WAR AND POLITICAL RISK INSURANCE. MECHANISM FOR UKRAINE

Since the outbreak of full-scale hostilities in February 2022, Ukraine and Ukrainian shave suffered enormous losses, not only in terms of people but also in terms of property. The World Bank, in its second Ukraine Rapid Damage and Needs Assessment, estimated that as of February 24, 2023, the total recovery and reconstruction needs exceeded US$411 billion, which is 2.6 times Ukraine's GDP in 2022. The following sectors suffered the greatest losses: housing, transportation, energy, trade and industry, and agriculture. Among the most affected regions are Donetsk, Zaporizhzhia, Luhansk, Mykolaiv, Kharkiv, and Kherson oblasts. For effective reconstruction and recovery, it is necessary to attract investors and entrepreneurs from all over the world.

Undoubtedly, investing in potentially war-torn areas involves great risks. Therefore, appropriate insurance of assets and other aspects of business activities is necessary. The Ukrainian government, as well as international organizations, are constantly working on this issue.

For example, already in 2022, MIGA (the Multilateral Investment Guarantee Agency, a member of the World Bank Group), which insures against several types of non-commercial risks around the world, launched a pilot project of an investment insurance mechanism during military operations, with a budget of USD 30 million. This year, the Agency plans to increase the fund to USD 1 billion. However, this support is available only to foreign companies planning to enter the Ukrainian market.

It is worth mentioning that insurance companies in some countries also offer their domestic investors insurance against political and military risks. For example, the Polish state - owned joint-stock company KUKE (Export Credit Insurance Corporation) is responsible for insuring investments of Polish entrepreneurs in regions characterized by a high level of political risk. Such insurance is guaranteed by the Polish state budget. The insurance policy may cover the following insured accidents: decisions of the authorities that restrict the realization of the investment, the announcement of a general moratorium on payments, decisions restricting or prohibiting the export of goods or capital, complete deprivation of the possibility to exercise the rights related to the investment or unforeseen force ma jeure (military actions, coups d'état, earthquakes, extreme natural phenomena, etc.). Nowadays there are three thousand companies with Polish capital operating in Ukraine. The possibility of using this insurance mechanism increases interest of Polish business and will give it more confidence.

Investment guarantees of the Federal Republic of Germany (DIA) provides investment guarantees exclusively to entrepreneurs, whose registered seat or place of residence is located at the territory of Germany. Furthermore, if at the moment of an insured event more than 50% of the capital or voting rights of the holder of the guarentee are in the foreign hands, or if the holder is controlled by the foreign government, losses are not covered. It covers totally 592 investment projects worldwide, which are guaranteed by the German government, with EUR 28,7 billion in active guarantees in 2020, of which only 20 projects were implemented in Ukraine.

The United States also offer investment insurance against political risks. The U.S. International Development Finance Corporation (DFC) offers a policy , which covers up to USD 1 billion in losses due to currency inconvertibility, government interference, political violence including terrorism etc. Protection against political violence includes hostilities as a result of declared or undeclared war, revolution, terrorism, sabotage, etc. Investors can insure assets, income or both at the same time. Additionally, insurance can cover evacuation costs or losses caused by damage to critical infrastructure.

All multilateral and domestic agencies are now subject to strict ESG requirements, which stands for Environmental, Social and Governance.

USAID - the United States Agency for International Development - is responsible for non-military US assistance to other countries. Thanks to its efforts, a mechanism for political risk insurance (PRI) was developed.  The developed mechanism has to serve immediate transactional demands while building the marketplace so that the Mechanism can be retired within 5-10 years, when Ukraine can be sufficiently served by pre­existing PRI providers. Taking into account political and military risks, present in Ukraine, the mechanism should perform the following tasks:

·      Ensure the accumulation and targeted use of a money pool that acts as a carrier of political risks related to investments in Ukraine.

·      Crowd in private commercial PRI insurance providers and make effective use of the existing infrastructure of the domestic insurance market.

·      Create a ‘first risk layer’ that can absorb a significant part of the losses under PR insurance contracts.

·      Carry out insurance indemnities for insured events related both to political violence and detrimental government interference.

·      Provide Ukrainian investors with the similar protection options as foreign ones.

·      Offer reasonable, simplified eligibility requirements and procedures in terms environmental standards to match market conditions and expedite reconstruction financing.

·      Promote awareness of how to access PRI with consulting support in obtaining insurance coverage and meeting the requirements.

In order to complete the tasks, the mechanism should be independent from the Government of Ukraine; support crucial investment projects, defined by Ukraine itself; place funds outside of Ukraine; apply effective international control over the funds; be limited only to the Ukrainian territory.

During the round table “Development of PRI in Ukraine”, which was organised by the USAID as part of the FinancialSector Reform Initiative, the creation of an allocation mechanism to protect capital investments was announced. During the discussion of experts, 4 options of opening Ukraine to foreign insurance market were presented. There are 4 strategies of implementation, which relate to to the delegation of roles and the structural organisation of the mechanism:

1.    Trust Fund and Underwriting Unit within an existing PRI agency

In theory, a well-established PRI agency (i.e., MIGA, DFC, Germany’s DIA) could assume all four of the aforementioned roles. The main feature of this solution is that the PRI agency acts as both the Organizational Platform and Underwriting and Administration Unit. This will allow to save time in the preparatory phase, use and leverage existing experience and contribute to the positive image of the project. However, an agency might be disabled to act by unsupportive governments, can face some complications arising from the present differences in corporate culture and be over loaded with the work due to limited human resources.

2.    Existing PRI expertise within a new governance structure

Option 1 provides many immediate advantages. However, it would need an influential institution of a powerful supporting state (e.g., the U.S. State or Treasury Departments) to act as Trust Fund Champion. Under this hybrid option, a sponsoring state or institution establishes the Trust Fund in combination with an experienced PRI agency that acts as the Organizational Platform and assumes responsibility as theUnderwriting and Administration Unit. On one hand, the Champion could take over persuading the donors and grantors to agree to relaxation of the ESG policies. A Trustee not related to a specific multilateral or national PRI agency would be more flexible in its operations. On the other hand, such a combination would require a significant coordination effort between two institutions of different legal nature, mandates and organizational structures. Concerns about the utilization of human resources are also applicable here.

3.    New PRI Agency ascends from an existing one

As with Option 2, an influential institution of a supporting state will act as Trust Fund Champion and Trustee.A national or multi-lateral PRI agency will act as the Organizational Platform and will incubate an Underwriting and Administration Unit, transferring knowledge, skills, and systems. The PRI agency could save significant time to build the Mechanism’s internal competencies by transferring its knowledge, experience, and ideas. The PRI agency also would not have to house the unit for the long-term or operate under two paradigms and the Underwriting and Administration Unit would not be bound or constrained by another agency’s mandate, culture or existing practices. Some concerns may raise due to necessity to negotiate the legal home of the Underwriting and Administration Unit.

4.    New PRI agency based on the global PRI market’s best practices

In this option, an influential institution of a supporting state will act as Trust Fund Champion and Trustee. However, the operational platform, methodology and underwriting expertise, and human capital could be provided by the private PRI market. The contractor to develop a ‘blueprint’ for the Underwriting and Administration Unit would be selected through a transparent and inclusive bidding procedure based on a comprehensive Request for Proposal. Given the difficulties related to other options described above, it could prove more effective in the medium term for the mechanism to achieve its objectives. However, an appointment of a private entity to develop the Mechanism’s Underwriting and Administration Unit might affect the Mechanism’s prospects in a way not easily to predict, it may not be perceived as credit worthy as a national or multi-lateral agency and it would demand more effort from the Supervisory and Management Board.

Whether this model can be implemented will depend crucially on the Administrator – a person with relevant experience in international insurance, appointed by the Mechanism’s Management Board to manage the PRI Mechanism’s regular business activities. More detailed information on the concept developed by the USAID Financial Sector ReformActivity Project is available at: bit.ly/3Kjn88G

On the 14 February 2023, the Bill No 9015 on Amendments to the Act "On Financial Mechanisms for Stimulating Export Activities", which aims to regulate the insurance of the investments against military risks in Ukraine, was launched in the Ukrainian Parliament. It is interesting to note that the legislator foresees broadening the powers of the Ukrainian Export Credit Agency, which will be entitled to insure domestic (internal) investments along with foreign ones against different types of risks, including military risks during hostilities and post-war renovation. The Bill is aimed at achieving an economically important goal and scaling up investment processes in Ukraine. However, broadening the scope of force of the Act outside the export activity changes its content as a whole and should not be limited only to the proposed changes. The Bill is still under consideration by the Committee.

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