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PowerPoint Slidesfor Professors

Spring 2010 Version

This file as well as all other PowerPoint files for the book, “Risk Management and Insurance: Perspectives in a Global Economy” authored by Skipper and Kwon and published by Blackwell (2007), has been created solely for classes where the book is used as a text. Use or reproduction of the file for any other purposes, known or to be known, is prohibited without prior written permission by the authors.

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W. Jean Kwon, Ph.D., CPCUSchool of Risk Management, St. John’s University101 Murray StreetNew York, NY 10007, USA

Phone: +1 (212) 277-5196E-mail:

risk management and insurance perspectives in a global economy 17 political risk management

Risk Management and Insurance: Perspectives in a Global Economy 17. Political Risk Management

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study points
Study Points
  • Modes of foreign market entry
  • Nature of political risk
  • Risk analysis and control
  • Financing the political risk exposure
  • Political considerations in emerging markets
modes of foreign market entry
Modes of Foreign Market Entry
  • Exporting
    • Use of a domestic intermediary
  • Foreign direct investment (FDI)
    • Joint venture
    • Wholly-owned subsidiary
    • Branch
political risk
Political Risk

Note on “Expropriation”

Depending on the country and jurisdiction, the property owner may receive some compensation but the amount is likely below the market value of the property.

  • Any governmental action that diminishes the value of a firm operating within the political boundaries or influence of that government
  • Elements (selected)
    • Nationalization (taking of property with compensation)
    • Confiscation (taking of property without compensation for criminal activity)
    • Expropriation (taking of property without compensation in eminent domain)
    • Contract repudiation
    • Currency inconvertibility
political risk management
Political Risk Management
  • Identification/measurement of loss exposure
    • Political/legal environment
    • Socio/ethnical environment
    • Economic/financial environment
    • Regional/international environment
  • Use of external data/analysis
  • Internal analysis
    • Frequency and severity of an adverse event
    • Changes in firm value
    • Benefit-cost analysis
top 10 news of 2009 by time magazine
Top 10 News of 2009 by TIME Magazine

1. America's Economic Crisis: Now for the Non-Recovery

2. Afghanistan: Can the U.S. Avoid a Quagmire?

3. Iran's Tumultuous Election and Its Aftermath

4. The Divisive Debate Over Health Care Reform

5. Massacre at Fort Hood: The New Face of Terrorism?

6. The Death of Michael Jackson

7. Pakistan: On the Verge of a Breakdown

8. Mexico's Bloody Drug War

9. H1N1: That's Swine Flu to You

10. The End of Sri Lanka's Cataclysmic Civil War

political risk control techniques
Political Risk Control Techniques

Integrative Strategies

Defensive Strategies

The cost of interference > the cost of letting the firm stay

Managerial approaches

Joint venture partner from outside the host country

Minimum use of host country nationals

Use and enforcement of intellectual property rights

Financial approaches

Source equity/debt financing from within the host country

Minimize retained earnings locally

  • Discourage the host government from interfering with the operation of the firm
  • Managerial approaches
    • Increase in communication and tighter relationships (e.g., use of local resources including personnel)
  • Financial approaches
    • FDI through joint venture
    • Fair, accurate and open financial reporting
financing the political risk exposure1
Financing the Political Risk Exposure
  • Retention
  • Insurance
    • Intergovernmental agencies
    • Governmental agencies
    • Private companies
multilateral export credit agencies table 17 2
Multilateral Export Credit Agencies (Table 17.2)

The correct name for the Arabian countries is “Inter-Arab Investment Guarantee Corporation.”

the multilateral investment guarantee agency
The Multilateral Investment Guarantee Agency
  • Created in 1988 as a World Bank Group member
  • Promote FDI in emerging economies
  • Offer political risk insurance (guarantees)
  • Over $2 billion in capital paid by 163 World Bank member countries
the inter arab investment guarantee corporation
The Inter-Arab Investment Guarantee Corporation
  • Established in 1975 to foster inter-Arab investment flows
  • Provide coverage for inter-Arab investments and export credits against non-commercial risks
  • $83 million capital in 2002
overseas private investment corporation
Overseas Private Investment Corporation
  • Established in 1971 to help US business investments overseas, foster economic development in emerging markets, and complement the private sector in managing the risks associated with FDI
    • Previously known as “Overseas Private Insurance Corporation”
  • Up to $250 million per project against:
    • Currency inconvertibility, expropriation or political violence
    • Protection of up to 20 years of equity life or maturity
the export import bank of the u s
The Export-Import Bank of the U.S.
  • Finance the export of U.S. goods and services
    • Does not compete with private sector lenders
  • Pre-export financing
    • Commonly one-year transaction-specific or revolving loan
  • Small Business Multi-Buyer Export Credit Insurance
    • Commercial losses due to insolvency, bankruptcy and default (up to 95% coverage)
    • Political losses due to war, revolution, cancellation of an import or export license, currency inconvertibility (up to 100% coverage)
public vs private insurance
Public vs. Private Insurance

Public Insurers

Private Insurers

Private insurers are for profit while avoiding undue risk.

These providers are perceived as being more flexible.

Their coverages can be more expensive.

Traditional actuarial methods are less applicable.

They use portfolio management and diversification to assure spread of risks.

  • They must consider governments’ policy objectives.
  • They rely more on published rate schedules than do private insurers
    • Government policy toward a particular country or region heavily influences pricing and coverage availability.
the importance of monitoring
The Importance of Monitoring
  • Circumstances that create political risk in one country may create it in another.
  • Marketing practices that are effective in a developed country may provoke suspicion and controversy in a developing country.
  • Managerial practices that are effective in the home country may precipitate labor unrest in a host country.
political considerations in emerging markets
Political Considerations in Emerging Markets
  • Eastern Europe
  • Asia
  • Latin America
  • Middle East
  • Africa
  • Persia until 1935
  • Became an Islamic republic in 1979
  • Religious scholars as political leaders
  • 1980-1988 war with Iraq
  • Designated as a state sponsor of terrorism
  • Nuclear development
  • Population 66.5 million
  • Median age 27
  • Urban population 68%
  • Gender ratio 1.02 male/female
  • Life expectancy
    • Male 69.65
    • Female 72.27
  • Ethnicity
    • Persian 51%
    • Azeri 24%
  • Religion
    • Muslim (Shia) 89%
    • Muslim (Sunni) 9%

Source: CIA World Factbook(February 2010)

  • Most economic activities controlled by the state
  • An economy dependent on oil revenues
  • Per capital GDP $12,900(purchasing power parity)
  • GDP real growth 2.6%
  • Other
    • Inflation 16.8%
    • Unemployment 11.8%
    • Pop below poverty 18%
    • Labor in services 45%
  • Managed floating exchange rate since 2002
iran international disputes
Iran – International Disputes
  • Coface Rating (February 2010)
    • D Country rating
    • C Business climate rating
  • S&P Do not rate
  • Moody’s
    • Withdrew rating action in June 2002
      • US government concerns that the rating was “inconsistent” with U.S. sanctions
insurance in iran
Insurance in Iran
  • The history
    • Initially serviced by foreign insurers
    • 1935 – First, state-owned insurance firm established
    • 1979 – The industry (with 12 foreign firms) nationalized, leaving only state insurers: Iran Insurance Company, Asia Insurance Company, and Alborz Insurance Company
  • The regulator
    • BimehMarkazi (Central Insurance, of Iran established in 1971
insurance in iran1
Insurance in Iran
  • The market
    • The market is closed to the private sector and foreign firms
    • Third party motor liability insurance is compulsory
  • Related activities
    • Social Security Organization (SSO) for workers’ compensation type of coverage
    • Medical Service Organization (MSO) for medical insurance to anyone who selects not to be insured by Iranian commercial insurer or SSO
    • Export Guaranty Fund of Iran (ECGD)
discussion question 1
Discussion Question 1

With increasing internationalization of national economies, would you expect political risk exposures to grow or diminish in importance? Justify your answer.

discussion question 2
Discussion Question 2

Could political risk exposures of MNCs might be hedged in the capital market? Speculate as to how this might be accomplished.

discussion question 3
Discussion Question 3

An entire national economy can be exposed to political risks in the sense that the actions of other governments can diminish its collective “value.” How should governments apply sound risk management principles to such exposures? Do government considerations in this respect differ fundamentally from those of firms?

discussion question 4
Discussion Question 4

Can governmental political risk exposures justify the creation, maintenance and protection of a domestically owned insurance industry? Justify your response.

discussion question 5
Discussion Question 5

We discussed two strategies for political risk management: an integrative strategy and a defensive strategy. Pick a country (or a political environment) for which an MNC might use an integrative strategy. Pick another country (or an environment) for which an MNC might use an integrative strategy. Support your choice for each with logical explanation. Would your choices of countries, tactics or both change depending on the nature of business?