by Dante Disparte and James Sisco
Traditional insurance coverage acts as a passive mechanism to protect against an unlikely but extreme financial loss. Particularly in emerging markets where historical loss information is limited, insurance underwriting requires multinational corporations to view risk through a different lens.
Models that incorporate qualitative factors such as social risk—threats that emanate from individuals, communities, activist networks and extremist groups in the form of litigation, protests, strikes and violence—allow companies to use insurance as a mechanism to improve investment decisions and operations. But enhancing the insurance process from being a line item cost to acting as a catalyst for investment and operational decision-making requires insurance underwriters, risk managers and other stakeholders to understand the drivers of social risk.
The Problem with Overlooking Qualitative Factors
Current political risk underwriting methods assign limited value to qualitative variables. The result is an overdependence on outdated quantitative risk models that rely solely on historical events. Compounding these challenges, underwriters often put a premium on “hard” security measures, such as physical and psychological barriers separating the firm’s operations from the population, which can actually increase conflict with the community. This not only misprices risk, but often dries up critical underwriting support except for a reserve of blue-chip brand names and projects.
During the peak of conflict in Iraq and Afghanistan, for example, many forms of insurance were available, if not required outright by government contracts. However, underwriting requirements called for customers to operate in high-profile armored convoys, reside in fortress-like compounds and, in some cases, be accompanied by armed guards. Doing so had the pernicious effect of creating targets while alienating the local population. This posture often created a placebo effect, making security and risk management seem adequate. It was only later in the conflict that security firms adopted a softer approach, opting for low-profile, soft-bodied vehicles, breaking convoys into smaller groups and donning unassuming attire.