Aon Corporation recently launched its Political Risk Exposure Profile (PREP) service, to provide customised political and country risk analysis for clients. John Minor, a senior vice president, and Sam Wilkin, country risk advisor, at Aon Trade Credit, talked to ERisk’s Alan McNee about the service, and the growing awareness of the need for political risk management.

How does the new service operate?

John Minor: The Political Risk Exposure Profile service combines three sources of data: first, client data on financial exposures and business activities. Second, country risk analysis, provided by WMRC and its WMO division, and third, data on the financial costs of political risk, taken from worldwide insurance markets, academic research and historical claims. These sources of data are combined, using a database system, to produce a customised financial report on the client’s global portfolio of political risk exposures.

How frequently is the report updated?

JM: This would typically be done for a client on an annual or biannual basis.

Sam Wilkin: The exposures we’re analysing are generally long-term exposures, such as a client’s foreign direct investments, exporting, overseas sourcing/imports, and so on. These things don’t generally change on a daily or weekly basis, and usually don’t change that much even on an annual basis.

How would it work in the case of a company wanting to invest in, or with existing investments in, a particular country?

SW: Ideally if you had an investment in Argentina one year ago, the service would have told you at the time that the country represented a moderate to high risk in terms of financial and economic stability. Political risk analysis will probably never be an actuarial science, but what you can do is run stress tests that show the likelihood of crises. It’s not a forecast, it’s a risk assessment.

In the case of Indonesia, for example, nobody could have predicted that there would be a currency crisis starting in Thailand and that [former president] Suharto would have reacted to that in a particular way. But what you might be able to say is that there are serious structural issues in Indonesia that make a crisis likely: the lack of a legitimate system for choosing a successor to Suharto, the ethnic and religious divisions exacerbated by a concentration of wealth in the ethnic Chinese community, the high level of corruption, a lack of independent economic policymaking institutions, and so on.

And you can come up with something akin to a value-at-risk number for country risk?

SW: I would say they are numbers that could then be plugged into a value-at-risk model by the client.

JM: Our analysis can be used to estimate the cost of risk, set an appropriate premium that reflects the political risk or determine the level of return that you would require before investing. It can be used to evaluate a company’s exposures against its risk tolerances.

Who is likely to use this service?

JM: The clients with most to gain from the PREP service will be multinational corporations who already have investments in a number of emerging markets. Many of these companies find it difficult to get an accurate picture of their aggregate exposure to a specific country, a region or a sector globally. The service gives them a uniform and systematic way of assessing risks across different countries and sectors.

How will it be priced and licensed? Will you license the software to users?

JM: It’s a consulting-based service for the time being. The cost therefore will be based on time and expense. The way the system works presently, the data we collect from the client must be translated into the language of the system.

What kind of data would you ask for from a client?

SW: We provide customised analysis of a company’s exposures, depending on their aims and their risk appetite. It’s an old saw in political risk insurance that there ‘are no bad countries, only bad risks’. If a client is doing something that’s a low-risk activity, and they have a lot of experience, it’s possible for them to operate in virtually any country. Conversely, if they are doing something that attracts a lot of negative host-government attention, or are operating without the right kinds of safeguards, even a country that is relatively low risk can turn out to be a hazardous place for that particular company.

There are two basic types of data we need. The first is financial exposure data, such as revenues generated and repatriated, property values and so on. And then there are the characteristics of the client business activities. This is important because, as I said, the nature of the business activity can have a huge impact on the risk level. For example, historical data shows that wholly owned investments are around three times as likely to be expropriated as joint ventures.

What clients do you have now?

SW: We’re currently in advanced talks with three different potential clients. We’ve done a couple of these sorts of projects on a beta-testing basis before. We carried out an analysis for a large auto manufacturer, as part of an enterprise risk management programme it was undertaking.

The global financial analysis that the service generates is invaluable for ERM. It’s also very useful for risk mitigation and risk transfer decisions, and for getting a picture of your global exposures and evaluating this against risk tolerances. WRMC tracks around 180 countries, so we can do it for virtually any emerging market.

Do you think companies are more concerned about political/country risk than in the past?

JM: Recent surveys, including one commissioned by Aon, have certainly pointed to that.As well as our own, there have been surveys by the World Bank and Michel Leonard of the University of Virginia, which suggest that political risk is being taken more seriously by firms. We know how fast the political risk insurance market has grown in the past five years or so, with robust growth in premiums of around 30 per cent, and for some, as high as 300 per cent. One big factor has been the effect of globalisation. As companies are forced to look at other markets, they have to look more seriously at country risk. Recent political crises in Southeast Asia, Russia and Latin America have also highlighted the relevance of political risks for companies.

SW: The critical point here is that historically, 60 per cent of world output has come from the industrialised nations. But now the percentage of output from the developing countries is increasing rapidly, and in 10 years’ time, around 65 per cent will come from what are now emerging markets. So firms that have traditionally had the luxury of doing business only in the developed world will no longer have that luxury, and will no longer be able to ignore political risk.

That is being reflected in the attitudes of company risk managers towards political risk. Only 26 per cent of risk managers polled in our survey said they felt they had achieved systematic political risk assessment, even though 80 per cent said they considered it a very important goal. And only 21 per cent said they felt well protected from political risk losses, compared with a large majority, who felt well protected from property & casualty, directors & officers, and other risks. Firms are deeply concerned about globalisation.