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Portfolio-based political risk insurance for private equity firms

Private equity funds must consider the significant risks that come with acquiring assets in emerging markets.

11/04/2024 · 5 minute read

Private equity funds looking to acquire or manage portfolio companies or infrastructure projects with assets in emerging markets must take into consideration the significant risks that could impact their investments.

Political risks, including security, trading, and investment challenges, can either derail a transaction or significantly impact the profitability and fair value of an investment. This underscores the need for private equity funds like yours to undertake extensive due diligence and consider implementing a robust political risk insurance program.

How can political risk insurance help organizations with investments in emerging markets?

Investment efforts in emerging markets have long been hampered by the potential volatility that tends to exist in these countries. Despite the geopolitical challenges, private equity funds are expressing increased interest in investing in assets in emerging markets.

A study by Standard & Poor’s, commissioned by Marsh, shows that political risk insurance can reduce a country’s risk premium, improve the valuation of investments in an emerging market, and enhance a project’s internal rate of return.

Political risk insurance policies help protect these investments by:

  • Providing downside protection when investing in tense political environments.
  • Acting as a key differentiator when seeking to secure limited partner support for risks in emerging markets.
  • Enhancing an exit strategy by expanding the range of potential buyers and/or reducing the risk level, which could impact the asset’s valuation.

Further, political risk coverage may be mandated by investors.

A tailored solution to address today’s complex risks

Political risks can significantly threaten investments, especially in turbulent emerging economies. Taking a portfolio-based approach to managing investments in regions with significant political risk can help private equity funds like yours to substantially enhance underwriting flexibility and gain access to more favorable insurance pricing, as well as terms and conditions.

Marsh specialists have worked with a major insurer to offer a tailored solution that provides political risk coverage on a portfolio basis. Our experienced political risk specialists will work with you to identify a portfolio of risks that can be effectively insured under one policy. Once you have portfolio-wide coverage established, we can help you to add new assets and investments, allowing you to extend portfolio-based benefits to these new investments.

Benefits of a portfolio-based approach

Traditionally, many private equity firms have purchased and evaluated political risk insurance on a deal-by-deal basis, focusing on individual assets. This approach, which tends to be inefficient, is often due to private equity funds having a fragmented and limited focus that could affect a broader portfolio of assets. Potential challenges with this individualized approach include:

  • Complex and time-consuming negotiations to agree on insurance terms and conditions for each individual deal, potentially resulting in higher premiums.
  • Lengthy processing times for each individual negotiation, policy review, and accompanying administrative tasks.
  • An inconsistent risk management approach with insurance coverage that varies across assets, which may make it more difficult to effectively manage and compare insurance options.

Marsh’s private equity clients have the option to purchase insurance on a portfolio basis, typically based on a fund’s assets in a geographic region, country, or industry. This approach can address some of the challenges noted above and introduce a number of benefits, including by:

  • Facilitating a thorough evaluation of political risks across specific regions, which can offer a more holistic understanding of the overall risk exposure and allows our specialists to help you identify potential aggregation risks. This proactive risk management strategy can also support targeted risk mitigation efforts designed to provide portfolio-wide protection.
  • Assisting in negotiations with underwriters, potentially leading to better rates and improved terms and conditions. The reduction of administrative burdens — both on the insured and carrier side — can lead to cost savings for private equity firms.
  • Offering the possibility of selecting a cross-portfolio policy limit that is lower than the sum of individual investment-specific policies.
  • Offering the flexibility of adding new investments or assets under the existing portfolio-based policy, expediting and simplifying the underwriting process, and paving the way for more adaptable risk management processes when presented with new risks.

What does a political risk policy typically cover?

Subject to the specific terms and conditions of the coverage purchased, political risk insurance policies typically offer coverage for:

  • Expropriation: Acts by a host government that interfere with the fundamental ownership rights or prevent or unreasonably interfere/delay fundamental rights. A political risk policy typically also covers so-called creeping expropriation, which happens when gradual acts by a governmental body eventually lead to expropriation.
  • License cancellation: When a government cancels critical operating licenses or permits, rendering an asset inoperable.
  • Breach of contract: Risk of non-payment of an arbitration award by a host government or a state-owned enterprise in accordance with the terms of a project agreement or a bilateral investment treaty.
  • Political violence: Physical damage to or loss of use of investments and assets located overseas due to war, revolution, insurrection, strikes, riots, civil war, sabotage, and terrorism.
  • Business interruption: Financial losses due to business operations that are interrupted by political violence.
  • Forced abandonment: Abandonment of a foreign enterprise as a result of extended political violence in the host country or a relevant region.
  • Inconvertibility/non-transfer: Delay or inability of a foreign enterprise to exchange local currency into hard currency or to repatriate dividends or other remittances to the insured parent corporation.
  • Forced divestiture: A requirement by the insured’s own government to permanently divest of all or part of the insured’s shareholding in the foreign enterprise in the foreign country.

For more information on portfolio-based political risk insurance, contact your Marsh representative.

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