Tuesday 28 February 2017 7:30 am

Political risk is about more than populist election victories, as UK insurers know

As the anti-globalisation stone gathers moss, political risk has been weighing on the minds of investors. Many worry that the tide of public opinion in the developed world is flowing towards tougher immigration restrictions and higher tariffs on imported goods, scrambling any chances of energising this feeble and joyless economic recovery.

In the last week, wealth manager Charles Stanley has launched a political stability index of the US, UK, Germany, France, Italy, Greece and Spain, to help guide investors through an era of unstable governance, growth-negative policies and populist leaders.

Much of the focus on political risk is trained on potential watersheds – namely elections. Would a President Le Pen trigger the collapse of the Eurozone? What if Angela Merkel is ousted?

Given that the threat is posed chiefly by political insurgents with little or no experience of government, whose policies they may or may not be able to implement if they win power, mitigating such risks seems at once pressing and also impossible. Markets await elaboration from Donald Trump on his tax plans, and question marks hang over his fiscal stimulus.

The sharp drop in the share prices of UK insurers yesterday is proof that it doesn’t take an electoral earthquake or major geopolitical shift for politics to do a lot of damage. The UK insurance sector was stunned by the government’s decision to change the way that personal injury claims are assessed by much more than had been expected, showing how damaging smaller risks can be.

Sweat the small stuff

The Ministry of Justice announced that it was cutting the discount rate used to calculate the lump sum amount offered to sufferers of life-changing injuries much further than the industry had expected.

The Ogden rate, as it is also known, will be cut from 2.5 to -0.75 per cent in March, meaning that insurance companies will no longer be able to assume that lump sums offered to claimants will accrue interest at 2.5 per cent, costing the industry millions and raising insurance premiums for customers. Analysts had been expecting a reduction in the Ogden rate to around 1 per cent.

Shares in Admiral Group and Direct Line Insurance Group tumbled. The latter ended the day down 7 per cent, having announced that its pre-tax profit could fall by £215-230m after reinsurance recoveries. The two insurers rank among the three highest dividend yielding stocks in the FTSE 100, based on 2017 forecasts. Russ Mould, investment director at AJ Bell, said that the news would be particularly concerning for income investors.

Of course, this is not the first time that the UK insurance industry has found itself on the wrong side of UK government policy in recent years. George Osborne torpedoed the share price of annuity providers in 2014 when he announced that pensioners would be able to take their entire pension as cash. An hour after Osborne’s Budget speech, Just Retirement had fallen 30 per cent, and had barely recovered 12 months later.

Others at risk

Some sectors are more exposed to the decisions taken in Westminster than others. Persimmon, Taylor Wimpey and other housebuilders rallied when the housing white paper was published earlier this month, while banks such as Lloyds and RBS are vulnerable to calls for overdraft fees to be capped, for example.

Firms in hospitality and retail, meanwhile, have been disproportionately affected by the introduction of the National Living Wage, which places the burden of extra wages directly on businesses.

Political risk is about more than landmark elections. Policymaking occurs all the time, and populists don’t need an electoral triumph to impact shareholders’ returns.