Overseas Investment: Issues Related to the Overseas Private Investment Corporation's Reauthorization
Released: 1997-09-08T00:00:00

Letter

Background

OPIC was established by the Foreign Assistance Act of 1969 (P.L. 91-175, Dec. 30, 1969) to pursue the U.S. foreign policy of mobilizing and facilitating the participation of U.S. private capital and skills in the economic and social advancement of developing countries. In carrying out this responsibility, OPIC took over the investment guarantee and promotion functions of the U.S. Agency for International Development. In the early 1970s, the U.S. approach to foreign assistance began to shift from one of providing government aid for infrastructure building and large capital projects to providing assistance to meet basic human needs. OPIC’s role was to support market-oriented private investment in various sectors.

More recently, the World Bank has estimated that $200 billion would be needed annually over the next 10 years to meet the infrastructure needs of developing countries. Obtaining this level of private investment will be a major challenge given the economic and political characteristics of emerging markets and the unique risks inherent in each project. Project financing is emerging as an important component in infrastructure development.

OPIC’s programs are designed to promote overseas investment and assume some of the associated risks for investors. Specifically, OPIC offers direct loans and loan guarantees to U.S.-sponsored joint ventures abroad, supports private investment funds that provide equity for projects abroad, and provides political risk insurance to U.S. investors. The political risk insurance covers investors for up to 20 years against losses due to currency inconvertibility, political violence, and expropriation. OPIC collects premiums and fees from the private sector for insurance and financing services. OPIC finance and insurance activities are backed by the full faith and credit of the U. S. government and are limited to a total exposure of $23 billion in fiscal year 1997. OPIC services are available in some 140 developing countries, although OPIC does not operate in some countries, largely for U.S. foreign policy reasons.

Projects eligible for OPIC assistance include new investments, privatizations, and expansions or modernization of existing plants. The sectors OPIC supports include power, financial services, telecommunications, and oil and gas. To obtain OPIC support, investors must meet specific criteria, including U.S. ownership requirements.

Over the years, Congress has placed various requirements on OPIC’s authority to support U.S. investment. For example, in carrying out its activities, OPIC is to administer its entire portfolio (financing, insurance, and reinsurance operations) on a self-sustaining basis and in a manner that ensures that the projects it supports are economically and financially sound; refuse support for any investment in countries that are not taking steps to adopt and implement internationally recognized worker rights; and decline participation in investments that are likely to significantly reduce U.S. domestic employment levels or pose an unreasonable or major environmental, health, or safety hazard.

Global Changes Have Reduced the Private Sector’s Perception of Risk, Yet Public Support Still Sought in Some Markets

A changing global environment has reduced the perception of risk for the investors we spoke with in emerging markets. Economic growth and liberalization have created investment opportunities in sectors that were previously dominated by government-owned companies or were simply off limits to foreign investors. Many countries, for example, have privatized their power and telecommunication sectors and enacted laws that permit foreign ownership, resulting in dramatic increases in foreign investment. More recently, private providers of project finance and political risk insurance are increasingly available to assist investors. However, according to many of the firms we surveyed, markets still exist where they are unable to obtain private finance or insurance services. As a consequence, they seek public support. Public support includes direct loans, loan guarantees, and political risk insurance from OPIC and the U.S. Eximbank; foreign agencies that provide such services (often called export credit agencies); or multilateral financial institutions, such as the World Bank.

Private Investment in Transition Markets Has Increased Considerably

The privatization of public enterprises, legal and regulatory reforms, and a more stabilized political and economic environment in developing counties, among other changes, have led to an increase in total private capital flows. As shown in figure 1, private capital flows to finance infrastructure projects and other private investments overseas have increased from $26 billion in 1986 to $246 billion in 1996.

During the 1990s, private sector finance has increased dramatically, especially to Asian and Latin American developing countries, despite setbacks associated with the Mexican peso crisis. Private flows going to infrastructure reflect these overall increases, particularly in commercial lending devoted to project finance. According to a 1996 International Finance Corporation report, these private infrastructure investments would not have seemed possible 10 years ago. Today, more and more countries are introducing competition and private participation in infrastructure ownership and management.

The 34 power and telecommunications companies that we surveyed indicated that their investment decisions have been significantly influenced by the recent developments in emerging markets. In general, 30 of the companies stated that changes in the legal and regulatory environment in emerging markets have led them to seek investments in countries where they had not invested in the past. At the same time, the U.S. power market matured, and U.S. power companies began seeking investment opportunities in emerging markets.

Availability of Private and Public Investment Services Increasing

The rise in overseas private investment has been accompanied by increases in investment support by public providers of finance and insurance as well as increases in private insurance coverage in some markets. Three countries—Japan, the United States, and Germany—are the largest public providers of political risk insurance. (See app. II, which identifies features of the services provided by the major public providers of political risk insurance.) Lloyd’s of London, the American Insurance Group, and Exporters Insurance Corporation—three major private insurers—have recently increased their insurance coverage.

Globally, public providers have increased investor coverage. According to the Berne Union, new investments insured by its members rose annually between 1991 and 1996, going from $7.1 billion to $15.2 billion. As of the end of 1996, the cumulative amount of investment covered by Berne Union members was $43.4 billion. According to data collected directly from the major public providers of political risk insurance, Japan led all public providers with $13.9 billion in cumulative exposure. OPIC was second with $13.4 billion in exposure, and the German public provider was third with $7.8 billion in exposure. These public insurers have traditionally dominated the public risk insurance market. Although the major public providers generally offer investment services in the same countries, each of the major providers’ business tends to concentrate in different markets. OPIC, for example, concentrates in Latin America, the Japanese in Asia, and the Germans in Asia/Pacific and Central and Eastern Europe. (See app. III for available information on the regional concentration of major public insurance providers.) Investors are also assisted by other Berne Union members, including the Multilateral Investment Guarantee Agency, a multilateral institution affiliated with the World Bank Group, with about $3.9 billion in exposure reported in 1997.

The level of coverage of privately provided political risk insurance has increased considerably over the past 2 years, according to the private insurers we spoke with. Although the volume of coverage provided by private insurers is difficult to determine, a political risk insurance expert estimated that several billion dollars of private political insurance coverage was provided in 1996. According to the American Insurance Group, one of the largest private providers of political risk insurance, it increased the length of its coverage from a maximum of 3 years to a cap of 7 years in 1996. Additionally, ACE, Inc., a private insurance provider, recently entered into a reinsurance contract with the Multilateral Investment Guarantee Agency, providing up to 15 years of risk coverage on the same terms as that agency. However, according to officials of a large commercial bank and a private political risk insurer, in some risky markets private insurers are only willing to provide insurance when a public sector entity is involved in the project. A private insurer we spoke to said his company had not provided coverage in Russia and most of the other newly independent states of the former Soviet Union.

Public and private sources also provide financing in developing countries. Public providers include OPIC; the International Finance Corporation, a multilateral institution affiliated with the World Bank Group; the U.S. Eximbank; and other bilateral credit agencies, such as the Japanese Export-Import bank. Private sector financing to developing countries is available through commercial banks and other private financial institutions. According to the World Bank, this source of financing has increased significantly during the 1990s, with about one-half of these resources directed toward project financing for infrastructure development.

Risk Determines Whether Investors Seek Public or Private Finance and Insurance

Investors’, private lenders’, and insurers’ perception of risk frames how projects are structured and financed. The risks assumed and the type of support sought by investors can differ by project and by sector. For example, based on the projects identified in our survey, more telecommunications projects were completed without public support and with investor self-insurance than were power projects. Power plants are costly and can take 10 years or longer to recoup the investment costs, according to an energy firm official we interviewed, making plant assets and income subject to long-term political risks. Telecommunications projects, on the other hand, may generate enough income to cover investment costs in just a few years.

Investors we surveyed told us that over the past decade, several Latin American, East Asian, and East European countries have taken steps to create environments attractive to investors. Specifically, 22 of the 34 firms we spoke to were comfortable with assuming investment risks after they had been successful in a country for a period of time. For example, one telecommunications company that is developing cellular telephone operations in Hungary told us that the availability of OPIC political risk insurance was a critical factor in its initial decision to invest $200 million when privatization allowed the company to enter the market. After 2 years, however, the company reassessed the political and economic risks of this investment and decided to drop its OPIC insurance in favor of self-insurance. A company with 10 projects in Poland told us that it developed 9 cable projects with private investment after completing 1 successful project in Poland that was financed by OPIC 5 years ago when private financing was not available. In another example, a power company that has used OPIC in other high-risk markets has made acquisitions of privatized public utilities in Argentina and Chile without official support by obtaining financing from European financial markets and locally syndicated money. Officials of the International Finance Corporation confirmed that investors are increasingly likely to cancel International Finance Corporation loans as lower-priced private financing becomes more available in lower-risk markets.

Despite these trends, some markets are still considered high risk by investors, lenders, and private insurance companies. Thus, obtaining commercial finance and insurance in these markets remains difficult, according to private firms we surveyed. Several of the power and telecommunications companies we surveyed concurred with the assessment that in several regions of the world, including Africa, Russia, the other newly independent states of the former Soviet Union, and Central America, the perception of risk remains high. Some companies told us that they are generally unable to raise the necessary financing for transactions in high-risk countries without public support. For example, four firms that we spoke to that invested in Russia or Ukraine said that private finance was unavailable for their projects. One telecommunications company with investments in Russia and Ukraine stated that without OPIC political risk insurance, it would have avoided these high-risk markets. A power company with a $150-million equity investment in El Salvador covered by OPIC political risk insurance told us that the availability of OPIC services was a key factor in the company’s decision to invest in the country. According to an official from this company, although it considers Guatemala to have great potential for the industry, private financial institutions and insurance companies still consider Guatemala to be high risk, and the company will not go forward with projects in Guatemala without OPIC or other public support. Additionally, private lenders and insurance companies we spoke with told us that they offer limited, if any, services in higher-risk markets such as the newly independent states of the former Soviet Union. Officials at the major international banks we visited noted that they are reluctant to lend in high-risk markets without some form of political risk insurance and that the private insurance companies often cannot provide the kind of insurance lenders need in these markets.

U.S. Investors Obtain Public Support in Some Non-OPIC Markets

In countries where OPIC services are not available due to U.S. foreign policy or operational reasons, such as Mexico, China, Pakistan, and Vietnam, we found that most of the U.S. investors we interviewed often seek other forms of public support to facilitate investment. As is the case in other emerging markets, investors’ decisions to invest in a project were predicated on their perceived risk. Our survey of U.S. investors showed that when U.S. firms believed they needed public investment support in a non-OPIC country, they sought investment support from the U.S. Eximbank or other foreign export credit agencies or multilateral financial institutions. Although such support facilitates the original investment, subsequent equipment and service procurements are often tied to the countries providing the support. Thus, if foreign export credit agencies provide the support, U.S. suppliers could be excluded.

In some non-OPIC markets, such as Mexico, U.S. investors may not always seek public support. According to a telecommunications company official, several risk mitigation factors enabled the company to make a $1-billion investment in Mexico without political risk insurance or other official participation in the project. Mexico’s historical and geographical relationship to the United States, trends in Mexico’s economic performance, the potential for free trade, and the contractual commitment of high-level government officials and the Mexican Central Bank, along with the company’s confidence in its Mexican partner, all helped lower the company’s perception of risk. In contrast, a $644-million power project in Mexico is being undertaken by U.S. investors facilitated by a $477-million U.S. Eximbank loan, $28 million in U.S. Eximbank political risk insurance during construction, and a $75-million Inter-American Development Bank loan.

In China, companies have entered into joint ventures with local companies that are affiliated with provincial governments, which lowers investor perception of risk. Depending on the size of the project, these companies were more likely to obtain a portion of their financing from multilateral institutions or foreign official sources. For example, one power company with several recent joint ventures in China financed smaller-sized projects (under $30 million) without public support. However, the same company is finalizing a $1.6-billion project and is obtaining support from the U.S. Eximbank and Hermes, Germany’s export credit agency. The opportunities presented by China’s large market potential may increase investors’ willingness to do business there despite the perceived risk.

In other markets where OPIC is not available, the U.S. firms we surveyed have used the services of multilateral agencies or export credit agencies.One telecommunications company mitigated its risk in Pakistan by obtaining guarantees and political risk insurance from the International Finance Corporation and the Multilateral Investment Guarantee Agency. Because OPIC was not available in Vietnam, a U.S. power firm used the Asian Development Bank and Coface (the French export credit agency) to finance a $160-million power plant.

U.S. investors’ use of investment support from sources other than OPIC may affect the source of procurements. Multilateral institutions generally do not tie their support to buying equipment from a particular country. However, some U.S. firms told us that they were unable to use U.S. suppliers when they obtained support from foreign export credit agencies. In testimony before Congress, an official of a large U.S. company testified that her company utilized or planned to use German, Japanese, or French equipment for projects in China, Pakistan, and Vietnam because the company obtained investment support from German, Japanese, and French export credit agencies.

OPIC’s Revenues Have Exceeded Its Losses, but Global Changes May Present Opportunities for OPIC to Further Reduce Portfolio Risk

Historically, OPIC has been self-sustaining, generating substantial revenues from its finance and insurance programs and its investments that together have been sufficient to cover actual losses. As of September, 1996, OPIC had accumulated $2.7 billion in reserves. According to a February 1996 J.P. Morgan Securities, Inc., report, OPIC’s reserves are more than adequate to cover any losses that OPIC might experience, excluding an unprecedented disaster. OPIC’s risk management strategies, which include maintaining reserves, setting exposure limits, performing pre-approval reviews, and applying underwriting guidelines, help limit U.S. taxpayers’ exposure to undue risk and prevent project losses. In 1994, OPIC raised the maximum amount of insurance and finance coverage it offers on a given project, a step that increases the government’s exposure to loss but may not negatively affect the quality of OPIC’s portfolio. Notwithstanding OPIC’s track record, the private sector’s willingness to have greater involvement in some developing countries has created opportunities for OPIC to take steps to further reduce the risk associated with its portfolio through greater risk-sharing. Some possible options to explore include obtaining reinsurance from other providers, utilizing coinsurance, and insuring less than 90 percent of the value of each investment. Adoption of any of these options, however, should be carried out with due consideration of U.S. foreign policy objectives.

OPIC Has Generated Sufficient Revenue to Cover Its Losses

Historically, OPIC has generated sufficient revenues from its insurance and finance programs to cover its operating costs and the losses associated with its portfolio.

OPIC’s Insurance Program

Since its inception through 1996, OPIC had about $500 million in insurance claims and recovered all but $11 million of this amount from the disposal of assets and recoveries from foreign governments. During the same period, OPIC has received over $922 million in premiums from its insurance activities. OPIC’s insurance revenues have exceeded its gross claims payments in all but 3 fiscal years, excluding recoveries that OPIC obtained after the claims were paid and liabilities were incurred but not reported. Also excluded is interest from Treasury securities.

OPIC’s Finance Program

According to J.P. Morgan Securities, Inc., OPIC’s finance program has operated at a small loss or close to breaking even. Although OPIC’s cash revenues from its finance program have exceeded all cash losses from loans or loan guarantees since 1984, when operating costs and loan loss provisions are included, OPIC’s finance program shows a net operating loss for each year since 1993. If income from Treasury securities were allocated for each of these years, the finance program would show a net income.

Under OPIC’s finance program, its direct loans, which by statute are only available to small businesses, have experienced higher rates of delinquencies and loan losses than its loan guarantees. Between 1984 and 1996, OPIC’s average direct loan loss rate was 4.4 percent; the loss rate was at its highest, at 11.7 percent, in fiscal year 1984. In the same time period, OPIC’s loan guarantee portfolio had an average loan loss rate of 0.56 percent for a combined rate (direct loans and loan guarantees) of 0.93 percent on average outstandings.

OPIC’s finance program has been subject to the Federal Credit Reform Act of 1990, which became effective in fiscal year 1992. The act requires that government agencies, including OPIC, estimate and budget for the total long-term costs of their credit programs on a present value basis. Based on the required estimation of subsidy costs under credit reform, OPIC’s finance program will cost the government $72 million in fiscal year 1997 and total about $135 million between fiscal years 1992 and 1996.

Historically, OPIC’s combined finance and insurance programs have been profitable and self-sustaining, including costs due to credit reform and administration. The J.P. Morgan Securities, Inc., report stated that OPIC’s finance program has operated at a small loss or close to breaking even and that much of OPIC’s profitability has come from interest earned on Treasury securities. This interest has accounted for over 60 percent of OPIC’s total revenue over the past 6 years. In fiscal year 1996, OPIC’s net income was $209 million, of which $166 million was interest on Treasury securities. From a governmentwide perspective, interest on Treasury securities held by OPIC represents transfers between two government agencies (that is, OPIC’s income from Treasury securities is a Treasury expense) that cancel each other out. From that perspective, OPIC’s net income from transactions with the private sector, that is, fees and premiums, amounted to about $43 million in fiscal year 1996.

OPIC Has Established a Risk Management Strategy

OPIC’s risk management strategy focuses on limiting OPIC’s maximum exposure to loss in any one country or sector. No single country accounts for more than 15 percent of OPIC’s portfolio, effectively protecting OPIC against the adverse consequences of catastrophic events in any one country. The purpose of risk diversification is to spread the risk of one transaction across a number of different transactions, thereby isolating OPIC against the risk of one “catastrophic event.” As shown in figure 2, OPIC’s portfolio is diversified across different regions of the world.

Although OPIC seeks to diversify its portfolio, figure 2 shows that the countries of the Americas account for more than 40 percent of OPIC’s portfolio. This trend is explained by the fact that U.S. firms choose to use OPIC support in these markets. In general, OPIC’s portfolio is consistent with U.S. foreign direct investment in emerging markets. Figure 3 displays OPIC’s portfolio diversification by investment sector.

OPIC’s risk management strategy also includes pre-approval review and underwriting guidelines that take into account some of the same factors other private and multilateral insurers use in evaluating projects. For example, a risk analysis is performed as part of OPIC’s insurance approval process, and a credit analysis is included in the finance approval process. OPIC officials said they consider the same factors that any commercial bank or insurance company would concerning the economics of a project under consideration for financing or insurance.

Additionally, as of September 30, 1996, OPIC had accumulated over $2.7 billion in reserves as part of its risk management strategy. These reserves were raised from fees or premiums paid by users of OPIC’s services and from the investment of these funds in Treasury securities. OPIC’s reserves as a percentage of the total current exposure to claims have declined somewhat in recent years due to the rapid increase in the size of OPIC’s portfolio since 1994. The reserves as a percent of OPIC’s total outstanding exposure have declined from 41 percent in 1992 to 34 percent in fiscal year 1995. Despite this decline, J.P. Morgan Securities, Inc.’s, 1996 report on OPIC privatization concluded that these reserves are extremely large relative to exposure by private sector standards and compared to OPIC’s historical losses. Further, analysts at J.P. Morgan Securities, Inc., see the reserves as adequate to cover OPIC’s losses in all cases but an unprecedented disaster.

OPIC’s Overall Project Limits Have Recently Increased

In 1994, OPIC increased per project financing limits from $50 million to $200 million and insurance coverage from $100 million to $200 million per project. Although larger transactions increase the government’s contingent liabilities, large loans are not necessarily more risky than small loans. For example, 13 of the 14 loans currently in technical default or in a non-performing status at the end of fiscal year 1996 were loans made to small businesses and ranged in value from $328,000 to $12.5 million. In addition, OPIC data show that its direct loans have historically experienced more problems than its loan guarantees, which are mostly for high-value loans to large companies. However, for insurance transactions, higher project limits may or may not raise the overall level of risk for the portfolio. On the one hand, OPIC could be subject to larger claims if a foreign government, for example, were to expropriate an insured project. On the other hand, if OPIC’s past experience with claims were to continue, the government’s potential liability may be small. Since 1971, OPIC has recovered over 98 percent of the claims it has paid.

We caution that OPIC’s past experience may not reflect future performance because OPIC has new exposure to losses in the newly independent states of the former Soviet Union, where it has had no previous experience. Furthermore, some countries in the region are considered to be very risky by the private insurers and bankers we spoke with.

Possible Options to Reduce the Risks Associated With OPIC’s Insurance Portfolio

The private sector’s willingness to have greater involvement in some emerging markets has created opportunities for OPIC to further reduce risks in its insurance program. OPIC could share the risk of losses with the private sector, which has shown an interest in emerging markets. For example, OPIC could lower the risks associated with its portfolio through reinsurance, coinsurance, and by decreasing project coverage or terms. However, OPIC’s efforts to support U.S. foreign policy objectives, which promote investment in risky markets, present challenges for OPIC when considering ways to reduce the risks associated with its insurance portfolio.

Reinsurance

Under the reinsurance scenario, OPIC could consider insuring part of its high- and medium-risk portfolio with private sector insurance companies at premium rates that are mutually acceptable. For example, OPIC could enter into a contract with a large private insurer that would pay a specified percentage of any claims to OPIC. Care must be taken to ensure that the private insurer is not providing support exclusively for the lower-risk transactions and that OPIC retains enough of the reinsured premiums to cover its administrative costs. According to OPIC officials, OPIC had used portfolio re-insurance by the private sector as a mechanism for managing risk and stimulating U.S. private sector interest in providing risk insurance until the mid-1980s. The Grace Commission concluded that given OPIC’s low claims experience, there was no justification for the U.S. government to pay reinsurance premiums that exceeded claims payments collected from the reinsurers. After the Grace Commission’s study of OPIC’s reinsurance practices, the Office of Management and Budget directed OPIC to stop this practice because it was not cost-effective. OPIC officials told us that OPIC is currently in discussions with the Office of Management and Budget about the feasibility of once again pursuing portfolio reinsurance. As noted earlier, private political risk insurance companies are showing greater interest in emerging markets. This trend presents OPIC with opportunities to negotiate fee or premium arrangements that it would not have been able to negotiate in the past.

Coinsurance

Another risk mitigation strategy that OPIC may use is providing more coinsurance. It could coinsure a project with other private or public insurers in order to share the associated risks and premiums. In this case, the coinsurer would provide insurance that might or might not be identical to the type provided by OPIC that would permit both parties to provide a higher level and scope of coverage. For example, OPIC could provide $100 million of coverage on a $200-million project, while a private entity or a number of entities could provide the other $100 million of coverage. An insurance industry official has publicly stated that OPIC could leverage its resources by inviting the private sector to provide 50 percent of the insurance required on a project. However, OPIC officials said that the private sector’s reluctance to take long-term risk in risky markets limits its opportunity to pursue coinsurance. OPIC has documented only 12 of 1,392 contracts that it has coinsured with the private sector since 1988.

Risk Sharing

A third risk mitigation strategy may be to reduce the coverage and terms of OPIC’s insurance program. OPIC currently offers standard 20-year insurance with 90 percent coverage of the value of the insured assets.One potential option would be that OPIC could insure less than 90 percent of the value of each investment. OPIC’s rationale for insuring 90 percent, rather than 100 percent, of the value of the assets is to ensure that the investor or project sponsor has an incentive to manage its assets prudently. Another option would be for OPIC to offer less than 20-year coverage. For example, rather than providing its current 20-year standard policy, OPIC could offer a standard 15-year term, as is the practice with other public insurers, and provide 20-year cover only in certain cases. Lastly, OPIC could require that the insured hold OPIC coverage for a minimum of 3 years. These measures would lower the value of assets covered, the length of coverage, and potentially the cost of coverage.

Regarding the risk-sharing option, OPIC officials said that reducing the coverage level below 90 percent would have an adverse impact on small businesses and might lead U.S. investors to seek insurance support from foreign or multilateral sources that provide 90-percent coverage. They also noted that it might not be practical to make a project sponsor hold the coverage longer than he or she thinks is necessary or prevent him or her from seeking alternative sources of insurance. However, since a reduction in coverage is likely to come with a reduction in price, U.S. investors might continue to seek OPIC coverage.

OPIC officials acknowledged that reinsurance, coinsurance, and greater risk sharing may be sound risk management options, but are not without trade-offs. For example, reinsurance may reduce OPIC’s income from premiums because OPIC would have to pay premiums to the reinsurer. Furthermore, OPIC takes on the credit risks of the reinsurer. The officials also stated that OPIC would need to maintain flexibility as to how and when to utilize these risk mitigation alternatives.

U.S. Foreign Policy Encourages OPIC to Invest in More Risky Markets

The U.S. foreign policy objective of promoting private investment in developing countries encourages OPIC to take risks that the private sector may not take without public support. OPIC, the State Department, and other U.S. government officials consider OPIC to be a major tool for pursuing U.S. foreign policy goals. One major U.S. foreign policy goal is to assist Russia in its transition toward a free market economy. According to OPIC officials, by entering into OPIC’s bilateral agreement in 1992, Russia began to establish the conditions necessary for attracting private investment. Further, OPIC operates to promote development strategies that are consistent with internationally recognized worker rights. For example, OPIC ceased operations in the Republic of Korea in 1991, due to concerns over worker rights, including the arrest and imprisonment of labor union leaders.

OPIC’s involvement in Russia was initially quite cautious, as it offered only coverage for expropriation and political violence. OPIC officials noted that as conditions improved in Russia, OPIC began offering coverage for currency inconvertibility risk. Since 1992, OPIC has accumulated a finance and insurance portfolio in Russia of $880 million and $1.6 billion, respectively. OPIC justifies its involvement in the high-risk markets of the former Soviet Union—currently 18 percent of its portfolio—by noting its central role in furthering the U.S. foreign policy objective of facilitating private investment in these markets.

The private sector has tended to perceive the markets that OPIC operates in as risky, and private investors have often sought support from official sources when investing in these markets. According to OPIC officials, OPIC’s goal is to support deals that would not be made without its support, and OPIC as an agency of the U.S. government has access to risk mitigation tools, including advocacy and intervention to avert claims, that are not available to the private sector. This implies that OPIC would seek transactions that the private sector believes would be too risky without public support. If OPIC is to continue pursuing its mission, its portfolio will always be considered more risky than the portfolios of private sector insurers.

If OPIC Is Not Reauthorized, Any Shutdown Legislation Should Address Future Management of OPIC’s Portfolio

OPIC’s authorizing legislation makes no provision for a phaseout process in the event the agency is closed. Any legislation shutting down OPIC should make clear whether OPIC’s portfolio should be moved to another agency or managed by a temporary organization until the portfolio expires. It could take as long as 20 years for OPIC’s portfolio to expire because many of OPIC’s insurance contracts run for 20 years, and OPIC had more than $5 billion in such contracts with 19-20 years remaining as of the end of fiscal year 1996. According to OPIC’s projections, about one-third of the portfolio would remain after 10 years. If the portfolio risk diminishes, Congress’ option to dispose of these assets is more viable.

Legislation Should Establish Who Would Manage OPIC’s Portfolio

If Congress decides not to reauthorize OPIC, any shutdown legislation would need to address whether OPIC would continue to manage the portfolio during a phaseout period or whether the portfolio should be moved to another agency. If the portfolio is moved to another agency, Congress would need to decide if any OPIC employees would be moved with it to ensure an adequate and knowledgeable work force. According to Office of Management and Budget officials responsible for overseeing OPIC and related agencies, OPIC staff may be best suited to managing the portfolio because they are familiar with the portfolio.

According to OPIC and private sector financial officials, OPIC’s portfolio could suffer losses if it is not properly managed, thereby increasing the cost of closing the agency. For example, a successor entity would need to monitor the construction of power and other projects, as well as political developments in host countries and the portfolio’s financial performance, to help prevent claims and/or defaults. Additionally, such an entity would need to perform OPIC’s administrative and legislatively mandated functions, including fee collection, repayment, environmental oversight, compliance with worker rights, and other monitoring to ensure that clients comply with their contractual agreements. According to OPIC officials, if finance projects encountered payment difficulties, an entity would also be needed to restructure the project and make collections where necessary.

If a decision were made to move OPIC’s portfolio to another agency, the U.S. Eximbank would be the closest fit, according to Office of Management and Budget officials who are also responsible for overseeing the U.S. Eximbank. U.S. Eximbank officials also stated that their agency has many of the appropriate skills to do the job. The Eximbank officials cautioned, however, that their employees would not be familiar with the various monitoring requirements that OPIC carries out. They noted that OPIC is a foreign policy agency that provides development assistance while the U.S. Eximbank is an export promotion agency whose emphasis is on expanding U.S. exports.

The U.S. Eximbank’s lack of familiarity with OPIC’s monitoring requirements would be less of an issue if OPIC staff were transferred to the U.S. Eximbank.

Officials from three other agencies with responsibilities for overseeing loans or insurance obligations, or for encouraging and tracking U.S. investment in key overseas markets, all said that their agencies lack the business skills and resources necessary to manage OPIC’s portfolio. These agencies include the Departments of Commerce, State, and the Treasury. Office of Management and Budget officials concurred that their agency also lacks these skills and resources. In addition, officials from the Agency for International Development, the agency from which OPIC was created, said that their agency would not be well suited to managing OPIC’s portfolio because the agency (1) does not provide political risk insurance, (2) provides mostly grants, and (3) lends primarily to public entities (OPIC lends to the private sector).

Other Issues to Be Considered If OPIC Is Not Reauthorized

Regardless of whether OPIC’s portfolio is turned over to another agency, certain Office of Personnel Management rules would affect OPIC employee entitlements as he or she is separated from government service. These entitlements may include (1) retirement or severance pay, (2) unemployment compensation, (3) the dollar equivalent of unused annual leave, and (4) settlement from any pending equal employment opportunity or other labor-related litigation. According to officials of the Office of Personnel Management, if OPIC’s portfolio is moved to another agency, Congress would have to decide if any OPIC employees are to be moved with the portfolio. These officials said that reassignment of OPIC employees to another agency, under current Office of Personnel Management rules, would be temporary, lasting only until OPIC’s portfolio expires or the government disposes of the portfolio.

If OPIC’s portfolio is moved to another agency, other issues might be considered for easing the transition. For example, a timetable could be established for transferring OPIC functions to the designated agency. In the absence of specific congressional direction, General Services Administration regulations would apply governing the disposal of OPIC’s property including the transfer of office furniture and equipment. In addition, OPIC said it has a commercial real estate lease that runs to June 30, 2007.

OPIC’s Portfolio May Take 20 Years to Expire

A phaseout of OPIC would require ceasing new business as of a certain date. Also, a phaseout could take as long as 20 years. OPIC’s investment funds run for 10 years; its loans and guarantees, a maximum of 15 years; and its insurance policies, a maximum of 20 years.

According to OPIC estimates, which assume a 10-percent annual drop in the declining remainder of the insurance portfolio due to both cancellations and policies ending at term, the agency’s potential exposure of $23 billion for all services would fall by 64 percent, to $8.2 billion, after 10 years. During the same period, OPIC estimates that its current staff of 200 would decrease by more than 70 percent to about 60 people as the portfolio diminishes. We compared OPIC’s assumptions concerning insurance cancellations and contracts ending at term to historical data and found these assumptions to be generally consistent with these data. According to OPIC, just under 10 percent of the original exposure would remain in the 20th year, with less than 8 percent of the staff needed to monitor it. The decline in OPIC’s portfolio is shown graphically in figure 4. The insurance portion of the portfolio is by far the largest, currently at just under $16 billion. This portion is about 3 times the value of the finance portion and almost 8 times that of the investment fund portion. In the 20th year, just the insurance portion would be left, having dropped by 86 percent to just over $2 billion (see fig. 4).

Disposal of Portfolio Assets Could Be Revisited in the Future

Although the government may wish to divest OPIC’s portfolio before its expiration by selling it to the private sector, such a decision would need to account for the relative riskiness of OPIC’s portfolio and any discounts such a disposal would necessitate. According to a recent study, a privatization of OPIC’s current assets could only be accomplished at a discount. As OPIC’s portfolio matures during a phaseout, external factors may affect the riskiness of the portfolio, either negatively or positively, and thus any potential privatization discount.

If existing economic and political trends continue in the markets where OPIC currently operates, OPIC’s portfolio may become less risky. With each year that passes, the length of the government’s obligation decreases and the insured as well as the government becomes more familiar with the risks and issues inherent in a given transaction. As stated earlier, OPIC’s clients tend to cancel their insurance coverage after a few years as they feel more comfortable with the political risks. On the other hand, OPIC’s portfolio may experience greater risk. In general, long-term transactions are riskier than similarly situated short-term loans, guarantees, or insurance transactions. Also, according to OPIC officials, cancellations are more likely to occur in the lower-risk segment of OPIC’s portfolio, thus making the portfolio riskier in the future than it is today. Either situation—less risk in the portfolio or greater risk—may occur.

Regardless of the risk characteristics of the portfolio over time, OPIC’s portfolio will decrease. As the portfolio decreases, the amount of the discount will decrease for a given risk in the portfolio. If the quality of the portfolio improves as a result of improvements in OPIC markets, then the rate of discount will likely be much lower or even disappear. If, on the other hand, the portfolio becomes more risky over time, the rate of discount is likely to increase. Since the condition of this portfolio a decade or more from now is unclear, the government has the option of revisiting its choice to sell the portfolio if the risk is reduced.

Agency Comments

OPIC provided written comments on a draft of this report. OPIC generally agreed with the information and analyses in the report. In commenting on the draft, OPIC provided additional information to further clarify its view of (1) the role of the private sector, (2) risk mitigation opportunities, and (3) phaseout issues. OPIC also orally provided technical corrections and updated information that were incorporated throughout the report where appropriate. OPIC’s comments are reprinted in appendix VI, along with our evaluation of them.

Scope and Methodology

To identify trends in private sector investment in developing markets and the public sector’s role in these markets, we focused on various characteristics. Specifically, we obtained and analyzed World Bank data on the extent and types of private capital flows going to finance infrastructure and the trend of these flows over time. To identify the recent developments in the volume and types of investment support provided by the public and private sectors for investments overseas, we obtained and compared information from (1) five large private providers of political risk insurance; and (2) the largest public providers of investment support representing France, Germany, Japan, Canada, Italy, the United Kingdom, and the United States. (see app. II) and the Multilateral Investment Guarantee Agency. We also discussed with the Berne Union information on the nature of political risk insurance and the role and capability of the public and private sectors. We obtained total insurance exposure data directly from the Group of Seven (G-7)insurance providers. Regarding financing, we obtained information from major financial institutions that provide financing to U.S. investors, including the Chase Manhattan Bank and Citibank, and the International Finance Corporation. We also discussed the international finance environment with Standard & Poor’s Ratings Services and Moody’s Investors Service, two large financial rating agencies. An important component of our analysis of private sector investment was the identification of the kinds of investment services U.S. investors have utilized in various developing countries or economies in transition as well as countries in which OPIC is not open for business (for example, China and Mexico). To obtain this information, we surveyed a judgmental sample of 34 U.S. investors that had made major investments within the last 5 years in the power and telecommunications sectors. We selected the power and telecommunications sectors because they (1) are listed as the major sectors of growth in emerging markets and (2) represented two of the four largest sectors supported by OPIC. Since these sectors have considerably different resource requirements and risks, their inclusion allowed us to make several important distinctions regarding the investment environments in which they operate.

To survey firms in the power and telecommunications sectors operating overseas, we (1) reviewed relevant literature including the Directory of American Firms Operating in Foreign Countries and U.S. Security and Exchange Commission data, (2) contacted appropriate Department of Commerce officials, (3) reviewed OPIC’s annual reports that list overseas investors, and (4) asked the firms contacted to identify their major competitors. We attempted to contact the 54 firms identified and successfully interviewed 34. We asked each firm to identify the projects it was involved in over the past 5 years, how these projects were structured, their views on the nature of the risks involved, and how it mitigated the risks.

To determine OPIC’s risk management strategy and the steps that OPIC may take, if it is reauthorized, to further reduce portfolio risks while pursuing its objectives, we obtained and reviewed documents on OPIC’s risk assessment policies and financial reports that detailed the condition of OPIC’s portfolio. We also gathered and reviewed information on the risk assessment policies of two World Bank institutions (the Multilateral Investment Guarantee Agency and the International Finance Corporation), organizations that have programs comparable to OPIC’s insurance and finance programs. To support our analysis of these policies, we interviewed OPIC, Treasury, and State Department officials. Furthermore, we interviewed officers of private banks, investment institutions, and political risk insurance companies about steps that OPIC could pursue in reducing the risks associated with its portfolio.

To determine the issues that would need to be addressed and the time it would take to phase out OPIC if it is not reauthorized, we reviewed laws and regulations and discussed applicable policies and practices with officials from the Office of Personnel Management, the General Services Administration, and the Office of Management and Budget. In addition, we reviewed our past work on the closure of the Resolution Trust Corporation and interviewed the Federal Deposit Insurance Corporation official responsible for managing the phaseout of the Resolution Trust Corporation. To determine how long it would take for OPIC’s obligations to expire, we obtained documents from OPIC on (1) its current financing and insurance obligations, (2) its insurance policy cancellation rates, and (3) its projections on the duration of its existing portfolio and the resources it would require to manage the portfolio. To assess the reasonableness of these projections, we reestimated OPIC’s analysis using a higher projected phaseout rate. With regard to which agency might be best suited to manage OPIC’s existing portfolio until the obligations expire, we interviewed officials from the Agency for International Development, the Commerce Department, the U.S. Eximbank, the National Economic Council, the Office of Management and Budget, OPIC, the State Department, and the Treasury Department. We also obtained Office of Personnel Management documents showing job classifications at OPIC and two other agencies—the Agency for International Development and the U.S. Eximbank.

We conducted our review from January 1997 to July 1997 in accordance with generally accepted government auditing standards.

We are sending copies of this report to appropriate congressional committees and the President and Chief Executive Officer of the Overseas Private Investment Corporation. We will also make copies available to other interested parties upon request.

This review was done under the direction of JayEtta Z. Hecker, Associate Director. If you or your staff have any questions concerning this report, please contact Ms. Hecker at (202) 512-8984. Major contributors to this report are listed in appendix VII.

Firms Contacted During the Review

Firms Surveyed

Power Companies

AES Corporation Coastal Power Energy CalEnergy Company, Inc. CMS Energy Corporation Constellation Power, Inc. Dominion Resources, Inc. Duke Energy International, Inc. Enron International GE Capital Corporation GPU International, Inc. Houston Industries Energy, Inc. Edison Mission Energy Ogden Energy Group, Inc. TECO Power Services Corporation El Paso Energy International The Wing Group Ltd. Co.

Telecommunications Companies

Adelphia Communications International African Communications Group, Inc. Ameritech Corporation Andrew Corporation BellSouth Corporation Comcast Corporation Chase Enterprises D & E Communications, Inc. GTE Service Corporation Hungarian Telephone & Cable Corporation Lucent Technologies, Inc. MCT of Russia, L.P. Millicom International Cellular, S.A. Motorola, Inc. Radiomovil Digital Americas, Inc. Telecel International, Inc. SBC Communications Inc. US WEST International Holdings, Inc.

Other Public and Private Entities Contacted

Main Features of the Group of Seven Investment Insurance Programs

Legal entities registered in France.

No restrictions.

No limit.

15 years. Expropriation, war, inconvertibility, breach of government commitments.

Domestic German entities.

No restrictions.

No limit.

15 years.Expropriation, war, inconvertibility, breach of government contracts.

Persons and entities existing in Japan.

No restrictions. $500 million per project.

15 years.Expropriation, war, inconvertibility, bankruptcy after 2 years of operation.

Persons or business beneficial to Canada.

No restrictions.

No limit.

15 years. Expropriation, war, inconvertibility.

Persons or entities domiciled in Italy.

Developing countries only.

No limit.

15 years. Expropriation, war, inconvertibility, natural catastrophe.

Persons and entities carrying on business in United Kingdom.

No restrictions.

No limit.

15 years extendable to 20. Expropriation, war, inconvertibility, breach of contract by host government.

U.S. citizens and entities and foreign entities 95% owned by U.S. interests.

Developing countries only. $200 million per project.

20 years. Expropriation, war, inconvertibility, breach of contract by host government.

Regional Investment Insurance Exposure of the Major Group of Seven Providers

OPIC data as of September 30, 1996.

OPIC Insurance Process

OPIC Finance Process

Comments From OPIC

The following are GAO’s comments on OPIC’s letter dated August 6, 1997.

GAO Comments

1. The points that OPIC highlights are there own interpretation of our analyses. Several points discussed by OPIC, such as the health of their reserves, filling a commercial void and the impact of its activities on U.S. employment, are not our specific conclusions. Rather, the report provides factual information and our analysis of the trends in private sector investment, the public sector’s role in emerging markets, OPIC’s portfolio and risk management strategy, and issues to be addressed if OPIC were not reauthorized. 2. Information in the report on OPIC’s risk management strategy is not restricted to a discussion of how OPIC limits exposure in any one country or sector. The report also includes a discussion of OPIC’s pre-approval review process and underwriting guidelines. Appendixes IV and V contain information on the application, approval, and monitoring processes for the insurance and finance programs. 3. Although the report notes that the larger finance projects tend to be less risky than smaller projects, we do not agree that the same is necessarily true for OPIC’s insurance projects. Financing involves commercial risks that well-capitalized and experienced private participants have greater influence in mitigating. However, political risk insurance only covers actions taken by governments—actions that are less within the control of the private sector. 4. The report discusses only the recent growth in privately provided political risk insurance. The extent to which the private market capacity for political risk insurance would be affected by changes in demand for property/casualty coverage is not certain. 5. We recognize that OPIC has in some cases pursued the risk mitigation options discussed in the report. However, we believe that the private sector’s current high level of interest in investing in emerging markets has created opportunities for OPIC to further reduce portfolio risk through greater use of the options presented. 6. The report provides OPIC data that show 18 (now 12) cases since 1988 in which OPIC coinsured with the private sector. Although there may be other cases in which the private sector provided insurance to investors also insured by OPIC, this information is more anecdotal and these instances would not represent cases in which OPIC formally sought to coinsure with the private sector. 7. We revised the report to reflect that any loss that was covered by a drawdown in reserves (that are comprised of Treasury securities) would become a budgetary outlay. However, we do not agree that such an outlay should then be compared to the offsetting collections that OPIC receives. If it were necessary for OPIC to redeem Treasury securities, then it would need more cash to cover losses than it would be taking in. 8. The report states that under the Federal Credit Reform Act of 1990, agencies are to estimate and budget for long-term costs of their credit programs on a present value basis. Subsidy costs arise when the estimated program disbursements by the government exceed the estimated payments to the government on a present value basis. The subsidy cost data in our report are based on OPIC’s reported estimates. In order to show lower subsidy costs, the costs must be reestimated, with key factors such as the credit risk of the borrowing country showing improvement. OPIC identified $72 million in subsidy costs for fiscal year 1997 programs.

With regard to OPIC’s statement about its interest earnings, only those earnings properly allocable to its credit program are relevant to the discussion of its credit subsidy estimates. Under credit reform requirements, interest earned on credit-related reserves is required to be included in estimating the subsidy cost. 9. We modified the report to include this information. 10. We modified the report to include this information.

Major Contributors to This Report

National Security and International Affairs Division, Washington, D.C.

Office of the General Counsel, Washington, D.C.

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