5 Key Types of Political Risks Every International Business Should Know

Introduction 

 In the world of international business, risks are inevitable. But one category of risk stands out—political risks. These risks arise from political events or changes in the host country that can impact your ability to operate successfully. Understanding these risks and knowing how to manage them is essential for businesses engaged in cross-border trade or investment. Here are five key political risks that every international business should be aware of. 

1. Expropriation and Nationalization

Expropriation refers to the government seizing foreign-owned assets, such as property or business operations, for public use, often without fair compensation. In some cases, this can evolve into nationalization, where a government takes control of entire industries, like oil or utilities. 

While expropriation has historically been more common in developing or emerging markets, it can occur anywhere, especially in industries considered vital to national interest. For businesses, the risk of expropriation can result in significant financial losses, especially if the seizure happens without prior warning. 

How to Mitigate This Risk: 

Political risk insurance can help safeguard against expropriation by providing compensation in the event of asset seizures. Companies should also carefully assess the political stability and government transparency of the countries they operate in. 

For more information on expropriation, see this post from Investopedia.  

2. Political Violence and Civil Unrest

Political violence can take many forms, including terrorism, protests, civil unrest, and even armed conflict. These events can disrupt supply chains, damage infrastructure, and put employees and assets at risk. 

Political violence often arises in regions experiencing political instability, authoritarian regimes, or social upheaval. Companies operating in such environments are vulnerable to property damage, business interruption, and potential loss of life. 

How to Mitigate This Risk: 

 Political risk insurance is crucial here as well, covering losses due to terrorism, civil unrest, and other forms of violence. Additionally, businesses should develop robust security protocols and disaster recovery plans for employees and assets in volatile regions. 

For more information on civil unrest, see this post from United Nations Office for Disaster Risk Reduction.

3. Currency Inconvertibility

In many emerging or politically unstable markets, businesses may face issues when attempting to convert local currency into hard currency (like USD or EUR). This can happen due to government-imposed currency controls, economic instability, or financial crises. Currency inconvertibility can limit a company’s ability to repatriate profits, pay international suppliers, or access necessary funds. 

How to Mitigate This Risk: 

 A political risk insurance policy can cover losses resulting from currency inconvertibility, ensuring businesses are compensated if they can’t access their funds. Additionally, businesses should consider diversifying their operations across multiple markets to reduce their reliance on any single currency. 

For more information on currency inconvertibility, see this post from World Bank Group. 

4. Breach of Contract by Government Entities

In some countries, governments may alter or ignore existing contracts between foreign businesses and local entities. This can include arbitrary changes in regulations, failure to enforce contracts, or retroactive changes to laws that affect business operations. 

For international businesses, especially those involved in long-term projects or infrastructure development, a breach of contract by a government entity can lead to significant delays, financial losses, and reputational damage. 

How to Mitigate This Risk: 

 Businesses should ensure they have legally binding contracts with local governments, ideally backed by international arbitration clauses. Political risk insurance can also help cover losses incurred if a government fails to honor contractual agreements. 

5. Changes in Taxation and Regulatory Policies

Governments have the power to change tax rates, impose new tariffs, or introduce new regulations that can impact a foreign business’s bottom line. Sudden increases in taxes or unfavorable regulations can reduce profits, raise costs, or even make it impossible to operate profitably in certain markets. 

These changes are often influenced by shifts in political leadership, changes in public opinion, or economic crises. Therefore, businesses must be prepared for the possibility of sudden changes in the regulatory environment. 

How to Mitigate This Risk: 

 Understanding the political climate and staying updated on regulatory changes is critical. Establishing good relationships with local government agencies and legal advisors can help businesses anticipate and navigate changes. Additionally, political risk insurance can provide compensation for certain types of financial loss due to changes in regulations or taxation. 

Conclusion 

Political risks are a real and constant threat for businesses engaged in international trade. Understanding the key types of political risks—expropriation, political violence, currency inconvertibility, breach of contract, and changes in taxation or regulations—can help companies take proactive measures to protect their assets and operations. 

Investing in political risk insurance is a crucial step for businesses looking to mitigate these risks and ensure continued success in global markets. By staying informed, diversifying operations, and leveraging the right insurance solutions, companies can navigate political risks and protect their interests abroad. 

In video format, here is more information about political risk, in video form via GlobalHub on YouTube.  

Key Types of Political Risks Covered by PRI

Political risk insurance covers a range of events that may disrupt trade. These include:

FAQ Section 

What is political risk insurance? 

 Political risk insurance is a type of insurance designed to protect businesses from financial losses due to political events like expropriation, civil unrest, currency inconvertibility, and government actions that disrupt business operations. 

Can political risk insurance cover all political risks? 

 While political risk insurance can cover a wide range of events, it may not cover every political risk. It’s important to work with an insurance provider to tailor coverage to the specific risks your business faces in different countries. 

Is political risk insurance only for businesses in developing countries? 

 No. While political risk insurance is commonly used in developing countries, it is also relevant in any market where political instability, changes in regulation, or government actions could affect your business operations. 

Since 2004, Securitas Global Risk Solutions, LLC (“Securitas”) has helped clients develop credit and political risk transfer solutions that provide value on numerous levels. As an independent trade credit and political risk insurance brokerage, Securitas is focused on developing comprehensive solutions that meet the needs of clients, ensuring a complete understanding of policy wording and delivering excellent responsive service.