3

Risk Management in International Business

Risk Management in the global supply chain in 2017 and beyond has become one of the most important elements in managing import and export responsibilities with “Best Practice” as a mind-set.

Understanding the exposures of international business is a skill set required for supply chain executives. This chapter explores the risks associated with international shipping, such as receivables, loss and damage, and political risk, and it discusses various insurance products and services available to transfer the exposures to third parties.

Private and governmental insurance concerns are readily available to provide various products for exporters to use to reduce risk and make them more competitive in world trade. In addition, this chapter provides insight into the skill set of risk management, which is vital for the continuation and growth of export trade.

THE LOGISTICS OF POLITICAL RISK MANAGEMENT IN EXPORTING

As exporting continues to make the world smaller, it can make it more complicated. The more complicated it is, the greater the risks. U.S. companies are increasing investment and trade activities in all parts of the world. Where there is certain political instability, like Sudan, Lebanon, Russia, Venezuela, Haiti, Nigeria, North Korea, and Syria, to name a few hot spots, there is a growing demand for corporations to analyze exposure, adopt risk transfer options, and provide loss control alternatives; in other words, do political risk management. When we consider the realities of political risk management, what are we saying? Or, in better terms, what are we asking?

These risks and exposure questions are germane to all size companies and must be considered by the most experienced and new export companies. Political risk management must become a function of the overall logistics management responsibility. Following are seven areas that should be reviewed thoroughly when evaluating the risk management functions of political risk before goods are shipped.

1. Limited marketplace. There are only a handful of markets here and abroad that can provide political risk coverage. The U.S. government by the Overseas Private Investment Corporation (OPIC), the Export-Import Bank of the United States (EXIM Bank), along with private companies like the Foreign Credit Insurance Association (FCIA), American Insurance Group (AIG), COFACE, and CNA are definite options, which can be explored using a corporate insurance broker.

2. Terms and conditions. Boilerplate policies are not adequate. The policies must be written to follow the nature of the trade, transaction, or contract occurring in the foreign market.

3. Analysis. Risk managers must consider the social, economic, political, and financial situations of the foreign buyer or partner, the host country, and the world situation in general. This is key to determining exposure!

4. Loss control options. One must look at options to minimize loss using engineering, contract wording, transaction planning, and other methods. In many instances, the purchase of insurance can be avoided by executing other options that are more secure and less costly.

5. Retention. Political risk covers financial loss. Typical exposures like confiscation, nationalization, expropriation, and deprivation (CNE&D), contract frustration, and unfair calling of financial guaranties require the risk manager to consider a coinsurance factor and a substantial waiting period that become the retention levels for the corporation.

6. Corporate communication. The nature of overseas sales, the bureaucracy of a large corporation, and the time and distance involved often leave “risk management” as an afterthought. The realities typically have the risk manager review a contract after it has been signed, sealed, and delivered. The risk manager needs to communicate to its operating divisions (1) what the exposures are, (2) what the risks are, and (3) how to access the terms before goods are shipped. This is key to a “total approach” effort for successful risk management.

7. Brokerage selection. The reality of who your political risk broker should be is a difficult one. The specialization of political risk requires not only basic insurance knowledge but knowledge of international trade, political science, banking expertise, and contract analysis. There are only a handful of specialized brokers in political risk who are spread throughout some of the major brokerage houses and some small specialty facilities. Marsh (merged with Johnson & Higgins), Gallagher, CO-FACE/NY, and Willis Faber are but a few of the experienced and qualified brokerage organizations.

These seven areas provide an overview for the exporter to consider before merchandise is shipped. It is key to remember that the U.S. government is committed to promoting exports and investment abroad, thereby reducing the deficit and enhancing our economic stability on foreign shores.

Using finely tuned risk management, the exporter now can deal with the realities of political risk exposure worldwide. Taking steps as part of the logistics process is significant to the U.S. exporting industry successfully competing in world markets.

POLITICAL RISK INSURANCE UPDATE: 2017 AND BEYOND

As the second decade of the new millennium matures, U.S. companies are increasing their overseas trade and investment activities. However, the recent wars in Afghanistan, Iraq, and Syria and destabilization in North Korea, Sudan, and certain countries in Latin America and West Africa heightened executives’ concerns over the risk of political instability. During the past three decades, Bosnia, Argentina/England, the Tiananmen Square incident, the Panama invasion, instability in Indonesia, the turmoil in Central and West Africa, the war in Iraq, threats in North Korea, and similar events have caused many a sleepless night for senior corporate executives. Political risk insurance is available to ease these concerns and provide stable international activity and investments. There are a host of willing brokers and underwriters anxious to manage and deal with political risk exposures. This chapter reviews the insurance options.

History

To understand the current political risk insurance arena, it is helpful to understand some of the history of this relatively new line of insurance. The first modern political risk policies were written in the early 1960s. Over the years, political risk policies have become clearer and more specific regarding the intent and scope of coverage. In some instances, these changes broadened coverage, while they made the policies more restrictive in others. The marketplace has also undergone changes over time. Ten to fifteen years ago, there were many insurers and reinsurers participating in the political risk insurance marketplace; today there are only a handful.

Perhaps the greatest change in political risk insurance since its inception is the underwriting approach used. Today, underwriters have strong skills in international trading, finance, and banking combined with underwriting expertise in international insurance. A political risk insurance underwriter must understand international trade first and underwriting second. To underwrite the vanilla type of political risk policy, like one covering confiscation and nationalization, a basic understanding of international trade is necessary. For more complicated risks like counter trade, currency inconvertibility, and contract frustration, the underwriter must be well educated in the art and science of international trade. Knowledge of banking, letters of credit, foreign contract negotiation, and international law is a prerequisite for successful underwriting. Because there are no formal schools that provide training in political risk insurance, insurers have developed their own training and education programs, and many of them are excellent.

Today’s highly educated underwriters require much more information than did their counterparts ten or more years ago. They ask hard, detailed questions. They also review copies of contracts and terms of trade to completely understand the transaction before binding coverage.

While the political risk insurance marketplace has waxed and waned over the years, the future looks bright. The insurers are positioned for effective underwriting and creative marketing to respond to the needs of U.S. companies engaged in international trade.

Spread of Risk

As with any line of insurance, it is important for insurers to achieve a spread of risk in their insurance portfolios to offer stable pricing and policy terms. Unfortunately, however, the buyers of this insurance have a natural tendency toward adverse selection; that is, corporations with sales or assets in a variety of markets or countries tend to insure only the political risks associated with those areas of the world that present current political instability. The tendency of exporters/insureds to retain “easier” risks while transferring “hot spots” to insurers frustrates insurers’ attempts to maintain a diverse spread of risk.

However, there is an inherent flaw in this philosophy of insuring only the difficult risks and retaining the less risky exposures. If an underwriter is provided with a broad spread of risk, a reduction of rates and more liberal underwriting terms may be obtained. The greater the spread of risk presented to an underwriter, the lower the rate that will be used to develop premium, up to a point. This may allow the insurance of more risk for the same premium than would be charged to cover only those countries, projects, or products that present the most exposure to the exporter.

There are several ways an exporter/insured can provide insurers with a spread of risk when buying political risk insurance, including the following:

Diversification of countries. Consider insuring all export sales, even sales to countries with a tradition of political and economic stability.

Diversification of products. Insure all products and not just those presenting the highest risk of loss.

Terms of sale/payment. Some methods of sale and payment present greater exposure than others. The most secure type of sale is one that has some form of guarantee, security, or collateral from an independent third-party facility, like a letter of credit where a third-party banking facility guarantees the financial aspects of the transaction. However, a significantly higher exposure is presented to the exporter/insured when sales are done on an open account, site draft consignment, or other terms whereby the customer in a third-world country is likely to receive the merchandise before being obligated to pay. By insuring secured sales along with those that have no third-party guarantee, the spread of risk is increased.

Timing. Spread of risk can be increased by making shipments over an extended period as opposed to adhering to a compact shipping schedule. This approach allows time for some shipments to be paid before other shipments are delivered. Adjusting the timing in this manner avoids exposing the entire value of the transaction at one time. Shipping schedules encompassing a one- to three-year period are viewed favorably by many underwriters, but some types of transactions will benefit from a longer period (e.g., seven years).

Political Risk Coverages

There are several types of political risks:

Confiscation

Currency inconvertibility

Nationalization

Devaluation

Expropriation

Unfair calling of financial guarantee

Deprivation

Trade disruptions

War, strikes, riots, and civil commotion

Terrorism

Contract frustration

There are several different types of political risk. In many respects, political risk insurance is like export credit insurance (and some people might include export credit insurance in the list). However, there are some distinct differences between these two categories of insurance. Basically, a political risk loss results from a peril originating out of a political or government eventuality, whether the consignee is a sovereign or private entity. An export credit risk, however, is typically defined as the credit exposure emanating solely from the actions or inactions of the private buyer.

The main distinction is that credit exposures emanating solely from private buyers are inherently more volatile than those that depend on the action of a governmental entity. This results in fewer insurers willing to write export credit coverage. When it is provided, a substantial volume of underwriting and credit information is required, the rates are high, and the coverage terms are restrictive.

Incidents like the Gulf War, Bosnia, 9/11, Iraq, Afghanistan, Sudan, Yemen, and Syria caused many people to focus on war and terrorism coverage. Virtually all property insurance policies contain war exclusions, making it clear that damage caused by a war between two or more countries is excluded. The application of a property insurance policy to terrorist acts may not be so clear cut, but some form of basic coverage is provided for terrorist acts by many property insurance policies. The approach used in the war exclusion of the latest Insurance Services Office, Inc. (ISO) is that commercial property forms are commonly used even in non-bureau forms. Such policies exclude only damage from war, rebellion, revolution, civil war, or warlike action of a military force. Property policies containing exclusions of this nature would typically be deemed to cover damage caused by most terrorist acts. However, some property insurance policies also exclude damage caused by a hostile or warlike action of an agent of a foreign government. Under this language, an insurer might be justified in excluding coverage if the terrorist act was proven to be inflicted by an agent of a foreign government.

ISO War Risk Exclusion

The ISO will not pay for loss or damage caused directly or indirectly by any of the following war and military actions:

1.War, including undeclared civil war

2.Warlike action by a military force, including action hindering or defending against an actual or expected attack, by any government, sovereign, or other authority using military personnel or other agents

3.Insurrection, rebellion, revolution, usurped power, or action taken by a governmental authority in hindering or defending against any of these

Coverage for the excluded property damage exposures is available in the political risk insurance marketplace in the form of a war risk, civil commotion, and terrorism policy. The need for this coverage is dictated largely by the stability of the regions in which the insured’s facilities are located and the scope of the war risk exclusion in the insured’s property insurance policy. Of course, war risk exclusions can vary considerably from policy to policy and must be carefully analyzed when evaluating the need for separate coverage.

CNE&D are the most commonly purchased political risk coverages. They are needed by organizations with assets, like refineries or manufacturing plants, that are permanently located in other countries. The policies respond when these assets are taken over by governmental action, as recently occurred in Libya, Iraq, and Nicaragua and, in the more distant past, Chile, Vietnam, and Iran.

Nationalization takes place when the host government simply takes over an asset. Deprivation is said to occur when the host government interferes with the foreign entity’s access to or use of its asset without taking possession of it. In either situation, the property owner can suffer a substantial financial loss. Confiscation and expropriation are similar actions; the host government takes over the foreign asset with the intent of returning it to the owner in the future. However, the time frame is usually not specified and often extends over several years, causing financial loss to the foreign-based property owner. Because of the similarities between these exposures, the best approach to structuring CNE&D coverage is to insure all four perils in a single policy. This approach minimizes the problems that could otherwise result from disputes with insurers as to whether an action falls into one category or another.

Another common political risk for which insurance is available is contract frustration. This entails the nonperformance or frustration of a contract with a host governmental entity or private buyer in a third-world country because of an invalid action. An invalid action is an activity detrimental to the U.S. interest that would be considered inappropriate or illegal in the United States. It can be further defined as an action that wrongfully invalidates an overseas transaction in such a manner that the exporter is unable to obtain payment for its product or recoup its assets.

As an example of the contract frustration exposure, assume a U.S. company has a contract with a third-world government to supply custom-designed parts for the construction of a factory. However, the third-world government cancels the contract without a valid reason prior to delivery of the product. In such a situation, it would be common for the company to have spent a substantial sum on the initial design and preparation to manufacture the parts. Because the project involved a custom design, it is unlikely that another buyer for the parts could be found, and the exporter would suffer a financial loss.

Currency inconvertibility is an increasing concern for U.S. exporters, particularly those that sell on open account or provide open terms of payment. This type of loss occurs when the insured’s customer pays in local currency and the local government is unable to exchange the local dollars into foreign currency. Examples of countries where this can be a problem are Columbia, Brazil, Nigeria, the Philippines, and Mexico.

Currency inconvertibility has become a problem in countries that underwent a tremendous expansion in the 1960s to the year 2017 because of foreign oil sales and the growth of foreign direct investment. When oil sales began to decline in the 1980s and the Organization of Petroleum Exporting Countries (OPEC) could not agree on pricing and sales quotas, affected countries suffered a trade imbalance, causing more hard dollars to leave the country than were arriving. This made it difficult for the national banks of these countries to convert the local currency into the currency of other countries because the banks were not able to purchase foreign dollars, yen, Swiss francs, and so on with hard currency. In other words, the banks may not possess an adequate amount of U.S. dollars or other currencies to make the exchange. Ultimately, what typically occurs in these situations is a rescheduling of the country’s debt over a multiyear period, implementation of strict economic controls internally within that country, and involvement by various international entities, like the International Monetary Fund (IMF), World Bank, and General Agreements on Trade and Tariff (GATT).

When insuring a trading activity in a country that commonly has problems converting its currency, underwriters typically will write the policies with a waiting period that corresponds with the time frame over which the conversion will occur. This waiting period ranges anywhere from 60 to 720 days. The purpose of the waiting period is to ensure the coverage applies only to fortuitous loss.

An often-overlooked exposure of many companies doing business overseas is the risk of an unfair calling of a financial guarantee. This risk usually arises with large transactions that take many months or years to complete. In such a situation, it is common for the buyer to make a down payment (for example, 15 percent of the contract price), followed by periodic installment payments as the project progresses. The buyer would typically require the seller to post a letter of credit or other financial guarantee against these payments, and the buyer would be able to draw down on that letter of credit in the event that something occurred that caused the supplier to default. The unfair calling of this financial guarantee is an exposure to the exporter/supplier, and unfair calling insurance protects the exporter against this risk.

Trade Disruption

Another exposure that companies involved in international trade often overlook is the business interruption exposure that is caused not by physical damage to a plant or other facility but by a political event. Both importers and exporters face this loss exposure. For example, assume a manufacturer relies on a single supplier in a third-world country to provide raw material that it imports for its U.S. manufacturing plants. A political occurrence, like a war, strike, change in government, confiscation of the supplier’s assets, change in politics, or change in law occurring in the source country could disrupt the flow of that raw material into the United States. The manufacturer’s ability to produce the finished product would be impaired, and a substantial financial loss may occur if an alternative source of the raw material could not be found. In a similar fashion, an exporter can experience a loss when the product is not delivered on time because of some event beyond the control of the exporter. Such exposures are insurable in the political risk insurance market.

It is important to understand that most executives tend to view their potential loss as the value of the physical product, failing to consider the potential loss of earnings, extra expense, loss of profits, and loss of market in the event a physical and/or political eventuality occurs. Trade disruption coverage can provide protection for these losses.

Markets

The political risk insurance marketplace can be divided into two basic categories: governmental markets and private markets. In the United States, the principal governmental market is the FCIA (now part of the Great American Insurance Company), which was authorized by the U.S. government via EXIM Bank. With headquarters in New York City and satellite offices throughout the United States, the FCIA provides many types of political risk coverage and export credit insurance for U.S. exporters shipping U.S. products to approved countries. Most non-Communist countries in the world that have favorable trading status with the United States are considered approved. COFACE, located in New York City, is also a growing option.

In the past, the FCIA was considered bureaucratic and unresponsive to the needs of most exporters. However, in recent years, this has changed and the FCIA has become more responsive by offering competitive and comprehensive programs, like the bank letter of credit and new-to-export buyer programs.

OPIC is the other U.S. government–sponsored market for political risk insurance. OPIC insures U.S. nonmilitary investment exposures, like confiscation and nationalization, in developing nations throughout the world. Its terms and conditions are broad, and the rates are as competitive as the FCIAs. However, only assets located in nations having favorable trade relationships with the United States qualify for coverage with OPIC.

There are two drawbacks to the U.S. government’s programs. First, they are subject to U.S. diplomatic and trade policies. When the U.S. government is following a restrictive trade policy with a country, the EXIM Bank and other governmental facilities tend to follow suit, thus reducing the availability of coverage or restricting coverage terms for that country. Likewise, when the government eases trade restrictions with a country, coverage availability and terms will increase.

While this may be good politics, it sometimes restricts coverage availability for transactions with countries that, while not on favorable trade terms with the United States, might present good business opportunities and be excellent credit risks for individual businesses. For example, several U.S. companies have been successful in trading with the Soviet Union over the past few years and have been paid regularly and responsibly. However, because of its unfavorable trade relationship with the United States, transactions with the Soviet Union are generally not eligible for most of the U.S. government’s insurance programs.

The second drawback to U.S. governmental markets is that they only cover U.S. companies and/or products. As an example of how this restricts availability, consider a company located in New York City staffed by U.S. personnel that exports Canadian products into Europe on an open account basis, thus creating an exposure that could be covered by export credit insurance. This company would not be eligible to buy credit insurance from the U.S. governmental facilities because the product is not manufactured in the United States.

Of course, this limitation of coverage availability is fundamental to the underlying purpose for which EXIM Bank and OPIC were created: to encourage and support the exportation of U.S. products and services. These facilities are not always profitable, but they provide an indirect means of subsidizing U.S. business interests overseas. Now, the U.S. government will only subsidize activity that directly benefits U.S. interests, products, or services.

Most other Western nations also have established facilities like the EXIM Bank and OPIC to insure export sales to other countries. U.S. companies with divisions domiciled in these nations can often access these local governmental programs.

The private insurance market provides coverages that are not available from the governmental markets, and it is not bound by the diplomatic policy of any one nation. This market is basically made up of some U.S.-domiciled insurance companies and London markets. The principal U.S. companies that write political risk insurance are Chubb, CNA, and American International Underwriters (AIU), but there are a handful of other insurers that occasionally write various types of political risk coverage. Most U.S. insurance companies with marine capability will write war, strikes, riots, and civil commotion coverages on overseas transactions. Along with Chubb and AIU, other underwriters include MOAC (Continental), CIGNA, Fireman’s Fund, and Great American.

Being commercially driven, U.S. insurers will write insurance in those areas where there is an opportunity for profit. The natural downside of this tendency is that it is difficult to obtain insurance from these insurers in countries where the possibility of loss is significant. In general, U.S. insurers offer broad policies and competitive rates and are willing to write on a spread of risk basis, affording the exporter a complete program covering all overseas sales.

The London market is composed of Lloyd’s of London, Institute of London Underwriters (ILU), and other insurers. This marketplace is as competitive as its U.S. counterpart. In addition, the London insurers typically are willing to put out more capacity and are more agreeable to manuscripting policy forms. London underwriters also have different perspectives on certain areas of the world than their U.S. counterparts and may provide coverage in areas where U.S. insurers are reluctant to do so.

Care should be taken in choosing an agent or broker to access the marketplace. The broker should be large enough to bring a substantial number of international resources to the table and have a staff that is knowledgeable in international trade and the political risk marketplace.

Loss Control

There are several loss-control tactics that U.S. companies doing business overseas should consider using. These measures help reduce exposure and secure more competitive pricing and more comprehensive terms from political risk insurers.

Political risk exposures are heavily influenced by the contracts underlying the business transactions. Contracts often are executed on overseas transactions without review by insurance advisers. Knowledgeable insurance advisers often can suggest alterations that will substantially reduce the exposure, making the transaction easier and less costly to insure. For example, underwriters view the inclusion of arbitration clauses favorably because such clauses substantially increase the likelihood that the exporter will get a fair hearing in the event of a dispute, as opposed to arguing its case in the local courts. Consider a situation in which an exporter is fighting the government of a third-world country on an unfair calling of a financial guarantee in that country’s court. There would be a serious disadvantage to the U.S. company in that situation compared to an arbitration proceeding in Zurich, London, or some other city outside that government.

Another consideration is to give the local government an interest in the overseas venture. For example, assume a U.S. company builds a plant in a third-world country.

Involving local personnel in the management and operations of a local venture can also reduce the political risk exposures. When a foreign-owned facility employs many local citizens, the government is less inclined to cause a disruption of its operations.

Careful consideration should be given to the currency transactions specified by the contract. A transaction that runs into problems because it requires that local currency be converted into U.S. dollars might flow more smoothly if some other currency, like yen or marks, could be used to complete the deal. The alternative currency might then be used in other international trades or converted to U.S. dollars. It is also important to set up contingency plans to follow in the event a political eventuality occurs that would disrupt the venture or transaction. This involves developing specific strategies for dealing with potential political problems.

In a time of global instability, political risk assessment is a critical aspect of managing overall supply chain risk in any company’s supply chain as a measure to both reduce risk and cost.

Conclusion

In the past few years, there has been a dramatic increase in U.S. exporting and importing activity. More U.S. companies than ever are making investments overseas and importing raw material or finished products from their overseas subsidiaries. These activities present substantial risks not faced by organizations operating solely in their home countries. Once these exposures are identified, they can be insured by government-sponsored facilities or in the domestic and London insurance marketplaces.

Political risk insurance is both a convoluted and comprehensive risk management strategy.

POLITICAL RISK: NOT FOR THE FAINTHEARTED

In the past twenty years, the primary market for political risk insurance had many players, most of them new. Reinsurance capacity was adequate. The demand for coverage was great and rates were high. Then the marketplace changed dramatically.

From the mid-1980s on through 2017, insurers have encountered significant losses. “Hot” areas like Lebanon, Libya, Iraq, Iran, Myanmar, and Venezuela produced frequent and large claims in underwriting exposures like war, terrorism, confiscation, nationalization, expropriation, deprivation, and currency inconvertibility.

In addition, the worldwide debt problem brought substantial and numerous claims in currency inconvertibility, devaluation, and contract frustration. Because of claims in countries like the Philippines, Iraq, Syria, Brazil, Argentina, Mexico, and Nigeria, insurers experienced an increase in loss frequency. Thus, many private insurers withdrew or significantly restricted coverage in certain geographic areas.

In the early 1980s to the late 1990s, insurers had written broad policies containing terms that should have been black and white but that were gray. One of these areas was related to currency devaluation. However, it did not take too many losses before underwriters made it clear that this exposure was to be excluded under their insurance terms.

Ultimately, because of the losses that hit the marketplace and fears of more in the future, the marketplace sorted itself out. There are several new underwriters, including those who write niche policies under specialty banners, that can be accessed via corporate insurance brokers.

As we enter the year 2017, some major players, like Lloyd’s, AIG, and Chubb, along with various government backed options, provide substantial capacity, although these insurers now write the risks in a more detailed and comprehensive manner than they did earlier in the decade. Lloyd’s has undergone a changing of the guard. Many Lloyd’s leaders that were in this business in the early 1980s to the end of the 1990s remain today, but others who attempted to write political risk insurance have abandoned it.

In addition, although the efforts were minimal, many marine underwriters in London did attempt to extend their policies to cover certain types of political risk. And war risk underwriters in London were, and still are, major players in CNE&D risks.

For example, during the past two decades, some banks have attempted to enter this market as insurers, brokers, or major assureds. In examining political risk insurance in the 1990s through to 2017, the major role played by governmental facilities must be considered. Most westernized trading nations have some sort of governmental agency that provides insurance on export sales. Typically, these programs are designed to promote export trading and foreign investment. Often they are politically motivated. The United States has OPIC and the EXIM Bank. OPIC primarily responds to fixed investments in third-world countries, while the EXIM Bank responds to all U.S. exports worldwide. The EXIM Bank is more inclined to help a U.S. trading or exporting company and provides a full range of political risk and export credit insurance programs.

Another quality insurer is the FCIA. At one time the FCIA was underwritten by a consortium of private insurance companies, but sometime between 1980 and 1982, because of poor loss experience, the programs became completely underwritten by the U.S. government by the EXIM Bank in Washington, D.C. The FCIA offers an array of programs and services via a professional staff of marketing, underwriting, and claims executives. It is now a private underwriter that is part of the Great American International Companies.

In the early part of 2016, the EXIM Bank was accused of being just another governmental agency with lots of red tape and bureaucracy, with little economic value, and was in jeopardy of being disseminated. The challenge from some very conservative legislators was not successful, and EXIM Bank was reinstated.

Recently it has upgraded its staff, streamlined its procedures, and modernized its programs and is becoming a lucrative option for exporters. FCIA’s programs are designed for large and small companies, first-time exporters, and financial institutions.

It is important to note that banks in EXIM Bank programs can receive their funds promptly when losses occur and not get caught in trade dispute problems that curtail cash flow. Consequently, the EXIM Bank should become an even more important player in this millennium as the U.S. government continues to emphasize U.S. exports and provides the resources to promote them. The agency’s challenge is to meet the needs and demands of the U.S. exporter and to make its programs known and easily accessible.

The demand for political risk insurance will grow in the year 2004, primarily because U.S. companies will increase their exports to westernized and third-world countries. To compete with foreign and domestic suppliers, U.S. companies will sell on extended terms, increasing their credit exposures.

The political risk underwriter will need to extend coverage to commercial credit risks. Currently, only a handful of underwriters will provide the export credit cover. Other markets willing to provide political risk exposure cover should step up to the plate and provide some sort of protection for sales to private buyers and the accompanying credit risks. Governmental insurance programs, which must meet requirements for “American” content, must be modified to address the need for “foreign” content as well.

Because of these needs, the development of appropriate underwriting skills in credit analysis, political risk review, and international trade also must proceed. The political risk underwriters of the future must be multifaceted and have talents beyond those required by “normal” underwriting. They must also be well versed in letters of credit, foreign banking practice, and current events on a multinational basis and should have an eye for hidden exposures covered by international trade terms.

Because political risk insurance is a unique exposure, special relationships exist. Numerous markets that may be involved in this area but do not make that information public make accommodations to suit their clients.

In addition, the seriousness of the political risk exposure calls for more of a partnership between the insured and the underwriter than do more traditional forms of insurance. The contract of sale between the exporter and the foreign buyer becomes the building block of the policy, ensuring terms and conditions. The insured and the underwriter must communicate openly, develop a complete understanding, and make certain that the intent of the policy is made clear. This is essential because the intricacies of international trade are not always black and white.

U.S. and some major foreign banks, which have played a functional role in political risk insurance, will also continue to be an integral part of the market. Many of the banks that have set up export trading companies to become directly involved in international transactions will attempt to become first-party insurers as well. Because banks continue to face legal challenges to their right to become involved with insurance, this development process will be tedious and slow but will continue to evolve. Banks first will attempt to buy and control brokers that can handle these risks, eventually becoming direct underwriters themselves.

Other Players

Europe, Hong Kong, and Japan will supply other players, in addition to the United States and London. For example, in the late 1980s, Pan Financial, a company formed in London because of a tri-venture of Skandia, Yasuda, and Continental, would underwrite certain classes of political risk and credit exposures. And COFACE out of Paris, France, has become a major player in political and credit risk insurance in markets worldwide. In New York City, the contact is [email protected] or 917-414-9572. The trading nations of the world recognize the need to provide insurance for exports, and both governmental and commercial resources will respond to this need.

Foreign markets will be particularly important for reinsurance because domestic capacity for these risks will remain limited. (The U.S. reinsurance market appears to have determined that the class is too difficult and that it has tremendous loss potential.) Reinsuring this class of underwriting calls for a different mentality from that required for reinsuring commercial covers. Political risk insurance has no set underwriting guidelines or rating structures. It does not have decades of loss tables or loss experience to measure trends on. It is a totally free market that depends solely on capacity and negotiation.

INSURANCE AGAINST POLITICAL AND CREDIT RISK EXPOSURE FOR THE SMALL- AND MEDIUM-SIZE ENTERPRISE

To grow and expand their worldwide market share and continue to have a high degree of profitability, small- and medium-size U.S. companies must increase their activity in the world market. This increase in activity will heighten the exposures faced by these trading enterprises, which can be broken down into four basic areas: export sales activity, personnel, corporate liability, and financing.

Overseas Sales Activity

U.S. companies are also selling more of their products abroad. In fact, just in the last quarter, American companies demonstrated the highest increase in over four years in exporting activity. A considerable amount of this business consists of exports to our Western friends; however, we have also seen an increase in sales to secondary trading partners and third-world countries. Many small- and medium-size companies make up this increase.

Another exposure facing companies involved in foreign trade is that of the buyer not honoring the terms of a payment, thereby extending the accounts receivable. Whether a product is sold to a Western and/or third-world country, the buyer, being a private organization, may not uphold its obligation to the seller. If this situation occurs, it is very difficult, if not impossible, for the seller to collect on the account receivable, as the means available to do so are extremely limited. The less economically advanced the nation is, the more difficult it is to collect. American companies can insure these accounts-receivable exposures, referred to as export credit risks, with various governmental and private resources. For smaller companies, the FCIA or EXIM Bank is a favored option. Larger risks can approach private sources like COFACE, CIGNA, AIG, and Chubb.

Particularly in third-world countries, one of the major exposures to U.S. sales activity, primarily in accounts receivable situations, is that of currency inconvertibility. This risk becomes reality when a private organization honors its obligation and pays for goods in local funds but a foreign government is unable to transfer these funds into U.S. dollars. Numerous losses of this type have occurred in countries like the Philippines, Syria, Nigeria, Mexico, Brazil, and Venezuela due to their tremendous debt-related problems. Slow currency convertibility in Russia and other former Soviet (CIS) countries is becoming a major detriment to trade to these nations as these problems grows into a serious dilemma for U.S. exporters.

For example, companies who need to do business in Russia often have no alternative but to sell on terms that create an account receivable. (Typically, this requirement means a site draft of sixty or ninety days.) Following the arrival of goods and clearance via Russian customs facilities, the Russian customers pay in rubles. Most exporters wait six months to a year for the Russian government to transfer the rubles into U.S. dollars. In some cases, this conversion has taken more than three years.

Exporters with export credit insurance policies could receive their funds just ninety days after the default has occurred. In these instances, the insurance company will subrogate against the host government and wait for the funds to be transferred. Under typical third-world moratorium debt conditions, underwriters are likely to see the funds in two to seven years, thereby suffering only a cash flow loss.

Personnel

With the increased activity of companies doing business overseas, there are more and more American personnel traveling to foreign countries. They are exposed to damage and/or loss of life. Statistics show that in the past ten years, almost 40 percent of all worldwide terrorism has been directed at American interests. The U.S. company can provide some level of protection using kidnap and ransom insurance. This insurance provides a third-party indemnification for any kidnap and ransom money that may need to be expended, but more important, it allows insurance company professionals to intervene and mitigate any loss that may occur. When a U.S. national traveling on business was kidnapped in a South American country two years ago, the company appealed to the U.S. government to intervene. Governmental agencies, however, were unable to provide timely and/or comprehensive assistance, and the company did not know how to proceed. At this point, the professional staff of the insurance company providing the kidnap and ransom insurance stepped in and obtained local talent who understood the situation and could negotiate the employee’s release. Approximately sixty days after the event, the employee was released, upset and emotionally damaged but in good physical condition. The employee later remarked that it was specifically the insurance company’s intervention that enabled the crisis to be resolved as smoothly as it was.

Another issue concerning personnel traveling overseas is that of the health insurance they require. Companies must ensure that their insurance policies extend indemnification and support services to foreign countries. Companies must also ensure that related insurance, like workers’ compensation, disability, and life insurance, cover employees’ travel abroad. The question is, if an employee goes to the hospital, who pays and how? Clearly these kinds of risks increase the more the exporter travels in areas with specific problems. The use of a specialized facility that assists U.S. nationals abroad called SOS Assistance Corporation in Philadelphia is highly recommended.

Liability Insurance

In the United States, companies are familiar with the exposures they face in the U.S. court and litigation system for third-party liability, especially as it relates to their product liability exposures for domestic sales. American companies have experienced a dramatic increase in product liability lawsuits. With augmented sales of American products overseas, more and more domestic companies are exposed to legal action local litigation systems abroad or in the United States. Thus, American companies must ensure that general liability policies extend coverage to overseas sales. Small- and medium-size companies can lose substantial amounts of money that will affect bottom-line results.

American companies must also consider the fact that foreign governments often take highly unfavorable stands on questions of the U.S. company’s liability when doing business in their countries. In certain nations, executives can be held personally liable and subject to heavy fines and imprisonment for the activity of their company in that country.

Companies must be aware of local law and legislation and ensure that their insurance policies provide indemnification in the instances to which the laws apply. It is just a question of asking a few questions.

Financing

Small- and medium-size companies typically have difficulty finding financing for their export activity, particularly financing with extended payment terms and for trade with third-world countries.

By using insurance as a tool, exporters can structure trade finance situations to expand their business. Once the bank or financing facility develops a comfort level achieved using insurance as a fallback, it becomes more willing to extend financing for export transactions.

The banks can become “named insureds” or “loss payees” as their interest appears. Export trade financing for $25,000 to $25 million has been arranged for an array of small- and medium-size trading companies, enabling them to successfully complete transactions and compete in world trade. While the asset base is important, the comfort level and the exporter’s trade finance experience become an important part of determining how much new business the exporter can take on.

Basic Steps to Protection

In general, trading companies have many types of exposures when they conduct business on a multinational basis. There are three basic steps a company should follow to protect its interests overseas:

1. Companies should acquire in-house expertise or retain it. Acquiring expertise on a transaction-by-transaction basis is possible as an alternative to having in-house staff spend more time than is currently warranted. Some transactions carry the full cost of the expertise. For others, consultants with fees independent of the transaction may be needed.

2. American companies must remain fully apprised of all possible options available to minimize or transfer risks abroad using governmental programs and private organizations. Knowing which governmental program to approach or how the balance shifts between governmental and private sector programs as conditions change means staying on top of the market.

3. Corporations operating multi-nationally must practice loss control measures like, but not limited to, contract review, use of local services in foreign countries, monitoring currency exchange laws and international trade trends, and being aware of political activities worldwide. Using these means to gauge the climate of the international marketplace, some forecasting can be accomplished that will reduce the risk of a political event damaging successful world trade activity.

Although the many exposures inherent in world trade complicate the trading environment, most transactions are completed, and for those companies that have prepared in advance, the responsibility for the problem items can be shifted to experts who are prepared to resolve them.

BASICS OF INSURING AGAINST POLITICAL AND CREDIT RISKS

To grow and increase global market share while maintaining a high degree of profitability, corporations around the world must increase global-scale activity. But of necessity, this also heightens the exposures faced by such multinational enterprises in the areas of fixed investments, sales activity, personnel, and corporate liability. Numerous companies are purchasing or building factories, offices, and other operational facilities overseas. The major exposure such companies face abroad, particularly in third-world countries, is the possibility of the host government’s confiscating, nationalizing, expropriating, or depriving the venture of its interest.

Many Western companies have witnessed this in Iran, Libya, Peru, Nicaragua, and some African nations.

For example, from a historical perspective in Iran, prior to the fall of the Shah, a company had a contract with the Iranian government to establish facilities to provide local telephone and related communication services to the Iranian people. Following the Shah’s demise, and with it the fall of the pro-Western regime, the government confiscated all of the company’s supplies, equipment, and fixed property for its own use. The company was uninsured at the time and lost between $10 and $15 million, which had to be absorbed internally. Had this client taken advantage of an option to insure such overseas exposure, the loss could have been transferred to an insurance company and been indemnified for 100 percent of the loss.

With an increase in the number of governments worldwide that are unfriendly to foreign interests, including nations in Latin America, the Middle East, Asia, and Africa, the multinational with fixed investments overseas should take steps to provide political risk insurance against these exposures.

In addition to making fixed investments in the world market, foreign companies are also selling more of their product abroad. From the 1990s to 2016, U.S. companies demonstrated the highest increase in exporting activity. And while a considerable amount of this business consists of exports to Western friends, there has also been a significant increase in sales to secondary trading partners and third-world countries. Since 2001, U.S. firms are also increasing manufacturing and business activity in many developing nations.

In 2008, the Obama Export Initiative also increased export sales activity by loosening up on export regulations and offering various trade program incentives.

As we enter the new administration under Trump, it is expected to increase export activity and neutralize import growth. Exporters from various countries also encounter other types of exposure, including embargo by the exporting government or the government of the country to which the merchandise is being shipped. For example, a company arranged to sell its product to Nicaragua when the U.S. government suddenly declared an embargo on trade activity with that country. This client had developed a product line specifically designed for a customer in Nicaragua, and all of the sales literature, packaging, and such had been designed specifically for this company. The goods were not shipped because such a shipment would have broken U.S. trade law at the time. The product had to be retooled and repackaged for shipment elsewhere. The expense exceeded $1 million. The company submitted a claim under the embargo provisions of its political risk insurance policy and received full indemnification.

More recent political events in Sudan, Libya, Yemen, Egypt, Indonesia, and Venezuela have had political risk losses to foreign investment in all those markets, along with another dozen or so countries with intense political instability.

POLITICAL RISK COVERAGE ANALYZED: TEN CRITICAL STEPS FOR RISK MANAGERS

With more corporations making direct investments overseas, increasing foreign sales activities, and dealing more frequently with third-world countries, the political risk exposure has increased, creating a need for risk managers to direct attention to this subject area.

Political risk exposures generally refer to losses emanating from governmental or political sources. They include confiscation, nationalization, expropriation, and depravation of assets by foreign governments like import/ export license cancellations, currency inconvertibility, war, strikes, riot, civil commotions, embargo, contract cancellation/repudiation, and boycott. Losses emanating from business dealing with private entities abroad are generally classified as export/credit exposures. Insurance can be purchased against one or all of these risks. Following are ten critical steps that a risk manager should take when purchasing political risk insurance.

1. Selecting a broker/underwriter. The choice of a broker is perhaps the risk manager’s most important concern because the broker is the first line of contact. There are many brokers who can talk around the subject of political risks, but there are few who can perform adequately in a limited insurance market.

There are few options in the choice of underwriting market today, but the number is increasing rapidly as more insurance companies enter the political risk arena to meet the demands of American businesses.

A properly selected broker and underwriter combination will maximize risk management effectiveness. Establishing broker/underwriter rapport will help accomplish mutual understanding, reliable service, continuity of coverage, and increased opportunities for competitive pricing.

2. Service requirements. In the process of selecting a broker and underwriter, an analysis must be made of what the corporate entity is looking for in the relationship. Aside from arranging the protection of assets, other services available include

Export financing

Filing of applications

Political risk intelligence

Loss control and claims handling

Contract and exposure review

Communication of coverage to divisions, subsidiaries, and others

The servicing area for political risk varies greatly among brokers, underwriters, and specialty consultants. Commissions and fees that affect the bottom line should reflect the services provided and the ultimate decision in a choice of broker and market.

3. Combining risks. Risk managers should combine various political risk exposures under one policy. This will maximize underwriting clout in obtaining favorable terms and conditions and will greatly help to reduce premiums. Underwriters will favor a spread of risk and react positively toward being the corporation’s only political risk market.

Because of the limited number of markets, minimal capacity, and a small underwriting/brokerage political risk community, it makes good risk management sense to concentrate risks into one market and not continually seek competition.

Risk managers also should combine other international risks in a coverage like kidnap and ransom, difference in conditions, business interruption, marine, and construction all-risk. Underwriters favorably view combining these insurance coverages in a package policy because they typically are more stable and predictable than other political risks and help provide more reasons for the market to perform.

4. Communication. Because political risk insurance is unique and cannot be explained to the layperson as easily as other conventional property/liability coverages, there is an absolute need to establish comprehensive communication channels between the risk manager’s office and operating units, like international sales, treasury, corporate finance and credit, and legal, to name a few. The following actions are recommended:

Set up in-house seminars to educate and inform employees.

Establish formal communication systems, including updates and weekly status reports.

Appoint local coordinators to become familiar with the subject area and operating plan if, because of distant operating units, logistics present problems.

Consider having brokers communicate directly with the divisional and operating personnel. This might expedite information transfers and provide additional support. However, the risk manager should always be kept informed of activity.

5. Contract review. The typical method of providing underwriting data to the market is by questionnaires. This is an excellent starting point; however, a thorough review should always include analysis and review of the contract, terms of sale, terms of payment, and other documents relating to the exposure. This will help assure that the proper coverage is obtained, the underwriter thoroughly understands the risks, and any questions as to intent are answered clearly.

Changes often can be obtained by altering contract wording, terms of sale, and other elements, which could greatly reduce exposure and/or increase underwriting ability.

6. Political risk intelligence. Political risk insurance focuses on economic, social, and political events. To assess the need for coverage, the exposures must be understood, and understanding the exposures requires information. There are numerous sources of international intelligence, including the U.S. State and Commerce Departments, private information services, banks, trade associations, embassies, and the media. As part of brokerage services, qualified facilities will assist in information support and provide up-to-date intelligence on world conditions.

7. Rates, terms, conditions. Consider that each market’s standard policy is different and that manuscripting is a necessity if proper coverage is to be provided. The exact exposure should be explicitly defined, and coverage should be tailored to meet the risk, whether it be for nationalization, currency inconvertibility, license cancellation, war, or something else. Other areas that should be addressed are

Deductibles and coinsurance

Waiting period

Rescheduling

Warranties and exclusions

Method of reporting exposures

Coverage for business interruption and protection of profits

Loss of market, delay

Changes or fluctuations in currency, an area for which it is becoming more difficult, if not impossible, to arrange coverage

Currency for claims payments

War risks

Cost, which appears to be controlled by market conditions, current economic and political situations, and quality of presentation, is typically a significant corporate expenditure.

Premiums vary greatly with each risk, but one must be assured that apples are not being compared with oranges. Compiling checklists comparing quotas is a good method for fair evaluation.

8. Export Credit. Most political risk coverages exclude export credit (the proximate cause of loss emanates from the private buyer). Risks like nonpayment and contract frustration are significant exposures that exist when dealing with private buyers. It is important to determine whether the ultimate buyer is private or governmental, as interests may be jointly held. The time to make this determination is before the policy is secured and not after a loss has occurred.

Markets for export credit coverage are more limited than for political risk, requiring specific underwriting details about the creditworthiness of the buyer and the payment track record. Obtaining this insurance is often a tool for increasing foreign sales because account receivables are protected and banks are more apt to provide lucrative export financing.

9. Loss control. Insureds should seek measures to minimize opportunity for loss and to entice the interest of local businesses. Such measures include

Use of local management, personnel, and others

Development of sales that require continuing support, like providing service, maintenance, spare parts, and accessories

Development of rapport with local officials by joining business associations, trade groups, and other efforts

Review of opportunities for local financing of the import or project

Analysis of the contract to further protect interests or secure favorable treatment from the host country

These will help control the fate of your venture in the event of a loss.

10. Claims procedures. Before a loss, written procedures should be developed addressing the who, what, when, where, and how of handling claims. List all personnel of the broker and the underwriter and include their home telephone numbers. Contingency plans should be developed to provide options in the event of loss so that business will stay on track with little interruption. Run drills and have meetings with key personnel. Procedures should be agreed to ahead of time to arrange for arbitrators in the event of contractual and/or claims disputes.

USE A SPECIALIST TO ARRANGE INTERNATIONAL PROTECTION

The Export Trading Act of 1982, supported in 2008 via the Obama Export Initiative, made it easier for the small- to medium-size company to do business overseas. Under Trump, Export Initiatives are expected to be even further enhanced. To be competitive, these companies must sell on terms where credit is extended beyond transfer of title or alternative credit and financing terms are offered. This poses two significant exposures: contingent marine and political/export credit. The inexperienced exporter typically overlooks these exposures until there is a loss. In addition, U.S. exporters are selling on terms where the importer is controlling insurance (cost and freight [C&F], free on board [FOB], free alongside [FAS], and others, and has terms of payment extended beyond the ocean voyage or after arrival at the ultimate destination).

The marine insurance problem arises when a loss occurs that is discovered at the destination and the buyer refuses payment or partial payment since not all the merchandise has arrived or is not in 100-percent-sound condition.

The exporter will advise the buyer that the full quantity of a sound product was shipped and that the buyer should seek payment from its insurance company. However, the buyer may never have arranged insurance or may have limited terms and conditions not covering this type of loss, or the policy may have a huge deductible. Whatever the reason, the buyer has the merchandise and has not paid for it. Other than litigation, there are few other means to seek indemnification from the loss. This is where the marine insurance policy can play a strategic role.

There are numerous insurance brokerage companies that specialize in managing these exposures.

This insurance is known as “unpaid vendor” coverage and can be easily arranged as part of the master cargo policy or on an independent special risk basis. This area is where most exporters leave the door open for exposure and most brokers and underwriters miss the boat. It takes a unique and specialized understanding of marine cargo logistics to do it well.

Specialized insurance brokers highlight other exposures like political risk/export credit that may be even more significant as they are a primary and direct source of loss, not “contingent.”

The risks faced come under a multitude of titles: import export license cancellation, private buyer guarantees, currency inconvertibility, confiscation, expropriation, war risk debt rescheduling, contract frustration, letter of credit drawdown, consequential damages, nationalization, deprivation, strikes, riots, and civil commotion.

Increasing those exposures is the U.S. exporter’s need to deal with the third-world political events in Iran. Afghanistan, Lebanon, Mexico, Nigeria, and Brazil have increased the demand for facilities to allow exporting corporations to transfer their risks.

There are numerous governmental and private insurance companies available to underwrite the political and export credit exposures. Lloyds of London underwrites a multitude of U.S. exporter exposures.

An increasing number of U.S. companies are participating in foreign governmental purchases and investments. The contracts involved have inherent political risk exposures. What if a foreign government, after placing a $3 million order and after 10 months of production (generating expenses of $1.5 million), experiences a coup d’état? The new government cancels the contract. Because of the nature of the sale, only $250,000 of the $1.5 million already expended can be salvaged, bringing the net loss to $1.25 million. This risk could have been insured.

What about the U.S. exporter who sells on consignment to Central America and ninety days after arrival, the private buyer has not paid—or the customer has paid, but because of a trade deficit the state bank is unable to convert currency? Where does that exporter turn for collection? These risks are insurable.

Political and export credit insurance can be expensive and developing underwriting data is time consuming; however, the exposure warrants the effort and expense because of the protection it provides from potential disaster.

Policies typically have deductible and coinsurance levels with long waiting periods between time of default and underwriters claim payment. These terms should be negotiated in accordance with your contractual obligations.

Terms and conditions vary from underwriter to underwriter, and competent brokerage support is mandatory to negotiate the most comprehensive coverage for a client’s needs. There are only a handful of competent insurance brokers. When choosing a broker, the exporter should review the broker’s capability to place the coverage and provide a country risk analysis, analyze sales contracts, work with international marketing executives, service the account daily, and assist in claims settlement.

Many U.S. exporters have used their policies in conjunction with export financing facilities to arrange lucrative export financing and have found this transfer of risk to be an avenue to increased foreign sales.

An exporting executive has the responsibility to protect the corporation’s assets. The application of contingent marine insurance and political risk/export credit covers are prudent steps in the overall functions of exporting management. The bottom line is protection of assets and profit and the opportunity to become more competitive in international sales.

TRANSPORTERS AND EXPORTERS NEED POLITICAL RISK COVERAGE

Political risk is an issue of rising concern for the transportation industry. As world trade becomes more extensive, especially with third-world countries, the need for political risk insurance is obvious. Although the political risk insurance market is tightening, with rising rates and shrinking capacity, coverage is available.

Shippers and transportation companies should be very aware of the fact that there are exposures and that there are ways to transfer or minimize those exposures. Most companies doing business overseas are exposed to political risk and in need of coverage, from Fortune 500 companies to one-person trading companies. There are many companies unaware of the need for or the availability of political risk insurance.

Traditionally, the U.S. government has had export insurance programs, but those programs are not the only options. U.S. private markets and Lloyd’s of London also provide protection. The most pressing political risk coverage needs are fixed assets exposure and accounts receivable exposure. As an example, the exposure to political risk for a steamship company with overseas operations can be far-reaching. Terminals, cargo handling equipment, and other overseas terminal area assets may be at risk if the political climate in the country in which the company is operating changes. Industrial mishaps or political revolutions can leave an overseas company with substantial losses.

CNE&D coverage is available for such an exposure that will reduce losses that threaten an international company.

Fixed assets coverage for assets on land in an unstable or politically turbulent foreign country is largely unavailable. Companies managing to obtain on-land fixed assets coverage will meet with limited terms and very high prices.

Coverage is available by any mode of transit, and underwriters limit terms in most cases and prices vary considerably. However, insurance is always available at a price.

Underwriters have suffered tremendous losses during the last twenty years. Thus, there has been a tightening up of the market, with insurance contracts becoming more detailed. The political risk market has incurred losses in such countries as Iran, Mexico, the Philippines, Brazil, Lebanon, Nicaragua, Russia, Korea, and El Salvador, with similar areas indicated as “potential hot spots.”

In addition to fixed assets exposure, companies doing business overseas, especially exporters and transporters, are subject to accounts receivable exposure. Export credit insurance is available for those political risks.

When a company exports goods or services to a country with an unstable economy, receiving payment is often a problem. The shipper can become a victim of inconvertibility of foreign currency. In countries where foreign exchange is controlled by the local government, conversion can take many months or, in some cases, years. If a foreign government decides to hold back on its foreign exchange of currency, an exporter can suffer a substantial loss. When the proximate cause of a loss emanates from a government or a political eventuality, it becomes a political risk exposure.

An exporter of goods or services also can suffer losses due to an action on the part of the U.S. government, thus creating a political risk exposure. An example would be a company that had contracted to build a telecommunications system for Libya, and due to political conflicts, the U.S. government cancelled all export licenses to that country, causing a loss for the telecommunications company. Because that loss was the direct result of a political decision on the part of the U.S. government, political risk insurance was needed to cover the loss.

There are numerous brokers and underwriters who are prepared to provide extensive loss control advice for political risk customers. In the case of an accounts receivable exposure, a company may be advised to bill using a foreign subsidiary where the foreign exchange climate may be more agreeable than that between the United States and the country to which goods are being exported. It may be easier to convert the local currency of a third-world country into Swiss or British currency than into U.S. dollars. Billing using a third country could, in some cases, minimize a risk.

There should also be loss-control measures in place for political risk clients with fixed assets exposure. A variety of measures are available. Exposure can be reduced by involving local management in the operation of an overseas facility. If a plant is run by nationals, rather than by foreigners, the company is in a whole different ballpark.

In addition, if a local government has an interest in an operation within its borders, political risk is lessened. It is recommended that corporate contingency plans for companies operating overseas to insure against loss of a plant or loss of future production be put into place.

While political risk capacity is shrinking due to recent losses, the need for coverage is growing. As the globe continues to shrink, with more and more third-world countries becoming part of the international commerce scene, the growing need for political risk insurance for shippers and transporters will continue.

GETTING MORE FROM MARINE INSURANCE

U.S. corporations in international trade are expanding their activity to increase overseas market share. Companies previously involved only in domestic sales are looking to foreign markets to increase greater growth and productivity. With this heightened activity, the requirements for comprehensive marine insurance programs are increasing, and the distribution manager’s role in arranging these programs is becoming more vital.

When buyers are not buying, when capital is scarce, when profits dwindle to a fraction of their former selves, distribution managers are put in a tough position. To put it more bluntly, it becomes time for them to cut their costs or pack their bags. When budgets must be trimmed to realize short-term economies, consideration of long-term benefits (other than job security) often goes out the window. One of the first casualties of these spontaneous purges is insurance. When people are forced to cut in any area they can, one of the first things they do is shop around for a less-expensive insurance program, and they may end up leaving an insurance company they’ve been with for thirty years to go with a new agent who does not know them as well. While this may result in lower premiums, it also results in having an agent who will not cooperate as well when there is a large claim or the company does not have fifty years of premium payments to support paying the big claims. That means there is a better chance of foot-dragging when claims service is needed down the road.

Another favorite budget-trimming technique used by under-the-gun exporters is changing transportation packaging to take advantage of cut-rate carriers. If the exporter has used a U.S. flag conference carrier, a third-world carrier with which the opportunities for claims recovery are minimal may be considered. Once again, from an insurance standpoint, the short-term savings may be far outweighed by the procedural problems that are likely to crop up down the road.

The shipper must recognize that insurance is not designed to yield short-term dividends. Insurance is not meant to be used that way. Manipulating insurance coverage to milk savings for the short run will defeat the ultimate goals of the best-laid insurance plans.

The mission of the distribution manager in the current market with regard to marine insurance should not be one of concentrating on the reduction of premiums or on downgrading packaging and carrier standards that protect cargo from the need for a claim in the first place. Rather, the emphasis should be on customizing insurance programs to take advantage of the opportunities to protect corporate assets and therefore affect the bottom line of transportation costs. Cost-effectiveness can be improved not only by cutting initial costs but by getting a greater return on the money companies have been investing all along.

Clearly, there are several steps an international shipper can take to help achieve the short-term and long-term insurance objectives of its company.

Terms and Conditions

All-risk and “warehouse to warehouse” are standard conditions offered in marine insurance policies.

You have inland transit lanes that are brutal to the cargo, justifying the need to insure the cargo from door to door. When you’re moving cargo to, for example, South America, a major market in the new millennium, the most severe leg of the entire journey is the inland transit on the import leg.

Overland movement subjects cargo to a different set of stresses than does an ocean leg that many shippers overlook as they design packaging to protect their cargo for an ocean shipment.

While much of loss and damage comes from rough handling, most shippers must protect their goods against more exotic causes of damage. All-risk insurance coverage provides a broad base of protection but does have exclusions, including delay, inherent vice, willful misconduct of the assured, and loss of market. For example, if an electronics manufacturer is shipping high-technology equipment overseas, the anticipated voyage includes outside storage, and the product becomes rusted or deteriorated because of the outside storage, underwriters could take the position that the loss is uncovered because it would inherently happen if the cargo was stored outside and was not properly protected against the environment. Distribution managers should make sure that product lines that are susceptible to an inherent type of loss travel under policies that are properly endorsed to provide that kind of protection.

Another type of risk is loss of market, which is covered by loss of profits or business interruption insurance. It provides coverage for cargo that is lost at sea, delayed, or damaged at the time of arrival with the result that the shipper loses a sale, is unable to complete a project, has an installation delayed, or experiences some other repercussion. Under this policy, the shipper can still recoup its financial losses.

In the appendix is a sample marine cargo policy, outlining standard terms and conditions.

Brokers and Underwriters

There are plenty of insurance brokers and underwriters around, but very few of them are specialists in international transportation insurance. The search for such a specialist is one of the essential tasks distribution managers must undertake when insuring assets.

If a company is shipping overseas, it should deal with a forwarder that specializes in overseas shipments. When dealing with a claim that originates overseas, the company will then be dealing with an attorney who is a specialist in international law. In the same way, when insuring an international shipment, a specialist is needed.

Corporate insurance and finance departments are good sources of advice on the selection of brokers and underwriters. It is important that the distribution manager carefully select the broker who will place and arrange insurance programs and that the underwriter is a well-established marine agency with worldwide servicing capabilities and a staff of professionals for in-depth backup and expertise.

Insurable Interests

On an FOB New York export sale, per international trade definitions as interpreted by International Commercial (INCO) terms, it is the buyer’s responsibility to recognize that it now has risk for loss and damage and therefore insure the cargo once it has been placed on the vessel. The terms of sale dictate where risk passes and therefore who has insuring responsibility.

However, the terms of payment can also come into play and determine insuring responsibility. A corporation could have an FOB New York sale, and terms of payment could be site draft sixty days. The U.S. corporation’s insurable interest would be up until the day it receives payment.

The vessel could sail from New York destined for Rotterdam and sink three days out. When the corporation attempts to collect payment from the buyer who was responsible for insuring the merchandise, it may discover that the buyer did not insure, has limited terms and conditions, has high deductibles, or other factors that will retard the company’s opportunities to collect full or partial payment.

Third-world nations are having an increasing effect on the insuring responsibilities of foreign shippers by implementing local regulations that require shippers to insure their cargoes in the local market. Failure to do so can result in fines or even seizure by governmental authorities. This necessity often burdens U.S. shippers with insurance policies that are characterized by high premiums and narrowly defined terms. In that case, a contingent or difference in conditions policy, which sits above anything that must be purchased locally, should be obtained. This provides protection in case the policy purchased locally falls short or if the buyers did not purchase the required insurance.

Contingency coverage is particularly useful when a shipper’s products have been sold on an accounts receivable basis. In this case, the risk is not only that merchandise will be lost but also that payment will never be received. The potential problem for shippers with this type of sale is that if part of the shipment is lost or damaged on its way to the buyer, the buyer may rightfully refuse payment. However, because the exporter shipped sound goods, it will expect payment and will advise the receiver to recoup the loss from the insurer. However, the buyer may not be sufficiently insured or may be carrying a huge deductible. Apart from legal action, the only way for the exporter to recover its loss in the event of such standoffs is by contingency insurance. The underwriters will expect you to seek payment from the buyer or the buyer’s insurance company and will only pay for the loss on a loan basis, but if settlement cannot be made, the loan becomes a final settlement.

The bottom line to the dilemma, insurable interests versus insuring responsibility, is to attempt to control the insuring function at all times, whether you are selling or buying merchandise to or from overseas.

COMPETITIVE MARKETS

Shippers who feel compelled to reduce their premiums should be able to do so without sacrificing the relationships they have built with their current insurance companies. Most of the worldwide marine insurance market continues into the year 2001 to be in a soft posture, which means that extremely competitive rates, terms, and conditions can be achieved now. This phenomenon has occurred during the past decade, and while it is always expected to tighten, it is still a soft marketplace. This could be beneficial to the distribution manager who is trying to reduce transportation costs. In other words, lower premiums may be there for the asking while insurance companies struggle to maintain their customer base.

Reduced Paperwork

Computerization of insurance reporting has not been among the most vigorously waged campaigns in the computer revolution. In most cases, the technology is ready for action, but shippers have not applied computer technology to more than a few specific tasks. Unfortunately, insurance reporting is not one of those tasks.

There are so many companies, including some of the biggest in the world, who duplicate and reduplicate paper for the reporting of insurance. Some have import/export order entry systems, and all of the information they need is in those computer systems. The same information included on invoices is also needed for insurance reports, but many companies are taking this information, which is computer generated for billing, and are copying it by hand into their insurance reports instead of generating those reports by computer as well.

One bright spot on the international documentation front has developed regarding certificates of insurance that are often used to meet commercial banking and customer requirements. Much has been done to eliminate the requirements for these certificates by using preprinted invoices and/or preprinted “sticky-backs,” which affix to the commercial documents that serve as proof of insurance.

Settling Fees

Marine insurance typically is rated by the shipper’s experience, meaning that actual claim experience will determine what premium rates the shipper will pay for marine coverage. Thus, the greater the claims activity of the shipper, the higher the premium rate will potentially be. There are ways to minimize costs in advance of actual losses that can save cash in the short-term on individual loss settlements and in the long-term in the form of lower premiums.

Expenses associated with claim activity are overseas settling fees for agents of the underwriter who handle the claim and survey fees incurred when ascertaining the nature and degree of loss or damage. Some studies have indicated that these expenses range from 5 to 25 percent of claims dollars. That means that for every $100 of claims paid, $20 of that amount could be associated with just handling or settling the claim. Many times, a small claim overseas, say $100, will have a $150 survey fee attached to it.

The opportunity exists to prenegotiate settling fees with overseas agents by using U.S. brokers or underwriters on a reduced-account or bulk basis. The old saying, “If you don’t ask, you won’t get,” holds true. There’s no reason not to ask for a consideration on reducing settling fees. Limits also can be determined, like for losses under $500, for which surveys can be waived and claims can be paid with the processing of a few documents.

Buy-Back Deductibles

Many shippers dislike the idea of deductibles on principle. They note that many claims are for relatively small losses. Without first-dollar coverage, the shipper pays for the entire loss out of its pocket and never recovers anything from the expensive insurance programs.

The insurer’s side of this is that a deductible program is more cost-effective and mitigates nuisance claims and costs.