Dig into the Details with F&I Provider Contracts

Inflation skyrocketed the past year at its fastest pace in over 40 years, hitting 8.5% in March, with costs for food, gasoline, housing and other necessities squeezing American consumers.

The pinch also impacted the auto industry as surging inflation and snarled supply lines reared their heads.

Inflation and inventory shortages caused new and used vehicle prices to soar, with Cox Automotive reporting the average new vehicle retailed for $45,927 in March, down slightly from a peak of over $47,000 in December. Used vehicle prices increased as well, rising an average of 30.4% in 2021, which iSeeCars.com attributes to the microchip shortage plaguing new vehicle inventories.

Parts shortages and rising labor costs now push up loss ratios and lead to lower retro/reinsurance earnings for dealers. Prices for parts are skyrocketing as parts shortages increase, largely because of pandemic lockdowns in Shanghai and the war in Ukraine.

Mike Butler, vice president of claims for AmTrust Warranty and Specialty Risk, warns these shortages may not only impact parts prices and availability but also GAP/vehicle service contracts (VSCs).

“We can expect to see lack of availability and inventory of replacement parts leading to higher severity,” he says. “We could see an increase in VSC claims as customers choose to repair used vehicles instead of buying new ones because of soaring prices. This also will lead to more contracts reaching the end of coverage before the customer buys another vehicle. Cancellations also may decrease.”

Further, Butler predicts plant closures due to supply shortages will extend inventory shortages of new vehicles and high values for used vehicles. “This also will lead to a lower number of GAP claims and smaller deficiencies to pay (lower severity),” he says. “We’ve seen this trend over the last two years because of the pandemic. But it really started to spike last summer. We expected this to begin to fade in Q3, but new plant closures could extend the trend.” 

Vehicle repairs now take longer and cost more, adds Elliot Schor, vice president of sales at JM&A Group, a leader in the F&I industry. He cites ongoing supply chain issues, increased demand for repairs and labor shortages as the reasons. 

He adds, “We all know transaction prices are at all-time highs. But what’s lesser known is the impact of inflation on car parts, car labor, maintenance and service, vehicle repair, accessories and tires. Inflation has definitely impacted prices there.”

“With higher priced parts, dealers can often pass that cost on with a labor rate increase, for example, or they may eat some of their margins if they are in a competitive market,” he adds. 

But, Schor says, it gets dicey with vehicle service contracts. “VSCs are a promise to pay for mechanical issues on a vehicle down the road,” he says. “The mechanical costs may or may not have a cost associated with them that includes parts and labor. The costs of parts and labor affect the cost of fixing vehicles, potentially effecting the loss ratios dealers have enjoyed along with their reinsurance, which will rise alongside that. It becomes important for dealers to ask the right questions and understand these dynamics to ensure their providers are taking affiliate fiduciary responsibility and pricing correctly.”

Reinsurance, Loss Ratios and More

In an uncertain market, it’s imperative for dealers to monitor their book of business and consider how their F&I insurance portfolio performs. They should examine loss ratios and know their average earn out per contract after claims. Dealers should consider when they last reviewed administration, obligor, ceding and claims handling fees, Schor adds.

He explains some F&I providers, like JM&A Group, have prepared for inflation and can act as true fiduciary partners to protect dealers’ business. Others have not. 

Reinsurance programs enable dealers to share in underwriting profits for the F&I products they sell, including powertrain, vehicle service contracts and more. But the industry developed most programs in a different market. Schor explains, “I don’t know that they have ever experienced something like this. Most dealers may not have drawn the lines to know what inflation means for their reinsurance positions.” 

If they haven’t, and their provider hasn’t as well, it could spell disaster. Every provider prices contracts differently and targets different loss ratios. “Some providers may target a 90% loss ratio, others may target a 50% ratio,” he says. “A dealer may expect an annual reinsurance check of a certain amount then those checks could all but disappear. Or they may be lower than what they expect because inflation has pushed up loss ratios.” 

Another impact may come from providers increasing their reserves to account for inflation. Some providers make annual increases for inflation. Providers like these envision modest increases next year. However, many providers do not take this step, and those providers may ask dealers for “significant reserve pricing increases next year,” Schor says. 

More or Less Contract Penetration?

In most states, dealers can choose to increase VSC prices to pass on increased costs to consumers. But that can come with risk.

“Business managers are going to push back on significant price increases,” Schor says. “It also can affect penetration if prices get too high. The increases will happen as interest rates and inflation go up. These things can impact penetration.”

Dealers, he adds, have enjoyed great profits in recent years. But the market may begin to self-correct because of inflation. “For right now, the market is still extremely healthy,” he adds. 

Anecdotally, consumer risk tolerance appears to be lower than before the pandemic. Schor explains, “Consumers are more inclined, because of inflation and uncertainty around inventory, to protect their vehicles, which may push up penetration.”

Ask the Right Questions     

Dealers must prepare now by asking the right questions of their F&I providers, adds Schor. These questions include:

• How do you create reserves?
• What have you seen from a loss-ratio perspective?
• How does my reinsurance check project out versus last year?
• Are you seeing increases in the severity of loss?

“Dealers also must examine their entire book of business, not just from a cumulative perspective,” he says. “Often dealers put all their business into one bucket, which projects out to an ultimate loss ratio for their entire book of business. Dealers must segregate their book of business so they can properly see what’s actually going on.” 

If dealers notice their provider has not prepared for inflation, they may consider moving to a new one. “They should seek providers who are disciplined with reserves and not asking for dramatic increases in reserve pricing,” he says. “Ask the right questions. How do you set reserves annually? What are my loss ratios? In the short term, what can we do to mitigate macro trends? What should pricing look like in 2023?”

The time is now to prepare for next year with F&I products, he adds. “It’s time for dealers to dig into the details and make sure they understand their administrative agreements and the fees associated with handling claims.”

Ronnie Wendt is an editor at F&I and Showroom.

Originally posted on F&I and Showroom