Our eLearning courses explain that political risks may negatively affect international trade by preventing payment of credit to a seller. Export credit agencies (ECAs) and private insurance companies can insure against political risks by providing export credit insurance to a seller when selling goods or services to a foreign buyer on credit terms. The export credit insurance covers the seller’s loss caused by the foreign buyer’s non-payment of the credit due to political and commercial events.
Learn more about political and commercial risks in the eLearning courses Risks in International Trade and Export Credit Insurance.
Political events that may cause a loss covered by ECAs and private insurers are defined in standard terms, which are usually very general. Due to the general wording of such definitions, they should be properly understood by sellers when applying for export credit insurance. This is important because many questions arise regarding the meaning and interpretation of such definitions.
The difficulties with interpreting definitions of political risks can be illustrated by an analysis of the word ’war’. The word ‘war’ is usually used for an armed conflict between two states, and it is a political event that may negatively affect the business of a foreign buyer. However, in the export credit insurance context, it can be unclear whether this word includes a war in which the foreign buyer’s country is not involved. In other words, is non-payment of credit caused by a war that takes place out of the foreign buyer’s country an event covered by an ECA or private insurer as a political event?
Another term used by ECAs and private insurers is ‘civil war’ ‒ usually understood as an armed conflict between various militant groups within a single state. Even in this case, the question arises whether it is acceptable for an ECA or private insurer that the foreign buyer may be negatively affected by a civil war that takes place out of its country. Other events like ‘riots’ and ‘civil disturbances’ are also mentioned in the definitions of political risks, and it should be clarified whether such events, when they occur out of the foreign buyer’s country, may negatively affect the business of the foreign buyer and cause its inability to pay the credit.
The foreign buyer may, for example, allege that the majority of its customers are from a country involved in a war or civil war and that these events have negatively affected the businesses of its customers, making them unable to purchase the foreign buyer’s products and pay for them. Since the foreign buyer has no other revenues, this causes its inability to pay the credit. Another example can be where the foreign buyer purchases the raw materials necessary for its manufacturing process from the country affected by war or other similar events. Since the supply of raw materials has been stopped, the foreign buyer’s production process has also been stopped, making the foreign buyer unable to pay its debts.
When analysing the above events and definitions of political risks used by ECAs or private insurers, it could be unclear whether an ECA or private insurer will find these events too remote from the resulting loss caused to the seller by non-payment of credit by the foreign buyer. The seller and the ECA or private insurer should clarify this issue during the export credit insurance application process.
The war, civil war, and other events mentioned above are included in the so-called ‘force majeure’ definitions of political risks usually used by ECAs or private insurers. Besides these events, force majeure clauses usually include and classify natural catastrophes like floods, earthquakes, tidal waves, etc. as political events. Some force majeure clauses define as political events ‘other extraordinary events’, which is a very general term. Nowadays, the question arises whether ECAs can accept the COVID-19 pandemic as such an extraordinary event. When analysing the COVID-19 pandemic, it can easily be argued that it is an extraordinary event, out of the control of the seller and the foreign buyer. The parties could not foresee the outbreak of the COVID-19 pandemic and avoid its negative effects when negotiating the contract. It is notorious that businesses of numerous foreign buyers have been closed due to the COVID-19 pandemic resulting in their inability to pay their debts. However, the question remains whether ECAs or private insurers will see the COVID-19 pandemic as an event too remote from the insolvency of the foreign buyer and its inability to pay the credit. ECAs and private insurers do not have unanimous practice in this respect, and the classification of the COVID-19 pandemic as a political event remains unclear.
Nowadays, after seeing the devastating consequences of global pandemics, it can be argued that such events should be expressly included as political events in the force majeure clauses used by ECAs and private insurers.
Finally, one may ask why it matters whether the COVID-19 pandemic will be classified as a political or commercial risk. If a political event does not cause the foreign buyer’s insolvency and inability to pay a credit, it will be classified as insolvency, which is a commercial event. ECAs and private insurers usually cover both political and commercial risks, and classification of the COVID-19 pandemic as a political risk should not be a problem. The insured seller will be eligible to claim indemnification in any case. This conclusion is correct, but only if the export credit insurance covers both groups of risks with the same percentage of coverage. An example of such insurance is when the coverage is 95 per cent of loss for both political and commercial risks.
However, if an ECA covers political risks with 100 per cent and commercial risks with 90 per cent, which is not unusual, it could result in different amounts of indemnification paid to the insured seller. If the non-paid amount of credit is, for example, 500.000 US dollars, and the ECA classifies the event that caused non-payment of credit as a commercial event, the ECA will indemnify the insured seller with 450.000 US dollars. If the event that caused non-payment is classified as a political event, the ECA will pay 500.000 to the insured seller. The difference is 50.000 US dollars, which is a lot of money for a small- or medium-sized company. In both situations, it can be argued that the foreign buyer has become insolvent, and that insolvency, which is a commercial event, is the reason for non-payment of credit. However, there is a huge difference between the insolvency caused by destruction of the foreign buyer’s facilities in war, which is a political event, and the insolvency caused by underperformance of the foreign buyer’s company due to the poor quality of its products, which is a commercial event.
Additionally, some small- or medium-sized companies choose to obtain export credit insurance for political or commercial risks only because the premium paid for such partial insurance is lower. If an event that caused non-payment of a credit by the foreign buyer is classified as a political event, and the insured seller has obtained the export credit insurance for commercial risks only, the insured seller will not be eligible to claim any indemnification from the ECA or private insurer. If the non-paid amount of credit is, for example, 500.000 US dollars, it would be a huge loss for any small- or medium-sized company.
See our eLearning courses Risks in International Trade and Export Credit Insurance