Making Political Risk Fit

By Wilkin, Sam | Risk Management, April 2001 | Go to article overview

Making Political Risk Fit


Wilkin, Sam, Risk Management


At one time or another, your company must examine the impact of politics on businesses--ignore that fact and expose your firm to potentially catastrophic and unrecoverable losses. While political risks are a unique class, they are manageable. It is possible to practically define and comprehensively identify political risks, usefully analyze risk probabilities and accurately assess risk impacts.

Defining Political Risk

To some practitioners, political risk means nothing more than political instability. In reality, it can encompass a broad range of events, including corruption, organized crime, infrastructure failures or boycotts by nongovernmental organizations.

Theoretically, political risk includes conditions or events brought about by circumstances outside of one's control, directly or indirectly, by the actions or inactions of government(s)--home or foreign--which give rise to financial or physical loss or damage.

But practically speaking, this explanation leaves something to be desired. To get a grasp on the risk, you must build an authoritative risk event list, using all the resources within your organization.

Risk Identification

Start with past events that have led to losses for your firm and others in the industry. List specific events that have had definable impacts on your company. The best practice for identification is the development of a comprehensive list of where political risks can originate. Where are investment projects located? With whom does the firm trade? From what countries does the firm source supplies? Where do overseas contracts take place? Risks such as expropriation and sabotage can have an impact on a company's assets, while kidnapping and local hiring requirements can affect personnel, and social unrest and export requirements can affect operations.

Often through this identification process, firms find their political risk management efforts have been poorly focused. One manufacturing firm, for instance, realized that it had been spending too much effort on investment risks and too little effort on managing supply disruption risks. A careful risk identification process revealed that the firm's international sourcing exposure was far greater than its investment exposure, due to its heavy reliance on materials from China.

Risk Assessment

Quantifying the threat posed by specific political risk events, risk assessment is an evaluation of two factors: probability and impact.

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