Made in Mexico: Assembling the Components of Risk for the Maquiladora System

June 2017 • Lockton Companies

Maquiladoras have been an integral part of the North American manufacturing industry since the introduction of the North

American Free Trade Agreement (NAFTA). Mexican maquiladoras Adriana Solomon Associate Account Manager represent 55 percent of Mexico’s manufacturing export and total 816.960.9707 [email protected] $85.74 billion. For the 70 percent of Fortune 500 companies that have maquiladora operations, managing the maquiladoras comes with unique risks, and the renegotiation of NAFTA has created additional risks and challenges.

Maquiladora: A factory in Mexico established by a US company that operates under preferential tariff programs established and administered by the United States and Mexico. Materials, assembly components, and production equipment used in maquiladoras are allowed to enter Mexico duty-free and are exported back to the US as finished products at lower tariffs.

LOCKTON COMPANIES June 2017 • Lockton Companies

Unique Nature of Maquiladoras towns, which are often considered dangerous. Out of roughly 2,860 maquiladora companies that operate in Maquiladoras are profitable as a result of policies Mexico, almost 90 percent are located in the northern established by NAFTA, such as reduced foreign border zone of Mexico in cities such as Matamoros, investment barriers and tax breaks. Ciudad Juarez, Nogales, Mexicali, Nuevo Laredo, Foreign Investment Barrier: NAFTA allows Reynosa, and Tijuana. US firms to have up to 100 percent foreign investment participation in the resources and Per the red24 KRE Global Monitor, Mexico management of a Mexican manufacturing has the highest rate of kidnap-for-ransom business without the need for special cases in the world, with a particularly authorization. high concentration of cases in the areas of Mexicali, Nuevo Laredo, Reynosa, and Tax Break: US firms can enroll in the PITEX Tijuana. program, which allows the firm to import machinery, raw materials, packaging, and Unique Risks Associated With Maquiladoras other assembly inputs into Mexico without paying import taxes. This program requires Maquiladora manufacturing facilities have incurred losses that the materials are not third-country due to their location in high-hazard zones for human components and are exported out of Mexico capital and political violence. A typical factory in a city as assembled products. such as Ciudad Juarez can have up to 3,000 workers in a single facility. Managers of these facilities earn The dependency of maquiladoras on trade policies well above the Mexican minimum wage and follow set and the political climate means that their benefits are schedules that make them targets for kidnapping groups. constantly at risk. For example, in the state of Tamaulipas (which includes the cities Nuevo Laredo and Reynosa), cartel groups The Trump Administration has proposed not only use kidnapping for ransom as a means of financing to renegotiate (and possibly repeal) NAFTA, but other activities. Cartel groups across the country target also implement a high tariff on Mexican imports to maquiladora workers and their families. encourage US domestic production and pay for the border wall between the US and Mexico. The repeal Maquiladoras’ locations are also prone to civil unrest of NAFTA may result in US manufacturing firms due to government policies and actions, such as the reevaluating their production strategies and changing recent Gasolinazo, meaning “fuel price hike,” in January their investment strategies to accommodate the increased 2017. These revolts were provoked by the 12 percent tariffs and foreign investment barriers. devaluation of the Mexican peso against the US dollar and the Mexican government electing to eliminate state While NAFTA policies may make maquiladoras oil subsidies. This caused a 20 percent jump in gas profitable, they are often located in Mexican border

2 June 2017 • Lockton Companies

prices and resulted in protests, violence, and looting destabilization, and looting can help protect assets and in the Tijuana area and across other parts of Mexico. promote safety. Political risk insurance can be used as a In this particular event, hundreds of businesses were way to cover political violence and terrorism acts, such looted, roads were blocked, and more than 600 people as looting, that can be a result of unfavorable policies. were arrested. Such events can cause disruptions to Terrorism coverage can also be added to existing businesses that operate in those areas. Protests often lead property programs or be bought on a stand-alone basis to a destruction of or disruption to infrastructure and to mitigate losses to inventory and materials that are at transportation of resources, which can mean delays in risk of looting and fire. Kidnap and ransom insurance manufacturing for maquiladoras. is available to cover executives of US companies, who may visit the manufacturing facilities, as well as the Possible Solutions facilities’ workers, management, and families. Business Despite the risks associated with operating maquiladoras, interruption cover can be utilized to initiate potential many companies continue to do so profitably. The losses in income due to road closures or disruptions to continued benefits of maquiladoras are, in part, made infrastructure that may result from civil unrest. possible by using different risk management solutions, Conclusion such as purchasing insurance and establishing loss control measures. Maquiladoras in Mexico continue to show their profitability and advantages. Both the insurance market Political risk insurance markets can offer risk transfer and attentive risk management can transfer and mitigate solutions for importers and exporters that would some of the risk, including the possible renegotiation cover the additional costs associated with the repeal of NAFTA. Your Lockton team can help you design a of NAFTA, and possibly from having to comply with risk management plan to meet your needs. whatever policy replaces it. For example, political risk insurance can be worded to cover losses due to contract Sources frustrations that result from changes in policy and https://www.usnews.com/news/best-countries/articles/2017-01-18/in-mexico- gas-prices-spark-revolts proposed tariff requirements. Policy changes could also https://www.cfr.org/backgrounder/naftas-economic-impact result in a need to renegotiate maquiladora contracts http://manufacturinginmexico.org/maquiladora-in-mexico/ with Mexican shelter companies, which comes with http://teamnafta.com/manufacturing-resources-pages/2016/4/18/nafta-and- additional costs. the-maquiladora-program

http://www.libertyspecialtymarkets.com/wp-content/uploads/2017/03/Kidnap- The use of security experts, such as Control Risks, Randsom-and-Extortion-Global-Monitor-Dec-2016-Mar-2017.pdf http://www.newyorker.com/news/daily-comment/the-gas-price-protests- and resources such as the US Department of State can gripping-mexico help companies create security strategies and protocols. Educating personnel of possible locations for protests,