demand for political risk is likely to grow. David Fox reports Just a year old, a Bermuda-based insurer that specialises in providing cover for political risks, is already a global leader in its field.

And the recent volatility in world markets could mean that Sovereign Risk Insurance Ltd. may find an increasing demand from third world countries for the specialty cover it provides.

Sovereign was just formed in the summer of last year by two Bermuda insurers, ACE Insurance Co., Ltd. and XL Insurance Co., Ltd., together with minority participation by Risk Capital Reinsurance Co.

Industry insiders expect the demand and need for political risk insurance to grow dramatically in the year ahead, as the heightening economic tension increases the risk of political and social unrest, and the erection of currency controls in under-developed nations.

Delegates to a seminar (The role of Political Insurance in Project Finance) at the annual meeting of the World Bank/International Monetary Fund last month, heard how political risk insurers will play a pivotal part in encouraging investors to invest in less developed nations that are presently starved for capital.

ACE chairman, president and CEO, Brian Duperreault told the seminar that political risk insurers "will play an increasingly important role in the economic development of developing nations.'' And he told The Royal Gazette , "We've had a liquidity crisis in the world.

People are fearful of credit risks and political instability caused by economic downturns.

"So banks are under pressure from a couple of different directions. They are going to loan money for a project in a market, that a year ago was terrific, but which is now considered to be much riskier.'' He said they are balancing the protection of the credit risk and the political side.

"There is,'' he said, "an aversion to risk in the world right now, particularly related to financing. And that stimulates the demand for protection. That is good for insurers which provide protection from risk.'' Insurance Finance & Investment, a publication of Institutional Investor, Inc., reported that the man overseeing project finance at Santander Investments, Ellis Juan, said that alongside the need for investment capital to boost economic demand, some $7 billion of short-term bridge loans to less developed nations would need to be refinanced by the second quarter of next year.

"Because of the market volatility,'' he said, "investors will be less willing to fund these loans, unless we find new ways to make investments secure.'' But more demand for insurance, means more risk for insurers' underwriting investment projects.

Mr. Duperreault was sceptical of the viability of one proposed solution: the securitisation of the political risk exposure with the transference of the liabilities to the capital markets.

At the moment, he said, it doesn't look like there could be a capital market solution.

There is some doubt that investors would be willing to buy insurance-linked notes that are highly-correlated to other financial instruments.

Mr. Duperreault pointed out that notes linked to political risk, unlike catastrophe bonds, are more likely to perform poorly as the global economy performs poorly. Sovereign Risk insures businesses with operations abroad against losses from political upheavals, including war, revolution, confiscation and incontrovertibility of currency.

ACE itself, in April 1997, entered into an unprecedented quota share treaty to reinsure the Multilateral Investment Guarantee Agency's (MIGA) political risk insurance for developing countries. MIGA is the insurance arm of the World Bank.

By the end of this March, Sovereign had signed a landmark ten-year agreement to provide the French Government Export Credit Agency (COFACE) with $80 million of private sector reinsurance coverage for COFACE's portfolio of French equity investments located in China.

Not much later Sovereign doubled its per project capacity limit to $100 million, and increased its country limits from $100 million to $250 million.

It also expanded its line to include contract frustration insurance (the repudiation of a contract, usually an investment agreement, due to political events in a country).

WEIGHING UP THE RISKS -- Brian Duperreault