Analysts at global specialty re/insurance group Chaucer have noted an increase in demand for contract frustration insurance amid widespread sovereign debt downgrades, caused in part by the Ukraine crisis and inflationary pressures.
A new report by the firm observes that sovereign debt worldwide has been downgraded 78 times by the top three ratings agencies in the last year, compared to 58 downgrades that sovereign debt received in the previous year.
Rising interest rates, inflation and a stronger dollar have led to increased concerns over the ability of an increasing number of countries to service their debt, with downgrades hitting countries such as Mexico, Turkey, Chile and Sri Lanka.
In October, rating agencies S&P and Fitch also cut the outlook on UK Government debt from ‘stable’ to ‘negative’, which is just a step short of a full downgrade.
Chaucer notes that governments are borrowing significant amounts to alleviate the effects of rising energy prices and broader inflation on their populations, but, at the same time, rising interest rates are increasing Governments’ debt servicing costs.
As a result, heightened concerns over the state of public finances globally has increased demand for contract frustration insurance, which insures against non-payment or cancellation of contracts by Governments
“More and more countries are struggling to pay their bills, which makes it ever more likely they will cancel or seek not to pay contracts with businesses,” explained Jonathan Bint, Senior Analyst & Underwriter at Chaucer.
“Due to the uncertain global environment, businesses are increasingly looking to mitigate the risk of contract cancellation by Governments,” Chaucer added. “Insurers are therefore seeing increased demand for contract frustration insurance as businesses seek a safety net.”
One area of demand is from private equity investors supporting infrastructure projects in emerging markets who are now looking to additional insurance against potential losses caused by Government’s cancelling infrastructure projects.
Other businesses which are particularly concerned about suffering losses as Governments come under financial pressure include construction companies with contracts related to Government infrastructure projects, as well as the energy and mining sectors.
“As the increase in sovereign debt downgrades suggests, the risk of losses from cancelled Government contracts is likely to grow further,” Bint continued. “Even countries such as the UK have been known to cancel major commercial contracts during times of economic stress. Contract frustration insurance is a way for businesses to shield themselves from subsequent losses.”
