Every day in Buy Here Pay Here, New and Pre-owned operations there are universal problems which all dealer’s face.  Mainly vehicles breakdown and customers don't have the money for repairs. Which equals upset customers and repossessed vehicles. So, you better have a plan. The options which I see most dealers choose include:

Buying a third party warranty or service contract to sell the customer? This has its own problems. Laying out that upfront cash, for a BHPH dealer, can put a big dent in your lending pool and is expensive for all dealers. Dealers using a third party warranty are faced with the fact that someone other than yourself is making the business decision of whether or not the repair for your customer is covered.  If the claim is denied you can beg, endure the frustration, put them on a side note or end-up paying for it as good will if you want to keep the customer and not tarnish your reputation .

Setting money aside (reserve) and pay for repairs as they come up. Sounds like a good idea, doing it yourself, but this reserve money must be counted as gross profit. Any money you set aside in an account or put in a drawer, you will have to pay taxes on that money. You can reduce your expenses with your claims, but paying 35% or so on what's left of your reserve seems like an expensive way to go. So unless you are going to fly by the seat of your pants and just take'em as they come, you need structure as well as reserve. What's covered, what's not, because if everything is covered with no parameters, you are by law implying a lifetime bumper to bumper warranty. In addition, keeping up with claims and accounting internally, can be very difficult and labor intensive and only gets worse if your customer breaks down out of town.

Using the 50/50 method where you and the customer split the repair bill. This might work for inexpensive claims, but again the customer is going to be required to come up with money and we know how effective that plan is. That leaves you paying all or most of the bill (once again dipping into gross profit) or enduring a tarnished reputation or increased repossessions. This again raises the question, what happens if your customer breaks down out of town and out of your control?

Your best option is setting up a Dealer Owned Reinsurance Company. Turnkey, Dealer Owned Reinsurance Companies, also known as Producer Owned Reinsurance Companies or 831(b) corporations, based on the Internal Revenue Code 831 (b). Reinsurance has been around for 30+ years and was first used by larger dealers to reinsure Credit Life,  Accident and Health Insurance, and warranty/service contract products. Reinsurance companies are formed with minimal capitalization requirements.

 By setting up a Dealer Owned Warranty Company you get all the benefits of a third party warranty company via claims management and accounting. Administrator Obligor. Structured coverage with Roadside Assistance including towing. An 800 number for customers to call for nationwide coverage with a professional claims team to look out for your best interest.  When a claim occurs our professional claims team will decide if the claim is covered, based on the warranty language initially agreed upon. You can custom design the coverage that is best for you and your customers. Another important difference from the third party warranty for the BHPH dealer is, customers can finance the cost of the warranty with your warranty company. A prorated portion of the cost of the warranty is collected and forwarded to the dealer's reinsurance company trust account.

Reinsurance Trust Accounts, which are located in the United States are, just as indicated, a Trust. Trust are recognized as the safest place to keep money and the dealer reinsurance trust account is not comingled, but stands on its own. Trusts do not have checking accounts nor do they make loans to others, like a bank, with your money. The unearned premiums in a Trust account can only be used as outlined in the Trust agreement. In this case, to pay your customers claims.

  The monies paid by the customer for their vehicle service contract (VSC) is set aside as reserve in your Trust account, as I indicated above. Any reserve not used to pay claims becomes profit. As an example if you sell an average of 20 vehicle service contracts per month, and $800 goes into reserve from each customer's VSC, loss ratios vary but for this example let’s say, $400 or 50% of every contract on average is used to pay claims. This leaves a $400 profit, which is $96,000 in additional dealer net profit per year and $480,000 additional dealer net profit at the end of five years. This does not include the retail profit made from the sale of the Vehicle Service Contract. If you sell third party vehicle service contracts now, the earned reserve is retained by the third party warranty company as their profit, in this case $96,000 per year.

  Another very important benefit to Owning your warranty company is tax benefits. I am not a CPA, but I know some good ones. They tell me in layman terms, these reinsurance companies are small Property and Causality companies.  "Small property and casualty insurance companies with less than $1,200,000 in annual net premiums may elect to be taxed only on investment income under Internal Revenue Code 831 (b).” Distributions are taxed at the dividend rate, currently 15%. These corporations, unlike "S corporations" or Limited Liability Corporations (LLC) where income flows through to the shareholders annually,  are "C corporations".  831(b) C corporations allow the shareholder a more long term approach. If a distribution is not desirable, you can retain the money in your reinsurance company or, you or your other business entities may borrow money from your reinsurance company.  831(b) Corporations make great retirement programs. Earned reserve can be invested in stocks, bonds or other securities within the Trust account. 831(b) corporations make a great estate planning tool.

  So, with a Dealer Owned Reinsurance Company, you have Nationwide Warranty Coverage which is paid for by your Customer. Accounted as a dealership expense, saving you tax dollars on the dealership side. Control over policy design. With a New Profit Center that is Income Tax Friendly, to say the least.

  Warranties and Vehicle Service Contracts are not the only products that can be reinsured. One which Buy Here Pay Here dealers may not be familiar with is Voluntary Debt Cancellation Coverage (DCC), but that's for another day.

Bio Data

Tim Byrd is Founder and President of Tim Byrd & Associates, Inc located in Gloucester, Virginia. An Auto Industry Expert on Dealer Owned Reinsurance Companies and F&I Development.  A 25+ year veteran of the car business, Tim is a trusted advisor to many car dealers. Tim is married and has 5 beautiful children. Tim has been featured in The Virginia Independent News, Special Finance Insider, Around the Commonwealth and the Dealer Business Journal.

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