Recent questions of economic uncertainty have dominated our news feeds with details of US tariffs, reciprocal tariffs from other countries, partial pausing of these plans and trillions of dollars of value being wiped off stock markets around the world. It is therefore unsurprising that we find our clients and other professional advisers asking us “What do these tariffs mean for my transaction?”.
Amongst other benefits, warranty & indemnity (“W&I”) insurance seeks to provide commercial certainty for parties involved in M&A activity. Willis have explored how the increases to tariff rates might impact W&I insurance coverage and what might be done to minimise any contemplated impacts.
It should be noted that a definitive approach to covering tariff risks is yet to be determined by the W&I insurance market and so this update sets out current thoughts and expectations as to their likely reaction, having had high level consultations with underwriters. This may well change. The topic of tariffs will be closely monitored as it evolves over the coming weeks and months. It is important to note that the situation around tariffs is fast evolving and there is no “one-size fits all” for all parties and each potential transaction may be affected in different ways.
The consistent message coming from underwriters is that there is no intention to introduce a blanket “tariff exclusion”. Instead, we understand they will consider each transaction on a case-by-case basis, seeking to ascertain through underwriting how a target may be exposed to tariffs. We can take comfort from this difference in approach compared to that adopted for other recent economic destabilising events, namely the conflict in Ukraine and Covid where W&I underwriters introduced standard Russia/Ukraine and Covid exclusions, respectively, across all W&I insurance policies as a reactionary measure. Only over time were underwriters able to analyse these risks, following which exclusions were/are only required as necessary, dependant on the underlying facts. This means that the anticipated starting point may be comparatively more favourable to the insured, as the onus will be on the underwriter to identify any tariff risks as opposed to the insured having to evidence why there aren’t any tariff risks. Of course, this does not mitigate the need for consideration and diligence of the impact of tariffs on the acquisition.
Underwriters recognise that every business is unique and that every transaction needs to be considered on its individual merits. Afterall, tariffs are not a new concept; it is the recent extreme fluctuation of tariff rates that is new and therefore the impact of these fluctuations is where underwriters intend to focus their attention.
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Instincts might suggest that “tariff underwriting focus” will predominantly revolve around tax risks. However, our present understanding is that the core perceived risk actually relates to the knock-on effects on supply chains and counterparty risks, in particular, any rights of termination or rights to materially reduce business that crystalise as a result of increased tariff rates. If such commercial terms exist but are not disclosed, this leaves a door open to a potential breach of warranty. This is why insurers have voiced the need to better understand the underlying commercial relationships with key customers and suppliers.
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Compliance with laws that relate to tariffs will likely form part of an underwriter’s “tariff underwriting focus”. In the coming months, we may see companies seeking to move products through different jurisdictions in order to benefit from lower tariff rates. Lawyers will need to advise on the legality of such arrangements. To the extent particularly high tariff rates remain in place, trading parties may seek to take shortcuts (for example vague classification of goods, or not properly comply with local customs requirements if seeking to quickly import/export goods via a third party country) and if proper process is not carefully adhered to, regulatory or financial consequences may follow.
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Whilst the primary areas of “tariff underwriting focus” stem from supply chain impact and regulatory compliance, we anticipate underwriters will still stress test the accuracy of tax warranties and accounts warranties in light of higher tariff rates. In the short term, we anticipate that insureds should see no material change as to how tax warranties and accounts warranties are underwritten. By definition, a warranty is a backward-looking statement of fact, whereas tariffs are forward-looking costs. However, in the medium to long term, this position may reverse as adherence with tariffs starts to impact the financials of the target entity. This may also be relevant where a deal has a split signing and completion and the warranties are to be repeated at completion.
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As any additional levied amount will likely result in an increased cost per unit of items within the scope of the tariff, and given that increased costs are often passed on (in full or in part) to the final consumer, we anticipate that underwriters may be keen to understand if the tariffs’ impact on operating costs, the value of the target’s inventory and potential loss of customers has been taken into consideration in negotiations. Underwriters are therefore likely to ask questions about how tariffs have been factored into the valuation of the target.
Another potential impact of the recent changes to tariff rates is a possible increase to W&I insurance premium rates. This is for two reasons: 1) tariffs may make a target’s compliance position more uncertain; and 2) loss suffered by an insured following a breach of warranty that can only be restored through the import of goods (e.g. a breach of warranty relating to condition of assets), may result in an inflationary impact on insurance premiums to cater for potential larger payouts.
Willis data shows that most W&I claims relate to breaches of tax warranties, but the largest claims relate to breaches of accounts warranties, commercial warranties and warranties relating to compliance with law. Accordingly, the messaging from underwriters as to how they anticipate tailoring their underwriting approaches on the subject of tariffs is consistent with Willis’ claims data.
As with all W&I insurance policies, quality diligence remains of paramount importance. Being able to demonstrate to underwriters that diligence scopes have considered the following matters should help underwriters attain comfort with any perceived tariff risks and mitigate the need for tariff focused exclusions:
During the course of writing this article, the US and the EU paused their respective proposed tariff increases for 90 days, and exemptions on certain categories of Chinese imports were tabled and subsequently overturned with the proposal of a “semiconductor tariff”. These continuous amendments to tariff policies are causing a great deal of uncertainty amongst our clients, who are querying how these changes might impact their insured transactions. One thing that is certain is that Willis will be on hand to help advise you on your transaction and provide the latest insights.
Willis’ Transactional Risks team is made up of experienced practitioners who have a deep knowledge of transactional complexities and commercial realities that clients face and are well placed to advise on bespoke insurance solutions taking into account the nuances of each transaction.
Willis’ Transactional Risks team is made up of qualified lawyers and tax and accountancy practitioners who are experienced in the transactional complexities and commercial realities that clients face and are well placed to advise on bespoke insurance solutions taking into account the nuances of each transaction.
We take time to properly understand each client and their position so that we can obtain the optimum insurance fit for them. Clients have plenty to consider when undertaking transactions and therefore the Willis team seek to make the insurance process as straight forward as possible, utilising our wealth of industry experience and leveraging trusted industry relations to negotiate purpose-built policies on your behalf.
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