or will already have
reacted while we were sleeping, by the time we receive the news. Perhaps
the impact of the collapse of the Thai Baht would not have been so dramatic
if the international marketplace were not so interconnected—if currency and
stock trading didn't occur 24 hours a day. This trend toward seamless
international financial transactions will continue at an even faster, even more
breathtaking pace in the new decade.

Consider the impact that political change has had on us all. The
Islamic Salvation Front, which is fighting for political change against the
government of Algeria, is an organization few North Americans had ever
heard of before the end of 1999. Yet this group, which has been fighting the
Algerian government for decades, apparently decided to export its version of
political change to the United States by attempting to smuggle bomb-making
equipment into the United States around the new year.

The actions of perhaps three or four individuals from this

organization had a huge impact on the New Year’s celebration plans of tens
of millions of people. In tandem with the expected (but unrealized) Y2K
impact, about 70 percent of Americans decided to stay home on New Year's
Eve. The incident also underscores the need for closer scrutiny of Canadian
immigration practices, which is sure to have an impact on the manner in
which Canadians and Americans can cross each other's borders in the future.

Consider what impact Turkey's accession to the European Union may

have on Europe and beyond in the coming decade. For decades, Turkey has
tried to join the European Union (and previously, the EEC), but strenuous
objections from Greece and other members kept it from succeeding.
Germany, for example, has long expressed concern about the impact that
Turkish immigrants have had on the composition of the country's ethnic
composition.

Now it appears that Turkey will soon become an E.U. member. Turks
will have the right to travel freely throughout the European Union (as all
other E.U. members do), but Turkey is Europe's only primarily Muslim
nation. There will undoubtedly be a corresponding rise in the influence of
Islam in European life and, because the United States has close ties to
European politics, economics, and culture, what impacts Europe, could
impact the United States.

What about the Panama Canal? When President Carter granted

ownership of the Canal to Panama in 1978, who imagined that in 1999,
when ownership was transferred, a Hong Kong company (Hutchison
Shampoo) would spread enough money around the power brokers in Panama
City to buy itself control over the ports at both ends of the canal. As a result,
some argue, Chinese political influence has a strong foothold in Central
America. In granting the concession to operate the ports to Hutchison,
Panama, which has no national army, has virtually assured that U.S. military
influence will be present in Panama for decades to come. This, in turn, will
impact how future U.S. military budgets are allocated and how tax dollars
are spent.
The Impact on International Businesses
The impact of political change on businesses is no less significant
than it is on individuals—perhaps even more so. At stake are trillions of
dollars of revenues derived from trading and investing abroad. For a
business, the political risks associated with political change are multifaceted.
For instance, the question of whether China is admitted to the World Trade
Organization certainly has an implied impact on U.S. consumers (cheaper
imported goods), but consider what is at stake for businesses operating in or
with China. If China is admitted, businesses operating in and with China will
be given a new level playing field. Suddenly, China will have to play by
everyone else's rule, rather than its own. However, if China is not admitted
to the WTO, there is likely to be a backlash against foreign-owned
businesses. China could make them pay for failure to secure its place in the
organization. If the U.S. Congress fails to approve the entry, U.S. businesses
could endure serious hardships. New laws restricting access to the Chinese
market by U.S. investors could be one result.

In general, an international investor often faces the risk of

expropriation of assets when a new government takes power or an existing
government changes its stance toward foreign investment.

The risk of not being able to convert local currency into hard currency
or to transfer hard currency out of a country because of a shortfall in the
national foreign exchange supply or a change in law is ever-present. And,
depending on where an investment is located within a country, the risk of
damage to a facility or an interruption of business operations because of
political violence can arise without warning.

For international traders, political risks are every bit as real. Imagine
exporting goods to a government buyer only to discover after the fact that it
doesn't pay its bills or the United Nation has just imposed an embargo on the
country or your own government has just cancelled your export license.
Wrongful calling of on-demand guaranties (for bid bonds, performance
bonds, or advance payment guaranties) by governments happens all the time.
Political change only accentuates the political risks inherent in trading
abroad.
Political Risk Insurance
Surprisingly, many international businesses are unaware that they can
protect themselves against political risk through insurance. Political risk
insurance has been in existence for decades and is now more widely used
than ever. Whatever the risk, an insurance product should exist to protect a
business against government actions that impact the ability to trade or invest
across borders.

The key test for whether a risk can be covered by political risk
insurance is determining whether the occurrence was caused by a
government action (a "political" risk) or was the result of a commercial risk.
Insurers make a distinction between the two types of risk because a political
risk is presumably not within the control of the trader or investor, and a
commercial risk is. For example, a provider of electricity should be able to
determine the nature of market demand for electricity and a realistic price
for providing it. A loss derived from inaccurately assessing market demand
or a realistic price for electricity is a commercial risk the power provider
accepts by engaging in a project. However, it may not be within the
provider's control to be able to ensure that the supply of coal required to
operate the plant remains uninterrupted or that the government doesn't
arbitrarily change the tariff arrangement between the provider and the
national power company. Usually, answering the simple question of whether
an action was in an insured's control or a government's control will answer
the question of whether a risk can be covered by political risk insurance.

Since more businesses are trading and investing abroad than ever before, it is
important that they realize that protection against government-inspired risks
is available and that increasingly more underwriters are providing the
coverage. Political risk insurance cannot be a panacea for every conceivable
political risk that can confront an international trader or investor. But in a
world filled with political change, obtaining political risk insurance can
make the difference between operating a profitable business and making a
costly mistake.