Among all the instruments that help international companies hedge against political risk to FDI abroad, political risk insurance (PRI) is one of the most impactful. In 2023 alone, new foreign investments worth USD 41 billion were underwritten, according to the Berne Union, a PRI industry association. And, in contrast to investment treaties, which tend to be little known in the business community, boardrooms and financiers frequently rely on PRI when deciding whether and where to invest. Policy-makers, too, should pay more attention to the instrument. Most PRI is distributed by state-owned insurers, which turns investment insurance into a powerful tool for advancing diverse public policy objectives.

Indeed, once you know where to look, PRI is everywhere. War insurance, a form of PRI that compensates companies for damages suffered in the context of armed strife, has been a key component of Western states’ support for Ukraine in the face of Russian aggression. PRI is also a crucial geopolitical tool. Both the G7 Partnership for Global Infrastructure and Investment initiative and China’s Belt and Road Initiative rely heavily on PRI to channel investment into partnering developing countries. PRI has also emerged as a tool for nudging companies into diversifying their supply chains, with Germany offering attractive premiums for companies investing in new jurisdictions. Finally, PRI forms a vital part in global efforts to fight climate change, including via debt-for-nature swaps that combine debt relief with nature conservation and would not work without the unique capabilities of PRI to de-risk financial commitments.

In short, it is high time we understood PRI and its role in the broader international investment regime better. This essay explains (1) what PRI is, (2) what risks it covers, (3) how it compares and links with IIAs, (4) what role it already plays today, and (5) how it could be leveraged to reform the future international investment regime.

What is PRI?

Investment insurance (sometimes referred to as an investment guarantee) protects investors against political risk abroad. It operates like every insurance: investors pay an insurance provider a premium (annual fees typically range between 0.5% and 3% of the investment’s book value) to receive a payout if a political risk event (as defined in a detailed insurance policy) occurs. But PRI is more than an insurance product. It is a policy instrument that sits at the intersection of development finance, export promotion, and commercial diplomacy.

Less than 10% of PRI coverage comes from private insurance providers. Instead, public insurers dominate the space in the form of multilateral (e.g., the Multilateral Investment Guarantee Agency [MIGA]), regional (e.g., Afreximbank) and national insurance providers (from the U.S. International Development Finance Corporation [DFC] to China’s SINOSURE). The public backing for PRI matters for two main reasons.

First, state-sponsored PRI is, in effect, a form of capital export subsidy because public PRI providers typically charge less than the market would ask for to cover the equivalent risk or provide coverage for risks that the private market would not otherwise insure. The additional risk that public providers assume is justified on a range of public policy grounds:

• development finance: PRI supports economic growth in less developed countries alongside traditional development aid.
• capital export promotion: PRI supports economic growth at home by helping domestic businesses expand to global markets.
• economic statecraft: PRI supports the home state’s foreign and security policy objectives, from climate change mitigation to supply chain diversification.

Second, with public money at stake, PRI transforms private relations between investors and home states into inter-state affairs. It is routinely, but incorrectly, asserted that investment relations have been de-politicized through the proliferation of investment arbitrations and investment protection treaties that ostensibly limit the involvement of the home state. In reality, the continuing importance of PRI means that home states are very involved in investment relations. Large capital-exporting states like the United States and Germany intervene directly in looming investment disputes as part of their wider commercial diplomacy to prevent their state-sponsored insurance from paying for injuries inflicted on their investors. Investors, in turn, value the backing of the home state, which, in some instances, may deter adverse actions by the host state. That is a major reason why investors tend to prefer public over commercial PRI. In short, state-sponsored PRI is fundamentally a tool of public policy and commercial diplomacy.

What types of risks do PRIs cover?

Traditionally, PRI has indemnified investors in situations of

• currency inconvertibility, for example, to enable foreign investors to repatriate profits;
• damages resulting from war or civil strife, for example, to indemnify investors for assets destroyed during a conflict;
• expropriation, to pay compensation if the host government seized the investor’s assets.

More recently, many PRI providers have expanded coverage to include

• repudiation of contracts, which protects investors against the unilateral cancellation of state contracts;
• nonpayment of arbitral awards, which pays the investor if a host country refuses to honour an international arbitration ruling.

The details of these coverages, as well as other terms and conditions, are outlined in the insurance policies that vary from provider to provider and that are governed (mostly) by the domestic laws of the insurance provider. Private insurers may also offer bespoke insurance products that cover additional risks.

There is no “right to insurance,” and not every investment project is insurable. Insurance providers apply various conditions, including (1) political restrictions (excluding coverage for investments in sanctioned jurisdictions), (2) economic considerations (imposing upper limits on the insurable investment amount), and (3) social and environmental criteria (refusing coverage for projects linked to human rights abuses or environmental harm). In practice, that means that PRI is selective about what investments it supports and can be tuned to advance different policy objectives.

Differences Between PRI and IIAs: Complements, not substitutes

Although IIAs and PRI partially overlap in terms of political risks covered, there are important differences that make IIAs and PRI complementary rather than interchangeable. First and foremost, while IIAs primarily focus on protecting investment stock, PRIs are about enabling investment flows. Most IIAs do little to actively attract or liberalize investment flows. Their primary purpose is to protect existing investments, including those made before the treaty’s conclusion. These treaties mostly become relevant when a state interferes with an investment and the investor seeks remedies for an already materialized political risk.

In contrast, PRI is typically obtained at the time the investment is made. By effectively de-risking investment projects and reshaping the risk-return calculus, PRIs play a pivotal role in securing financing and making investments viable in the first place. Treaties, on the other hand, at best play a minor role in de-risking investment projects. Research suggests that investors tend to know little about IIAs and do not take them seriously as a de-risking mechanism. That is understandable given the vagueness of treaty terms, the length and unpredictability of arbitration processes, and the uncertainty of obtaining compensation even if a claim is successful. By contrast, PRI policies are precise in their terms, and payouts occur promptly once a political risk event materializes. PRI thus matters more than IIAs when it comes to mobilizing capital.

While PRI excels at mobilizing investments, it is less potent at protecting them. IIAs tend to provide broader protections, such as commitments not to discriminate and to provide fair and equitable treatment, which are not typically included in PRI policies (although PRIs include unqualified war insurance, which is a protection not offered in IIAs). Additionally, PRI generally insures only the book value of the investment and typically limits recovery to 90% of the investment’s value. Consequently, payouts under PRI policies tend to be lower than damages awarded by investor–state arbitration tribunals under IIAs that typically take into account future profits when assessing the market value of an investment.

Despite these differences, PRI and IIAs are interconnected in significant ways. Most of the protections offered by PRI overlap with the obligations host states have under IIAs regarding foreign investors. In fact, PRI policies typically define expropriation in relation to the international law concept. Moreover, there are important historical ties. The first BIT between Pakistan and Germany in 1959 arose out of Germany’s PRI system. The idea was that payouts provided to investors under the PRI could be recuperated from the host state (in this case, Pakistan) through the BIT.

Investment treaties include subrogation clauses, which allow home states to “step into the shoes” of the investor after an insurance payout. In practice, it is rare for states to invoke subrogation clauses or to pursue arbitration claims directly against host states. Instead, home states rely on clauses in their PRI policies that require insured investors to act as agents of their insurer following an insurance payout. Indemnified investors can thereby be instructed to launch an arbitration claim, and, if successful, they are obligated to forward any compensation they received to their home state insurer, up to the amount of the insurance payout. In cases where arbitration is unavailable, or host states fail to pay, home states often use diplomatic leverage to recover funds. For instance, the United States reportedly recovers 90% of all payments made to its investors under its PRI from host states. Similarly, Germany has developed a practice of blacklisting countries that fail to reimburse investors, which prevents new PRI coverage for investments in those countries. This leverage has enabled Germany to recover millions in payouts from host states.

In summary, while investment treaties and PRI serve distinct purposes, they form a tightly interconnected ecosystem. This system enables foreign direct investment that might otherwise be too risky. At the same time, the system is skewed toward developed home states, which not only benefit from the premiums paid by investors for PRI coverage but also from reimbursement payments extracted from developing host states.

What PRI Does—Security, geopolitics, and environmental protection

Three use cases—the war in Ukraine, Germany’s efforts to diversify supply chains, and debt-for-nature swaps—help illustrate how PRI shapes investment flows and its role in addressing diverse public policy challenges.

Security: How PRI helps rebuild Ukraine

No business wants to invest in a war zone. That is why Ukraine’s First Deputy Prime Minister, Yulia Svyrydenko, successfully pushed like-minded states to provide war risk insurance. In May 2023, G7 leaders expressed political support for leveraging PRI to spur investment into Ukraine. The subsequent Ukraine Recovery Conference in June 2023 launched the London Conference Framework on War Risk Insurance for Ukraine, a coordinated effort to mobilize private investment through PRI. Today, all G7 countries except for Canada offer war risk insurance for Ukraine through their national PRI programs. These efforts are complemented by regional organizations, such as the EBRD, and multilateral institutions, including MIGA, which have PRI programs tailored to Ukraine’s context. The German government has reported a noticeable increase in investment guarantees for Ukraine, highlighting the tangible impact of these efforts.

Diversification: How Germany’s PRI is redrawing supply networks

Germany’s PRI, administered by PricewaterhouseCoopers but directed by the federal economy ministry, is the second largest investment insurance program worldwide, covering over EUR 30 billion worth of investment stock in 2022. Germany long conceived of its PRI program as demand driven: wherever German companies wanted to invest, the government provided, as far as possible, its backing. In 2022, Germany pivoted to using its PRI more strategically. Worried about overexposure to specific markets, particularly China, and attending risks of economic coercion or supply chain disruptions, Germany reimagined its PRI program as a set of sticks and carrots to diversify supply chains.

On the sticks side, Germany implemented measures to limit PRI coverage with a view to manage overdependencies on foreign jurisdictions, especially China. Four investment guarantees requested by Volkswagen for projects in Xinjiang were denied in May 2022 due to forced labour concerns. Germany also capped the total exposure for single companies and host countries at EUR 3 billion and increased PRI premiums for investments in jurisdictions with high investment stock concentration.

On the carrots side, Germany has introduced incentives to redirect foreign investment to alternative markets. Improved PRI terms—including reduced premiums and waived fees—are now offered for projects in 20 selected regions and countries, such as Turkey, India, and Chile. These markets were identified based on their economic potential, alignment with Germany’s foreign policy priorities, and their role in fostering a rules-based global order.

These changes have already yielded measurable results. The number of accepted applications for PRI in preference countries has risen, while Germany’s exposure to China in terms of both applications and overall guarantee volumes has declined sharply (the overall PRI exposure to China fell by EUR 5.5 billion since 2021).

Environment: How PRI enables debt-for-nature swaps

For the past two decades, PRI has been an active tool for aligning investment with sustainable development criteria. Many public PRI providers screen investment insurance projects for their human rights and environmental impact (see Germany, United States, and MIGA). More recently, Germany’s PRI explicitly incorporated climate considerations to align the scheme with the Paris Agreement. It now categorizes investment projects into three tiers: green (climate-friendly, eligible for enhanced support such as reduced rates), white (neutral, supported under standard terms), and red (incompatible with climate goals, excluded from support).

The most impressive use of PRI to achieve environmental objectives, though, concerns a recent wave of debt-for-nature swaps. These swaps take the existing sovereign debt of developing countries (Belize in 2021; Ecuador and Gabon, 2023), which was subject to high interest rates, and refinance it with a lower interest rate, which frees up funds for environmental conservation. PRI plays a crucial role in making these schemes work. The structure of these swaps is complex, but in a nutshell, the PRI protects creditors against the sovereign debtor’s failure to honour an arbitral award regarding the nonpayment of debt. This coverage, in turn, enhances the credit rating of the restructured debt, reducing borrowing costs and unlocking funds that can be used for environmental conservation. Crudely simplified, the PRI allows developing countries to borrow at close to the rate of the PRI provider (here, the United States’ DFC). As part of these swaps, a consortium of stakeholders, including nature conservation organizations, ensure that the freed-up funds are used for their intended purpose. In short, debt-for-nature swaps are clever financial schemes that use PRI in novel ways for debt relief and nature conservation.

What Else Could Be Done: Using PRI to reform the investment regime

Although states already use PRIs to creatively tackle new public policy challenges, the tool remains underexploited when it comes to reforming the investment regime more broadly. There are two main reasons for this.

First, investment policy-makers tend to be more familiar with investment treaties than PRI. Yet, often PRI rather than IIAs should be the focus of attention. The energy transition, with its massive need for new capital investments, illustrates why that is the case. IIAs are part of the problem because they lock in protections for existing fossil fuel investments that need to be phased out. PRIs, by contrast, are part of the solution because they use public guarantees to generate new private investments and can thereby channel capital into renewable energy projects, including in otherwise high-risk developing countries. In short, policy-makers should pay less attention to IIAs and more attention to PRI to tackle pressing public policy challenges.

Second, the interplay between IIAs and PRI is little known and underappreciated, which then forecloses reform options. The current investment regime is systematically inequitable. While PRI, as a capital export subsidy, could be a tool to fulfill developed countries differentiated responsibilities, e.g., for doing more to combat climate change, IIAs ensure that the costs of that subsidy are rolled over to developing countries who reimburse developed states either indirectly through investor claims or directly via diplomatic channels. A different approach is needed. For example, the coverage of PRIs could be expanded, and the coverage of IIAs could be reduced to ensure that some of the de-risking burden stays with developed states. Alternatively, the laws of damage calculation in IIAs could be adjusted to deduct at least parts of the payment investors receive from home states from any damage paid by the host state.

What is certain is that the investment policy community should pay more attention to PRI. It is the key to transforming the investment regime.

Author

Wolfgang Alschner is Hyman Soloway Chair in Business and Trade Law at University of Ottawa