The mitigation of country risk using political risk insurance (PRI) has long been undervalued by foreign direct investors. While the market intuitively understands the benefits of PRI, it is often perceived as “expensive”, because the financial benefits of coverage have not been adequately quantified. Customarily, when evaluating PRI as part of an investment, lenders and investors have assigned little to no value to the existence of a PRI policy in the valuation process. The result has been to impede broader use of PRI as a risk mitigation tool.
The lack of a robust analytical framework to guide decisions around whether to insure political risk has denied financial decision makers of the means to make informed and well-supported assessments. Conversely, we assumed that using a nuanced country risk premium (CRP), developed by dissecting the elements of country risk, and methodically integrating the potential benefit of PRI into valuations, could be of great value to investment professionals.
To help companies and investors better evaluate PRI, Marsh’s Credit Specialties practice worked with S&P Global, an independent third party, to use its Country Risk Investment Model (CRIM) to evaluate the benefits of PRI. The study’s initial hypothesis was that a well-crafted PRI policy should result in a non-zero improvement in the CRP, and that this should be captured for the benefit of investors when undertaking a valuations exercise. A more robust and granular approach to quantifying the benefits of PRI should enable companies to justify investing in one or more projects with a CRP that might fall outside their traditional internal risk tolerances. The new approach examined in this study demonstrates that PRI typically improves the CRP and credit rating equivalent of an emerging market investment, and improves the project’s internal rate of return (IRR).
The key conclusions of the S&P Global study Proof of Concept, Using Country Risk Investment Model to Analyse Benefits of Political Risk Insurance (August 2021) are as follows:
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The S&P Global economics and country risk team takes an intelligence-led approach to forecasting the full spectrum of commercially relevant political, economic, legal, tax, operational, and security risks, in 211 countries. They provide risk solutions that are data-driven, leverage data science and geospatial analytic tools, and are informed by the largest team of country, banking, and sector risk analysts in the market. The country risk team has more than 110 dedicated analysts and data scientists.
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