Rebuild or abandon? Are project finance deals adequately covered for political violence?

Within the area of political violence insurance, the concepts of terrorism and war are widely discussed, but often poorly understood. Zoe Towndrow, Practice Lead, Political Violence, BPL Global, examines the complexities of the policy wordings and reveals how banks and sponsors can ensure project finance deals are suitably covered for adverse geopolitical events.
Zoe Towndrow
Zoe Towndrow
Practice Lead, Political Violence, BPL Global
22/07/2022

Addressing the complicated project financing concerns relating to war and terrorism more broadly can be a formidable task. Banks need to be equipped with the knowledge of what is covered and how it is defined to ensure they are positioned to effectively manage risk and support projects across a range of geographies in this increasingly volatile world.

In today’s geopolitical climate, determining what constitutes ‘terrorism’ and how it differs from ‘war’ has been cast once more into the insurance spotlight. For businesses and insurers engaged in project finance, navigating the nuances of these complex and sensitive terms is a challenge – and getting it wrong can have considerable consequences.

On the face of it, terrorism and war have many common characteristics. Both entail extreme violence and are motivated by ideological and strategic factors. What’s more, these terms are often used interchangeably, with expressions like ‘war on terror’ serving only to entangle the two.

But the grey area between the definitions is more than just semantics. The need to effectively differentiate these terms is crucial to the decision-making process when seeking appropriate cover or structuring policies within project finance. Ultimately, the choice of whether a project is abandoned or rebuilt hinges on the nature of events on the ground. An insurance approach therefore needs to cover both eventualities.

Terrorism: Got it covered?

Understanding the distinction between war and terrorism is crucial. Often sponsors that purchase terrorism insurance are lulled into a false sense of security when it comes to mitigating their exposure to risk because the words ‘terrorism’ and ‘war’ are so frequently used synonymously.

Consider the following scenario of a bank that is financing a project and tasks the sponsor to coordinate the relevant insurances. If that project is then impacted by war, even if terrorism cover has been purchased, the project will not be adequately covered. This is because two key considerations are often overlooked:

Firstly, when viewed in the broader context of the political violence risk spectrum (as demonstrated in Figure 1), the coverage afforded by a terrorism product is incredibly narrow. The rest of the perils on this spectrum would be excluded in the policy wording.

Secondly, the terrorism market's standard wording (T3), used by worldwide insurers, is not always effective in all geographies. This is because T3 was conceived in the wake of the 9/11 terrorist attacks – which resulted in $35 billion in insured losses[1], making 2001 the costliest year in insurance and reinsurance history up to that point – and was designed specifically with North American markets in mind.

The T3 wording, therefore, is unsuitable for emerging markets where events of conflict, disorder and violence may cross the fine line of what is deemed to be terrorism, and will be therefore excluded from the cover by virtue of being considered ‘war risks’ (as demonstrated in Figure 1). This creates a huge insurance void for project financing deals in these regions.

The Arab Spring changed insurance buying habits across the Middle East. Prior to 2011, T3 was widely purchased throughout the region as it was felt to be the correct cover. However, in hindsight the exclusions in the T3 wording are everything the Arab Spring was about. A wording which excluded ‘riots and civil commotion’, ‘civil commotion assuming the proportions of or amounting to an uprising’, ‘insurrection, rebellion and revolution’, and ‘civil war and war’ was totally inappropriate and therefore T3 did not respond to the contagion of events as they occurred. Many policyholders in North Africa and the Levant had to find out the hard way that they were without adequate coverage.

Over a decade after the Arab Spring, it is clear that many stakeholders involved in project financing deals, especially in emerging markets, are still exposed to similar risks, and therefore need to reassess their approach to political violence insurance and terrorism.

The abandonment blind spot

So, is the solution as straightforward as buying full political violence wording which covers physical damage due to war?


Figure 2: Further coverage

No. While this option does go further than standalone terrorism coverage – such as by covering property damage due to the total breakdown of law and order – it is not a comprehensive solution and ignores the other main issue.

Importantly, the terrorism and full political violence wordings are, at heart, property damage covers which assume that the insured will want to repair and replace. If the sponsor decides to leave the country, however, then abandonment due to war would not be covered. We have seen this play out in countries including Ethiopia and Libya, and more recently, Russia and Ukraine.

The two-part solution

As complex as this may seem, there is a simple solution where both project sponsors and banks can purchase cover which responds to their different needs.

The project sponsor must buy a full political violence product to cover the property against physical damage by the spectrum of war risks along with delay in start-up insurance (which covers the financial impact of temporary project setbacks).

The bank needs to buy lenders political risk coverage which will repay the financing in the event of the abandonment of the project due to war.

Only then will the project be fully covered!

  1. https://whr.tn/3yeK8RP Warton School of Risk Management

More BUlletin Publications

Celebrating 90 years of supporting trade and investment

26/02/2024

Celebrating 90 years of supporting trade and investment - 1934 - 2024

Reflecting on Berne Union’s origins and celebrating its achievements. What does the future hold?

 

Climate Working Group: The continuing momentum for change

19/09/2023

Climate Working Group: The continuing momentum for change

The Berne Union’s Climate Working Group is proving a helpful forum for sharing good practice. How is it progressing, and how can our industry continue to help with this initiative?

Claims: Controling Chaos, and Risk Versus Reality

29/06/2023

Controling Chaos, and Risk Versus Reality

In this edition we explore BU claims data and its relation to predicting risk since the pandemic, we also feature a broker's eye view of the state of the CPRI market, the bold restructuring of Denmark's investment and export financing with EIFO, how EDC is looking at ESG risks and ...

Landmark modernisation for OECD Arrangement

25/04/2023

Landmark modernisation for OECD Arrangement

A bold agreement for the Arrangement marks a positive development for our industry. Also featuring
digital access to export finance for China SMEs, challenging the 'China debt trap' narrative for Africa,
insolvency trends, analysing service ...

What's on the horizon for 2023?

28/02/2023

What's on the horizon for 2023?

The pick of key issues to look out for in 2023 – from macro trends, potentially choppy seas for smaller ECAs,  possibilities for using Islamic finance in the renewable energy transition, China’s reopening, a bumpy CPRI outlook, and reinsurance complexities. 

Authors look at...

Digitalisation as a business leadership imperative

25/11/2022

Digitalisation as a business leadership imperative

Technology-driven trade and client interaction are nothing new. But increasing investment in digitalisation of fundamental business processes and decision making is driving a new way of looking at trade finance and risk underwriting. Authors highlight successes and challen...

Mobilising Africa's Potential

06/09/2022

Mobilising Africa's Potential

Despite the challenges there are many positive opportunities emerging for Africa today

Curated by the BU Sub-Saharan Africa Working Group, authors for this special edition of the BUlletin explore areas of growth and the role of different sources of international finance tapping this

Ripples and After-effects

22/07/2022

Ripples and After-effects

exploring the multiple secondary impacts of both the pandemic and the war in Ukraine

from sovereign risk in Africa, to energy security, political violence and the private CPRI market

Shocks and Short Circuits: The Rewiring of Global Trade

07/04/2022

Shocks and short-circuits: The re-wiring of global trade

The bright shoots of economic growth are under threat once again
Assailed by commodity supply shocks and political instability exacerbated by the war in Ukraine
Contributors this month look at the complex impacts on trade and investment across developed and...

Diverging Risk

14/01/2022

Some predict that 2022 may finally bring us beyond the thrall of the COVID-19 pandemic

But the events of past two years have brought significant divergence of risk across economic and geographic boundaries

Authors this month look at how this is playing out in a range of cases

New Foundations

29/09/2021

If the global economy is truly on the road to recovery how can we build the surest path to sustainable growth in our new net-zero world?

New foundations in tech, data, and cooperative frameworks may help guide us into the next phase

Illuminating Climate

22/07/2021

Now widely recognised as an economic as well as environmental imperative
The momentum to tackle climate change is building
Changing perspectives, policy, products and processes across the export credit industry

In search of claims

30/04/2021

Where is the avalanche of claims and insolvencies expected to emerge from COVID-19?
The picture so far is uneven across geographies, sectors and business lines
And for the future? Well, it depends...

Cross-roads for Africa's recovery

21/04/2021

The economic impact of the COVID-19 pandemic on Africa has been considerable and the path of recovery depends on maintaining the support of local, regional and international stakeholders. But which approaches can best build upon the opportunities presented by growing intra-regional trade, and investment in sustainable infrastructure?

Navigating the Brave New World of Trade

23/03/2021

With the wounds of the pandemic still under triage, a rebound in trade could the best hope for governments and businesses alike.
But trade is under immense pressure from myriad directions.
How can we maintain supply of finance, in the face of growing demand and irregular patterns of risk?