September 3, 2007 – Should dealers create an insurance company?
August 30, 2007
Filed under Features
By Neil Pascale
A few high-volume powersports dealers are adding to their F&I profits by following an established practice in the auto industry: creating their own insurance company.
The creation of such a company is part of a F&I method called reinsurance, which allows the dealer to hang on to additional extended warranty or prepaid maintenance profits without having the burden of additional liability or extra paperwork.
“In the car business, they’ve done a real good job of wringing out all the profits on the back end and that’s what we’ve been doing during the last three years,” said Sean Hayes, a partner of RpmOne Inc., a provider of F&I and dealer development services for the powersports industry.
RpmOne has set up a couple of dozen powersports dealers with reinsurance companies, which do not require a pre-established capital sum to start under the RpmOne model.
Here’s how re-insurance works in an example that mirrors current practices: A dealer sells a $600 extended warranty policy and pockets $350, sending the remaining $250 to an OEM or aftermarket insurance provider. With reinsurance, the dealer would keep the $250, putting $150 of that into a reserve account with the remaining $100 going toward administrative costs. Part of that $100 goes to a large insurance company, which agrees to take on any additional claims that exceed the amount the dealer placed into the reserve account ($150). Part of the $100, in this made-up example, also goes toward RpmOne and a company that administers claims.
The reinsurance method does not rely on dealers to handle any extra claims, paperwork or liability issues. Those matters are handled outside the dealership.
“It’s running real smooth,” said Bob Glenn, owner of Granny’s Motorsports, Sarasota, Fla., one of the dealerships that started a resinsurance company with RpmOne. Glenn, who started his reinsurance company in March, joined two other dealers in saying that there have been no unexpected surprises or downfalls to the reinsurance system.
The approach is a potential profit-winner for dealers in two ways: it allows them to make interest on the reserve account and keep any money that is not used for claims. Hayes said RpmOne has seen the percentage of lost claims hover around 40 percent over the past few years, meaning in the $150 example, dealers would average netting $90 per extended warranty, not counting any interest.
The initial fee of starting an insurance company, not to mention the annual fee thereafter, could limit the number of dealers that would want to pursue reinsurance. Dealers have to pay a start-up fee of $3,500, which also covers operating expenses, like tax preparation. The following year and thereafter the dealer pays an annual fee of $2,950.
So dealers that average selling at least 50-75 extended warranty and prepaid maintenance contracts per month would be suitable for a reinsurance company. That number of contracts also satisfies larger insurance companies, which are less apt to be concerned about risk considerations if a fair number of contracts are being processed. After all, one or two high-dollar claims would not be a problem if a dealer is writing 50-75 contracts per month. On the other hand, a couple of expensive claims could be eye-opening if only 10-20 contracts per month are being written.
As more powersports dealers generate higher new unit sales volumes, RpmOne President Barry Miller expects the number of dealers to start using a reinsurance system will swell.
Currently, Miller said 50 percent of service contracts in the auto industry are run through a dealer-owned reinsurance company, sometimes referred to PORCs (principal-owned reinsurance company). About 25 percent of RV service contracts are written through PORCs while roughly 17 percent of the service contracts in the marine industry are using this approach. Currently, Miller believes the percentage of powersports industry service contracts written through PORCs is well south of 10 percent.
“We’re changing that over the last few years with dealers becoming more progressive and with dealers doing the volumes that give them the ability to take advantage of this,” he said.
RpmOne sets up the insurance company out of Turks and Caicos, a Carribean island known for its insurance-friendly regulations. A dealer’s reinsurance company is still considered a U.S. company and still pays federal and state taxes. However, because it’s located out of Turks and Caicos, the small insurance company is not required to start with an initial large capital sum. Miller of RpmOne notes that because most new powersports vehicles come with one-year warranties, dealers often have a year to build up their reserves before they start paying claims on new units.
When would dealers potentially see a profit from the reinsurance company? It depends on the type of coverage. For a typical three-year extended warranty plan, it would probably be after a year and a half before some of the reserve account is accessible to the dealer as profit.
“One of the things that we’ll preach to our dealers is if you want to pull it out, you absolutely can,” Hayes said of the profits from the reinsurance company. “There’s no advantage or disadvantage to RpmOne if you pull it out or don’t because you’re making the interest off it, so it’s indifferent to us.”
However, Hayes and Miller do advise dealers to look at the reinsurance company as a 401K, or as Hayes put it, “a long-term, silent savings” for retirement.
When money is taken out of the reinsurance account, the dealer “would enjoy a tax benefit that says any money would be treated as a dividend, and they would pay a 15 percent tax plus whatever state tax, rather than ordinary income tax,” Hayes said.
There is one catch — the dealer cannot put more than $1.2 million into the insurance company’s reserve account per year to qualify for the tax benefit.
That $1.2 million would equal approximately 800 extended warranty contracts per month — a figure that most dealers won’t be near.
If dealers also do prepaid maintenance, then the number of contracts per month under the tax benefit figures to shrink.
“We do the math for them and say, ‘Hey, it’s going to be a long time before you write this many contracts per month, and we have a solution for you if you ever do get that limit,’” Hayes said.