Walkthrough of Reinsurance Programs & Dealer Owned Warranty Company Changes with Growth
Walkthrough of Reinsurance Programs & Dealer Owned Warranty Companies Changes with Growth
Walkaway Programs
What it is
Walkaway programs represent the simplest structure of an F&I program. Under this arrangement, the dealer sells someone else’s program, typically the preferred program of its OEM or another third party. The dealer makes money through its mark-up (or commission) on the sale of each contract, and dealer principal and other personnel are often paid bonuses (management money) on a monthly basis.
Who it’s for
Smaller groups with one to two dealers or small groups that are not manufacturer diverse.
When to change
New and small dealers should emphasize building their team and getting sells penetration in their market, as well as building fixed coverage. During this time, the F&I program is not a primary concern, and a walkaway program represents the perfect risk arrangement while these dealers establish a foothold in the market. Once a dealer is established and becomes more sophisticated, it tends to move on to one of the participation programs below.
Retro
What it is
Retro programs provide additional compensation under the aforementioned programs from administrators and insurance companies. In addition to the benefits of a walkaway program, a retro program pays a portion of the profit from each contract as the underlying claims reserves are earned out. This typically represents a profit-sharing style arrangement, in which the dealer gets some exposure to the underwriting of the contract but avoids any downside risk of potential excess losses from heavier-than-anticipated claims volume.
Who it’s for
Smaller dealers who have accrued some negotiation power with their provider. This program can protect the smaller, less manufacturer-diverse group from brand-specific risk exposure.
When to change
Once a dealer becomes more established, additional risk exposure within its F&I program represents an opportunity to maximize every dollar spent in its stores. For dealers that are not risk diverse (few stores, single brand), the retro program represents an effective way to get exposure to the underwriting profit from its program without risk of loss. The downside is that it will only receive a portion of the underwriting profit, and the insurance company receives the rest. Once a dealer is comfortable that its book of business is performing either at or above expectations, or that it’s grown to a sufficient size to obtain proper risk distribution, it will seek a larger portion, if not all of the underwriting risk on its business.
Reinsurance
What it is
Reinsurance represents the most common form of risk participation in the industry due to its flexibility. These programs offer dealers the ability to fully share in both the underwriting profit and investment income generated from the F&I products they produce. Typically, the dealer reinsures a portion or all of the underwriting reserves (from the primary insurance company) to a related-party owned corporation. These companies take multiple forms, including domestic reinsurance captives, controlled foreign corporations (“CFC”), and non-controlled foreign corporations (“NCFC”).
Who it’s for
Smaller dealer groups will typically pursue a CFC structure in order to take advantage of the IRS 831(b) election for small insurance companies, which allows the premium to be non-taxed. Due to the strict size limitations on premiums and number of CFC’s that a principal can have, a growing dealer will quickly realize the limitations of this strategy. For instance, a five to 10-store dealer might need multiple CFC’s that will need disparate ownership (minority partners or family members) in order to remain under the 831(b) limits. This usually means that growing dealers will need to explore an NCFC structure, which does not have a size limitation, but will maintain the tax benefits of the CFC. NCFCs have significant limitations and are typically targeted towards wealth management clients.
When to change
As a dealer grows into medium-size group with five to 10 stores, it will typically start to look for ways to fund future growth, vertically integrate, and refine its brand identity. And although reinsurance provides a lot of promise in this area, the size and control limitations of the CFC will lead many dealers to look for a structure that allows them ultimate control over their business.
Dealer Owned Warranty Company
What it is
A Dealer Owned Warranty Company is typically formed as a US corporation, and although it acts much like a primary insurance company (it is the obligor for the contract), it is not regulated as an insurance company. Dealer Owned Warranty Company programs are typically formed by a third-party administrator (TPA) that administers the pricing, contracting, collection of premiums, cancelations, and claims related to the underwritten contracts. The Dealer Owned Warranty Company usually purchases a “failure to perform” contractual liability insurance policy (“CLIP”) from an insurance company, which shares the risk of the underwritten agreements and reduces the amount of cash needed by the Dealer Owned Warranty Company to cover its potential liabilities. With this coverage, the CLIP provides more access to cash than a reinsurance program and represents a good source of additional investment capital for dealership growth. Unlike other arrangements, this setup allows the dealer to have more control over its entire program and integrate it into the dealer’s brand identity.
Who it’s for
Dealer Owned Warranty Company arrangements represent an attractive option for larger dealer groups (typically five to 100 plus stores) that are looking for:
- More access to cash in order to fund dealer growth, offset floorplan cost, or invest in other assets (i.e. remodels)
- A large pool of assets that can be utilized during challenging economic times
- Significant control over customer experience
- Maximum F&I returns
- A branded program
- Fewer redundant and extraneous fees from their program
When to change
Once a dealer is underwriting its own risk, there is usually no need to revisit previous structures; however, not all Dealer Owned Warranty Companies are created equal, as some TPA’s will essentially take their reinsurance program and copy it for the Dealer Owned Warranty Company, which short-circuits some of the advantages of a Dealer Owned Warranty Company. A properly run Dealer Owned Warranty Company program should give the dealer maximum flexibility and control over every aspect of its program.
Things to think about when entering a TPA Relationship
- Branding
- Products (core and specialty)
- Pricing
- Risk Controls
- Reporting
- Cash/Investment Management
- Accounting
- Tax planning
- Ownership structure
- Run-out planning
- Dealership investment support
- Regulatory Compliance
These structures represent the most common progression through the life cycle of an F&I program as a dealer grows; however, it does not encompass every possible option, including:
- Dealer Obligor (DO)
- Cash Advance
Any tax discussions are for information purposes only and should not be construed as actual tax advice. All programs include the dealer commission or mark-up that the dealership receives upon the sale of a contract.
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NationsGuard handles setup and all daily operations of the program. Full-service turn-key Dealer Owned Warranty Company operation (no full-time dealer staff needed).