Ronald Gift Mullins looks at the political risk joint venture between Bermudian giants ACE and XL.

If Price Lowenstein and his team continue to underwrite political risk insurance with the same intensity, deliberation and dedication that they invested in forming Sovereign Risk Insurance Ltd, of which Mr Lowenstein is CEO and President, the company will surely prosper and grow.

The concept of political risk insurance began shortly after the end of World War II, when the US government provided currency conversion protection to encourage companies to invest in rebuilding Europe. Political risk insurance was first sold by private insurers (AIG and several Lloyd's syndicates) in the mid-1970s. At a dinner in London in 1994, Mr Lowenstein, at that time a political risk broker with Guy Carpenter & Co, listened as several Lloyd's underwriters bragged that American International Group (AIG) and Lloyd's of London were the only private insurers that wrote political risk insurance. There were a number of government entities that wrote the coverage - the US Overseas Private Investment Corporation (OPIC) formed in 1971 and World Bank's Multilateral Investment Guarantee Agency (MIGA), created in 1988 - but no other private insurers had ventured into this precarious field.

Persuading his boss at Guy Carpenter to give him time to explore the possibilities of creating a private political risk insurance company, Mr Lowenstein investigated and examined the field for the better part of a year. The more he became involved with the core elements of providing this form of specialised insurance and the potential market for the coverage, the more he became convinced that the world was ready for a fresh company devoted to writing political risk insurance, but with a significant difference - it would not resort to reinsurance.

Over the course of a further twelve months, Mr Lowenstein and Chris McGhee, a colleague from Guy Carpenter, developed a business plan that was presented to Marsh McLennan Risk Capital. The idea proved to have merit, but where to launch such a pioneering enterprise? The answer seemed obvious - Bermuda.

Accordingly, the proposal was presented to ACE and XL, at that time relatively new Bermuda-based re/insurers, but both organisations which had shown consistent interest in pursuing innovative ventures, In December 1996, after further negotiations lasting almost a year, Mr Lowenstein was encouraged to put a team together and begin writing business in the New Year. The enterprise was now almost ready to go - except it had no name.

After a spirited competition among the principals, Sovereign Risk Insurance Ltd was selected as they felt it expressed the business of the company, while conveying independence and superiority.

50/50 arrangement
The final arrangement resulted in a 50/50 ownership by XL Insurance (Bermuda) Ltd and ACE Bermuda Insurance Ltd. Each company shares 50% of all risks and pays 50% of all claims. Sovereign underwrites its risks using these companies' more than $75bn in capital and is the only net lines political risk underwriter in the market. "By not depending on the vagaries of the reinsurance market, Sovereign can insulate its clients from the highly cyclical nature of the commercial reinsurance markets," said Mr Lowenstein. In the summer of 1997, the start-up company was initially given space in the XL claims department in Hamilton, Bermuda, but eventually moved to its own offices on the island.

"We are highly specialised," he said. "We write political risk only, not trade credit insurance. The global political risk insurance market is roughly divided in half, half written by government agencies and half by private insurers." AIG ranks as the largest private political risk insurer, followed by Sovereign and Zurich. In its 2002/2003 full year, Sovereign wrote gross premiums of approximately $62.7m.

The company provides political risk insurance contracts for terms of up to

15 years and in amounts of up to $125m per project, currently the largest limits in the private market, according to Mr Lowenstein. Increased limits can be obtained if the risk warrants it. "Because of the tightening reinsurance market," he said, "AIG's limit is now down to $80m, Zurich's is at $70m."

Stron ROC
Since 1997, Sovereign has written approximately $225m in gross premiums and has had losses of roughly $17m, with $5m recovered to date. "Our results have generated a good return on capital for ACE and XL," he said, adding that the joint venture structure with the two re/insurers has worked out well. "Their alignment of interest in Sovereign is very strong."

With more than $5.75bn of exposure from 225 in-force policies spread over 75 emerging markets, Sovereign's clients include major financial institutions, national export credit agencies, multilateral institutions and multinational corporations. "Our operation can accommodate a variety of manuscript contracts and offers customised coverage for individual transactions," Mr Lowenstein said.

The company's portfolio is divided roughly into three main segments of business: about one-third is facultative reinsurance of multilateral agencies and national export agencies; one-third is direct insurance supporting commercial banks' loans to private companies in emerging markets against the risk of expropriation and currency inconvertibility/non-transfer; and the final third is for investment banks and capital markets, including providing convertibility/non-transfer risk for publicly placed bond offerings that enable issuers located in emerging markets to achieve investment grade ratings.

Menu of solutions
Clients can select from a range of innovative solutions to manage and transfer political risks in emerging markets.

Real exchange rate liquidity is a structured insurance product that partially mitigates the impact of large currency devaluation on an infrastructure project's ability to meet dollar-denominated debt service obligations.

Expropriation coverage protects lenders and investors against a broad range of actions by the host government that reduces or eliminates fundamental creditor or ownership rights in the insured loan or investment.

Non-honouring of investment agreements (also called breach of contract) covers the failure of the arbitral process in conjunction with the dispute resolution provisions of fundamental investment agreements to which the host government is a party.

Currency inconvertibility and non-transfer coverage protects against losses arising from the inability to convert local currency into foreign exchange and transfer it outside the host country.

Political violence coverage compensates an equity investor for damage or loss of tangible property and a lender for interruption of debt service caused by politically motivated events of war, civil war, revolution, insurrection, sabotage, terrorism and civil strife.

Contract frustration coverage protects against financial losses due to non-payment of amounts owed by the host government in respect of loans, sales or service contracts. In the case of private buyers, the protection responds to a buyer's failure to make payment as a result of political events in the host country.

Unfair calling coverage protects against loss resulting from an unfair (i.e. illegal or capricious) calling by a government buyer or contractor of on-demand instruments, including bid, advance payment and performance bonds, furnished in respect of a particular project.

Non-repossession coverage protects against loss resulting from host government interference with an insured's ownership rights with respect to aircraft or other mobile equipment, including exercising the right to repossess and re-export those assets.

Sovereign can also customise political risk coverage to protect against financial losses due to trade embargoes, licence cancellations, default on arbitration awards and other political risks specific to individual transactions.

Nine of ten rejected
The demand for political risk insurance is well in excess of supply. The company receives about ten submissions a day and rejects nine after a review by the underwriters. Critical to the continued profitability of Sovereign has been its underwriting team. Each transaction has its own characteristics and particular risk elements, and Sovereign's nine-member staff, with more than 50 years of combined underwriting and legal experience in both national agencies and the private market, has been noted for assisting clients quickly and effectively.

"The team members are very experienced in international affairs," said Mr Lowenstein. "We are 'emerging market' junkies - a very esoteric subject that would bore most people. You have to be really interested in political and economic events in emerging markets or you're in the wrong business."

Extensive due diligence is performed on a risk before a contract is signed. "In some cases the degree of diligence depends on the location of the risk," he said. "Some are straightforward and others are highly complex."

Staying up-to-date on the latest political and economic changes in distant and somewhat obscure countries requires a constant monitoring of major bulletins from the world's global banks and investment houses, and several politically-oriented, specialised news services. "Then, we have consulting groups that are more esoteric," Mr Lowenstein said, "James Bond-type guys, who are on retainers to get specific information in some of our more exotic markets that we can obtain (information on in) no other way."

Looking at further growth in geographical terms, Russia, Eastern Europe and parts of Asia have potential, according to Mr Lowenstein. The recent economic and political turmoil in Argentina has lead to Sovereign paying out on three small claims, and the company continues to monitor its exposures there closely. "But the results have been better than what we were thinking they might be," he said. At present, the company has reached its exposure limit in Brazil, but Mr Lowenstein believes that Brazil's economy will continue to grow at a very fast pace.

Given that Sovereign has reached a superior level of achievement in little more than six years, its future seems solid, secure and successful.

By Ronald Gift Mullins
Ronald Gift Mullins is an insurance journalist based in New York City.