Trend driven by high inflation and rising global interest rates
As per new insights from global specialty re/insurance group Chaucer, sovereign debt worldwide experienced 43 downgrades in the past year, driven by high inflation and rising global interest rates, heightening concerns over the ability of numerous countries to manage their debts. Notably affected countries included the United States, France, Argentina, Tunisia, and Bolivia.
The increase in interest rates has made it more challenging for governments to service their debts, as they face higher costs on new bonds and index-linked bonds. This situation escalates the risk of default, particularly for governments with substantial dollar-denominated debt, which has become costlier due to the dollar’s strengthening value over the last decade.
These growing concerns over global public finances have spurred demand for contract frustration insurance. This type of insurance protects businesses against non-payment or cancellation of contracts by governments. Jonathan Bint, senior analyst and underwriter at Chaucer, notes that governments under financial strain are more likely to breach contracts with businesses.
“As a result of this uncertainty, businesses are increasingly seeking to mitigate the risk of contract cancellations by Governments and state-owned entities (SOEs) by ensuring that they have a safety net. Contract frustration insurance is thus a way for businesses to shield themselves from resulting losses. A telling sign of how raised financial stress and high interest rates are making businesses nervous is the range of countries that insurers are protecting against,” Bint said.
Previously stable regions, now rated around the BBB credit range, are showing a significant uptick in demand for this insurance. This shift was not as prevalent even five years ago. One area witnessing increased demand is investments in infrastructure projects in emerging markets. Investors are concerned that public sector bodies under financial pressure might alter the terms of offtake agreements or other contractual payments.
Political instability in Western and Central Africa, including coups in Niger and Gabon, has also heightened business concerns. These sudden government changes increase the likelihood of public sector bodies defaulting on contracts.
Bint also highlights the discomfort businesses face in regions with high risks of regime change, where contract cancellation risks escalate. As the global economic outlook worsens, concerns over canceled contracts extend beyond emerging markets. Insurers are now observing a rise in interest in contract frustration insurance for projects in mid-size, traditionally “safe” investment destinations.
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