Multinational Risk

Stop Tariffs from Decimating Your Supply Chain with These 3 Insurance Products

Risk managers should assess how global protectionism will impact their supply chain.
By: | July 11, 2018 • 7 min read

Writer, historian and philosopher Voltaire once quipped, “Uncertainty is an uncomfortable position. But certainty is an absurd one.”

Though Voltaire lived and wrote during the Enlightenment period, he very well could have been reflecting on today’s international political risk climate. Uncertainty, it seems, can be added to the very small list of life’s “sure things” — right next to death and taxes.

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For multinational businesses, today’s uncertainty is, in part, a result of the growing trend toward trade protectionism both in the United States and abroad. Trade protection is the drive to limit imports or promote exports by creating barriers to trade (such as tariffs) with foreign nations. The Trump administration and nationalist government actors abroad have increased the focus on trade protection.

“We live in interesting times,” said Richard Abizaid, XL Catlin’s head of the Americas for political risk, credit and bond.

“Contrast this era to the post-World War II era where the liberal world order was the dominant political and economic system with the United States at its head. It created an atmosphere of predictability and allowed businesses to operate globally based on the assumption that the rules of the game were known to all,” he said.

Today, economic protectionism is creating a climate of increased instability, which is a shift from the years of predictability, said Abizaid.

The Trump administration’s unraveling of the Trans-Pacific Partnership, its efforts to renegotiate the North American Free Trade Agreement and the push to renegotiate the free trade agreement between the U.S. and South Korea are a few examples of how trade protectionism is playing out on the world stage.

Experts predict this is only the first act.

Richard Abizaid, head of the Americas for political risk, credit and bond, XL Catlin

President Donald Trump campaigned for the presidency on this issue, among other things, and appears to be committed to following through on this promise. But whether the current course is a long-term shift toward nationalism or simply a Trump strategy used to create a better negotiating climate for the U.S. remains to be seen.

Either way, with a president characterized as impulsive, sometimes hostile and often lacking prudence, even a well-planned strategy could go awry, thus adding to the uncertainty and risk.

“The President seems to be throwing some of this out there to get the attention of other nations, so he can start renegotiating some of the deals he sees as unfavorable to the U.S.,” said a brokerage executive who specializes in global political risk.

“He has made some exceptions, such as those for Canada and South Korea, so maybe he’ll make an exception for some of the other countries or industries as well. Trade wars are a concern on business leaders’ minds, and no one wants to see this escalate and get out of control,” he added.

At Risk & Insurance® print time, the Trump administration, on May 1, delayed for 30 days the imposition of tariffs on steel and aluminum for Mexico, Canada and the European Union. The move was met with both anger from allies who want more than a short-term fix and a collective sigh of relief from those who feared tariffs would spark retaliation.

But relief is temporary, because this issue is far from resolved. Financial and other business consequences could yet be costly to industry and consumers alike.

Supply Chain Tariff Risks

“There are different scenarios that could take place that would be detrimental to business,” said the executive. Among them are tariffs (paid on a class of imports or exports).

“Tariffs add cost to the supply chain. This could impact costs by raising the prices of goods associated with the supply chain,” he added.

Evan Freely, global practice leader credit specialties, Marsh

“Businesses would need to reassess their costs. If their margins are still good they probably won’t do anything. But if they have higher costs — so high that the project is no longer valuable, then they will need to act. This is a tough one to bring to the insurance market,” the executive said.

Evan Freely, global practice leader credit specialties, Marsh, noted when tariffs increase companies’ costs and subsequently affect market price for their products, consumers shoulder the burden.
“This is when the pain is passed on to the consumer,” Freely said.

“U.S. companies hit by retaliatory tariffs could see a loss of jobs and a loss of market share. Certain agricultural companies, for example, also are at risk.”

Trade Barrier Risk

In addition to tariffs, an escalation of other international trade barriers has multinational businesses concerned. For example, if the situation between the U.S. and China results in either government limiting or prohibiting selling to or importing from the other country, businesses could be without needed manufacturing materials thus negatively affecting the supply chain.

There is concern that China, in particular, could react to policies of the U.S. government by using “back-door methods” to make business more difficult for U.S. companies.

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“Companies with investments in China could be targeted for retaliation by the Chinese government,” said Abizaid.

“And for us, the potential credit degradation of companies impacted by potential and unknown retaliatory Chinese tariffs is a source of concern.”

Worldwide political and economic influence is also at stake.

“The plot thickens when you think of China’s growth,” said Abizaid.

“China’s exports to Asia have doubled, while U.S. exports have declined by half over the last 10 years. This gives China significant influence not only in the Asia region but worldwide. China has been very determined and active in increasing its international influence and trying to establish itself as a global leader. The Chinese government reach extends well beyond just Asia and trade.”

Risk Management Strategies

Despite this uncertainty, there are things risk managers can do to mitigate risk caused by protectionism.

Among these strategies is diversifying your supply chain. If a company’s supplier is located in a region that is vulnerable to unrest, tariffs, trade barriers or acts of war, it could result in the supplier being unable to deliver its product or make the product cost-prohibitive.

So instead of ordering all supplies from one factory, savvy risk managers are recommending a diversification of suppliers — simply put, ordering from several strategically located suppliers.

“It’s all about being agile,” Freely said. “The more progressive companies are agile and seek multiple suppliers in more regions or countries.”

Even with diversification of suppliers, risks still ensue. Companies, which have vetted suppliers, still can’t fully know the risks that exist to their suppliers’ suppliers.

Additionally, the political climate worldwide is such that a region stable today could very quickly become a region of unrest, thereby rendering suppliers unable to deliver.

Three Political Risk Insurance Products

“A big part of our job is educating risk managers on the potential impact on their business of an unpredictable geopolitical environment and how political risk insurance products can provide some balance sheet protection,” said Abizaid.

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“Risk managers know a lot; they have a great depth of knowledge. They will come to us having identified where their company is exposed to political risks and say here is the situation, and we work with them and their brokers to structure a political risk insurance program to help meet their needs.”

Those recommendations, among other things, include political risk insurance products. Some are standard, while others can be manuscripted to deal with very specific situations. They include:

  1. Trade disruption insurance: This product can help protect a company’s income in the event their supply chain is disrupted due to political risks such as war, embargos and government actions that restrict exports.
  2. Contract frustration insurance: If a multinational business has a contract with a government buyer and is concerned that it may not get paid due to credit concerns of the buyer or the political risks posed by doing business in an emerging market country, contract frustration can be used to protect a company’s account receivables.
  3. Expropriation: This product covers government interference with a company’s investment. Key here is its ability to cover more subtle actions such as political retaliation from a foreign government that denies the ability of the company to continue to operate.

For example, this could include the cancellation of licenses which are critical to continue running its business or the implementation of excessive taxes or tariffs that no longer make the business economically viable.

Geopolitical Results Of Protectionism

Even with strategic planning, diversification and insurance coverage, the consequences of trade protectionism for the U.S. and multinational U.S. business might not be worth any gains made.

“If the U.S. pulls out of some of our agreements, it will almost guarantee China’s growing influence at our expense,” said Abizaid.

“The U.S. used to consider trade as an extension of our geopolitical influence. The U.S. government was a guarantor of democracy around the world,” he added.

Given this, and the damage to relationships with our long-term allies, such as Britain, perhaps it is time for the U.S. government to consider less the “price” of things and focus more on their “value.” &

Mercedes Ott is former managing editor of Risk & Insurance. Comments or questions about this article can be addressed to [email protected]

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The R&I Editorial Team can be reached at [email protected]