What is Political Risk?

Political risk is the risk that governmental and socio-political action, inaction, or instability will adversely affect the legal position, economic value, or operational continuity of an enterprise or investment. It arises where sovereign power, public policy, or political behavior can change the rules of the game through legislation, administrative practice, or through shifts in ideology, coalitions, or social movements.

Political decisions can create new rules in governance, risk management, property rights, contract enforcement, and market access. This includes classic sovereign risks like expropriation and nationalization, but also currency inconvertibility and transfer restrictions.

Regulatory and policy risks arise when rules governing licensing, data, competition, labor, climate, tax, or foreign ownership are revised, selectively enforced, or ambiguously administered.

Geopolitical risks include sanctions, export controls, extraterritorial laws, trade barriers, and conflict driven disruptions to logistics, energy, commodities, and critical inputs.

Social and governance risks emerge from protest movements, civil unrest, strikes, corruption, patronage systems, and erosion of judicial independence, any of which can impair due process and create arbitrary outcomes.

Macropolitical risk is the risk arising from political events, decisions, or systemic changes that affect all entities, sectors, or investors within a given country or region (not a specific firm or industry). It reflects the exposure of organizations to shifts in national or supranational political conditions. It is a risk to the business environment as a system, not to a single actor within it.

Macroprudential risk is fundamentally different from macropolitical risk (both use the prefix macro and it could lead to confusion). Macroprudential risk arises within the financial system, not the political system. It is the risk of instability in the financial system as a whole, across banks, insurers, and markets, caused by the collective behavior of institutions, structural vulnerabilities, or systemic shocks.

The macroprudential framework is a regulatory and supervisory architecture designed to safeguard the stability of the financial system by addressing risks that are system wide, not institution specific.

Micropolitical risk is the risk arising from political events, decisions, or systemic changes that selectively affect a particular firm, sector, project, or transaction.

Micropolitical risk affects particular entities or activities. It includes denial of permits or licenses, targeted taxation, and politically motivated investigations. It is often formally lawful, but the discretion allowed by the legal system becomes a vector for influence, retaliation, or protectionism.

Microprudential risk is fundamentally different from micropolitical risk (both use the prefix micro and it could lead to confusion too). Microprudential risk arises at the level of individual financial institutions, such as banks, insurers, or investment firms, due to weaknesses in their governance, risk management, or capital adequacy, which may threaten their own solvency or soundness but not necessarily the stability of the financial system as a whole. It is focused on ensuring that each regulated entity remains financially robust, manages its risks responsibly, and complies with regulatory requirements designed to protect depositors, investors, and policyholders.

Measurement, Monitoring, and Early Warning

Political risk management blends structural indicators with event based monitoring.

Structural indicators include constitutional checks and balances, judicial independence, administrative capacity, and corruption control.

Event indicators include elections, cabinet decisions, populist mobilization, fiscal stress, security incidents, sanctions announcements, regulatory consultations, and emergency measures.

Stress testing scenarios should reflect political events and the legal mechanics, and how these would affect the organization. They must quantify impacts on revenue, working capital, and market access.

Reverse stress tests must identify political conditions under which the business model fails or is materially affected. The objective is clarity for the board and the risk committee.

Political risk must be embedded in the enterprise risk management framework with clear ownership lines. Board-level oversight starts with a statement of risk appetite specific to political risk, defining tolerances for jurisdictional concentration, sanctionable exposure, and dependency on public concessions. In practice, that means explainable decision processes for market entries and exits, policies and procedures assigning responsibility for political sensitive approvals, and engineered kill switches for high risk operations, contracts, or data flows when red lines are crossed.

In simple words, political risk is the governance risk of operating under public power. It cannot be eliminated, but it can be priced, structured, and governed. In a world defined by regulatory competition, geopolitical fragmentation, and the politicization of technology and sustainability, political risk is material for legality, market access, profitability, and license to operate.

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Learning from the Annual Reports

Political risk, from the Annual Report, Hannover Re

Credit, Surety and Political Risks

Loss ratios increased only slightly in credit and surety insurance as well as in the political risks segment despite the global recession. This reflects wide-ranging government support programmes on the fiscal and monetary side as well as state guarantees given in favour of mostly European credit insurance business.

In countries where state guarantees were provided in credit insurance, a significant part of the loss expenditure was ceded to the government in question – along with a corresponding share of the underlying premium. As a result, the premium volumes for insurers and reinsurers in credit insurance have temporarily declined.

As a further factor, premium growth slowed in all three product lines – credit, surety and political risk – owing to the economic downturn around the world.

The protracted uncertainty in the face of the soft economic environment led to a modest rise in reinsurance demand and in the underlying prices.

Even though no significant increase in the burden of losses was evident in the reporting period, it may be assumed that the current macroeconomic situation will result in a heightened risk of insolvency for some companies, especially in certain industrial sectors. With this in mind, we set aside additional reserves of EUR 248.6 million in the year under review.

The gross premium for the Credit, Surety and Political Risks reporting category increased in the financial year by 5.2%.

In the second half of the year Latin America was again heavily impacted by unrest in multiple countries. In light of this increased exposure, considerable adjustments were made on both the primary and reinsurance side, especially in the assessment of political risks and the pricing for corresponding covers.

Political risk, from the Annual Report, Nippon Export and Investment Insurance

Trends in Recoveries

The amount of recoveries decreased by 25% year on year to approximately JPY 23.5 billion in FY2020. Recoveries of claims associated with political risk events, including debt rescheduling, accounted for 89% (approximately JPY 20.9 billion). The remaining 11% (approximately JPY 2.5 billion) was associated with commercial risk events.

Trends in Claims Paid

Claims paid in FY2020 were approximately JPY 23.1 billion, down 59% year on year, due to a decrease in claims paid for political risk events.

Insurance for export, intermediary trade, and technical cooperation

In cases where Japanese exporters export cargoes to foreign countries, engage in intermediary trade, or provide technology such as construction work, this insurance covers losses due to:

i) force majeure such as war, revolution, terrorism, import restriction/prohibition, and natural disaster, or

ii) inability to ship cargoes due to bankruptcy of the business partner, etc., as well as losses resulting from inability to collect payment after the cargoes have been shipped or after the technology has been provided.

Policy coverage extends to all types of losses due to political action and instability, including:

- Confiscation, expropriation, or nationalization.

- Currency inconvertibility and non-transfer.

- Political violence (including terrorism and war).

- Contract frustration due to political events.

- Sovereign payment default.

- Wrongful calling of on-demand guarantees and bonds.

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Examples, Political Risk Insurance Coverage

1. AIG, Political Risk Insurance

Backed by more than 30 years of experience, AIG can provide tailored coverage that addresses the risks specific to your markets and line of business. And while political climates may shift, with AIG, your coverage will remain non-cancelable and secure.

Policy coverage extends to all types of losses due to political action and instability, including: Confiscation, expropriation, or nationalization.

- Currency inconvertibility and non-transfer.

- Political violence (including terrorism and war).

- Contract frustration due to political events.

- Sovereign payment default.

- Wrongful calling of on-demand guarantees and bonds.

2. AON, Political Risk Insurance

Doing business with unstable countries entails not only economic risk, but also political risks that are difficult to calculate. The private insurance market also offers cover against political risks. Not only Lloyd’s of London but also internationally specialised insurers from various global markets offer political risk insurance designed to meet their clients’ needs.

Risks

Risks that manifest themselves during the manufacturing period and after delivery, or in respect of capital, holdings and investments abroad:

- War / civil unrest

- Import or export embargoes

- Arbitrary termination of contract by a state purchaser

- Withdrawal of license, loss of receivables through non-payment

- Exchange, transfer and payment bans

- Other arbitrary intervention by the state

- Non-issue of a confirmed letter of credit

- Unjustified drawing on bank guarantees made payable “on first request”

- Nationalisation and confiscation by the sovereign authority

- Expropriation of machinery and equipment

- Revocation of rights of disposal

- Transfer ban for investment income

Insurance cover

Over and above the largely standardised cover offered by the state, the private insurance market offers the following solutions and options:

- Insurance of selected individual risks

- Individualised cover

- Calculation of risk-appropriate premiums

- Willingness to cover unconventional risks

- Independence of national restrictions

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