faced by the ocean mining industry. Subsequent to the creation of a legislative incentive for private sector pooling, a risk which was initially perceived as being "uninsurable" became insurable within a short period of time. I must candidly note that such incentives are conspicuously absent from the guaranty provisions of S. 2053. To the extent that spreading of risk may be a precondition to the attraction of private insurance underwriting, I believe that any legislative proposal should incorporate the other types of features which go into the spreading of risk for uncommon insurance problems. The list would commence with: (a) a degree of pure retention of risk by the consortia themselves (through deductibles or captive insurance arrangements), (b) the formation of mutual insurance arrangements among the consortia to handle other layers of risk, (c) the general layering of risk at other determined liability levels, with different mixes of government and private financing capacity and techniques being applied to absorb the risk at each level, and (d) the utilization of the layering of risk to engineer the political risks involved, thereby reducing the likelihood of large-scale losses. The possibility of pooling OPIC-type funds with the funds of similar insurance schemes for their own nationals has also been overlooked for purposes of exploring the possibilities of pooling and spreading. Reference to the above options and possibilities does not instantaneously solve the problem. However, my research to date suggests that substantially more options will exist when these types of features are further investigated. At the present time I am not aware of any insurmountable barrier to a carefully devised solution to the risk spreading problem. E. DEVELOPING A WORLDWIDE CAPACITY FOR COVERAGE The "capacity" of the insurance industry to provide coverage for a particular risk is measured in terms of the amount of money which may be pooled at any given time to cover the risk described in a given policy. Capacity for the purposes of a treaty risk must be measured somewhat differently. Depending on the way in which the U.S. government might become involved in the funding and facilitation of investment protection, the risks and the amount of exposure to loss which would be faced by the industry and/or the government could vary widely. I can envision circumstances in which the total losses per consortium might be kept below $50,000,000. I can envision other circumstances in which the combination of the Enterprise (depending on its authority and regulations) and the domestic legislation might result in losses by the government or by the consortia up to the full amount of each project investment. Consequently, depending primarily on the precision with which the domestic legislation is drafted, and depending secondarily on the outcome of the LOS negotiations, I would estimate that contingent losses could range from as low as $25,000,000 to as high as $1,000,000,000 per project. This substantial variation in estimate should serve as a telling symptom of the degree to which there will be a relationship between the losses incurred and the structure of the domestic legislation. Serving as an umbrella over the entire scheme, of course, is the nature and text of the treaty which is eventually ratified. The foregoing estimations are based on an assumption that the CNT would be adopted in full and that adverse interpretations of most key provisions are applied. I do not believe that an operable or conclusive estimate of the "capacity" of the private insurance market or other money markets to participate in financing this risk has yet been presented. I state this because I do not believe that a full array of facts and feasible options has been made available to any party who has made such an estimate to this date. Rather than viewing capacity estimates as a ceiling on the possibilities of private participation, I view them as a bottom line which, combined with an imaginative government program, could be leveraged to provide vastly greater amounts of private capacity. The essential premise is that private capacity should be leveraged rather than be relied upon as an exclusive solution. In estimating the amount which can be leveraged, I should point out that it is very difficult to obtain precise figures on the amount of political risk insurance which has actually been underwritten throughout the world. There are indications that syndicates at Lloyd's of London are already collecting more than $100,000,000 per year in political risk premiums. Similarly, we may observe that Lloyd's has participated in a re-insurance agreement with OPIC for the past six years under which Lloyd's has set aside a capacity of $45,000,000 for one risk/per day/per country. I am also personally aware of the possibility of obtaining capacities, through domestic sources, for land-based political risk in the range of $10,000,000-$20,000,000, and I am also aware of capacity being discussed with international underwriters in amounts ranging from $20,000,000-$40,000,000. Consequently, it is fair to suspect that the existing private capacity from direct underwriting of traditional political risks, irrespective of domestic legislation in this fact situation, may be at least in the approximate range of $40,000,000-$150,000,000. The challenges to this Committee, therefore, are: (1) to devise the best available government mechanism to leverage this and other potential private capacity, and (2) to reduce the financial exposure of the American taxpayer. II. Legislation As a Vehicle for Risk Engineering and Risk Reduction Although the foregoing review of traditional insurance issues demonstrates my agreement with the identification of problems, I part company with prior testimony when the focus turns to solutions. I do not view the most efficient and essential government role as being that of an outright guarantor. I agree with the view expressed by Mr. Hunt from OPIC that, when dealing with with political risk management, the industry, not the government, should be "out front" at the inception of risk. I also agree, however, with the various mining, banking and insurance industry witnesses who have stated that some form of government participation is needed in order to allow the mining projects to reach fruition. A desirable means of integrating the need for government participation with the goal of reduced financial guaranties is to use domestic legislation as a catalyst, or last resort, rather than as a guarantor up-front. The insurance industry principle which would support such a role is that of risk management and engineering. With traditional property or casualty risks, an insurer relies upon itself to enforce safety and construction standards upon the insured in order to manage the insured risks. There are substantial limits, however, on what insurers can do alone to engineer or manage political risks. Accordingly, a premier role to be played by a system enabled by domestic legislation is in the area of managing the political risk by managing the financial means employed to reduce the consequences of political risks. Legislation designed to provide investment security, while it minimizes government financial and political involvement, should include and address the following items in order to engineer the risks involved: 1. Subrogation and salvage capacity; 2. Incentives for the attraction of private debt and equity investment capital; 3. Incentives to secure and attract private insurance underwriting capacity; 4. Incentives to leverage a reduced level of direct financial participation by the government; 5. Requirements for reasonable amounts of risk retention by consortia participants; 6. Layering of risk and defining the mix of risk sharing on each level of liability; 7. Conversion of guaranty features into loans and other recoverable financing instrument; 8. Incentives to sound management by mining companies to reduce losses and for insurance companies to act to reduce risk; and 9. Multi-lateralizing of risk bearing. III. Requisite Amounts of Contingent Government Liability Under Hybrid Financing Concepts and Under Pending Legislative Proposals An investment security partnership comprised of a government facilitating agency (with some contingent guaranty powers and imaginative enabling powers), combined with consortia members, private underwriters and defined relationships with the financing community, would have the capacity to provide investment security at a significantly reduced cost to the government. Although my colleagues and I have not had the opportunity to model or professionally cost-out a hybrid program, my sense of the relavent variables indicates that approximate maximum government exposure in the event of loss would be 10-15% of the total investment. I make that estimate on the assumption that each consortium would realize a substantial recovery of invested capital, as would secured creditors. Translating this into a ballpark figure, the approximate loss, assuming a carefully designed program, would reach about $50,000,000-$75,000,000 on the upside. I would like to emphasize that all figures presented above are merely estimates. Because of what I perceive to be complex interrelationships among various aspects of proposed and contemplated legislation, I might offer substantial variations in estimates depending on changes which might be made to each proposal. The key variables in reaching an estimate are (1) the text of domestic legislation, (2) regulations issued by the agency charged with implementation of a domestic licensing framework and (3) the text and regulations adopted by the United Nations and the international regime. In making my estimates, I have accepted the CNT under its most adverse interpretation and I further assume detailed legislation which reduces the variables which might otherwise ensue from unpredictable regulations and contract terms. The details of the legislative program thus emerge as the primary factor in the determination of potential liability. IV. Conclusion: Government Participation Would Be Desirable and May Be Appropriate, But Not in Presently Contemplated Roles Having examined the types of issues and perspectives introduced in this testimony, I endorse the concept that it is probably not reasonable to expect the ocean mining industry to continue to operate on a viable level without government or private sector assistance in the resolution of a serious problem of legal uncertainty. Although I do not share the view of some others that all risks emanating from the treaty are purely political, it must be acknowledged that a number of unusual political risks exist, and that those risks threaten the ability of the industry to mature into viable forms. Accordigly, I believe that government participation in sharing some portion of the political risk, and in enabling the private sector to participate in absorbing political risk, is an important variable in the future of the ocean mining industry. The point at which I depart from other views which have been expressed is the point at which others would conclude that the only meaningful government assistance can be in the form of an outright investment guaranty. I greatly appreciate the opportunity which these Committees have extended to me to offer my views on these interesting and important issues. SIGNIFICANT LEGAL AND ECONOMIC ISSUES IN LEGISLATING POLITICAL RISK PROTECTION FOR OCEAN MINING INVESTMENTS A REPORT TO THE NATIONAL OCEANIC AND ATMOSPHERIC ADMINISTRATION, UNITED STATES DEPARTMENT OF COMMERCE Alan H. Kaufman, Esq. Cambridge, Massachusetts 02138 SIGNIFICANT LEGAL AND ECONOMIC ISSUES A REPORT TO THE NATIONAL OCEANIC AND ATMOSPHERIC ADMINISTRATION, UNITED STATES DEPARTMENT OF COMMERCE The findings compiled in this report, and interpretations expressed therin, do not necessarily represent the viewpoints of the National Oceanic and Atmospheric Administration or the United States Department of Commerce. The United States while making this information available because of its obvious value and in the public interest assumes no responsibility for any of the views expressed therein. - Alan H. Kaufman, Esq. Cambridge, Massachusetts 02138 Consultant to the July 15, 1977 |
