The increasing popularity of Bilateral Investment Treaties (BIT's), in the late 1990's-early 2000's, was heralded as a major step forwards for the protection of international trade. Companies investing in developing nations certainly identify political risks as one of their main concerns, and so some commentators have speculated as to whether these new protections would spell the end for political risk insurance. They have noted that treaty rights are more direct, provide wider rights and operate more effectively in favour of the investor. More importantly, treaty rights are free — no need to pay premium to insurers who, the critics argue, are likely to seek to deny any claim, or to block the insured from reaching a political solution on the basis that this affects their recovery rights.

 Some 20 years after the take-off of BITs, political risk insurance is still very much alive. So why has the BIT protection failed to live up to the hype? There is no doubt that the treaties do offer valuable protection, but not all of the perceived benefits have materialised. Why is this? Let's explore some of the points put up in favour of BITs, and see if they have lived up to their promises.

1. Treaty rights are wider than the rights under political risk policies.

On their face, the treaties do give generous protection. In addition to protection against expropriation without prompt and adequate compensation, an investor may receive promises of non-discriminatory treatment, for example in relation to taxation, and of fair and equitable treatment. Many treaties also promise "most favoured nation" treatment, which guarantees that the investor will be treated no worse than an investor from another nation.

Political risk insurance is negotiated individually, and may exclude any risks that underwriters consider too great for them to bear. Treaty rights apply equally to all qualifying investments. They do not feature such bespoke exclusions.

This protection, however, depends on a treaty actually being in place between the investor's country and the developing nation. Moreover, treaty rights can vary between treaties. The combination of these factors can lead to investors structuring their arrangements so as to take advantage of the most favourable treaty provisions. This can backfire and lead to jurisdiction challenges in any arbitration, on the basis that the nominal investor is not the true investor.

2. Treaty protection has a longer tenor than political risk insurance.

It is fair to say that political risk policies generally have a limited duration, although underwriters are often happy to renew policies for a longstanding investment.

It is, however, generally the early years of an investment project which are the most risky. Many insureds only take out cover for these early years, or cancel a longstanding policy after the initial period. Political risk insurance does, therefore, provide cover for the critical years, even if the policy is of limited duration.

3. Political risk insurance can act as a bar to political solutions to disputes.

As with most insurance, political risk policies contain requirements that the insured does not do anything that may prejudice insurers' recovery rights – if a claim is paid, insurers wish to be able to pursue the State for recovery.

This does not mean that insured will be unable to entertain sensible discussions with the State. On the contrary, insurers generally welcome efforts by their insured to resolve disputes without recourse to proceedings. Although there can be practical issues where an insurer has not confirmed cover, for example, due to a lack of information, genuine attempts to minimise loss will rarely be criticised as long as the insurer is kept informed of developments.

4. Treaty rights are a reliable way of ensuring a State complies with its obligations.

Treaty rights are generally enforced through arbitration before the International Center for the Settlement of Investor Disputes (ICSID). ICSID is part of the World Bank, and there is an undeniable stigma associated with non-payment. Generally, awards do get paid — eventually.

This time lag may be unattractive to an investor. By way of example, in late 2013 Argentina agreed to pay US$450 million, plus interest, in respect of five awards made between 2005 and 2008. The awards related to disputes stemming from events of 1990-2002. 23 years between the loss and payment will not have assisted the investor's cash flow.

5. Treaty rights are free.

By this, the critics meant that the investor does not pay premium in respect of those rights. This is true, but although the rights may be free, enforcement is not, unless the State accepts that it has infringed the investor's rights and pays out with no need for arbitration.

A Kluwer Arbitration blog-post dated 29 February 20161 estimated that the average claimant costs for an ICSID arbitration were US$5.6 million, with a median of US$2.9 million. The average respondent costs were US$4.9 million, with a median cost of US$3.6 million. The average tribunal costs were US$800,000.

Political risk insurance is an expensive product, and the insured will also face legal fees should a claim be disputed, but the costs associated with ICSID arbitrations mean that any investor thinking that the treaties offer complete protection at no cost will be in for a nasty surprise.

6. Insurers do not pay claims.

Political risk insurers are in the business of paying valid claims. Political risk claims are, by their nature, complex, requiring detailed assessment and a thorough understanding of the insured's dealings with the foreign government. Cooperation from the insured goes a long way to helping with this assessment.

As with all insurance, political risk cover is not an unconditional guarantee, and it is important that an insured understands that the cover will have limitations. These limitations, combined with the price, may explain the relatively low market penetration compared to the overall scale of foreign investment in developing countries. It is recognised that there is an inherent difficulty in describing a risk with sufficient particularity to enable identification of the range of sovereign actions for which cover is provided, whilst still retaining language which is sufficiently broad to ensure that all intended triggers are captured. It is also accepted that there can be a degree of subjectivity regarding whether or not the policy has been triggered.

These factors lead to some confusion about the scope of the cover, and to some issues which may not be expected by investors. Political risk cover is not all risks cover. It responds to named political perils. An insured can perhaps be forgiven for thinking that the policy will respond to any action by a government, whatever its nature, which impacts on the foreign investment. The simple fact is that a policy cannot give comprehensive cover at a price which would be acceptable to an insured, and so there will always be an element of risk sharing between the insured and the insurer. This potential source of dispute can and should be avoided at the underwriting stage by full discussions between the underwriter, insured and broker as to the precise scope of cover.

With more than 2500 BITs in force, the protection that they afford to investors cannot be understated. But political risk insurance continues to provide valuable cover to companies investing in developing nations, and will be an essential aid to international trade for the foreseeable future.



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