Take cover
Economic infrastructure in all its forms is facing an increased
threat of political violence. In emerging markets these types of
assets are often more at risk because they are more accessible. The
risk should not be seen simply as the risk of physical damage to
project assets. Merely the threat of terrorist action against a
project, or a country's economic collapse caused by civil or
international conflict, can force the interruption or abandonment
of operations with a devastating impact on cash flow.
Much has been made of the withdrawal by general insurers of terrorism cover since 9/11. And conventional ?all risks? project insurance is likely to do very little, if anything, to deal with terrorism and war risks. However, the specialist investment insurance and political risk insurance market has the capacity and appetite to address these risks.
A range of government and private insurers offer a variety of political violence coverages that can respond both to physical damage to project assets and to interruption and abandonment risks. Some policies address loan or bond default caused by political violence. Others seek to help avoid such defaults following war or terrorist attack, by providing property damage cover to pay for the cost of repairing and replacing facilities.
While the removal of terrorism cover from general insurance policies since 9/11 has created a significant coverage gap, it is worth reflecting that the general insurance market has never catered for the full spectrum of political violence risks, or offered a complete solution to the problem.
However, until recently, terrorism was thought to pose less of an aggregation threat. As a result terrorism, riots, strikes, civil commotion and other forms of political violence short of war or civil war, were often included in general insurance policies.
The tragic events at the World Trade Center have changed that perception. The aggregations associated with targeted terrorist attacks are now considered in the same category as war risk: too large to be soundly underwritten in a general insurance account. Special treatment is needed.
The burden of terrorism insurance has to some extent fallen back on governments, particularly in the developed world. The most recent example is the US Federal Terrorism Insurance Act that was signed into law in November 2002. The Act requires insurers of US located risks to offer to reinstate terrorist cover. As a quid pro quo, the Federal government provides reinsurance protection against catastrophic terrorist losses. Other countries like the UK and South Africa, with an historic problem of terrorist attack, already had government schemes in place. Others governments are developing or have developed responses to the current terrorism insurance crisis prompted by 9/11.
However these government terrorism schemes are unlikely to be the solution for many projects. They only offer cover for assets in their home country. They cover only part of the spectrum of political violence and do not extend to war risks. Many are more focussed on property damage and its aftermath, rather than the less tangible risks associated with abandonment of operations. In particular, they are unlikely to provide any solution in most emerging markets, where the risk is often highest.
It is against this background that the coverages available from the specialist investment insurers and private sector political risk insurers have been thrust into the spotlight. The flow of business into the specialist markets has increased dramatically over the last 18 months and the market has responded with capacity and innovation.
The market collectively has capacity for individual projects measured in the $100s of millions. Additionally it offers a wide range of political violence insurance products. These range from conventional property forms, geared to physical loss or damage and business interruption losses triggered by physical damage, to equity and lender based forms catering for the needs of investors, sponsors and lenders, and forced abandonment type covers.
The specialist market divides in two. First, the government and private sector investment insurers who offer political violence cover usually as part of a wider investment insurance product also covering such risks as expropriation and currency inconvertibility. Second, the political risk insurers mainly in the London market who offer war and terrorism coverage on a stand-alone basis.
The investment insurers consist of both multilateral and government schemes like MIGA, OPIC, ECGD, EDC and others, and their counterparts in the private sector like AIG, ACE Global Markets, Chubb, Sirius, Sovereign, Unistrat and Zurich. They are joined by those at Lloyd's who usually only write political violence cover as part of an investment insurance package.
The investment insurance community are complimented by those in the private market who have the ability to offer war and terrorism cover on a stand-alone basis. These include Catlin, Beazley, Wellington, Kiln, XL London Markets, Ascot in Lloyd's, and Inter-Hannover, Berkshire Hathaway, Montpelier Re and others in the companies market. These insurers may also write political violence insurance as part of a wider investment insurance. But it is their ability to write these covers on a stand-alone basis that is of interest here. Other insurers offer stand-alone cover for terrorism, but not war, and include AIG Crisis Management, QBE and SRIR.
I emphasise the difference between the investment insurers and the stand-alone political violence insurers because they have different origins and traditions, and very different approaches to the subject as a result. Both have an important role to play as far as project financiers are concerned. However, it is perhaps the role of the stand-alone terrorism and war risk insurers that I wish to emphasise, partly, as they are less well known in project finance circles than the investment insurers.
Before turning to the stand alone insurers, it is worth dwelling a little on the main characteristics of the investment insurers. Usually commentators focus on the difference between the government and private sector insurers. There is of course the difference that government insurers generally only insure new investments and have eligibility criteria relating to nationality of policyholder, for example. For the purposes of this paper, I would like to emphasise the similarity of approach of the investment insurers, public and private and contrast them with the characteristics of the stand-alone market.
The capacity for political violence risks remains strong among the investment insurers. Though the balance may have swung marginally in favour of the government schemes, the private sector capacity remains significant. Periods remain multi-year: there is still plenty of capacity for 5 and 10 year periods. 15 year periods are still available in the public sector and occasionally from the private sector.
An important shared characteristic of the public and private investment insurers is that their political violence covers are designed from the perspective of the investor or lender, the usual policyholder. The project company is not the policyholder. This is an advantage for the lenders in one respect, in that in a lenders policy the indemnity is directly geared to default on the payment obligations under a loan or financing. However this is not always an advantage.
We often find that a lenders' policy covering political violence is not sufficient cover. This is not an issue of numbers but policy form. Take for example a $500 million power project with $300 million of tangible assets financed by $100 million of equity and $400 million of debt. If the debt has Lenders Political Risk Insurance including political violence the project has $400 million of political violence cover in place and only $300 million of assets.
But who pays for a terrorist or war loss that causes $50 million of repairable damage to the power plant? The Lenders PRI policy is not intended to pay for property losses. It only responds to default. Lenders will want to avoid project default by rebuilding. However this is not the intent of the Lenders PRI cover, and at best the lenders have a difficult sue and labour claim against the investment insurers.
This highlights a key issue in the planning of political violence cover for projects, that of abandonment versus rebuilding. In what circumstances would you rebuild following property damage due to terrorism or war? In what circumstances would you abandon? And if you want to rebuild, who bears the cost? Our conclusion is that if Lenders PRI is not complimented by the right type of stand-alone political violence insurance covering property damage you have a problem.
This issue has not been addressed sufficiently by investment insurers. Partly this is because the war and political violence cover in an investment insurance policy has been treated as the poor relation. The focus of investment insurers has been on expropriation, breach of contract and currency inconvertibility. A deep-seated reason for this is that these latter types of political risk are all recoverable. Political violence losses are by their nature not recoverable losses. This makes many investment insurers nervous.
This is why the role of the stand-alone political violence insurers is important, refreshing and highly relevant in today's environment. Not least of all, this is because their underwriting is not geared to recovery. For them, as in other classes of property and other insurance, a loss is to be paid out of the accumulated premium fund with insurers accepting that there will be little or no chance of recovery.
The market for insuring land based assets on a stand alone basis has grown naturally from the Lloyd's and the London marine and aviation war risks market that have flourished since the Waterbourne Agreement in 1930s covering ships and aircraft against war risks. This has been a most successful market.
Little was written in the specialist market for land based assets before 1996: war risks were off limits; and terrorist cover was included in general property policies. Then in 1996, an exception was granted to the Agreement to permit the writing of war risks on land within a specialist account. This liberalisation is based on the belief that a specialist account can be written where aggregations are carefully monitored using modern technology. As a result, insurers control their aggregations by monitoring exposure world wide per square kilometre. We think this approach is sound.
The development of the market has increased since the general insurers started excluding terrorism cover. The capacity available per risk across the market is again measured in $100s of millions, but there is more capacity for terrorism than war risks.
It is difficult to generalise about price. However in the broadest terms rates in the stand-alone market for political violence cover are often between 0.1% and 0.5% per annum. Coverage periods are usually written for a 12-month period like other property insurances, but policies are normally non-cancellable and may be extended every six months, to ensure better continuity of cover.
The coverage from the stand-alone market is usually geared to physical loss and damage. Unlike with the investment insurers, coverage is often bought at the project level, by the project company.
However it is worth repeating that the risk to a project is not just physical damage. One is reminded of the mining project in Papua New Guinea that was closed in the 1980s due to the persistent harassment of their work force by local rebels. Though the mine was lost, a property-based policy would not respond because there had been no damage to physical assets. Abandonment coverage that does not require the project assets to be damaged by political violence has its role in planning an insurance program for these types of risk.
There is no doubt that sooner or later other projects will suffer serious physical loss and defaults due to political violence. General insurance policies, which have always excluded war risk, are now unlikely to respond to terrorism losses either. However the specialist insurance market, consisting of the investment insurers and the stand alone political violence insurers, has considerable capacity for addressing these risks. Project financiers should make sure that the political violence insurance program has been properly designed and implemented.
Much has been made of the withdrawal by general insurers of terrorism cover since 9/11. And conventional ?all risks? project insurance is likely to do very little, if anything, to deal with terrorism and war risks. However, the specialist investment insurance and political risk insurance market has the capacity and appetite to address these risks.
A range of government and private insurers offer a variety of political violence coverages that can respond both to physical damage to project assets and to interruption and abandonment risks. Some policies address loan or bond default caused by political violence. Others seek to help avoid such defaults following war or terrorist attack, by providing property damage cover to pay for the cost of repairing and replacing facilities.
While the removal of terrorism cover from general insurance policies since 9/11 has created a significant coverage gap, it is worth reflecting that the general insurance market has never catered for the full spectrum of political violence risks, or offered a complete solution to the problem.
However, until recently, terrorism was thought to pose less of an aggregation threat. As a result terrorism, riots, strikes, civil commotion and other forms of political violence short of war or civil war, were often included in general insurance policies.
The tragic events at the World Trade Center have changed that perception. The aggregations associated with targeted terrorist attacks are now considered in the same category as war risk: too large to be soundly underwritten in a general insurance account. Special treatment is needed.
The burden of terrorism insurance has to some extent fallen back on governments, particularly in the developed world. The most recent example is the US Federal Terrorism Insurance Act that was signed into law in November 2002. The Act requires insurers of US located risks to offer to reinstate terrorist cover. As a quid pro quo, the Federal government provides reinsurance protection against catastrophic terrorist losses. Other countries like the UK and South Africa, with an historic problem of terrorist attack, already had government schemes in place. Others governments are developing or have developed responses to the current terrorism insurance crisis prompted by 9/11.
However these government terrorism schemes are unlikely to be the solution for many projects. They only offer cover for assets in their home country. They cover only part of the spectrum of political violence and do not extend to war risks. Many are more focussed on property damage and its aftermath, rather than the less tangible risks associated with abandonment of operations. In particular, they are unlikely to provide any solution in most emerging markets, where the risk is often highest.
It is against this background that the coverages available from the specialist investment insurers and private sector political risk insurers have been thrust into the spotlight. The flow of business into the specialist markets has increased dramatically over the last 18 months and the market has responded with capacity and innovation.
The market collectively has capacity for individual projects measured in the $100s of millions. Additionally it offers a wide range of political violence insurance products. These range from conventional property forms, geared to physical loss or damage and business interruption losses triggered by physical damage, to equity and lender based forms catering for the needs of investors, sponsors and lenders, and forced abandonment type covers.
The specialist market divides in two. First, the government and private sector investment insurers who offer political violence cover usually as part of a wider investment insurance product also covering such risks as expropriation and currency inconvertibility. Second, the political risk insurers mainly in the London market who offer war and terrorism coverage on a stand-alone basis.
The investment insurers consist of both multilateral and government schemes like MIGA, OPIC, ECGD, EDC and others, and their counterparts in the private sector like AIG, ACE Global Markets, Chubb, Sirius, Sovereign, Unistrat and Zurich. They are joined by those at Lloyd's who usually only write political violence cover as part of an investment insurance package.
The investment insurance community are complimented by those in the private market who have the ability to offer war and terrorism cover on a stand-alone basis. These include Catlin, Beazley, Wellington, Kiln, XL London Markets, Ascot in Lloyd's, and Inter-Hannover, Berkshire Hathaway, Montpelier Re and others in the companies market. These insurers may also write political violence insurance as part of a wider investment insurance. But it is their ability to write these covers on a stand-alone basis that is of interest here. Other insurers offer stand-alone cover for terrorism, but not war, and include AIG Crisis Management, QBE and SRIR.
I emphasise the difference between the investment insurers and the stand-alone political violence insurers because they have different origins and traditions, and very different approaches to the subject as a result. Both have an important role to play as far as project financiers are concerned. However, it is perhaps the role of the stand-alone terrorism and war risk insurers that I wish to emphasise, partly, as they are less well known in project finance circles than the investment insurers.
Before turning to the stand alone insurers, it is worth dwelling a little on the main characteristics of the investment insurers. Usually commentators focus on the difference between the government and private sector insurers. There is of course the difference that government insurers generally only insure new investments and have eligibility criteria relating to nationality of policyholder, for example. For the purposes of this paper, I would like to emphasise the similarity of approach of the investment insurers, public and private and contrast them with the characteristics of the stand-alone market.
The capacity for political violence risks remains strong among the investment insurers. Though the balance may have swung marginally in favour of the government schemes, the private sector capacity remains significant. Periods remain multi-year: there is still plenty of capacity for 5 and 10 year periods. 15 year periods are still available in the public sector and occasionally from the private sector.
An important shared characteristic of the public and private investment insurers is that their political violence covers are designed from the perspective of the investor or lender, the usual policyholder. The project company is not the policyholder. This is an advantage for the lenders in one respect, in that in a lenders policy the indemnity is directly geared to default on the payment obligations under a loan or financing. However this is not always an advantage.
We often find that a lenders' policy covering political violence is not sufficient cover. This is not an issue of numbers but policy form. Take for example a $500 million power project with $300 million of tangible assets financed by $100 million of equity and $400 million of debt. If the debt has Lenders Political Risk Insurance including political violence the project has $400 million of political violence cover in place and only $300 million of assets.
But who pays for a terrorist or war loss that causes $50 million of repairable damage to the power plant? The Lenders PRI policy is not intended to pay for property losses. It only responds to default. Lenders will want to avoid project default by rebuilding. However this is not the intent of the Lenders PRI cover, and at best the lenders have a difficult sue and labour claim against the investment insurers.
This highlights a key issue in the planning of political violence cover for projects, that of abandonment versus rebuilding. In what circumstances would you rebuild following property damage due to terrorism or war? In what circumstances would you abandon? And if you want to rebuild, who bears the cost? Our conclusion is that if Lenders PRI is not complimented by the right type of stand-alone political violence insurance covering property damage you have a problem.
This issue has not been addressed sufficiently by investment insurers. Partly this is because the war and political violence cover in an investment insurance policy has been treated as the poor relation. The focus of investment insurers has been on expropriation, breach of contract and currency inconvertibility. A deep-seated reason for this is that these latter types of political risk are all recoverable. Political violence losses are by their nature not recoverable losses. This makes many investment insurers nervous.
This is why the role of the stand-alone political violence insurers is important, refreshing and highly relevant in today's environment. Not least of all, this is because their underwriting is not geared to recovery. For them, as in other classes of property and other insurance, a loss is to be paid out of the accumulated premium fund with insurers accepting that there will be little or no chance of recovery.
The market for insuring land based assets on a stand alone basis has grown naturally from the Lloyd's and the London marine and aviation war risks market that have flourished since the Waterbourne Agreement in 1930s covering ships and aircraft against war risks. This has been a most successful market.
Little was written in the specialist market for land based assets before 1996: war risks were off limits; and terrorist cover was included in general property policies. Then in 1996, an exception was granted to the Agreement to permit the writing of war risks on land within a specialist account. This liberalisation is based on the belief that a specialist account can be written where aggregations are carefully monitored using modern technology. As a result, insurers control their aggregations by monitoring exposure world wide per square kilometre. We think this approach is sound.
The development of the market has increased since the general insurers started excluding terrorism cover. The capacity available per risk across the market is again measured in $100s of millions, but there is more capacity for terrorism than war risks.
It is difficult to generalise about price. However in the broadest terms rates in the stand-alone market for political violence cover are often between 0.1% and 0.5% per annum. Coverage periods are usually written for a 12-month period like other property insurances, but policies are normally non-cancellable and may be extended every six months, to ensure better continuity of cover.
The coverage from the stand-alone market is usually geared to physical loss and damage. Unlike with the investment insurers, coverage is often bought at the project level, by the project company.
However it is worth repeating that the risk to a project is not just physical damage. One is reminded of the mining project in Papua New Guinea that was closed in the 1980s due to the persistent harassment of their work force by local rebels. Though the mine was lost, a property-based policy would not respond because there had been no damage to physical assets. Abandonment coverage that does not require the project assets to be damaged by political violence has its role in planning an insurance program for these types of risk.
There is no doubt that sooner or later other projects will suffer serious physical loss and defaults due to political violence. General insurance policies, which have always excluded war risk, are now unlikely to respond to terrorism losses either. However the specialist insurance market, consisting of the investment insurers and the stand alone political violence insurers, has considerable capacity for addressing these risks. Project financiers should make sure that the political violence insurance program has been properly designed and implemented.
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