We invited Julie Martin, a Senior Vice President at Marsh Inc. and veteran of many multiple-insurer PRI placements, to discuss how the difficulties that syndications pose can be overcome.
Syndicating an insurance placement is often necessary, particularly to obtain adequate amounts of coverage. The goal in any syndication is to have all underwriters write on the same clear policy wording with pricing and terms to satisfy both the insured and the underwriters. While syndications are fairly common in most lines of insurance, they can be particularly challenging in the political risk insurance (PRI) market.
In some instances, underwriters have competed aggressively to provide cover. However, these circumstances are rare in the PRI market. With that reality in mind, let’s examine some of the key challenges typically associated with syndicated political risk insurance placements.
Policy Wording: In difficult placements, the final policy wording often reflects the lowest common denominator. The reason for this is that underwriters want to cover risks on the same terms and conditions as others in the syndicate whether they are on a quota share coinsurance, layered so that some insurers pay after losses exceed the limits first absorbed by other insurers, or on a reinsurance basis. Insureds benefit if underwriters have a unified and coherent approach to claims, claims-cooperation, and recoveries. In pursuit of these objectives, the most conservative wordings generally prevail. In addition, while some underwriters are flexible regarding policy wordings, most prefer to start with their own. This is particularly true of official agencies such as OPIC or MIGA. When combining underwriters, many of their varying policy wordings have to be reconciled. For example, is the measure of compensation the book value of the foreign enterprise or the insured’s net investment value? What is the standard for expropriation cover? Is it violation of international law or is it an action that expressly and permanently deprives the insured of assets or interests? Other limitations on flexibility in wording result from exclusions in individual underwriters’ reinsurance agreements, such as losses arising from devaluation; from differences in underwriting standards (e.g. environmental conditions exclusion); or from statutory limitations, such as insured’s eligibility. All of these, and other issues, must be debated and resolved.
Eligibility: Underwriters have different approaches to eligibility, but official agencies impose the greatest constraints. In general, most underwriters require that there be a cross-border investment. Some will require that the recipient country be an emerging market nation. Others may be willing to look at developed countries or perhaps a combination of developed and developing country exposures. For US-based underwriters, the recipient country cannot be subject to US sanctions, such as those imposed upon Iran, while certain Lloyd’s syndicates can cover such countries. For many public agency underwriters, the transaction must meet particular guidelines: MIGA and OPIC require it to be a new investment; most ECAs require the transaction be an export from the underwriter’s country. Some recipient countries, such as Iraq, Venezuela, Bolivia, Ecuador, may be barred by one underwriter’s reinsurance terms while capacity considerations may limit another underwriter’s interest. The public underwriters vary in their requirements regarding social, environmental and other public policy matters. All must be accommodated in a multi-party syndication. There is also a spectrum of approaches for covering equity where the shares are pledged to lenders, ranging from there being no issue, to charging a premium for potentially impaired insurer security, to refusing to compensate if the insurer is not assigned free and clear title to the shares. It takes experience and market knowledge to reconcile all of these issues.
Pricing: When substantial capacity is required in a country regarded as particularly risky, the challenge is to bring pricing down. This often requires layering the coverage so that some underwriters are farther from the first-loss risk. Some underwriters would prefer to earn the higher premium and/or enjoy the leadership status associated with primary layers while others would rather participate on a limited basis as far away from the risk as possible. Some underwriters prefer to use their entire per-project capacity, and others prefer to participate in multiple risks for smaller amounts. Underwriters on bottom layers expect to earn more than those on higher layers, and it has occasionally been a challenge not to allow the top layers to drive pricing.
How the pricing is calculated is often more complex than would be expected. One attorney, whose practice includes a number of political risk underwriters, claims that his clients fight more frequently over pricing calculations than many other issues and often ask him to draft this wording relating to issues such as day count, estimated premium, etc. After legal input, pricing calculation is often the most complicated provision.
Timing: Projects move only as fast as the slowest participant moves—whether it be the project lenders, underwriters, or sponsors. In political risk insurance, it is generally the public agencies whose processes cause the most delay to the detriment of investors who require coverage to move forward. For the London markets, a committed, respected lead underwriter is critical to placing coverage efficiently as many underwriters in that market may defer commitment until such a lead is in place.
Tenor: The political risk market policy term ranges from approximately one year to a maximum of 15 years for a few private underwriters, or 20 years for some public agencies. There is a tradeoff between price and policy tenor for the private market that public markets are less likely to make. For long-term projects, weaving together varying terms and finding the “sweet spot” between pricing and tenor presents a challenge.
Claims: Claims cooperation among underwriters has sometimes been an issue. Although the insured may have to allow coinsurers to make independent determinations, it is important that with respect to loss mitigation, recoveries and other matters, the insured not be confronted with conflicting guidance and obligations. This must be sorted out in advance. Another problem is that public agencies have been unwilling to share their “preferred insurer” status which is their presumptive rights to preferential status among creditors, or to favorable treatment in investment dispute matters, unless they are rewarded.
Approach: Bringing together multiple parties in a timely way always has its challenges, particularly when underwriters in a syndicate do not have comparable levels of sophistication, temperament, and experience. Differing negotiation styles must also be navigated. Some brokers prefer to settle structure and pricing first, followed by wording. Others believe that wording affects pricing and may prefer to do both at once—but this can complicate timing and approach. Not all underwriters require the same information about a transaction, but every underwriter wants to see as much information as any other underwriter. Managing the flow of information, responding to questions, and negotiating with underwriters with different styles and with the insured can be an exercise in diplomacy as well as in technical capability.
Practitioners have often said that political risk insurance underwriting is more of an art than a science. While they are probably referring to the lack of actuarial foundation for underwriting political risks, it is equally true that solving the problems outlined above calls for case-by-case craftsmanship. In the real-world examples that follow, there were no handbook solutions—each case called for a tailored solution.
Greenfield Project in an African Country
Challenges: The insured wanted to obtain cover from a public agency to benefit from the agency’s “deterrent” capabilities, however, it would likely take a year to secure that agency’s commitment, while the insured’s exposure would begin sooner and would vary over time. Also, given the country risk, pricing was a concern, as was the need to achieve policy wording acceptable to both the public and private markets.
Solution: The timing issue was solved by placing shorter-term bridge coverage from the private market with the full expectation of the public agency’s participation at a later date. The wording issue was addressed by utilizing a public-agency wording that had been accepted by underwriters for a similar transaction. They managed pricing by utilizing a quota-share coinsurance structure for expropriation coverage, and a layered structure for political violence coverage. They addressed anticipated variations in the policyholder’s exposure over time through a monthly calculation of premium and anticipation of the fluctuations up front.
Expansion in a South American Country
Challenges: A company’s existing public-agency coverage could not, for policy reasons, be increased to cover additional investment. A supplementary private market program was placed at a very competitive rate, but it did not have the same perils, definitions, compensation calculation, etc. The new program did not drop down to fill gaps in the agency’s coverage (e.g. the underlying policy did not cover Forced Abandonment) and was inadequate for the expansion.
Solution: The public agency’s policy issues were tackled and overcome, allowing it to increase its participation. Since it had the least flexible approach to wording, its policy was used as the basis for negotiation among the parties. The program was completely restructured as a public/private market coinsurance but with the private market participation layered. For the highest coverage limit that required multiple insurers, coverage was layered to achieve optimal pricing. The longer tenor participants were on the bottom layer and received the highest premium, with the shorter tenor participants at the top layers. For other coverages with lower limits, a single, competitively priced placement sufficed. The wording was essentially the same for all 11 markets, including the United States, Bermuda, London and the public agency, but there were some minor differences in various layers to reflect the requirements of individual market or reinsurance agreements. This was the first time that many of the participants had written on this public agency wording and it was key to educate the private market about the agency’s language.
Transaction in a South Asian Country
Challenges: The transaction outpaced the readiness of some underwriters to commit coverage. It also involved two public agencies, each with its own eligibility and other criteria. One agency would have been required to obtain certain additional internal approvals which would have further delayed its participation. Another agency could write on a different underwriter’s policy wording only if the agency were reinsuring rather than coinsuring.
Solution: As the exposure was incurred over a period of time rather than all at once, the first agency provided coverage for the full amount of the early exposure. Once the policy wording was negotiated, the private market agreed to take half of the ultimate exposure amount on essentially the same wording, on a coinsurance basis. The strategy then was to bring in the second agency, using the same wording. As a reinsurer, the second agency was able to accept the first agency’s wording, which it could not have done as a co-insurer. This was its first time working in this capacity and while it was efficient in obtaining internal approvals, it still had to address some details. The first agency could not take the credit risk of the reinsurer without additional approval, so it structured an agreement to give the insured direct recourse to the reinsurer.
Challenges: This project involved multiple countries and several public agencies. Each agency had different eligibility requirements and policy approaches. The slowest of the agency processes drove the timing.
Solutions: Because the coverage was relatively straightforward, the project carefully structured, and the underlying documents clear, the policy language even from the most inflexible participant was acceptable. Still, it was necessary to structure the investment in separately insured tranches to avoid the impairment of coverage that one participating insurer’s coinsurance policy otherwise would have imposed. Timing became an issue and the line size of one of the leading potential underwriters was reduced when it proved unable to obtain all approvals in time. To meet one agency’s eligibility requirements it was also necessary to bring in an insurer from the private market as primary with the agency as reinsurer. Navigating the approval procedures, policy issues, and wording constraints to successfully place cover for this challenging project required strong cooperation between the project team and underwriters.
Bringing multiple parties to a placement can have substantial advantages including combining the benefits of public agency deterrence with the greater flexibility of the private market. Involving multiple insurers is often the only way to achieve the level of capacity required for large projects. The political risk market has made dramatic strides in working together to achieve these goals but still is not as commoditized as other insurance markets. Careful structuring around various hurdles is required to achieve an outcome that satisfies and delights all parties. ■