Insuring against Country Risks: Descriptive and Prescriptive Aspects

Kunreuther, H.C. & Kleindorfer, P. (1982). Insuring against Country Risks: Descriptive and Prescriptive Aspects. IIASA Collaborative Paper. IIASA, Laxenburg, Austria: CP-82-036

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Abstract

Today multinational firms face grave uncertainties with respect to their investment strategies in other countries. This paper stresses the importance of integrating the descriptive aspects of this problem with prescriptive recommendations. It does so by raising two interrelated questions: (1) How do multinational firms and insurers deal with the problems of international risk in making their decisions on what investments to undertake? (2) What role can analytic approaches, including insurance mechanisms, play in better managing risk and uncertainty in international transactions?

These questions are addressed by developing a conceptual framework which emphasizes the importance of problem formulation, institutional arrangements and decision processes as a basis for prescriptive recommendations. The problem is characterized by lack of a detailed statistical data base to estimate probabilities and consequences of different types of political, economic, and social risks. Corporate planners and risk managers who have responsibility for these investment decisions would Like concreteness. Hence, their actions appear to be greatly influenced by past experience and personal contacts.

Our prescriptive recommendations are designed to widen the statistical data base by the use of experts and Bayesian analysis as well as to broaden the responsibility for investment decisions within the organization. We also propose a jointly operated US private-federal insurance program which maintains features of current government operated systems but has private firms marketing policies and settling claims.

The above theoretical concepts are illustrated with a case study of Indonesia's investment evaluation problem pursuant to their decision to provide the United States with liquefied natural gas in the early 1970's. This case study illustrates the political risks of firms investing even in highly developed economies such as the United States.

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