Chaucer reports surge in sovereign debt downgrades

In the past year, Chaucer, global specialty re/insurance firm, has observed a staggering 43 sovereign debt downgrades worldwide.

The combination of soaring inflation and escalating global interest rates has sparked concerns about the ability of numerous countries, including economic heavyweights like the United States and France, to meet their debt obligations.

The surge in interest rates is making it increasingly challenging for governments to service their debts, with higher coupon payments on new bonds and increased costs on index-linked bonds elevating the risk of default.

Countries burdened with substantial dollar-denominated debt face an even more precarious situation, as the strengthening value of the dollar over the last decade amplifies the cost of servicing such debt.

Notably, this economic turbulence has led to a spike in demand for contract frustration insurance, as businesses fear that financially strapped governments may renege on commercial contracts.

Jonathan Bint, Senior Analyst and Underwriter at Chaucer, emphasises, “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 seeking to mitigate the risk of contract cancellations by securing a safety net through contract frustration insurance. This insurance provides coverage against non-payment or cancellation of contracts by governments or state-owned entities, offering a shield against resulting losses.

The trend is evident across various regions, with a notable increase in interest for contract frustration insurance in countries around the BBB credit range.

Even traditionally stable regions, considered safe for investment, are witnessing heightened demand. Investors in emerging markets, particularly those supporting infrastructure projects, are gravitating towards this insurance to protect against potential alterations to contractual terms by financially strained public sector bodies.

Political instability in Western and Central Africa has further fueled concerns, with coups in Niger and Gabon raising the specter of sudden government changes leading to contract cancellations.

Businesses operating in regions facing a high risk of regime change are particularly uneasy, as control shifts between governments, increasing the risk of contract disruptions.

In response to the deteriorating global economic outlook, insurers are experiencing increased interest in contract frustration insurance for projects in mid-sized economies traditionally considered safe investment destinations.

Jonathan Bint notes, “Like-for-like premiums are up around 20-25% from 2022. A one-notch downgrade on a country across all rating agencies could see around +20-40% in pricing (all else equal).”

Neil Edwards, Deputy Head of Political Risks and Credit, underscores that demand has risen notably in Eastern Europe, with countries like Estonia, Serbia, and Poland seeking increased coverage due to proximity to Russia and sovereign downgrades.

Edwards attributes the rising demand to a combination of factors, including global uncertainty stemming from events like Covid-19, Russia/Ukraine tensions, Israel/Gaza conflicts, and a sharp rise in global interest rates, coupled with incidents of default in countries like Ghana.

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