2011 F&I Office Protection Products
Fundamentals of Risk Transfer
The Risks Facing the Vehicle Buyer/Borrower and How Those Risks Are Transferred to Various Corporate Risk Takers Tuesday, November 1, 2011
CREDITRE 330 Grapevine Hwy., Hurst, Texas 76054-2429 Phone: (817) 788-8121 Fax: (817) 788-8123 E-mail:
[email protected] Web: www.creditre.net
Disclaimers: This seminar is designed to provide information in regard to the subject matter covered. It is presented with the understanding that neither the presenters nor the publishers of the text are engaging in rendering legal, accounting, or other professional services. If legal or other expert assistance is required, the services of a competent professional should be sought. Every effort has been made to make this presentation as complete and accurate as possible. However, there may be mistakes, both in typography and in content. Therefore, the information provided by both the presenters and the text should be used as a general guide and not the ultimate source of information, particularly those matters relating to taxation. Neither the presenters nor the publishers of the text shall have any liability or responsibility to any person or entity with respect to any loss or damage caused or alleged to be caused directly or indirectly by the information contained in this seminar manual. Any tax advice contained in this text was not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions. CREDITRE 330 Grapevine Hwy., Hurst, Texas 76054-2429 (817) 788-8121 www.creditre.net
F&I Office Protection Products Conference Fundamentals of Risk Transfer The Risks Facing the Vehicle Buyer/Borrower and How Those Risks Are Transferred to Various Corporate Risk Takers Tuesday, November 1, 2011 Begin
End
Session Description Defining Risks and Risk Transfer Types of risks a vehicle buyer accepts in buying and financing a vehicle and the F&I protection product industry's answers to mitigating those risks; definition and illustrations of risk transfer.
9:00 AM
10:30 AM
Contractual Risk Transfer Survey of contractual ways to transfer risk from the vehicle buyer, such as warranty, insurance, service contract, GAP or other contractual waiver, obligor contract for tire and wheel, prepaid maintenance agreement, roadside assistance plan, and others; complimentary blanket promise. The Risk Takers Survey of initial corporate risk takers, such as manufacturer, insurer, dealer-obligor, administrator-obligor, subsidiaryobligor, and marketing-obligor. Risk Insurance Structures Introduction to insurance entities, such as U.S. domiciled insurer and reinsurer, offshore insurer and reinsurer, protected cell insurer and reinsurer, risk retention group, and captive.
10:30 AM 10:50 AM
Break Insurance and Reinsurance Contracts The contractual liability insurance policy (CLIP), reimbursement insurance policy (RIP), reinsurance agreement, finite reinsurance agreement, reserve transfer agreement, and assumption reinsurance approaches to risk transfer.
10:50 AM 11:50 AM
11:50 AM 1:00 PM
1:00 PM
2:30 PM
2:30 PM
2:50 PM
2:50 PM
4:00 PM
4:00 PM
4:05 PM
4:05 PM
5:00 PM
5:00 PM
6:30 PM
Let's Put the Knowledge to Use—VSC Models in the Marketplace 1) The original insurer producer affiliated reinsurer (PARC) model from credit life and disability insurance, mechanical breakdown insurance, and GAP in insurance states, then— 2) The industry's conversion to obligor VSCs and the CLIP-PARC model: (a) the dealer-obligor performance-guarantee offshore CLIP-PARC model, and (b) the administrator-obligor VSC-performance-guarantee offshore CLIP-PARC model. Lunch Provided by CREDITRE Marketplace Models—GAP The GAP waiver models used in the marketplace and the fundamental differences from the VSC obligor model. State Regulation State regulation of insurance, reinsurance, and obligor (non-insurance protections); plus the basics of statutory accounting practices of risk transfer agreements and their impact on operational and organizational structures. Federal Regulation Brief discussion of federal regulation of insurance, risk retention groups, risk purchasing groups and of optional federal charter. Regulation of Obligors Federal and state insurance laws and regulations. Break Accounting Systems Comparison of statutory, GAAP, and tax accounting systems. Introduction to Taxation Tax positions for a U.S. corporation licensed as an insurer or conversion from a controlled foreign corporation to a U.S. taxpayer via § 953(d) election. Determining insurance company status for tax purposes—501(c)(15) and § 831(b) and small life insurance company. Non-controlled foreign corporations. New proposed ruling regarding protected cell companies. Brief Stretch Break Tax Principles, Cases, and Issues Importance of statutory accounting as it affects tax accounting, DAC tax, legal cases, IRS Code § 845 evolution and impact, front-commission-levels issues, related-party risks, stockholder dividends treatment, and controlled group definitions. Transaction Taxes Premium taxes for life and P&C insurance by state, state taxes on VSC and GAP, obligor franchise taxes, procurement taxes, and excise taxes. Treaties, Trusts, Letters of Credit Reinsurance treaties, custodial trusts, and letters of credit. Networking Cocktail Hour at Manager's Reception at the Hotel
Contents Products that Transfer Risk from a Vehicle Buyer .................................................................................. 1 What Is Risk Transfer? ............................................................................................................................... 5 Optional Insurance and Obligor Contracts ............................................................................................ 11 Complimentary Obligor Programs .......................................................................................................... 20 Aleatory Contracts and the Effect on Risk Transfer.............................................................................. 22 Initial Corporate Risk Takers ................................................................................................................... 25 Business-to-Business Risk Transfer ...................................................................................................... 26 Entities Accepting Risk Transfers ........................................................................................................... 28 Insurance and Reinsurance Risk Transfer Terminology ...................................................................... 30 Risk Participation Structures ................................................................................................................... 31 Forms of Business-to-Business Reinsurance ....................................................................................... 33 Laws and Regulations .............................................................................................................................. 35 Risk Retention Group (RRG) .................................................................................................................... 36 Risk Purchasing Group (RPG) ................................................................................................................. 38 Marketplace Models .................................................................................................................................. 39 Reinsurance Company Structures .......................................................................................................... 49 Single Owner Reinsurers Reinsurance Domiciles................................................................................. 52 Comparison of Significant Accounting Methods................................................................................... 60 Forms of Coinsurance .............................................................................................................................. 67 Single-Owner Offshore Reinsurer v. NCFC Multi-Class ........................................................................ 75 Taxation of Risk-Taking Entities.............................................................................................................. 78 Corporate Procedures and Permanent File .......................................................................................... 110 Reinsurance Treaties and Trusts .......................................................................................................... 113
Products that Transfer Risk from a Vehicle Buyer What risks do vehicle buyers accept when buying and financing a vehicle? What protection products are offered to the vehicle buyer to transfer the risk? Risks
Product
Inherent defects in the vehicle
Manufacturer’s warranty Tire warranty
Risk of mechanical breakdown of vehicle parts
Manufacturer’s extended warranty Vehicle service contract Mechanical breakdown insurance
Requirement for periodic maintenance
Prepaid maintenance contract
Need for roadside assistance and locksmith services
Roadside plans, AAA Automobile clubs
Risk of road hazards
Tire/road hazard protection Paintless dent repair
Appearance hazards
Fabric and paint sealants
Theft of vehicle
VIN etching LoJack
Inadequate property insurance proceeds to pay off vehicle loan after a total loss (negative equity)
GAP waiver GAP insurance
Inability to repay balance of loan: Death of the borrower
Credit life insurance All-cause-death debt waiver
Inability to repay balance of loan: Disability of the borrower
Credit disability insurance Disability debt waiver
Inability to repay balance of loan: Involuntary unemployment
Credit involuntary unemployment ins Job loss debt waiver
And the list goes on. Color Code: Warranty, Obligor Contract, Insurance Policy
F&I Activities When the Vehicle Purchase Is Financed
Review agreed-upon vehicle package and vehicle prices Offer F&I office protection products Present payment options and arrange financing whenever possible Complete, explain, execute, and deliver all required paperwork Consummate the vehicle purchase transaction
Financing Transactions and Terminology Relative to the F&I Office Vehicle Buyer Options to Purchase a Vehicle at the F&I Office 1. Cash sale or financed outside the F&I office Buyer uses personal funds or check from pre-arranged loan (e.g. credit union loan). 2. Lease Buyer makes down payment, agrees to make monthly lease payments for the term of the lease, and has the option to purchase the vehicle at the end of the lease for the lease-end value (a.k.a. residual value). 3. Financed at the dealership then assigned to a financial institution a. Buyer enters into a financing contract with the dealership. The buyer receives ownership of the vehicle by making a down payment and agreeing to make monthly payments for the term of the financing contract. A lien is placed on the title. The buyer agrees to keep collision insurance on the vehicle. b. The dealership immediately assigns that financing contract to a financial institution. The financial institution pays the dealer a sum of money and all rights and obligations under the financing contract are assigned to the financial institution that becomes the “holder in due course.” In industry terminology, the financial institution (a.k.a. indirect lender) buys the “paper” from the dealership.
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Terminology – Then and Now Old School but Often Used Auto Loan
2012 Financing Contract Retail Installment Sales Contract (RISC)
Monthly Installment Payment
Monthly Payment; Balloon Payment
Lender
Dealer, Dealership
Indirect Lender
Financial Institution or Assigned Lender
Dealership Profit on Financing Transaction
The financial institution pays the dealership the present value of the stream of installment payments at a quoted discount rate that is lower than the interest rate the F&I office has quoted the vehicle buyer. The dealership earns a profit equal to: The spread between the interest rate charged the vehicle buyer in the installment sales contract and the discount rate the indirect creditor charges the dealership; OR A fixed-dollar profit per deal.
Examples of Financial Institutions:
Vehicle acceptance company National or state bank Federal or state credit union Finance company
A FINANCING CONTRACT IS NOT A LOAN; THE DEALERSHIP IS NEVER A LENDER. That said, the financial transaction contained in a vehicle purchase financing contract operates financially the same as a loan. The role of the dealer in a vehicle purchase financing contract is comparable to that of a lender in a loan. There are important legal differences however.
F&I Office Offerings – Then and Now 1970 Finance and Insurance (F&I)
2012 Finance and Everything but Insurance
Finance the Vehicle Sale
Optional Obligor Contracts (Vehicle Service Contract, GAP Waiver, Vehicle Protection Products, Road Clubs, Debt Waiver, Vehicle Return Program)
Offer Credit Life and Disability Insurance
Complimentary Obligor Contracts (Job Loss Protection, Trade In GAP Protection, Trade-In Value Protection, Vehicle Return Program; or any fortuitous life event) Optional Insurance Contracts (Mechanical Breakdown Insurance, GAP Insurance, Credit Life and Disability Insurance)
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Moving the Vehicle Buyer’s Risk Using a Series of Two-Party and Three-Party Contracts
The Risk Typically Ends Up in a Corporation Owned by the Dealer
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What Is Risk Transfer? Risk Transfer Defined The transfer of a risk of loss, which would otherwise be one’s own risk of loss, to a separate party, also known as “risk shifting.”
What Is a Contractual Obligation? An obligation or duty that binds a party legally or ethically to do or to not do; imposed on that party by the terms of a contract or agreement; entered into with another party; and that requires one party, for a consideration, to undertake, do, or refrain from doing some act in accordance with the wishes of the other party.
What Is an Obligor? The party agreeing to accept an obligation under an obligor contract.
What Is Contractual Risk Transfer? The use of contractual obligations—such as insurance, reinsurance, obligor contracts, debt waivers, payment waivers, service fee waivers—to pass along to others what would otherwise be one’s own risk of loss.
Terminology Vehicle Buyer Risk Transfer
Insurance
Obligor Risk Transfer
Vehicle Buyer Contract
Insurance Policy
Obligor Contract
Accepting Risk Taker
Insurer
Obligor
Corporate Risk Transfer
Reinsurance
Obligate or Re-obligate?
Corporate Contract
Reinsurance Treaty
Obligor Contract
Accepting Risk Taker
Reinsurer
Obligor
Contractual Alternatives to Transfer Risk From the Vehicle Buyer to a Corporation 1. Warranty: Vehicle Buyer to Original Equipment Manufacturer (OEM), to Dealer, or to Third-Party Warrantor (new vehicle warranty) 2. Insurance: Vehicle Buyer to an Insurance Company (mechanical breakdown insurance) 3. Obligor Contracts: Vehicle Buyer to an Obligor (vehicle service contract)
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The Most Important Response When Asked, “Is It a Warranty? Is It Insurance? Then, What Is It?” DRAW Pictures and Diagrams for Each Step in the Risk Transfer Path 1. When Does Contractual Risk Transfer Constitute a Warranty? A warranty is a promise to replace or repair any mechanical product that fails because of an inherent defect in the product. Under federal law (Magnuson-Moss Act) A warranty can be provided by the manufacturer, an entity in the chain of distribution of the product, or an unrelated third party. No identifiable charge can be levied for the warranty. A warranty is a special form of a complimentary contractual promise. A warranty is never considered insurance under state law or for federal income tax purposes. No fortuitous event has occurred. The defect existed when the product was sold; it’s just a question of when the defect is discovered. Never use the term “extended warranty.” It was originally used to denote what we now call a vehicle service contract; it is no longer a precise phrase. It is better to say a contract is either a “warranty” or a “service contract.”
2. When Is Contractual Risk Transfer Insurance? Contractual risk transfer is insurance whenever: It meets the legal definition under the law of a state or country, or It is deemed insurance in a pronouncement issued by a regulator acting under the regulator’s statutory powers. The telltale verb that MAY result in it being classified as insurance is the word “PAY.” If the promise on an optional protection product is “if this fortuitous event happens to you, we will PAY …” the promise may be an insurance promise. Note that it is only “may be insurance” NOT “is insurance.” There may be dispensations in laws or regulations decreeing that the contractual promise is not insurance, e.g., vehicle service contracts. In general, simply having one clause that transfers risk within a contract that exists primarily for other purposes does not make the contract an insurance policy; such as, a GAP waiver attached to a financing contract.
3. When Is Contractual Risk Transfer just an Obligor Contract? Whenever there is contractual risk transfer that is NOT a warranty or an insurance product.
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Take It One Step at a Time in Tracing the Path Consider a vehicle service contract ultimately reinsured to a producer affiliated risktaking corporation. 1. Vehicle buyer to an administrator-obligor via a vehicle service obligor contract 2. Administrator-obligor to a contractual liability insurer via a contractual liability insurance policy 3. Contractual liability insurer to producer affiliated risk-taking corporation via a reinsurance treaty
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The Consumer Level Contractual Promise What contractual promise is given to the vehicle buyer? In plain language, what is the contractual promise? Who is giving the contractual promise to the vehicle buyer? Read the contract. Who promises to perform? Who is “we”? What is the purported nature of the contractual form of promise? Does the contract purport to be a warranty or insurance? Is there an identifiable charge for the contractual promise? If the protection is optional, the vehicle buyer pays for the contractual promise; otherwise, the protection is complimentary; i.e., there is no identifiable charge to the vehicle buyer. In New York, however, a complimentary promise still constitutes insurance.
Types of Contractual Promises at the Vehicle Buyer Level For F&I Office Protection Products Warranty Contracts (Must be Complimentary)
Vehicle Warranty
Tire Warranty
Optional Insurance Contracts
F&I Product Dealer-Provided Warranties, Warranties, such as LoJack such as LLPW
GAP Insurance
Mechanical Breakdown Insurance
Credit Life and Disability Insurance
Optional Obligor Contracts
“Vehicle Protection Products”
VSC
Road Clubs
GAP Waiver
Debt Waiver
Vehicle Return Program
Complimentary Obligor Contracts
Job Loss Protection
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Trade-In GAP Protection
Trade-In Value Protection
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Vehicle Return Program
Almost Any Life Event
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Warranties Protection Products Every Buyer Gets at the F&I Office: Warranties Provided by Manufacturer or ManufacturerAffiliate
Certified Vehicles
New Vehicles
Base Warranty
Extended Powertrain Warranty
Base Tire Warranty
Base Warranty
New Vehicles
Dealer – Provided
Limited Lifetime Powertrain Warranty
Extended Powertrain Warranty
Base Tire Warranty
Used Vehicles
Extended Tire Warranty
Base Warranty 3, 6, 12 Months
Limited Lifetime Powertrain Warranty
Oil
Product Warranty
Pennzoil, Castrol, Mobile 1 Oil Warranties
Valvoline Engine Guarantee
Manufacturer’s New Vehicle Warranty “The administrator will reimburse you for reasonable costs to repair or replace any of the covered parts listed in the Agreement if required due to a mechanical breakdown, hereafter referred to as a loss. A “loss” is defined as the failure of a defective covered part or faulty workmanship of a covered part as originally supplied by the manufacturer. It does not include gradual reduction in operating performance due to wear and tear. Damaged parts may be replaced, depending upon availability, with like quality, used, rebuilt, remanufactured, or new parts. When the cost of repair for both parts and labor exceeds the cost of replacing the damaged unit with a used, rebuilt, or remanufactured unit, the administrator reserves the right to select the method of repair.”
Tire Warranty Limited Warranty: “If a Michelin Self-Supporting Zero Pressure (ZP) tire becomes unserviceable due to a workmanship or materials condition or a road hazard injury during the first 24 months of service or before 50% of the tread is worn, whichever occurs first, Michelin will furnish a comparable new Michelin Self-Supporting Zero Pressure (ZP) replacement tire at no charge. No charge will be made for demounting/mounting/balancing, but the consumer will be responsible for paying any other dealership charges and applicable taxes.”
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Used Vehicle Lubricant “Warranty” “The obligor will reimburse the warranty holder up to the limits of liability for the reasonable cost needed to repair or replace the specified parts listed under “What Is Covered.” For purposes of this warranty, it shall be presumed that damage to the specified parts has been indirectly caused because the warranty products did not provide improved internal lubrication and/or protection to prevent such damage. The reasonable cost of repair will be determined by average cost for similar repairs.”
Definition from CA Ins. Code Section 116.5: “An express warranty warranting a motor vehicle lubricant, treatment, fluid, or additive that covers incidental or consequential damage resulting from a failure of the lubricant, treatment, fluid, or additive, shall constitute automobile insurance, unless each of the following requirements is met: a) The obligor is the primary manufacturer of the product. b) The commissioner has issued a written determination that the obligor is a manufacturer as defined in subdivision (a). c) The agreement covers only damage incurred while the product was in the vehicle. d) The agreement is provided automatically with the product at no extra charge.”
LoJack Warranty Limited Parts and Labor Warranty: “If the LoJack unit which is installed in your vehicle, exclusive of backup battery system, proves to be defective in material or workmanship within two (2) years from the date of installation we will, at our option, either replace the LoJack unit, or will provide without charge the labor and the parts necessary to remedy any such defects. LoJack’s responsibility is only to replace or repair the LoJack unit and not for any additional payment, regardless of the nature. For a period of 90 days after installation, LoJack will provide parts and labor or service to replace any part of the backup battery system which proves to be defective in material or workmanship.” Limited Recovery Warranty: “If, within two (2) years from the date of installation of the LoJack unit, the Purchaser’s vehicle is stolen and not recovered within twenty-four hours from the time that report of the theft is officially recorded by the police department having jurisdiction, LoJack Corporation will pay you an amount equal to the purchase price paid for the LoJack unit up to a maximum of $995.”
Pennzoil Oil Warranty “SOPUS Products warrants you, the vehicle owner or lessee whose name appears on the front of this Limited Warranty document (“you”), that it will repair or replace, at its option and at its expense, the engine parts listed below, that fail on account of engine wear or which experience abnormal wear, because Pennzoil motor oil failed to provide proper lubrication. The Lubrication Limited Warranty includes all the terms listed below. This Lubrication Limited Warranty is free."
Valvoline Engine Warranty “If the engine in a Qualifying Vehicle has a Qualifying Engine Breakdown, Valvoline, a division of Ashland Inc. (“Valvoline”), will pay the reasonable expenses for the repair or replacement of Covered Engine Parts and the associated labor to restore these Covered Engine Parts to operation, subject to the exclusions, limitations, terms, conditions, Eligibility Requirements, and consumer obligations set forth in this limited warranty (collectively, this “Limited Warranty”).”
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Optional Insurance and Obligor Contracts The Vehicle Purchase Transaction: Cash Sale Available
F&I Office Products
VSC
Etch
Body Protection
Not Available
Fabric Protection
Maintenance Prgm
Road Clubs
GAP Waiver GAP Insurance
Debt Waivers
WalkawayTM
The Vehicle Purchase Transaction: Financed by a Loan
Direct Credit Union Loan
Type of Transaction / Lender
Direct Bank Loan
Debt Waiver for Job Loss, Disability, Death
Loan Protection Products
Credit Life and Disability Insurance GAP Waiver Mechanical Breakdown Insurance
GAP Waiver
The Vehicle Purchase Transaction: Financed at F&I Office Financing Contract
Type of Transaction
Financial Institution
F&I Office Products
Manufacturer’s Acceptance Companies (GMAC, FMCC, TMF)
VSC
GAP Waiver GAP Insurance
Other Acceptance Companies
Etch
Other Financial Entities
Body Protection
Fabric Protection
Maintenance Prgm
National and State Banks
WalkawayTM
Road Clubs
Federal/State Credit Unions
GAP Waiver (All States)
Debt Waivers
The Vehicle Purchase Transaction Financed by a Dealer Type of Transaction
F&I Office Products
Financing Contract via Buy Here Pay Here (BHPH)
90-Day Warranty
Vehicle Service Contract (VSC)
Vendor Single Interest (VSI)
The Vehicle Lease Transaction Lease via Lessor
Type of Transaction
F&I Office Products
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Complimentary All Cause Death (Termination without Penalty)
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Complimentary GAP
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Mechanical Breakdown Protection Mechanical Breakdown Insurance (MBI): P&C Insurance Definition: P&C insurance, issued by a licensed P&C insurer, and sold to a vehicle buyer by the vehicle dealership marketing the product to the buyer in its role as the agent for the P&C insurer. If a mechanical breakdown occurs because of mechanical failure not covered by the manufacturer’s warranty, the insurer will PAY the dealership to repair the vehicle.
Vehicle Service Contract (VSC): An Obligor Contract Definition from CA Ins. Code Section 12800: “‘Vehicle service contract’ means a contract or agreement for a separately stated consideration and for a specific duration to repair, replace, or maintain a motor vehicle or watercraft, or to indemnify for the repair, replacement or maintenance of a motor vehicle or watercraft because of an operational or structural failure due to a defect in materials or workmanship, or due to normal wear and tear. A vehicle service contract may also provide for the incidental payment of indemnity under limited circumstances only in the form of the following additional benefits: coverage for towing, substitute transportation, emergency road service, rental car reimbursement, road hazard protection, reimbursement of deductible amounts under a manufacturer’s warranty, and reimbursement for travel, lodging, or meals. ‘Vehicle service contract’ also includes an agreement, for separately stated consideration, that promises repairs at a discount to the purchaser for any combination of parts and labor in excess of 20%.”
Key Clause: The obligor has insured its risk with a licensed insurance company, ABC Insurance Company. If at any time the obligor fails to perform under this VSC, you may contact ABC Insurance Company at ________________ and it will perform under this VSC.
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