Political Risk a Hot Market for Lloyd’s Underwriters

The political and trade credit risk market can be highly profitable to Lloyd's underwriters in turbulent times such as the present, but the risks can be high as well.

The risks that underwriters must consider are as immediate as the daily headlines: turmoil in the Middle East and North Africa, the crisis over the euro and the wider effects of the rise of China.

"Over the economic and the insurance cycles, we would expect to make healthy margins out of this business, but we do get smacked occasionally by the odd crisis," said Adrian Lewers, political and credit risks underwriter at Beazley Group. "The financial crisis of 2008 was quite painful for us and for the market."

Alyson Warhurst, chief executive officer of Maplecroft, a U.K.-based global risk consultancy, says areas of political risk include the Middle East and North Africa, countries exposed to euro funds, sub-Saharan Africa, and South Asia. Maplecroft has a broad definition of the time span of political risk. It ranges from "the next few quarters" to the long-term, Warhurst said.

"More than ever, I think political risk insurance is going to be absolutely critical to support businesses in this new challenging, exciting growth landscape," she said.

Lewers believes the unresolved issue of European debt is not a good sign for the growth of trade, which is the lifeblood of the political and trade credit risk insurance market. "It's hard to see that investment or trade will be particularly robust in terms of growing year on year," he said.

Beazley is planning to increase its account in 2012. This optimism is based on expected expansion outside London, notably in New York, Singapore and in a new operation in Paris, Lewers said.

James Bamford, head of war, terrorism and political risk at Talbot Underwriting Ltd., said figures on international trade and investment provide sobering clues as to the direction of the insurance market.

The forecast for foreign direct investment in 2011 is $1.5 trillion, down from a high of $2.3 trillion in 2008, Bamford said. In 2010, he added, investment going into developing countries rose by 30%. This figure represented 40% of global investment flows. Bamford also cited a 6% drop in global trade finance, to $114 billion in 2011, compounded by a particularly steep decline in the third quarter.

Trade finance refers to the amount of capital that is needed to allow international trade to take place.

Bamford describes Talbot as "a midsize player in the Lloyd's market," with about 5% of the Lloyd's market capacity. He would not discuss Talbot's premium income.

Despite the gloomy macroeconomic indications, Talbot is expecting to increase its political and trade credit risk premium volumes by about 5% to 10% this year. Bamford noted Talbot's success in seizing market opportunities in the disarray that followed the 2008 global financial crisis. Between 2008 and 2011, Bamford said, Talbot increased its political and trade credit book by 100%.

In an email response, XL Group plc declined to predict the growth of the market in 2012. But XL said it does see "steady and continued growth as the most likely scenario over the coming years."

The growth of the market in recent years has been influenced by an increased awareness of risk and by changes in the regulatory environment, according to XL.

XL mainly offers primary cover in the private insurance market, but it can support export credit agencies with reinsurance. XL declined to discuss the size of its own book. But it did note, "We are a new unit and just getting started."

Beazley breaks the political risk market down into three main product areas. The first, known as pure political risk, is essentially investment or project risk. The other two areas are trade and trade-related risks. The first of these, known as contract frustration, covers business that is done with government agencies. The second, which involves business between commercial entities, is known as credit risk.

Lewers said the market can provide per-risk capacity in investment and contract frustration at just over a billion dollars and capacity at about $850 million for pure credit or commercial risk. These levels of cover would assume all the underwriters are in for their maximums, Lewers said.

In addition, there is market with a total premium value of about $1.5 billion that is related to the activities of the export credit agencies, which he describes as "quasi-government owned insurers who operate in the trade space," Lewers said.

Lewers concedes this figure represents his suspicion, rather than solid data. "It's hard to get a good grip on premium because nobody really tells you how much premium they write," he said.

Beazley writes all three product areas, for a total premium income of about $50 million. "Lloyd's tell us that we have about a 10% market share of the Lloyd's business," Lewers said.

Beazley, which leads about 75% of the business it writes, has a capacity per risk of $30 million and the authority to issue policies for up to seven years out, Lewers said. The business is written out of London, New York and Singapore, with Paris to be added soon.

Pricing variation is likely to be strongest in the credit area, Lewers said.

"It is in pretty robust health," he said of the political and trade credit risk market.

The growth of per-risk capacity during the past two or three years has enabled the commercial market, and Beazley, to meet client needs, Lewers said. For Beazley, this means being able to cover risks generated by infrastructure projects, investment programs and trade.

And while an abundance of capacity in the market has led to disappointing prices, Lewers expects new underwriting opportunities to appear over the next year.

The market "has recovered well from the financial crisis in 2008, which spilled over into 2009," he said.

The crisis in the Middle East and North Africa produced "a bit of a shocker" for the market, Lewers said. But this situation has turned out better than had been feared, he said. "So we're in a pretty good place going forward."

Over the coming months, Lewers sees plenty of tests for the risk selection skills of underwriters. A key to the resolution of the euro crisis, he believes, will be the fate of Greece — whether, for example, Greece remains within the euro.

There is improvement in the economic picture in the United States, said Lewers. But he is concerned about the possible effects from the global economy on China and "whether China has a hard or soft landing."

Lewers, who has detected a move by the political risk market in London toward credit risk, expects the risks that have developed in the Middle East and North Africa as a result of the Arab Spring to have a long-term effect the on political risk environment.

Lloyd’s and units of XL have current Best’s Financial Strength Rating of A (Excellent.

(By Robert O'Connor, London editor: [email protected])