Recently I had the pleasure of moderating a session on best practices for carrier and administrator relations at the VSCAC conference in Las Vegas with representatives from both leading carriers and administrators.

Before discussing the best practices of maintaining a fruitful relationship between these parties, let’s briefly review the structure of the industry.

An administrator will generally design and market a service contract program, as well as administer the contracts by providing customer service and claims services.

While there are many administrators, there are a limited number of carriers which regularly service the independent administrators.

A carrier’s primary role is, of course, providing an insurance component to the service contract.

In addition, a carrier can provide valuable assistance with all aspects of the program because carriers will have experience with a large number of programs. For example, carriers can potentially provide analytical, actuarial or legal support in the design of the program.

In evaluating a program or administrator, what do carriers typically desire?

• Profitability

Obviously, programs need to be profitable for both parties.

• Transparency

In discussions with carriers, transparency is always mentioned as a key. Because carriers have limited information about a specific program, it is important that there be complete transparency in all aspects of the service contract – from design, administration, claims, and financial reporting. Carriers may have different metrics than the administrator for evaluating programs – this is due to having a different role in the business as well as standard metrics so they can evaluate a large number of programs.

For example, consider a new program which is meeting volume expectations but the loss ratio is higher than projected. If a carrier has access to all information, they can form an opinion on whether the adverse experience is due to claims settlement, pricing issues, bad luck, or perhaps an early surge of claims due to preexisting conditions.

• Trust

As in any relationship, trust is key. Trust and transparency are critical in solving any problems that arise with the management of a service contract program.

• Compliance

Compliance is critical for carriers. Administrators should be vigilant in being compliant with the many regulations and laws regarding service contracts. Of course, most carriers can assist in being compliant.

For administrators, the key factors are similar but differ in a few ways:

• Marketable program

Administrators need marketable programs. Programs are expensive to develop and market and administrators will need volume to offset the fixed expenses of administration and hopefully make a profit.

• Profitability

Of course, administrators are also concerned with the profitability of a program. While volume may be key initially, it is the overall profitability which will ensure that the program is a success. Administrators often have significant participation in the overall results of the program.

• Flexibility

Administrators need carriers to be flexible in the rapidly changing world of service contracts. New products are rapidly being developed and marketed. A good carrier will be responsive to an administrator’s needs.

• Partnership

Good administrators look for long-term partners and relationships. Administrators want carriers who are committed to the service contract market and the independent administrator business model. Similarly, carriers also seek long term relationships and not administrators who look to move books simply to gain a few commission points.

For administrators, the benefits of maintaining good relationships are clear — a steady reliable carrier for your products.

Carriers need administrators to be profitable, trustworthy, transparent and compliant – kind of like boy scouts!

While the independent administrator market is currently healthy, it is important to realize that this market only exists due to the willingness of the insurance carriers to provide their services.

It is critical that the general state of relationships remain good between the parties since the “independent administrator” model is not viable without carriers.

Vehicle service contracts have traditionally been sold as a single pay product purchased at the time of vehicle purchase. While the typical retail charge for the vehicle service contract (VSC) can be in the thousands of dollars, the availability of the vehicle finance contract provides a ready source of funds to pay the full cost.

However, there are many excellent marketing opportunities for a service contract where a finance contract is not available to pay this cost. These include:

• Follow-up sales after delivery of the vehicle
• Service drive sales
• Direct market sales
• Inability to finance the service contract with the lender

Currently, the typical approach in these situations is to use a finance company that specializes in VSCs to finance the cost over a period that is usually one-half or less of the time term of the VSC.

Month-to-month (monthly pay) VSCs are an alternative product for the above scenarios where special financing is otherwise needed. This product may also appeal to customers who do not want to pre-pay the cost of the VSC.

A month-to-month vehicle service contract provides one month of coverage for each monthly payment. The contract is generally renewable to a predetermined mileage and/or time limit and the monthly rate may be guaranteed for some or all of the term. The contract can be designed to renew at lower coverage levels and/or a higher price level as the covered vehicle ages, thus making longer terms more attractive to the administrator or underwriter.

Month-to-month VSCs are not likely to replace single pay VSCs in situations where funds are available to pay the total cost upfront for one obvious reason— cash flow. With a single pay contract, all parties involved in the transaction (dealer or seller, administrator, insurer, agent, etc.) get the money upfront instead of waiting for their share of the monthly payments. Most, not all, of the parties involved prefer to collect upfront.

Another disadvantage is that in some states an obligor can offset claims against cancellation refunds for a single pay VSC. This money is not available in a month-to-month VSC, so it must be considered in pricing.

There are advantages to the obligor for month-to-month over single pay contracts. In the case of cancellations, the refund due to the consumer will be much smaller since there is very little unearned exposure. This eliminates most of the unearned portion of the fees paid to every other party involved in the sale of the VSC and the possibility that that party won’t be around to pay its share of cancellation refunds.

Another advantage is the ability to non-renew or adjust rates due to the experience of the service contract. For example, a problematic vehicle could be surcharged or non-renewed if there is a persistent issue of claims.

Currently, there are two approaches to determining claim eligibility under a month-to-month VSC— time only and time plus miles. Using time only, a vehicle is eligible so long as the monthly payments are made through the date of claim, subject to the overall mileage limitation. If eligibility is determined by time and miles, then each monthly payment extends the vehicle eligibility by one month and a certain number of miles. In this case, it is important to have some mechanism to make a reasonable estimate of miles driven per month at time of sale and to get updated information from the customer after initiation of the month-to-month VSC. If the customer is and continues to be a regular service customer, this information will be readily available at the time of sale and for adjusting the miles per month purchased in future months. If not, this information can be obtained by having the customer provide regular updates using an online form.

The time only approach is simple to explain and easier to administer at time of claim because a customer won’t be in a position of needing to make extra payments to extend mileage eligibility in the event that he didn’t purchase enough miles per month. However, the time only approach does create a subsidy of high miles per month drivers by low miles per month drivers. A simplistic example illustrates this point.

If the overall term and mileage limit for a month-to-month VSC is 72 months and 72,000 miles from time and mileage at purchase and the monthly charge is $40, a customer that drives 3,000 miles per month will exhaust the coverage in 24 months and pay a total of $960, but a customer that drives 1,000 miles or less per month will exhaust the coverage in 72 months and pay a total of $2,880.

A third approach that is not exactly month-to-month is providing coverage for the customer’s maintenance interval. The service contract can be sold at the time of regular vehicle maintenance and designed to cover the time and miles to the next regular maintenance visit.

This month-to-month product design is very new, so there are issues to overcome for it to be viable in the long term. These issues include: adapting administration systems to capture monthly payments and make appropriate adjustments to determine claim eligibility and obtaining regulatory acceptance. The possibility of anti-selection will probably lead to a slow roll-out of this product within each market to ensure that customers will make enough monthly payments to cover any potential shortfall caused by early claims.

The month-to-month VSC has tremendous potential to favorably increase VSC sales to the many customers who are not able or would not prefer to finance their contract. In time, systems will be updated, regulators will be taught its value to consumers and the month-to-month VSC will become one of the standard products offered by VSC administrators.

SCOTTSDALE – CNA National announced that Tim Schilling was appointed to the newly created position of actuarial director, effective Oct. 17. Schilling bring and extensive background in reserving, pricing, market research, business development, product development and underwriting, according to CNA National.

“We are excited about the breadth of experience and focused knowledge that Tim brings to CNA National,” said Joe Becker, company president and CEO. “Tim will be working closely with both our senior management team here in Scottsdale and our home office in Chicago as we continue to build and grow our business.”

Most recently, Schilling served for several years as vice president and chief actuary for Fidelity National Title Group, reported F&I and Showroom magazine. He also served as a senior actuary of non-standard auto pricing for Nationwide Insurance, lead pricing actuary in the Specialty Insurance Division at GE and senior vice president of GE Auto Warranty Services.

“Being able to join CNA National — an established company that takes a long-term view toward underwriting while emphasizing customer service — was a tremendous opportunity for me,” Schilling said. “I look forward to contributing to the firm’s future in every way I can.”

Gary Fagg, a consulting actuary with CreditRe and one of P&A Magazine’s Actuarial channel contributors recently approached P&A to review some online GAP protection material that he will be providing AFIP for their certification program for F&I professionals.

His experience in the actuary, accounting, risk management, and risk transfer solutions related to vehicle protection products, precedes him and he has been asked to speak at the upcoming Vehicle Service Contract Administrators Conference held at the Las Vegas Hilton from September 26-28.

The editorial staff here at P&A Magazine thought who better to open the review to than our own Provider and Administrator subscribers because you are the experts in the industry. So, we are inviting you to click on the following link to review and comment on the material to be presented.

GAP Protection Offered by the F&I Office in Conjunction with a Retail Installment Sales Contract

The basic questions we are asking of this material are:

1. Does this document contain all the information an F&I practitioner needs regarding the GAP product?
2. Are there any technical errors, omissions, or commentary?

We appreciate the time that any of our readers can contribute to reviewing the document provided in the link above and welcome any comments, corrections, etc. that you can provide.

A trade-in guarantee program, when first viewed, may look like a lease-end, keep-the-vehicle value program for purchased vehicles. The basic promise is simple enough: an obligor promises the vehicle buyer a minimum resale value if the vehicle buyer replaces the vehicle during a specified replacement time window.

Trade-in guarantee programs, however, are marketing programs. In addition, the actual guaranteed trade-in value may be the least important factor in estimating the expected loss cost and in determining the wholesale cost the obligor will charge the provider for making the contractual promise.

If the vehicle buyer’s actual trade-in value at replacement time is more than the guaranteed trade-in value, the vehicle buyer receives the actual trade-in value. Otherwise, the vehicle buyer receives the guaranteed trade-in value, and the obligor pays the difference between the two values. Examples are shown in the following chart.

The complimentary version has no identifiable charge to the vehicle buyer, so it is a clear win-win decision for the vehicle buyer. A provider like an original equipment manufacturer (OEM) or lender can likely obtain an insured program for $300 or less if the provider is adding the benefit on all vehicles or loans, or a specified subclass.

The optional version presents the provider with degrees of cost recovery or even a profit on the sale, but the underlying motivation remains a marketing opportunity. As with most F&I protection products, the obligor “buys the product wholesale and sells it at retail.” The wholesale cost can range from $300 to $500, depending on the terms and conditions, the maximum benefit available, and the volume of anticipated sales. The provider ends up with a no-cost or low-cost product that has real marketing potential.

One optional approach is to treat the program as a typical dealership F&I office protection product, but this means a retail price similar to GAP.

Possible Providers

Possible providers include OEMs, dealerships, direct lenders, and indirect lenders.

The most obvious of possible providers is the OEM.

Hyundai released the newest component to its Hyundai Assurance protection package on May 1, 2011. A complimentary trade-in value guarantee is provided on all new 2011 and 2012 vehicle purchases (not leases or fleet sales). The ad campaign kicked off during the NBA playoffs and was another masterful commercial in the same league as the original Hyundai Assurance “walkaway” component in 2009. The 30-second commercial leaves one word in the viewer’s mind—GUARANTEED. The Hyundai program is administered by Interstate National Dealer Services.

Another OEM program has recently been created for a comparable soon-to-be-released complimentary promotion. This program was designed by Brian Olson, Kenny Olson, and Tony Wanderon of TradeCycle Management/Family First Dealer Services (TCM/FFDS) using its TradeLock trade-in value guarantee product. TradeLock is administered by cynoSure Financial, Inc. and insured by a residual value insurance carrier.

Since 2009, Subaru of America has offered a slimmed-down version of a trade-in guarantee. The Subaru dealership will provide the customer with a guaranteed trade-in amount if the customer trades in a pre-owned Subaru on the purchase of a new Subaru.

A dealership is the next provider candidate. The dealership has the option of a complimentary program or an optional program. “There are challenges entering the F&I office that already has established programs,” said Brian Olson of TCM/FFDS. “But when dealers see the demand from consumers wanting programs that hit home with current media trends, like protecting resale values, these programs quickly become standard practice. In addition, these programs can be made available on cash purchases, opening up new opportunities for the dealers and OEMs.”

A direct lender, such as a credit union, is a clear potential provider because it presents the lender with a direct method to bring the vehicle buyer back to the lender during the repurchase phase.

An indirect lender is also a potential provider of a complimentary product, but the promise probably will require a dual trigger of the buyer returning to the same dealership and the dealership then placing the replacement purchase financing with the same indirect lender.

Large national indirect lenders may be able to make a unilateral lender-only promise requiring only that any replacement dealership place the replacement purchase financing with that indirect lender.

Relating Terms and Conditions to Marketing Goals

As with all obligor promises, the product designer can specify the exact benefit, the terms, and conditions for qualifying for the benefit. Now that a few programs are being marketed, administrative/marketing organizations, obligors, or insurers have current programs to start with and then modify.

Today’s marketplace programs contain conditions that serve specific marketing goals. For a dealership, dealer group, or OEM program, these are some of the conditions and goals they serve:

• For complimentary programs, the vehicle must be bought during the promotion period.
• For the current sale transaction, the trade-in guarantee serves to counter the vehicle buyer’s purchase objection that the OEM’s/make’s historical or prospective resale values are a concern to the vehicle buyer.
• The trade-in value applies to a specific time window for the replacement purchase. This period can be set with the goal of advancing the repurchase time cycle.
• The vehicle buyer must return to the provider to purchase the replacement vehicle.
• The vehicle buyer must have all scheduled maintenance performed, AND the maintenance must be performed at the provider’s dealership(s). The goal is to improve dealership service revenue and to raise dealership, dealer group, or OEM absorption rates (the percentage of dealership overhead covered by gross profit from service and parts).
• The replacement vehicle must be a financed purchase through provider-arranged financing or for an OEM, possibly a captive financing arm.

For a lender, similar conditions and goals apply, but the primary goal is to be the first stop when the vehicle buyer begins the search for the replacement vehicle. Various versions and new options are just now being explored. The lender may be the sole provider, or there may be various combinations of lender plus dealership, dealer group, or OEM. Some of the dealership program requirements, such as performing all scheduled maintenance, may be retained to control loss costs even though the lender does not have a specific marketing goal in mind.

Loss Frequency and Severity

The development of the loss frequency contains some or all of the following components:

• Probability that the vehicle will be in service during the qualified replacement time window and will not be disqualified (e.g. commercial use), multiplied by
• Probability that the vehicle will be traded-in on a qualified replacement vehicle during the qualified replacement time window, multiplied by
• Probability that the vehicle buyer will return to the provider for the replacement vehicle, multiplied by
• Probability that the vehicle buyer will have performed scheduled maintenance at the specified service provider, multiplied by
• Probability that the vehicle buyer will finance the replacement at the qualified financing source, multiplied by
• Probability that the vehicle buyer will remember the protection, and THEN multiplied by
• Probability that the guaranteed trade-in value will exceed the appraised value.

Finally, the average loss severity must be determined. This can be done by high-powered modeling, but by this point, a conservative estimate will likely serve for pricing purposes.

Working in the F&I industry stays interesting because of the great products that our industry continues to develop to meet the needs of the public.

In developing a new product, there are, of course, many issues regarding policy language, pricing, marketing, systems, etc. We want to focus on some general considerations when developing a product from a pricing and accounting standpoint.

Do I have any claims experience?

Obviously, if you have related claims experience it can be of tremendous help in determining the potential exposure for your product. If so, you will need to adjust the claims experience for any changes in the product. For example, if you are adding a new feature to an existing product, you might be able to use the frequency of claims for the current product and adjust the average claim for the new feature.

You should also bring the claims level in your historical database to current levels by applying the expected inflation costs from the time the original products were sold. For example, if you are looking at experience on 2009 sales for a product you plan to introduce in 2012 you will have 3 years of inflation to consider.

Be extra careful if you are considering pricing coverage based on the historical behavior of insureds. A classic example is a “refund program” which refunds a portion or the entire price if the buyer does not make a claim. Historical experience may show a low percentage of non-claimants. However, buyers will not file small claims if there is a financial incentive to avoid doing so.

Therefore, the percentage of contracts without claims on a refund program are much higher. Assume that buyers of your product will adjust their behavior based on their financial self interest.

How is the product marketed?

Similar products can have vastly different claims experience depending on how they are marketed. Will the product be marketed to new buyers or to current owners? Is the product marketed at the dealership or direct marketed? What is your expected pricing?

The amount of money that a consumer pays can impact claims consciousness as well. A low price product will have lower awareness. A product that is automatically added as part of the sale will have even lower costs.

How am I going to earn the premium?

This is a critical assumption for evaluating early experience. Claims occur on F&I products at vastly different rates depending on the product. Some products (even profitable ones) have an initial surge of claims as the buyer may seek to repair some preexisting issues that cannot be fully excluded. Never assume that exclusions can prevent all claims.

To evaluate the experience correctly, you must earn the premium in the same ratio as the claims flow. You may need to earn premium differently for accounting and refunding than you do to evaluate the program. While earnings are necessarily subjective, be careful to use your best estimate.

How do you react to results?

Everyone who develops a product expects it to succeed. Don’t let your prior assumptions blind you to the results in your book!

Most F&I products are relatively high frequency/low severity products which reach credibility in a short amount of time. If you are earning your exposures correctly (see above), your results should be actionable in a few months. Plan on frequent monitoring after the product launch to ensure that the program is performing to your expectations.

Divide the experience into months or quarters by policy inception date and examine the experience of the most mature contracts carefully. For example, if you expected a “claims surge” for the first months of a product are you seeing the claims from your oldest contracts dropping? If not, you may need to reevaluate your assumptions.

If an insured makes a claim, will they be in a better financial position?

Most insurance products operate on the premise that the insured will not be better off financially after a claim. For example, auto insurance will pay the actual cash value of your car. In theory, you could go out and buy the same model car with similar mileage. You cannot buy a brand new car.

Some products such as GAP insurance actually improve your financial situation. If you have a GAP claim, the negative equity in your vehicle is erased. A similar example occurs in homeowner’s insurance with “replacement value” which pays for the replacement value of your house and contents. If a fire destroys your house, you will receive new furniture and clothes – not the old stuff you had.

These insurance products work because the vast majority of people do not wish to have a fire or a car wreck even if it improves their personal balance sheet slightly. However, you can expect that these types of products will have higher claims because there are always a few people who will use the product to their advantage.

Will the claims be correlated with the economy?

For most products, this is not true. Car repairs and vehicle accidents are examples of random events. While certain people and certain vehicles may be more likely to have a claim, in general the claims among similar risks are random.

However, this is not true for all products. Some products will show a higher propensity of claims due to the economic environment. This type of risk can occur when insuring the underlying value of an asset (such as GAP or residual value insurance). If the used car market shows a big drop in prices, then the likelihood and severity of claims will increase across the board.

If your product is correlated with the economic environment, be prepared for a wide range of results depending on the conditions of our economy.

Conclusion

New products are what make the F&I business one of the most exciting places in insurance for product development. While the considerations listed above may give you pause, we encourage our industry to continue to develop products which meet the needs of all participants by providing peace-of-mind to the buyer with and an adequate return to the underwriter and business partners.