PowerPoint Slides for Professors Spring 2010 Version

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.

Visit the following site for updates:http://facpub.stjohns.edu/~kwonw/Blackwell.html.

To change the slide design/background,[View] [Slide Master]

W. Jean Kwon, Ph.D., CPCUSchool of Risk Management, St. John’s University

101 Murray StreetNew York, NY 10007, USAPhone: +1 (212) 277-5196

E-mail: [email protected]

Risk Management and Insurance: Perspectives in a Global Economy

17. Political Risk Management

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3

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

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Modes of Foreign Market Entry

Exporting• Use of a domestic intermediary

Foreign direct investment (FDI)• Joint venture• Wholly-owned subsidiary• Branch

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Political Risk

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 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.

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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

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Public Information Sources (Table 17.1)

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Top 10 News of 2009 by TIME Magazine

1. America's Economic Crisis: Now for the Non-Recovery2. Afghanistan: Can the U.S. Avoid a Quagmire?3. Iran's Tumultuous Election and Its Aftermath4. The Divisive Debate Over Health Care Reform5. Massacre at Fort Hood: The New Face of Terrorism?6. The Death of Michael Jackson7. Pakistan: On the Verge of a Breakdown8. Mexico's Bloody Drug War9. H1N1: That's Swine Flu to You10. The End of Sri Lanka's Cataclysmic Civil War

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Political Risk Control Techniques

Integrative Strategies 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

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

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Financing the Political Risk Exposure

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Financing the Political Risk Exposure

Retention

Insurance• Intergovernmental agencies• Governmental agencies• Private companies

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Multilateral Export Credit Agencies (Table 17.2)

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

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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

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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

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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

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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)

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Public vs. Private Insurance

Public Insurers 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.

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.

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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.

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Political Considerations in Emerging Markets

Eastern Europe

Asia

Latin America

Middle East

Africa

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Case Study: Iran(Not in the book)

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Background

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

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People

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)

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Economy 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

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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

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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• Bimeh Markazi (Central Insurance, www.centinsur.ir) of Iran

established in 1971

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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)

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Insurance Data – Premium

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Premium Distribution

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Claims Distribution

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Loss Ratio

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Market Players

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Relative Position of the Country

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Discussion Questions

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Discussion Question 1

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

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Discussion Question 2

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

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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?

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Discussion Question 4

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

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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?