Transcript Chapter 17 - Bauer College of Business

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Risk Management and Insurance: Perspectives in a Global Economy
17. Political Risk Management
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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
3
Modes of Foreign Market Entry
 Exporting
• Use of a domestic intermediary
 Foreign direct investment (FDI)
• Joint venture
• Wholly-owned subsidiary
• Branch
4
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.
5
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
6
Public Information Sources (Table 17.1)
7
Top 10 News of 2009 by TIME Magazine
1. America's Economic Crisis: Now for the Non-Recovery
2. Afghanistan: Can the U.S. Avoid a Quagmire?
3. Iran's Tumultuous Election and Its Aftermath
4. The Divisive Debate Over Health Care Reform
5. Massacre at Fort Hood: The New Face of Terrorism?
6. The Death of Michael Jackson
7. Pakistan: On the Verge of a Breakdown
8. Mexico's Bloody Drug War
9. H1N1: That's Swine Flu to You
10. The End of Sri Lanka's Cataclysmic Civil War
8
Political Risk Control Techniques
Integrative Strategies
Defensive Strategies
 Discourage the host government
from interfering with the
operation of the firm
 The cost of interference > the
cost of letting the firm stay
 Managerial approaches
•
Increase in communication and
tighter relationships (e.g., use of
local resources including personnel)
 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
•
•
FDI through joint venture
Fair, accurate and open financial
reporting
 Financial approaches
•
•
Source equity/debt financing from
within the host country
Minimize retained earnings locally
9
Financing the Political Risk Exposure
10
Financing the Political Risk Exposure
 Retention
 Insurance
• Intergovernmental agencies
• Governmental agencies
• Private companies
11
Multilateral Export Credit Agencies (Table 17.2)
The correct name for the Arabian countries is
“Inter-Arab Investment Guarantee Corporation.”
12
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
13
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
14
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
15
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)
16
Public vs. Private Insurance
Public Insurers
Private Insurers
 They must consider
governments’ policy objectives.
 Private insurers are for profit
while avoiding undue risk.
•
 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.
•
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.
17
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.
18
Political Considerations in Emerging Markets
 Eastern Europe
 Asia
 Latin America
 Middle East
 Africa
19
Case Study: Iran
(Not in the book)
20
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
21
People




Population
Median age
Urban population
Gender ratio

Life expectancy
•
•

Persian
Azeri
51%
24%
Religion
•
•
Source: CIA World Factbook (February 2010)
69.65
72.27
Ethnicity
•
•

Male
Female
66.5 million
27
68%
1.02
male/female
Muslim (Shia)
Muslim (Sunni)
89%
9%
22
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
Unemployment
Pop below poverty
Labor in services
16.8%
11.8%
18%
45%
Managed floating exchange rate
since 2002
23
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
24
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
25
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)
26
Insurance Data – Premium
27
Premium Distribution
28
Claims Distribution
29
Loss Ratio
30
Market Players
31
Relative Position of the Country
32
Discussion Questions
33
Discussion Question 1
 With increasing internationalization of national economies,
would you expect political risk exposures to grow or diminish
in importance? Justify your answer.
34
Discussion Question 2
 Could political risk exposures of MNCs might be hedged in
the capital market? Speculate as to how this might be
accomplished.
35
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?
36
Discussion Question 4
 Can governmental political risk exposures justify the
creation, maintenance and protection of a domestically
owned insurance industry? Justify your response.
37
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?
38