Foreign direct investment plays a critical role in the economic growth of developing countries. However, political risks such as political instability, government changes, wars, legal uncertainty and state interventions may threaten the sustainability of these investments. Political risk insurance is an important tool for minimising these risks and securing investments.
Political risks refer to the losses that foreign investors may face due to political events or government decisions in the countries of investment. These risks include expropriation, war, civil unrest, transfer restrictions, breaches of contract and currency convertibility problems. For example, if a government seizes a foreign investor’s property or prevents profit transfers, it can lead to serious financial losses for the investor. Political risk insurance covers a significant portion of risks outside of commercial risks.
Political risk insurance generally covers the following risks:
- Expropriation, confiscation and nationalisation
- Transfer restrictions and foreign exchange barriers
- Contract violations
- Political violence, war, civil war, terrorism
- Licence cancellations and legislative amendments
- Changes of government and political regime changes
Function of Political Risk Insurance
Political risk insurance is a type of insurance that aims to protect foreign investors against the risks mentioned above. This insurance aims to compensate the losses that may occur as a result of political risks that the investor may encounter. Especially for companies planning to invest in developing countries, this insurance ensures that their investments are secured.
Insurance policies can usually offer long-term coverage for up to 12-15 years. Insurance providers make pricing according to the country where the investment is located and the characteristics of the project. The coverage rate is usually 90 per cent, with 10 per cent of the risk remaining on the insured.
International Political Risk Insurance Organisations
Many organisations around the world offer political risk insurance. Insurance providers include export credit agencies, international organisations and private insurance companies. MIGA (Multilateral Investment Guarantee Agency) affiliated to the World Bank Group, ICIEC (Islamic Corporation for the Insurance of Investment and Export Credit) affiliated to the Islamic Development Bank Group and private insurance companies such as AIG, Lloyd’s of London, Zurich-American stand out among the organisations providing political risk insurance services.
Impact on Foreign Investments
Political risk insurance reduces the risk perception of foreign investors and positively affects their investment decisions. Insurance aims to increase the sustainability and profitability of the investment by minimising the political risks that investors may face. Moreover, thanks to insurance, investors become more resilient to political uncertainties in the countries they invest in.
A study on G7 countries found a statistically significant and negative relationship between political risk and FDI. This finding indicates that foreign investment decreases in countries with high political risk.
Political risk insurance is an important assurance mechanism for foreign investors. It is critical for the protection and promotion of foreign capital. By protecting investments against political risks, this insurance promotes economic growth, increases the sustainability of international investments and encourages investors to move towards developing countries. Therefore, it is of great importance to popularise political risk insurance and introduce it to investors, especially in developing countries.
