Beyond the obvious humanitarian issues, the crisis in Ukraine has magnified the threats currently facing the global economy and has complicated any potential solutions.
The countries of Ukraine and Russia combined may account for less than 2% of the world’s GDP but they also produce 70% of the world’s neon, a critical component in the production of semiconductors. These have a wide application across multiple industries. Additionally, Russia is a vitally important supplier of oil, natural gas and metals. Nearly 40% of Europe’s natural gas and 25% of its oil comes from Russia.
While at the time of writing the effects on markets are still playing out, Russia’s invasion and subsequent sanctions have already led to increased commodity prices and further strains on supply chains. Both of these issues will have an impact, not only on the availability of goods but also on the trade routes available to move them. Ultimately, this will lead to increased operating costs and strained cashflows for many businesses.
With respect to its underwriting approach, the Credit & Political Risk Insurance (CPRI) market seems to be following other industries. As a result, many insurers are not currently writing any risks with Russian involvement (regardless of whether these transactions are currently allowed under sanctions or not).
So far, the focus has been on the markets writing Credit Risk “CR” (i.e. default under a contract by a privately owned entity) & Contract Frustration “CF” (i.e. default under a contract by a state owned entity). However, Political Risk Insurance “PRI” (i.e. asset risk) is set to become an area of increasing concern for many businesses who operate internationally.
The positive news is that the insurance market remains open to these risks. In fact, during a time when the news on political instability is increasingly dour, appetite from insurers for this product is buoyant.
This appetite is being driven by a desire for many insurers to diversify their books away from CR & CF. However, where a more formulaic approach has traditionally been adopted to structuring PRI programmes, there is now a growing trend (and requirement) for programmes that follow a thorough business review and provide genuine risk transfer for clients.
In the wake of Covid-19, many insurers in the CPRI market adopted a more conservative underwriting approach, focusing on key partner insureds and, in the case of credit risks, counterparties further up the credit curve.
Insurers tended to base their underwriting approach almost as much on the strength of the insured, as on the merits of the credit risk itself. The rationale behind this being that insurers want to partner with insureds who can illustrate a deep understanding of their counterparties’ business and a willingness to help resolve issues when they inevitably arise. The insurance product is to be seen as a port of last call, not the primary route of recovery in a default situation.
This trend is likely to continue through 2022, as counterparties face tighter margins and supply chain issues begin to compound.
In order to consider writing a “weaker” transaction (i.e. approximately single B rated in the case of credit risks) it would need to benefit from a strong security package and in the case of government buyers/obligors, be of significant strategic importance to the host country.
While the above doesn’t paint a pretty picture, there are several ways for an insured to best utilise the CPRI market successfully. In order to do so they should focus on:
Quality submissions – a well-structured submission supported by detailed analysis will be viewed more favourably than one with little detail or sign of internal risk analysis.
Treat insurers as partners – insurers prefer to work with clients who adopt a portfolio approach to risk selection, using CPRI insurance to complement their business. Conversely, insurers are increasingly wary of the market being used to shift high-risk deals off a firm’s balance sheet (aka “risk dumping”).
Risk retention – a key way to create an alignment of interest with insurers is to be prepared to hold a fair retention of the risk. For more challenging transactions, many insurers will now offer a line equal or less than the size of the uninsured participation.
Where CPRI adds value
As commodity prices continue to increase, insurance can be used to leverage a firm’s internal credit limits. Doing this allows them to continue to serve their end clients as demand for credit increases, without taking on levels of credit risk beyond internal appetite.
Additionally, by choosing to partner with an insurer over syndicating with competitors, a firm can protect key relationships from the competition.
For further information, please contact:
Charles Purvis, Political & Credit Risks