There is no magic in maintaining a highly-profitable dealer-owned vehicle service-contract program.

The lowering of loss ratios is the key to lowering extended-warranty rates, and lower rates make vehicle service agreements more affordable for consumers and ultimately more profitable for the dealer.

Controlling and lowering loss ratios requires everyone to be on the same page. Everyone in this case, means the dealer principal, your program administrator, and, believe it or not, every employee in your dealership.

Many dealers and their general managers understand their service-contract programs, but let's assume that we are all starting out at square one.

Loss Ratios

A loss ratio is calculated by dividing the incurred losses (the amount of total claims paid) by the earned core reserve.

To understand this better, lets look deeper into the administrative process. The obligor collects a one-time fee to pay for all the claims over the entire term of the vehicle service agreement. This fee is called the core reserve.

As each month goes by, a small portion of the core reserve gets “earned.” The amount earned is pre-determined by the administrator based on historical claims data that parallels the expected occurrence of claims. So if historically the Toyota Camry has a low occurrence of claims, the core reserve would earn out better than a vehicle that had a higher occurrence of claims.

Earnings Patterns

Now we should take a look at earnings patterns. People called actuaries determine service-contract earnings patterns. It seems like actuaries spend their lives locked up in the basements of insurance companies with claims receipts and calculators. But, really, actuarial data is the backbone of the entire program.

Actuaries consider several items when they determine earnings patterns and risk rates. Examples: specific vehicle makes, models, mileage tiers, term of the manufacturer's warranty, and of course the coverage terms of the service agreement.

Earnings patterns are set up to ensure the strength of the program's entire book of business, based on the most accurate historical underwriting data available.

In many service contract programs, most of the earnings come in the later years of the service agreement. But as your entire book of business matures, your overall earnings will even out.

There are several different methods of establishing earnings patterns, which are important elements of the service-contract program. If you don't know what method is used in your program, ask your administrator to explain it, and how it will affect your dealership's profitability.

Okay, by knowing all the insurance terms, you will have a better understanding of why I recommend implementing the seven following everyday “habits” at your dealership. Maintaining these seven policies or habits, will ensure a strong book of business for vehicle service contracts.

Strive to sell service contracts on all vehicles: Let me clarify before you say, “Duh! Why wouldn't we do this.” Be sure your finance and insurance mangers are presenting the service-contract options to every single customer, and that the F&I manager knows at least two good transition statements and two good ways to overcome customer objections.

F&I managers often fall into the trap of only offering service contracts to customers who appear to have an obvious need for one, such as high-mileage drivers or people buying used vehicles that approach or exceed the limit of manufacturer warranties. These customers are perceived as easy targets.

But some vehicles produce better loss ratios than others, and service-contract programs depend on a good vehicle mix.

Vehicles that perform better will offset those that don't. The golden rule for selling F&I products: Present 100% of the products to 100% of the customers 100% of the time.

Thoroughly inspect and repair all vehicles on your used lot. Don't let a used-car manager cut his reconditioning costs and put “question mark” vehicles on the lot. Implement an inspection checklist for every used vehicle, and strictly enforce its use. This will cut loss ratios, improve customer satisfaction and instill the sales force with confidence in your inventory.

Don't reward service writers for needless “up-selling.” In other words, do not encourage the repair of items that have not failed. Service contracts are designed to cover repair items that have failed, not cover preventative repairs. Over zealous service writers can sink your profits.

Strongly encourage having scheduled maintenance done at your facility: This is of double importance. First, lack of routine maintenance could lead to more claims and may affect coverage of the service agreement and therefore customer satisfaction. Second, performing repairs at your facility will give you greater influence over repair expenses and, therefore, greater control over your loss ratios.

Sell higher deductible plans: For a number of reasons, these plans generally have lower loss ratios. Customers will think twice about filing questionable claims, if they have to pay the $100 deductible. Historically, higher deductibles mean lower loss ratios.

Sell shorter-term plans: Such service agreements will earn out faster, and will have less exposure to loss, and may also shorten your customer's trade cycle.

Use factory/aftermarket remanufactured and like-kind-and-quality parts when possible: It is completely reasonable to do this, especially if you have a claim on a vehicle that is over the “half-life” of the warranty miles.

Eric A. Kauk is vice president of industry relations for PrimeSource Solutions Inc. He is at 877-333-5800 and ekauk@primesourcesolutions.com