Tag Archive | "Steven Pearl"

Reinsurance and Loss Control

In a past issue of P&A magazine, we discussed the parties that agents represent and some key aspects of loss control. In this article, I would like to discuss the benefits and idiosyncrasies of reinsurance as well as how loss control fits in.

Our goal as agents is to sign a dealer and keep them forever. As farfetched as this may sound, it is entirely possible if you put the dealer on reinsurance. Once they start seeing the statements and receiving checks, they frequently will not even entertain seeing the competition, because they have their “own company.”

Vital Information

Your first responsibility is to ascertain whether the carrier you are using has the proper program for the dealer. In a panel I moderated Agent Summit 2014, we had a discussion among some of the sharpest minds in the industry. There was consensus on numerous items, including:

  1. Be sure your carrier has the support you need. The big box carriers have all the suits that can come in and put on a pretty good show, but this is frequently style over substance. You need a carrier that will not only supply you with sales support but is willing to have claims or accounting personnel come out and assist in the explanation of reports.
  2. Be sure that the carrier will supply timely reports and detailed loss data. I cannot stress this enough, especially having reports that drill down to great detail on where the claim was repaired and whether it included multiple components, among other details.
  3. Review the treaty. You should see an administrative fee, which includes your commission, as well as a reserve to pay claims and a ceding fee. Sometimes the carrier’s administrative fee and ceding fee are combined, so you have to look at them together as one expense. Under no circumstance should you have to pay a claim fee, and the structure should not change if the dealer were to quit writing with that carrier.

Expert Advice

The dealer is going to need accounting and legal support. Frequently, the dealer will say he wants to use his own accountant and lawyer. However, the dealers’ trusted advisers are not likely to be familiar with reinsurance transactions and thus are not qualified to advise the dealer on this transaction. In such cases, I would always just say “OK” and then call the dealer’s accountant and lawyer. I would explain to them that there are firms that specialize in these transactions and could prepare the tax return for less than $5,000. At this point, most advisers will be happy to have an “out” and will recommend the dealer use the specialist. The fact that the dealer’s trusted advisers are giving this advice, rather than the agent, is an important distinction.

To find these specialists, you can start by looking at some of the presenters and panelists at Agent Summit. You can also ask your carrier if they have any recommendations. Quality, fees, and service levels can vary, so be sure to get recommendations from other agents or industry professionals.

Proper Structure

The structure as to how to hold the shares and or equity of the reinsurance company can vary, but we have usually recommended an LLC be formed to hold the shares. This allows increased flexibility if you want to make ownership changes. It is highly recommended that minority ownership shares be issued to key personnel at the dealership and that it becomes part of their pay plan. The personnel should be selected based upon their ability to influence the operating results of the company and effect loss ratios. Recommendations include the service manager, new and used car managers, F&I managers and controller.

The operating agreement of the LLC should include “golden handcuff” provisions as well as an exit strategy in case one of the management personnel leaves or dies. Golden handcuff provisions include a vesting provision so that the shareholder may only be 100% vested after a given period of time (say five years) or a gradual vesting (such as 20% per year). The exit provision usually is at book value on a given date, perhaps at year-end of the exit or at the previous year-end book value if the exit is prior to June 30.

It is imperative that all relevant personnel, such as service writers, know that this is the dealer’s company that claims are coming out of. This will enforce good claim practices and further align the dealer with the fronting carrier in controlling loss ratios. We wish to avoid reconditioning used cars on a vehicle service contract, upselling multiple claims on the service drive or repairing a component that might break in the future but is currently operating within factory tolerances.

A dealer who truly understands reinsurance and is committed to the concept will reap significant financial rewards and be a great ally for the carrier and agent. We once had a dealer who did not want to pay any claims from his reinsurance company and wanted them all goodwilled. He understood that a goodwill claim is deductible at his ordinary income tax rate whereas as a claim paid from his reinsurance company is effectively deductible at his long-term capital gains rates, which is likely 20% or so less. The problem with this is the IRS would claim tax avoidance and there could have been serious repercussions. We had to explain to him that all legitimate claims have to be paid from the reinsurance company — but under no circumstances should he or his employees push to have a claim goodwilled out of his reinsurance company. Instead, it must be paid by the dealership, due to tax considerations.

Similarly, a dealer who understands reinsurance would push to have the highest reserves possible. This too moves income from ordinary to long-term capital gains. There is some wiggle room to increase reserves from some carriers, but they have to be justifiable increases. The IRS would again look at such increases as tax avoidance if they cannot be justified.

Such justifications could include a premium due to the dealer’s past experiences, the carrier’s history in the geographic area, the carrier’s history with a particular make or model, or simply the fact that the reinsurance company is starting out with a low capital base and there is need to build up reserves in case of a shock loss. In this case, the reserves would need to be revisited later and adjusted up or down accordingly. Most carriers file a rate with a variance acceptable to the state for these types of circumstances.

Reinsurance is a win-win-win situation. The dealer gets to participate in underwriting profits while enjoying the tax advantages of long-term capital gains. The agent wins because he now has a “sticky” client, who is looking to you, his trusted advisor, for guidance. You might make less per contract due to the exposure of fees, but you will sign larger dealerships and keep them longer. Finally, the carrier is a winner, because the dealer’s and agent’s goals are more likely aligned with theirs. So select your carriers, find the right accounting and legal firms, and enjoy increased success.

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A Brief History of F&I

Recently I’ve been reminiscing about the changes I’ve seen in F&I over the last 40-plus years. The industry originated in the midwest, and many of the pioneering companies – or their offspring – are still in business. Initially, they sold CLAH, CLAH and CLAH.

It was considered an accomplishment to obtain $100 per retail unit, which was completely found money. Contracts were executed by hand and charts were used to calculate payments. Customers were in the dark, but often so were the dealers and the guy in that new management position – the F&I manager.

The early and mid-70s brought two significant developments. Calculators, and then computers, were developed that could compute the payments, then actually print the contracts. Names like “Wang” and “Oakleaf” became prominent. The biggest development, however, was the advent of the vehicle service contract (VSC). VSCs were generally not regulated and any price could be charged.

All of a sudden F&I income started to soar. It was at this time that payment packing became prevalent and the method “Assume Quote and Explain” (AQE) became en vogue. In essence, this meant that you were supposed to assume customers wanted all the products, quote them a payment including those products, and then explain to them what they had purchased. That last step was frequently forgotten by the F&I manager.

We all worked to develop and promote products and techniques that not only increased the F&I profit, but benefited the consumer as well. GAP continues to be one of the most beneficial products for all parties. It’s a classic case in which the customer benefits if the vehicle is stolen or totaled because he or she can purchase another car at a reasonable payment. The dealer benefits by having another opportunity to sell the customer a car and make a profit in F&I.

The many ancillary products that have come along have had a similar impact. If a product offers a real benefit to the consumer and the dealer can make a fair profit, that’s capitalism at its best.

So where are we now? Many of the changes in products and techniques resulted from laws that came about due to the abuses committed by a few bad apples. Not fully disclosing payments and selling products with minimal benefit compared to the price led to increased regulations. I remember a product called “Aqua Magic.” The aqua was the water used to wash the car pre-delivery and the magic was the $199 dollars or more charged for it.

As with most things, the pendulum swings too far in one direction as a result of having swung too far in the other. Today, extreme care must be taken to protect both the dealers’ and the consumers’ interests. If you’re not using a computer menu on every deal and having it signed by the consumer, you are – quite frankly – a fool. Not only does the menu make the F&I manager’s job easier and increase F&I profit, it also protects the dealer and F&I manager from future claims and lawsuits.

Continuing education is paramount, especially for management. Certifications such as AFIP go a long way toward avoiding problems and providing a good defense if a legal situation arises.

This leads us to the question, “Where are we going?” There will definitely be increased regulation, regardless of who controls Washington. Some of the laws will be federal and some will be state and local. The industry will fight the unjust, unfair and just plain bad laws and their enforcement, but many will remain on the books.

I would be shocked if the rate spread charged to the customer does not change to a flat amount, perhaps based on FICO scores so the F&I manager’s hard work in obtaining credit for the less qualified is recognized. Industry leaders will continue to innovate with new products, and technology will continue to streamline the entire process. In short, the future is bright for those willing to adapt and change methods and products. For those who are stuck in the past, it’s time to move on.


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