How Safe Is Your Service Contract?
By George Angus
Recent publicity regarding the insurance industry’s woes, AIG, etc., has created some concern in the marketplace about
insurance products that dealers sell, most especially service contracts. As a consultant, F&I trainer, and F&I process
development specialist, I have had many dealers ask me recently what service contract they can count on to be around
to pay claims. We do not sell any F&I products or endorse any particular product or company so our dealer clients are
confident that we can be objective in that advise. This seems like a simple question but the answer gets a little bit
involved and I’ll share the best advice I have to offer after working with service contract companies and observing the
automobile business for 30 years.
There are three types of service contract suppliers that make up the majority of the service contract industry. (A fourth
type are dealer owned and operated service contracts. I won’t address them here because only the dealer knows how
secure their internal finances are).
The first type of service contracts are the manufacturers’ programs. On first glance it would seem that these are the most
secure programs for the dealer. However, with the recent news of major auto makers going to the government for
bailouts and help, one could be concerned that even the manufacturers could have trouble paying claims. As one dealer
recently told me, “If the factory goes under, it won’t make any difference to me anyway”. This isn’t necessarily true,
however. With multiple lines and the dealers’ personal and business future on the line, a major calamity involving service
contract claims is never acceptable. In our experience, the major reason dealers stray from their manufacturers service
contract has to do with cost. If there is a significant price/benefit difference between the factory program and a secure
independent, a little quick math sends the dealer looking.
The second type of service contract is the type that service contract companies provide the forms, cost sheets, and the
dealer sells the product, keeps the commission, and the service contract company pays the claims. The dealer has no
involvement in claims, losses, and cost setting. The important security issue here is not the service contract company,
but rather, the insurance underwriter. To point out how important this is I’ll go back in time a little. (There are more
recent examples but there may still be litigation pending so I’ll stay away from those). In the 1980’s there was a company
in Seattle called Northwest Underwriters. They were well known for the best service contract pricing, coverage, and
claims handling. They became very large, very quickly, and dealers just loved them. They advertised that they were
insured by a B rated, stable insurance underwriter and no one ever gave it another thought. They enlisted the best
general agents they could find and became a major player in the service contract business. Then it happened. One day
the phones stopped being answered at the corporate office in Mercer Island. No one could reach the claims department
and the dealers were in a panic. But wait, they were reinsured, right? Well, as it turned out, the secure, B rated company
that reinsured them was owned by the same people that owned the service contract company. The reserves were
nowhere to be found and the dealers contracted with other service contract administrators to handle claims that the
dealer had to pay out of their pocket. I was a young general manager then and I can tell you it was painful.
In contrast, everyone remembers General Warranty, right? If you are new to the business, General Warranty was, by far,
the service contract giant for several years. They put on the huge, elaborate displays and parties at the NADA
conventions, flew around in private jets, and gave not only the appearance of stability, but success. They were the big
players and everyone knew it. Then it happened. One day the news started spreading that General Warranty was going
under. Again, dealers started to worry. However, General Warranty was backed by a huge A rated insurance company
that had the financial power to assume all of the claims, losses, refunds, and administration of the huge book of business
that General Warranty had amassed. There was some discomfort but nobody lost their shirt. The point here is that a
dealer has to examine and research the underwriting insurance carrier, assess the underwriting agreement, and make
an informed decision about the risk involved. This type also covers the programs that rebate to a dealer every month.
Those programs basically add money to the price list for service contracts and then give it back to the dealer every
month. (For some reason, some F&I managers don’t like those deals. Go figure).
What are A and B ratings? The ratings I refer to are the financial rating published by AM Best Company. They are
basically a credit bureau for insurance companies; however, they go into much greater detail and investigate insurance
carriers thoroughly. You can find out all you want to know about an insurance company there. You can access the
information for free at www.ambest.com or go to www.teamonegroup.com, leave us a note, and we will help you research
your insurance carrier.
The third type of service contract is the dealer participation or reinsurance program. In this case, the dealer participates
in the loss ratio of claims to reserves. That just means that if there is any money left after all the claims have been paid, it
goes to the dealer. The service contract company handles administration for a fee and there is usually an insurance
carrier involved to pick up the slack if claims far exceed the reserve amounts. This program is generally adopted by
larger dealerships that can amass large enough reserves to cover losses and earn significant enough investment income
to make it worthwhile. While the service contract company and insurance underwriter need to be chosen carefully, (after
all, they will be dealing directly with your customers), it is important that the dealer knows exactly where their reserves are
being held, closely monitors investment income and claims ratios, and has direct access to those reserves in case of
default of the service contract company.
To sum it all up, I advise dealers to exercise due diligence in choosing their service contract programs. Just listening to
the service contract company’s sales pitch is not enough. No matter how big the company is they can have problems and
the dealer will ultimately be on the hook to their customers. Run an AM Best report on every insurance carrier you use.
Look as hard at your service contract supplier as closely as you would a new business partner. In many important ways
they are just that.
George Angus has had over 100 articles published in news and trade publications. This
article is a recent example of George's reporting of information derived from researching,
training, and working with the leading F&I managers in the US and Canada.