Investment Insurance
International business, including exports and direct investments, involves substantial commercial and political risk. The focus of this chapter is on insurance products that support foreign direct investment (FDI). Trade-related risk-mitigation products are covered in chapter 5. In order to facilitate third-party equity and debt for investments in emerging markets, Washington-based agencies offer a variety of risk mitigation products. Insurance products cover equity and debt investments on a conditional basis against various types of risks up to 100% in some cases. Typically, however, insurance products involve a deductible, or self-insurance requirement, which is in the 5%–10% range. The exact conditions under which an insurance claim may be paid are clearly defined and are specific to each contractual agreement.
The uncertainty of the political climate in emerging markets often poses a considerable risk to investors looking to enter these countries. In order to encourage FDI, organizations such as the Multilateral Investment Guarantee Agency (MIGA), the Overseas Private Investment Corporation (OPIC), and other development finance institutions (DFIs) offer political risk insurance (PRI) to cover such noncommercial risks. See appendix J for a comprehensive list of DFIs. PRI covers the actions of foreign governments that may adversely affect an investment. Actions typically covered include expropriation, breach of contract, currency transfer restrictions, war, and political violence. A PRI policy in favor of lenders may also allow projects to secure better credit terms and overall savings compared to an “uncovered” loan. Similarly, certain equity investors may demand a PRI policy as a condition to investing in a project.
Suppose you are the developer of a large oil and gas project in Ecuador. To provide comfort to potential lenders and co-investors, the government of Ecuador has provided a concession for the project. Given the political climate in Ecuador and the potential for expropriation, however, you and your equity partners elect to obtain expropriation and breach of contract coverage from MIGA to protect your investment. After completing its due diligence, MIGA decides to provide guarantee coverage on the sponsor equity and loan facilities provided by commercial lenders. Due to its participation in the project, MIGA, through its experience mediating disputes, makes it less likely that a dispute will ultimately give rise to a claim.
The following is a list of topics covered in this chapter:
• Political risk coverage
• Commercial risk coverage
• Foreign exchange risk
• Interest rate risk
• Leasing insurance
Inter-American Development Bank (IDB)
Guarantees
IDB offers political risk and credit guarantees to cover private sector lenders who make loans to projects in Latin America and the Caribbean. Coverage may be provided up to 100% for specific political risks, such as sovereign contractual obligations or transferability.
Political risk guarantees provide IDB coverage for breach of contract, currency inconvertibility, and other political risks such as expropriation or related arbitrary governmental actions. Coverage can be tailored to each project and can be extended to up to 50% of project costs or $150 million, whichever is less. Annual premium rates are determined on a case-by-case basis.
Structured and Corporate Finance Department
Inter-American Development Bank
1300 New York Avenue, NW
Washington, DC 20577
Tel: (202) 623-3702
Fax: (202) 623-3096
Web: http://www.iadb.org
Multilateral Investment Guarantee Agency
The guarantee program of MIGA, an arm of the World Bank Group, is designed to encourage the flow of foreign private investment to emerging markets by mitigating political risks associated with a project. MIGA offers long-term political risk insurance to project sponsors (i.e., equity coverage) and cross-border lenders for new investments in developing member countries. Beyond insurance protection, MIGA’s participation in a project enhances confidence that the investor’s rights will be respected, an advantage inherent in MIGA’s status of a voluntary association of developing and developed countries. Since its inception in 1988, MIGA has issued 980 guarantees for projects in more than 100 developing countries, totaling $22.4 billion in coverage, with its exposure as of October 2010 at $7.7 billion. Although MIGA has issued 980 guarantees for projects since its inception in 1988, it is important to note that MIGA has only paid 6 claims.
Long-Term Risk Insurance
The following insurance coverages may be purchased separately or in combination with other coverages. The maximum amount of coverage that MIGA can retain for a single project is currently $180 million, although the amount of coverage mobilized can be expanded considerably through MIGA’s collaboration with other insurers. The following types of coverage are offered by MIGA:
• Transfer restrictions protect against loss arising from an investor’s inability to convert local currency into foreign exchange for transfer outside the host country. Currency devaluations, however, are not covered.
• Expropriation protects against loss of the insured investment as a result of acts by the host government that may reduce or eliminate ownership of, control over, or rights to the insured investment.
• War and civil disturbance protects against loss from, damage to, or the destruction or disappearance of tangible assets caused by politically motivated acts of war or civil disturbance in the host country, including revolution, insurrection, coups d’état, sabotage, and terrorism.
• Breach of contract protects equity losses arising from the host government’s breach or repudiation of a contract with the investor (e.g., a concession). MIGA typically requires the investor to obtain an arbitral award as a condition to claim payment under this coverage.
• Nonhonoring of sovereign financial obligations protects against losses resulting from a government’s failure to make a payment when due under an unconditional financial payment obligation (e.g., a guarantee of the payment obligations of a utility to an independent power producer). It typically does not require the investor to first obtain an arbitral award.1
MIGA can insure straight equity, shareholder loans, or third-party (bank) loans. Usually MIGA requires bank loan coverage to be purchased as a package with equity insurance.
MIGA also insures new investments originating in any member country and destined for any developing member country other than the country of origin. New investment contributions associated with the expansion, modernization, or financial restructuring of existing projects are eligible, as are acquisitions that involve the privatization of state enterprises. Other forms of investment, such as technical assistance and management contracts, asset securitizations, capital market bond issues, leasing, services, and franchising and licensing agreements, may also be eligible for coverage.
MIGA’s standard term of coverage is between 3 years (1 year for bank loans) and 15 years. Coverage may, in extraordinary circumstances, be extended to 20 years if MIGA finds that the nature of the project justifies an extended term. MIGA may insure equity investments for up to 90% of the investment contribution, plus an additional 500% of the investment contribution to cover earnings attributable to the investment. In the case of loans and loan guarantees from commercial sources, MIGA may insure up to 95% of the principal, plus an additional 150% of the principal to cover interest that will accrue over the term of the loan. Debt sourced from DFIs and Export Credit Agencies (ECAs) does not require MIGA coverage. For technical assistance contracts and similar agreements, MIGA insures up to 90% of the total value of payments due under the insured agreement.
MIGA has established a fee structure for determining the premium rates that will apply to a specific investment. MIGA’s risk assessment focuses primarily on the risks associated with the individual project and coverage, taking into account general economic and political conditions in the host country. Accordingly, the base rates may be raised or lowered for a particular project depending on the project’s risk profile.
MIGA charges a single premium for current and standby cover. Current fees range between 0.45% and 1.75% depending on country and project risks, while standby fees are calculated as a fraction of the current fee. Standby coverage is very useful in case of loans that take many years to amortize or equity investments that are deployed over an extended period of time. An investor seeking coverage from MIGA is encouraged to submit a preliminary application before an investment will be made or irrevocably committed; however, this is no longer required. Once investment and financing plans are established, an investor should promptly complete and return the Definitive Application for Guarantee to MIGA along with any relevant project documentation, such as a joint venture contract, feasibility study, or an environmental assessment. The Definitive Application provides the detailed information needed for review and preparation of a contract of guarantee. This information includes the eligibility of the investor, the amount and type of investment, types of coverage desired, the developmental effects of the project, and substantiation of the project’s financial and economic viability.
Fees
There is no charge for filing a preliminary application; however, MIGA charges an application fee, which is refundable at the time of signing, of either $5,000 or $10,000 to process Definitive Applications, as outlined in the following schedule:
• Guarantees up to $25 million: $5,000
• Guarantees more than $25 million: $10,000
• Natural resources, oil and gas, and infrastructure: $10,000
MIGA also charges a processing fee for exceptional underwriting costs incurred in evaluating projects that are environmentally sensitive (e.g., oil and gas, mining, infrastructure) or whose complex financial structures require retention of outside advisors. In these cases, the initial processing fee is $25,000. If the exceptional costs incurred are less, the unused balance will be refunded to the applicant. If greater, the applicant will be billed for the additional amount.
Small Investment Program (SIP)
MIGA’s SIP program is designed to facilitate investment into small- and medium-sized enterprises (SMEs) involved in the finance, agribusiness, manufacturing, and services sectors. Investments are eligible for coverage under the SIP if they are related to the establishment of an SME, or made into an existing SME, in a developing member country. In order to qualify as an SME, the project enterprise must fulfill at least two of the following criteria:
• No more than 300 employees
• Total assets not more than $15 million
• Total annual sales not more than $15 million
Investments in the financial sector are eligible under the SIP if they are geared toward providing financial services for SMEs and at least 50% of clients related to the investment are SMEs.
The SIP offers
• coverage up to $10 million (the actual size of the investment may be bigger);
• a guarantee package covering currency transfer restriction, expropriation, and war, terrorism, and civil disturbance (breach of contract is not covered under SIP);
• no application fee for eligible smaller investors;
• a quick approval process.
The SIP has no restrictions with respect to the size of the investor. However, the program is specifically designed to assist small- and medium-sized investors (SMIs). The application fee is waived for SMIs. In order to qualify as an SMI, the company must have no more than 375 employees and must have either no more than $50 million in assets or more than $100 million in annual sales.
Multilateral Investment Guarantee Agency
1818 H Street, NW
Washington, DC 20433
Tel: 202-473-1000
Fax: 202-522-2630
Web: http://www.miga.org
Overseas Private Investment Corporation
OPIC provides political risk insurance to U.S. investors, contractors, exporters, and financial institutions involved in international business transactions in developing countries. OPIC insurance is available for investments in new ventures or expansions of existing enterprises and can cover equity investments, parent company and third-party loans and loan guarantees, technical assistance agreements, cross-border leases, assigned inventory or equipment, as well as other forms of investment.
Currency Inconvertibility Coverage
This coverage assures that earnings—returns on capital, principal and interest payments, and other remittances, including payments under technical service agreements—can continue to be converted into U.S. dollars. The insured will be compensated by OPIC for host-country currency restrictions, whether active (host-country authorities deny access to foreign exchange through regulations) or passive (host-country monetary authorities fail to act on an application for hard currency). In either case, OPIC makes payments in the U.S. dollar equivalent of the local currency amount at an exchange rate in effect before OPIC received the application for compensation. Inconvertibility coverage does not protect against currency devaluation.
Expropriation Coverage
This coverage protects against the nationalization, confiscation, or expropriation of an enterprise, including “creeping” expropriation (i.e., host government actions that deprive the investor of fundamental rights in a project for at least 6 months). Expropriation coverage does not protect against losses due to lawful regulatory or revenue actions by host governments or actions provoked or instigated by the investor or foreign enterprise.2
Political Violence Coverage
This insurance protects investors from property and income losses resulting from violence undertaken for political purposes. Actions of political violence covered by OPIC include declared or undeclared war; hostile actions by national or international forces; civil war; revolution; insurrection; and civil strife, including politically motivated terrorism and sabotage. OPIC compensates for two types of losses: business income losses (losses of income resulting from damage to insured property) and damage to tangible property.
Special Insurance Programs
Several insurance programs are offered that are tailored to meet the special needs of certain types of investments. Investors are urged to contact OPIC to receive additional information on special insurance programs.
• Financial institutions. This program allows U.S. banks and other institutional investors to better manage their cross-border exposures by insuring a wide range of banking activities, including project loans made or arranged by banks, gold loans, commercial paper transactions or floating-rate notes purchased by eligible institutions, cross-border leases, debt-for-equity investments, and commodity price swaps.4
• Capital markets. In response to growing demand, especially for infrastructure projects, investors and their financial advisors have sought new sources of financing, and have turned to the capital markets to supplement traditional bank financing. Consequently, capital markets transactions, such as 144A bond issues, are playing an increasingly important role in financing projects in emerging markets. OPIC can provide inconvertibility and expropriation of funds coverage for capital markets transactions similar to the coverage provided under OPIC institutional lending. The coverage may enable investors to mobilize capital markets funding for transactions where it was previously unavailable.
• Oil and gas. To encourage petroleum exploration, development, and production in developing countries, OPIC provides enhanced political insurance coverage that better meets the needs of the oil and gas sector. OPIC’s enhanced expropriation coverage compensates the investor for losses caused by material changes unilaterally imposed by a host government on project agreements, including abrogation, impairment, repudiation, or breach of concession agreements, production sharing agreements, service contracts, or other agreements between the U.S. company and the foreign government.
• Natural resources (except oil and gas). For exploration-phase natural resource projects, OPIC insurance not only insures against confiscation and political violence losses to tangible assets but also insures against the unlawful withdrawal or breach of mineral exploration, development, and other vital rights by the host government. Coverage under this program extends to equity, parent company or institutional loans, owners’ guarantees of loans (including completion guaranties), leases of equipment to project companies, and others.
• Contractors and exporters. OPIC’s insurance coverage for contractors and exporters protects the U.S. company from wrongful calling of bid, performance, or advance payment guarantees, and customs bonds; loss of physical assets and bank accounts due to host country confiscation or political violence, as well as inconvertibility of proceeds from the sale of equipment used at the site; and losses due to unresolved contractual disputes with the foreign buyer. This insurance can protect U.S. companies acting as contractors in international construction, sales, or service contracts, and exporters of heavy machinery and other goods. Coverage under this program is issued when the U.S. company has a contract with a foreign government buyer.
Lease Insurance
OPIC offers political risk insurance coverage for cross-border operating and capital-lease transactions with terms of at least 3 years. OPIC’s insurance for assets leased under an operating lease provides coverage for the original cost of the leased assets (including duties, freight, and installation) incurred by the lessor. Insurance for capital leases covers the stream of payments due under the lease agreement. OPIC’s insurance provides coverage against the following:
• Currency inconvertibility. Deterioration of the investor’s ability to convert profits, debt service, and other remittances from local currency into U.S. dollars.
• Expropriation. Loss of an investment due to expropriation, nationalization, or confiscation by a foreign government.
• Political violence. Loss of assets or income due to war, revolution, insurrection or politically motivated civil strife, terrorism, and sabotage.
Coverage is also available for equity investments in, and loans to, offshore leasing companies for management and maintenance agreements involving leasing companies and for consigned inventory. OPIC also insures against host government actions that prevent lessors from enforcing their rights to repossess, reexport, and de-register leased equipment.
Coverage
OPIC insures investments in new and existing enterprises for a term up to 20 years. With the exception of principal and interest from loans and leases from financial institutions to unrelated third parties, OPIC covers up to 90% of an investment (OPIC’s statutes require that investors bear the risk of loss of at least 10%), not to exceed $250 million per project. Furthermore, OPIC typically issues insurance commitments equal to 270% of the initial investment—90% representing the original investment and 180% covering future earnings. While rates vary based on type of coverage and the risk profile of the project, OPIC will generally charge a current fee between 0.18% and 0.60% per coverage, with a standby fee of approximately 0.20%.
Eligibility
OPIC may insure an investment by an eligible investor assuming it meets OPIC’s policy and environmental criteria. OPIC may also insure an investment in a project controlled by foreign interests, but it is only the eligible investor’s share that is insured, not the entire project. Eligible investors are U.S. citizens, corporations, partnerships, or other associations substantially owned by U.S. citizens, created under the laws of the United States, or of any state or territory of the United States. Eligible foreign businesses must be at least 95% owned by investors eligible under the preceding criteria.
Application
Prior to applying for PRI coverage, investors are required to register their projects with OPIC’s insurance department before an investment is made or irrevocably committed. Project registration is free of charge and all information is treated as confidential. A registration is valid for 2 years, and may be renewed in 1-year increments. In order to process the application, OPIC will charge the investor a retainer fee that will be used to reimburse OPIC’s out-of-pocket expenses associated with the review process. In the event that OPIC offers insurance coverage for an investment and the investor accepts, any unused portion of the retainer fee will be refunded. Similarly, if OPIC is not able to offer insurance, any unused portion of the fee will be returned. However, if the investor declines the offered coverage, the fee is nonrefundable.
Enterprise Development Network (EDN)
The Enterprise Development Network (EDN) is a partnership between public and private sector organizations and was established with the assistance of OPIC. EDN is a growing network of organizations around the world and is designed to bring together the resources necessary to attract capital (i.e., debt and equity) and political risk insurance for small- and medium-sized enterprises (SMEs) to pursue business opportunities in developing countries.
Overseas Private Investment Corporation
Applications Officer-Insurance Department
1100 New York Avenue, NW
Washington, DC 20527
Tel: 202-336-8799
Fax: 202-336-7949
Web: http://www.opic.gov
E-mail: [email protected]
World Bank
World Bank guarantees are provided to private lenders and are typically associated with financing infrastructure projects where the demand for funding is large and political, sovereign risks are significant, and long-maturity financing is critical to a project’s viability. By covering risks that the market is not able to adequately bear or evaluate, guarantees can attract new sources of financing, reduce financing costs, and extend maturities.
Partial Risk Guarantee (PRG)
The International Development Association (IDA) offers PRGs, which cover specific government obligations spelled out in agreements with the project entity and ensure payment in the case of debt service default resulting from the nonperformance of contractual obligations undertaken by governments or their agencies in private sector projects. Typical government contractual obligations include:
• Maintaining the agreed regulatory framework, including tariff formulas
• Delivering inputs, such as fuel supplied to a private power company
• Paying for outputs, such as power purchased by a government utility from a private power company or bulk water purchased by a local public distribution company
• Compensating for project delays or interruptions caused by government actions or political events
Coverage under the Partial Risk Guarantee protects against the performance of government-owned entities, including payment obligations of a utility, obligation to supply fuel, and obligations to provide foreign exchanges. It also protects against changes in law, political events in the host country, and certain natural events relating to the government entities.
Finance Solutions
Finance Economics & Urban Department
The World Bank
1818 H Street, NW
Washington, DC 20433
Tel: 202-473-6188
Fax: 202-522-0761