What it means
Investing abroad carries risks that have little to do with the quality of the business. A government may seize a factory, block a company from taking its profits out of the country, or cancel a contract.
MIGA was founded in the late 1980s to offer guarantees against these events so that investors and banks are more willing to commit capital. The agency does not make loans; it issues guarantees.
If an insured event occurs and the investor suffers a loss, MIGA pays a claim and then seeks recovery from the government concerned. Because it is part of a respected international group, the presence of its guarantee also tends to discourage governments from taking harmful action in the first place.
Cover can be long term, often well beyond ten years, which suits infrastructure, energy and large manufacturing projects that take a long time to pay back. Lenders often value the guarantee even more than equity investors do, because it can improve the credit rating of a loan and lower the interest rate.
In practice, a guarantee can be the difference between a project being financed or not. For finance readers, the important points are what is covered, how much, and for how long.
The guarantee covers specific political events, not ordinary commercial failure, so it will not pay out merely because a project loses money. Premiums are charged annually as a percentage of the insured amount and depend on the country, the sector and the type of risk.
Private insurers and national agencies offer similar cover, so MIGA is one option among several. Its particular strength is its ability to work in countries where private insurers hesitate and to bring in additional lenders and investors.
Sponsors should also consider the claims process and the conditions that go with the cover. Policies normally require the investor to follow certain rules, such as disclosing material changes and trying to resolve disputes with the host government first.
Failing to meet these conditions can delay or reduce a payout.
In practice
Real-world examples.
Example
A European energy company plans a $120,000,000 solar farm in a developing country. It buys political risk cover against currency transfer restrictions, so that profits can still be paid out if the government limits access to foreign currency. The cover is arranged before construction starts, because insurers rarely cover a risk once a problem is visible.
Example
A commercial bank is asked to lend $200,000,000 for a toll road in an unfamiliar market. It agrees to lend only after the sponsor obtains a guarantee covering the risk that the government cancels the concession. The guarantee allows the bank to lend for a longer period and at a lower rate than it would otherwise offer.
Example
A mining company building a processing plant worries about civil unrest near its site. The risk manager arranges cover for damage from war and civil disturbance, which lowers the cost of the company's other insurance and finance. The board approves the premium as a normal cost of the project and includes it in the budget.
Formula
Calculation
Insured amount = Investment x Coverage percentage
Annual premium = Insured amount x Premium rate
Suppose a company invests $50,000,000 in a power plant abroad and buys cover for 90% of the investment. Insured amount = 50,000,000 x 0.90 = $45,000,000. If the premium rate is 0.80% a year, the annual premium = 45,000,000 x 0.0080 = $360,000. Over a ten-year term, the premium cost would be 360,000 x 10 = $3,600,000, which the project team compares with the potential loss it avoids.Case study
Seen in the real world.
Sandstone Water Holdings is an illustrative, fictional company that wants to build an $80,000,000 water treatment plant in an emerging economy. Local banks will not lend for the length of time needed, and foreign lenders are nervous about the risk that the government might change the tariff agreement.
The finance director arranges a guarantee from a multilateral agency covering 85% of the equity and lenders' exposure against breach of contract and currency transfer restrictions. This gives the lenders enough comfort to lend for fifteen years at a lower margin, saving an estimated 1.5% a year on a $50,000,000 loan, or $750,000 a year.
The annual guarantee premium is about $400,000, so the net saving is around $350,000 a year. The illustrative lesson is that political risk cover has a price, but it can pay for itself by lowering financing costs.
Watch out
Common mistakes.
- Assuming the guarantee covers any loss on the project, when it covers only listed political events.
- Thinking MIGA lends money, when it provides insurance and guarantees.
- Leaving cover to the last moment, when it usually needs to be arranged before the investment is made.
Questions
People also ask.
What is political risk insurance?
It is insurance against losses caused by government actions or political events, such as seizure of assets, currency restrictions or war.
Who can buy cover?
Investors and lenders putting money into projects in developing member countries, subject to eligibility rules on the investment and the host country. A project in a country that is not a member of the agency, or an investment that harms the environment or local people, may be refused.
Does the guarantee pay if the project fails commercially?
No, ordinary business failure is not covered, only losses caused by the specified political events.
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