Entering 2020, corporate policyholders already faced a hardening insurance market. But as the COVID-19 pandemic continues to wreak havoc on global markets and sow civil unrest throughout the globe, and the insurance industry faces unprecedented losses, the market has further deteriorated entering 2022.
In fact, Reuters reported COVID-19 losses of $44 billion so far, which represents the third-largest cost to insurers of any catastrophe to date (behind Hurricane Katrina and the 9/11 terrorist attacks). These factors have not only made some insurance companies reluctant to extend new coverage, but have also incentivized insurance companies to deny or delay claims until their balance sheets recover.
At the same time, businesses with substantial investments in foreign countries face escalating risks of expropriation. Recent world events — from civil unrest in Kazakhstan leading to Russian military intervention, to instability in Myanmar related to the military’s coup d’état, to riots following the imprisonment of a former president in South Africa — highlight the need for foreign investors to protect themselves from losses they may suffer related to the political instability that can grip the countries they invest and operate in (the “host countries”).
The multimillion-dollar question is — in light of the pressure on the insurance industry, can businesses expect insurance companies to acknowledge coverage and promptly pay losses under insurance policies covering such expropriation risks?
To answer that question, it is important to first understand the way political risk insurance products work and some of the arguments political risk insurers might raise to deny or delay payment of claims.
What Is Political Risk Insurance?
Political risk insurance (PRI) is an important tool for companies with investments in emerging markets to help ensure they are adequately protected against certain risks. PRI policies generally cover losses a foreign investor might suffer as a result of adverse action or inaction by the host country’s government.
Covered losses stem from an array of exposures a foreign investor may face when working in developing countries or other countries with a history of political instability, often including: partial taking of assets of the insured enterprise before a complete taking (expropriation); legislative or regulatory actions or inactions that disproportionately affect foreign investors (selective discrimination); political violence; an inability to convert, transfer or repatriate funds related to an investment (currency inconvertibility); a prohibition on exports or imports; and contract frustration.
Other niche-related insurance markets also have been implicated by the current global circumstances, including trade credit and coverholder insurers. These political risk-related covers are important to a multitude of companies and foreign investors across several industry segments, including project developers, mining/metals entities, construction companies, energy services entities and financial institutions, to name a few.
How Political Risk Insurance Typically Operates
To understand how a PRI policy typically works, take the example of an investor who has insured equity or debt in a venture operating in a foreign country, such as a metal mining company. A new government regime comes into power in the host country and decides to seize the assets of the foreign venture or improperly prohibit the export of its product that was being mined or manufactured in the foreign country. The government may do so to try to extract more favorable terms in the underlying mining license and related agreements with the mining operator or to further the political interests of the new regime. Because the foreign venture is unable to operate or export its product, the investor suffers lost income and/or equity value.
To establish coverage for such losses under most political risk policies, the investor is generally required to show the following:
- The government’s conduct triggered one or more of the insuring agreements. As a threshold matter, the investor must establish that an action or inaction by the government of the host country caused an expropriation, selective discrimination, political violence or other event that falls under one or more of the specific coverages in the policy. As discussed below, an investor may be able to establish an expropriation based on a series of actions that collectively result in an expropriatory taking depending on the policy language. Further, in most policies, a complete restriction of the operations of the foreign enterprise is not required to trigger coverage.
- The loss was caused by the government’s conduct. Generally, the loss must result from the government’s actions or inactions and not the investor’s own conduct. So, in the example described above, if the investor’s operations generated particulates that were allegedly polluting nearby waterways in violation of the host country’s environmental laws, resulting in the host government instituting an order temporarily halting operations until the activity can be remedied, losses resulting from the stop order might not be covered if the cause of those losses was, in fact, the investor’s violation of the country’s environmental laws.
If, on the other hand, the operator’s particulate emissions were within the limits permitted by law and the government’s stop order was for discriminatory purposes (e.g., to force the operator to renegotiate contract terms that, for example, provide the government much larger royalties from the operator’s exports), PRI policies should cover the operator’s losses, subject to the policy’s waiting period.
- The government’s conduct continued throughout the applicable waiting period. Additionally, most political risk policies require that the triggering event or conduct by the government of the host country remain in effect for a certain period of time before a loss is covered. This “waiting period,” which typically ranges from 90 to 180 days, functions essentially as a deductible/self-insured loss. However, the PRI policy should respond and cover the foreign investor for its loss so long as the waiting period is exhausted, regardless of how long the action affects the investor beyond the waiting period.
Many policyholders erroneously assume that if they are returned to the status quo after the waiting period has expired ( if in the above example, the government lifted the stop order of operations), they did not suffer any real “loss” and are not entitled to recover under their PRI policies. That is not the case and the insured should be compensated for its loss during the period of expropriation.
Coverage for “Creeping Expropriation”
Often government expropriations occur under the guise of proper and lawful government oversight. However, most PRI policies provide that the government’s stated intent is given little if any weight, with the critical factor being the effect of the government’s actions on the foreign investor. Similarly, it is increasingly rare for a host government to outright confiscate or nationalize an investment. (See “The Concept of Expropriation Under the ETC and Other Investment Protection in Treaties” by Christoph Schreuer, in Investment Arbitration and the Energy Charter Treaty 108, Clarisse Ribeiro, ed., 2006.) Most policies account for this and provide coverage for a government’s “indirect” or “creeping” expropriation.
“Creeping expropriation” refers to a series of “steps that eventually have the effect of an expropriation” (Siemens A.G. v. Argentine Republic, ICSID Case No. ARB/02/8, Award, Feb. 6, 2007, 263). Because each of these steps “must have an adverse effect but by itself may not be significant or considered an illegal act,” it can often be difficult to determine when creeping expropriation has reached the point such that coverage is afforded. Because of the waiting period requirement and the potential impact on the measure of loss, PRI insurers frequently dispute both the existence and timing of a creeping expropriation.
In analyzing this issue, arbitral tribunals — the typical procedure for resolving these policy disputes — have focused on whether the government’s interference was of such a degree as to substantially deprive the investor of its investment, and on how permanent or irreversible the government’s interference is. The government’s intention to expropriate the investment is sometimes considered, though may be wholly irrelevant depending on the specific language of the insurance policy.
Common Coverage Defenses Insurers Invoke to Deny or Delay Payment of Claims
Given the scale of the losses at issue in most PRI claims, it is common for insurers to engage third-party adjusters to assist in conducting a claims investigation. However, in this hardening insurance market, some PRI insurers have been unnecessarily protracting the investigations to delay payment and increasingly forcing the insured to initiate arbitration when there is a significant nine-figure loss. Even in cases where coverage should be uncontested, some PRI insurers will still deny or delay payment based on coverage defenses to try to force the insured to materially compromise the amount paid under the policy.
Note: Though coverage under political risk policies is infrequently litigated in U.S. courts, a few decisions highlight the types of coverage defenses raised by PRI insurers. See, e.g., Gerald Metals, S.A. v. Great N. Ins. Co., No, 3:06CVl207(AWT), 2007 WL 9753904 (D. Conn, Sept. 27, 2007); Am. Nat. Fire Ins, Co, v. Mirasco, Inc., 249 F. Supp. 2d 303 (S.D.N.Y. 2003), vacated on other grounds, 144 F. App’x 171 (2d Cir. 2005); and CT Inv. Mgmt. Co,, LLC v. Chartis Specialty Ins, Co., 130 A.D.3d 1 (N.Y, App. Div. 2015).
The following are two common coverage defenses raised by PRI insurers:
- Rescission/Avoidance. PRI policies frequently include a warranty or representation that the insured was not aware of facts or circumstances that could lead to a loss and that the insured did not knowingly misstate or withhold material information from the insurer in the application process. In many policies, a breach of this representation may allow the insurer to limit or void coverage, but most policies ring-fence the permitted circumstances allowing rescission. Thus, it is not uncommon for PRI insurers to contend that facts and circumstances about the foreign enterprise and its dealings with the host country, which were discovered in the course of the insurer’s claims investigation, should have been disclosed in connection with the underwriting of the policy and, as a result, threaten to rescind or void the coverage.
However, to successfully void coverage, an insurer typically must show some degree of intent (innocent nondisclosure is not enough) and that the information allegedly not disclosed in underwriting was material to the risk. Further, many PRI policies are governed by English law, and unbeknownst to many policyholders, the UK’s recent Insurance Act 2015 outlines new specific — and more onerous — elements an insurer must prove to void or limit coverage. This law is a welcome development for policyholders where English law applies and insureds should utilize experienced, knowledgeable coverage counsel to hold insurers accountable to the rigors of the new law before accepting a denial of coverage or an insurer’s offer to “shave” loss owed under a PRI policy based on alleged misrepresentations in the insurance application.
- Illegal or Unlawful Acts Exclusions. Another common exclusion invoked by PRI insurers is an exclusion for loss caused by the failure of the investor or the foreign enterprise to comply with the laws of the host country. As noted above, in recent years, most expropriatory acts are conducted under the cloak of legal authority and often pursuant to the pretext of responding to some illegal or unlawful actions by the foreign enterprise. For example, the government may halt manufacturing or mining operations due to purported violations of environmental or labor laws in the host country. Further, in cases where there is a parallel proceeding in international courts against the host country for its expropriatory action, it is common for the government to allege illegal or unlawful conduct by the foreign enterprise. PRI insurers often point to such allegations as a basis to deny coverage even when there is no factual or contractual basis under the PRI policy to do so.
Despite These General Principles, the Policy’s Specific Language Is Critical
There are no set standard forms for PRI coverage, and the provisions can vary greatly with significant impact to the policyholders. Though the above discussion reflects some of the general coverage terms and issues seen across PRI policies, policy-specific language is especially important in the PRI area because most PRI policies are manuscripted. Accordingly, it is important to have experienced coverage counsel and a broker with PRI expertise to assist in policy contract negotiations, as well as advising (likely behind the scenes) during the claim submission and investigation process.
Careful attention must be given to the definition of “loss,” the scope of exposures insured, exclusions to coverage, as well as provisions covering the recoveries, subrogation and assignment of claims. In short, many foreign investors will purchase one, two or several hundred million dollars’ worth of insurance, and it is therefore crucial that a policyholder obtain the expertise of coverage counsel familiar with PRI insurance, as well as a qualified broker to assist with placement of the coverage and, if needed, facilitate the claims process.
Importance of Prompt Recovery in the Foreign Investment Context
PRI insurance is marketed as a means to provide prompt funding for the foreign investor after a loss so it can attempt to remedy or cover its losses through other means or otherwise deploy the lost investment elsewhere in other operations. However, in light of the current significant capacity issues with reinsurance treaties, and the continuing hard commercial insurance market across nearly all lines of coverage due to COVID-19 and other market factors, both domestic and international PRI insurers recently have been reluctant to pay what are clearly covered claims or have been significantly delaying the claim’s investigation and payment process.
This, of course, can have an existential impact on the foreign investor, who may have lost hundreds of millions of dollars as a result of the host government’s actions and who, absent timely payment under the policy after the waiting period, can face even greater losses to its global operations. In addition, such delay or denial could result in the ultimate demise of the company if the PRI insurer improperly withholds the claim payment for many months or years. It is imperative that the policyholder investor carefully review and understand the notice of claim and other conditions in the PRI policy and obtain the assistance of experienced PRI coverage counsel to facilitate the claim process and ensure prompt payment.
McGuireWoods works closely with clients and their risk managers to collect from their insurers for losses arising from adverse government action or inaction related to the foreign investors. We have obtained billions of dollars in insurance recoveries for our policyholder clients, including substantial recoveries under political risk policies for foreign investors who initially received coverage denials from their insurers after suffering losses stemming from adverse government actions.