Gilbert Blog

Can U.S. Companies Insure Against a Trade War?

January 22, 2020

The recent trade deal between the U.S. and China was welcome news for U.S. companies with investments in China.  The tenuous relationship between the countries, however, continues to cause substantial uncertainty for U.S. investors.  Their concerns are not unique to China—the Trump Administration has taken an aggressive trade stance even with nations usually considered friendly, including Brazil, Argentina, and France.

A growing number of companies are turning to political risk insurance to protect their foreign investments.  Such policies typically cover a variety of commercial losses stemming from political events, including expropriation, political violence, or currency conversion restrictions.

Are political risk policies a valuable tool in a company’s arsenal for mitigating the uncertainties of doing business in China or other countries embroiled in a trade war with the United States?  The answer depends, in large part, on the specific wording of the policy at issue.  There is no standard political risk policy form, and jurisprudence on such policies is extremely limited.  Potential policyholders must evaluate their needs carefully and be strategic during policy placement to ensure they are maximizing potential coverage.  For example:

Expropriation:  Political risk policies may cover losses stemming not only from a government’s outright nationalization or expropriation of a policyholder’s assets, but also from more subtle forms of unlawful discrimination against foreign entities.  The bounds of such coverage, however, are not always clear.  Many policies exclude incidental damages arising from lawful or legitimate acts of governance, which may give rise to disputes between policyholders and insurers as to the nature and motivation of a particular governmental act.

For example, the Chinese Government imposed tariffs and restrictions on U.S. companies doing business in China throughout 2019.  A policyholder seeking coverage for losses suffered due to these measures would argue that the restrictions were retaliatory acts in response to the U.S.-China trade war, meaning that its damages arose from covered acts of discrimination in violation of international law.  An insurer seeking to limit its coverage obligations may argue that China imposed these restrictions based on its view that the companies had violated market rules or otherwise damaged the interests of Chinese companies for noncommercial reasons—in other words, that these were legitimate act of governance taken in the public interest.

Given the lack of case law on the intended scope of expropriation coverage and the fact-intensive nature of disputes over the legitimacy of a particular governmental act, companies should seek to include the broadest possible definition of “expropriation” in their policy and to clarify the bounds of any exclusions.

Political Violence:  In addition to coverage for expropriation and related governmental acts, political risk policies also may provide coverage for losses stemming from physical damage to property due to protests, riots, or other acts of violence intended to achieve a political objective.  While U.S. investors may not commonly associate trade wars with physical violence, recent protests and riots over economic issues in countries such as Chile and Ecuador demonstrate the potential for severe economic turmoil (a common result of any trade war) to cause such violence.  As a result, U.S. companies with warehouses, offices, or other property in countries facing aggressive trade restrictions by the U.S., or in any nation suffering from substantial economic uncertainty, may find such coverage appealing.

The potential benefit of political violence coverage may depend, in large part, on how a policy proposes to determine the value of any damaged property or resulting financial losses.  Potential policyholders should ensure, for example, that a loss is valued pursuant to objective accounting standards and/or by a neutral third-party, as opposed to the insurer, who may have an interest in minimizing its liability.

Currency Inconvertibility:  A third component of political risk insurance is currency inconvertibility coverage—i.e., coverage for losses arising from a policyholder’s inability to convert currency due to exchange restrictions posed by a foreign government.  For example, such coverage might apply if a policyholder is unable to obtain repayment of a loan to a Chinese entity because of new restrictions by the Chinese Government on conversion of local currency to U.S. dollars or the transfer of funds to U.S. banks.  U.S. companies with investments in countries facing particularly extreme economic instability, such as Venezuela, may benefit most from such coverage, as those countries are most at risk for collapse of their currency exchange system.

As with political violence coverage, a policy’s proposed standards for valuing a currency inconvertibility loss are once again crucial to maximizing a policyholder’s protection.  Policies often calculate the value of a policyholder’s loss using the foreign country’s exchange rate on the date of loss.  In such scenarios, policyholders may benefit from defining the “date of loss” as occurring the first time the policyholder is unable to convert currency, as opposed to after a waiting period has occurred or after the insured has made multiple conversion attempts.  This may minimize the risk that the value of a covered loss decreases if the exchange rate in the country plummets while the insured fulfills other conditions for coverage.

Political risk policies likely cannot insulate U.S. companies from the full impact of a global trade war or other politically-inspired disruptions.  However, U.S. businesses can maximize the benefits of such coverage through careful policy drafting and strategic evaluation of their individual risk profile.