Hedging Tariff Risk

Trade wars and high tariffs force companies to find new suppliers and adjust logistics, which often result in shortages of materials, parts, and components—and higher costs.

This has become a recent pain point for companies across the United States as the Trump administration has initiated an unpredictable tariff policy against scores of other countries.

“In some cases, clients understand their supply chain well and in other cases they don’t,” says Richard Waterer, global risk consulting leader at Aon.

Jerry Paulson, senior vice president in Hub International’s Complex Risk Practice, offers a similar perspective. “Despite the threat of high tariffs being telegraphed pretty well [by President Donald Trump], we were surprised that many of our clients in different businesses hadn’t given [it] much thought until it happened,” he says. “In conversations with clients, a lot of them were caught flat-footed. They did not have a plan in place for who pays for the tariff—they or their customer—as it was not contemplated in the supply contracts. That either decreased or eliminated their margins or created headaches by having to pass along the tariffs to customers, leading to some order cancellations.”

Clients that understand the impact of topsy-turvy tariffs on their balance sheet, says Waterer, are doing the best they can: passing on the price of the levies to customers, shifting production to countries with less risk of high tariffs, and stockpiling more product in inventory. “Most clients recognize the need to hedge the risk of higher tariffs through these options, working through the different scenarios to change the wider risk profile of the company,” he says.

Brokers maintain that clients that did not give much attention to trade credit insurance in the past suddenly found a need to buy the coverage, given the risk of non-payment, particularly from customers abroad. “Trade credit insurance is something clients that have never considered before [but] are now considering,” Paulson says. “Due to the risk of non-payment, inquiries [to buy the coverage] increased from once a week before to once a day between February and April. Not all actors in the supply chain have the liquidity to eat the cost [of non-payment] or finance the cost of tariffs, leading to potentially insolvency.”

Timing is of the essence. Businesses face a potential “mismatch” between trade credit insurance supply and demand, according to a recent report from Boston Consulting Group. “As global uncertainty mounts, demand for coverage on receivables is increasing. However, this growth could be limited by insurer caution, particularly around expanding credit limits in volatile markets,” the report stated.

In a May survey report, WTW stated that higher than expected claims activity will increase prices appreciably for new insureds entering the trade credit market. “We were hearing back in January that trade credit claims would be up around 10% for the year, but that prediction is likely to be shredded—much higher— by the tariffs,” says Kevin Humphrey, managing director, trade and credit risk, at Brown & Brown. Given ongoing tariff uncertainty, Humphrey said it is too early to even guess at how much claims may rise. In this environment, brokers strongly urge clients to insure their receivables risks. “Now is a good opportunity to protect one of the biggest assets on the balance sheet—accounts receivable. Once insured, the client is set up for a more attractive borrowing relationship should it need to increase access to working capital,” says Paulson.

Humphrey concurs: “We all know that counterparties are at risk of being financially weakened by tariffs, hence the importance to avail oneself of all the available [insurance] tools. The good news is that the credit markets are still writing policies, including good deals for companies with solid [loss] histories.”

Paulson also emphasizes the value of another insurance product, trade disruption coverage. The relatively obscure product protects goods in transit against geopolitical decision-making. As an example, he cites a ship that was carrying fruits and vegetables between two countries. Frictions between those nations led the receiving country to intentionally delay the movement of the goods through the port to the point that the fruit and vegetables expired.

A country hit with a huge tariff increase on exports to the United States could initiate a similar “knock-on retaliatory action” against a cargo vessel flying the U.S. flag, Paulson says. Assuming a company has trade disruption insurance, it would be covered for losses resulting from the delay or non-arrival of goods. “It’s just something clients should be thinking about.”

Supply Chain Scenario Modeling

Supply chain threats are top of mind in the U.S. business sector. Surveying 1,000 U.S. business owners, Gallagher found that 69% fear they will face disruptions to their supply chain in the coming year. Among preparatory measures cited by respondents, 75% said they had identified backup suppliers in the event of disruptions.

In this environment, insurance brokers are positioning to improve client visibility into their supply chains, identifying critical suppliers based on drivers of profit or strategic value. Aon’s Supply Chain Impact Analysis modeling tools, for instance, model credible supply chain risk scenarios and quantify the impact of supplier disruption. “It’s something we’ve become really good at, helping our clients think about the critical supplies they need and the risks likely to impact these suppliers,” Waterer says.

In late May, Hub announced the launch of its Supply Chain Risk Solutions, offering clients integrated data and tracking, supply chain AI, and stock throughput insurance, a marine insurance policy that covers physical loss or damage to goods during transit and in storage.

“What I would say to businesses caught in the spiral of the current trade wars and supply chain upheaval is this—are you managing your relationships with customers and vendors; are you fully aware of the different insurance solutions that can be brought to bear at this critical time; and are you ready to maintain more working capital, not just from current bankers but also from other sources?” says Paulson.

Regarding working capital, he points out that as the cost of raw materials, parts, and components rise, companies may need alternative sources of working capital besides a letter of credit, such as trade finance and receivables factoring, a financial transaction in which a business sells its unpaid invoices to a third-party financial company. “We can find replacements for a letter of credit that clients may have to post, so they gain liquidity through insurance,” Paulson explains.

Brokers’ supply chain risk modeling capabilities put them in competition with major consulting firms. KPMG, for instance, recently unveiled a modeling tool that receives detailed government inputs on tariffs in real time. “We update the tariff changes 24/7 to model and forecast their impact across a client’s supply chain,” says Sanjay Sehgal, KPMG advisory head of markets.

On a dashboard, the firm’s clients simulate the cost of tariffs on different supplies from different countries and their related impact on logistics. The simulations account for hub and route changes, inventory management adjustments, lead time variability, and customs processing and delays, Sehgal says, enabling clients to consider their options in real time. Demand for the modeling tool is considerable. “Since January, clients have been coming to us in droves.”