Global sovereign debt downgrades spark surge in contract frustration: Chaucer

In the past year, a staggering 43 sovereign debt downgrades have swept across the globe, with concerns mounting over governments’ ability to meet their financial obligations, according to global specialty (re)insurance group Chaucer.

High inflation coupled with rising global interest rates has intensified worries about servicing debts, prompting downgrades for nations including the United States, France, Argentina, Tunisia, and Bolivia.

The surge in interest rates has created challenges for governments in paying higher coupons on new bonds and increased payments on index-linked bonds, elevating the risk of default.

Countries with substantial dollar-denominated debt face an additional burden due to the strengthening value of the dollar over the past decade.

This unsettling trend has prompted a notable increase in the demand for contract frustration insurance, as businesses seek protection against potential non-payment or cancellation of contracts by financially strained governments.

Jonathan Bint, Senior Analyst and Underwriter at global specialty (re)insurance group Chaucer, notes, “When Governments find themselves under financial pressure, they are increasingly likely to breach contracts that they or other public sector bodies have with businesses.”

Businesses are now taking proactive measures to mitigate the risk of contract cancellations by governments and state-owned entities, turning to contract frustration insurance as a safety net against resulting losses.

The heightened uncertainty in public finances globally has expanded the appetite for such insurance, particularly in regions traditionally considered stable.

Investors supporting infrastructure projects in emerging markets are among those seeking protection, as financial pressures on public sector bodies may lead to attempts to alter contractual terms.

Heightened political instability in Western and Central Africa, exemplified by coups in Niger and Gabon, further compounds concerns about sudden government changes and potential contract reneging.

Jonathan Bint points out, “Businesses find it particularly uncomfortable when there is a high risk of regime change in regions that they operate in. When control is shifting around between governments, the risk of contracts being canceled increases.”

Even in emerged mid-size economies typically seen as safe investment destinations, the caution over canceled contracts has spread as the global economic outlook worsens.

Insurers report a substantial increase in interest for contract frustration insurance in these previously deemed secure regions.

Moreover, the economic downturn has prompted a surge in insurance premiums, with premiums rising by approximately 20-25% since 2022. A one-notch downgrade in a country’s credit rating across all agencies could see a further increase in pricing, ranging from 20-40%, all else equal.

Neil Edwards, Deputy Head of Political Risks and Credit, emphasises the ripple effects of global uncertainty from events like the Covid-19 pandemic to geopolitical tensions in Russia/Ukraine and Israel/Gaza.

The sharp rise in global interest rates, combined with incidents of default in countries such as Ghana, has led to a universal increase in pricing for contract frustration insurance across the board.

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