Is VSC Right For Your Credit Union?
Vehicle Service Contract (VSC) programs. Extended warranties. Mechanical Breakdown insurance.
Different names. Same class of protection.
And commonly offered alongside auto loans, with the other mainstays of credit insurance and GAP coverage.
So, is it worth it?
For simplicity, we’re going to refer to Vehicle Service Contracts as VSC throughout this article.
Our company, GreenProfit Solutions, offers a VSC program for credit unions. We see it as a valuable addition to a credit union’s lending strategy. Of course, your credit union is unique, and a VSC program may or may not be a fit.
In this article, we are going to look at the Pros and Cons of a VSC program. The goal is to empower you with the information necessary to decide what path is best for your credit union.
What’s so great about VSC? Let’s start with the positives:
Vehicle Service Contract Pros
VSC is a risk-management tool for your credit union.
Which is worrying, considering the average vehicle repair cost is between $500 and $600, according to AAA. That same study found a third of drivers delay or neglect repairs, making the eventual breakdown even more costly.
The chances of a member’s loan going delinquent is much greater when their car experiences an expensive mechanical breakdown. If they can’t afford to get it fixed, will they keep paying for a broken vehicle?
With a VSC, that member can keep the vehicle in running order without surprise expenses or extended downtime.
A Vehicle Service Contract can be an excellent revenue stream for your credit union.
Any program you choose generates non-interest and interest income.
Some also include Profit Share.
Think of it a bit like your credit insurance program; you get a piece of the profits from your provider. This can exponentially increase income through a third revenue stream, so keep an eye out for providers offering it.
Non-interest Income (ie. Fee Income)
This is your institution’s mark-up above the net cost of the VSC. Typically, most credit unions settle on a fee of $250 to create their retail pricing. (Note: with MBI, there is a commission percentage of the premium).
Keep in mind: All VSC (and also mechanical breakdown insurance) plans are cancellable with a pro-rata refund. These early terminations may reduce your credit union’s full (in this example) $250 profit.
Look for plans with a No-Chargeback option. These ensure your CU retains the entire profit so long as the contract is in force for at least 90 days.
According to Edmunds, the average new car loan term is 79 months, and the average used car term is 72 months.
Of course, many loans don’t make it to term, for a range of reasons. However, whatever your loan runoff period may be, that’s interest income generating time.
An average VSC plan ($1800 on a 72 month loan at 5%) can generate $319.11 in additional interest income over the entire term.
The industry jargon for this is “underwriting profit”.
Chances are, you never see any of this money with your current VSC provider.
The administrator keeps it. However, some plans now offer these dollars to the credit union.
Here’s how it all works:
VSC programs contain 3 cost factors:
- Administrative fee
- Credit Union markup
- Claim reserves
To determine reserve amounts, actuaries use current parts and labor costs, inflation rate, and overall past experience history. They then perform complicated actuarial stuff (if not an official term, it should be) to come up with the needed reserve.
Money also gets set aside for catastrophic or worst-case scenarios.
In an average year, 55-65% of portfolio reserves will be paid out in claims. As each contract “earns out” every year, this leaves about half, or 45-55%, which is available for profit-share.
This is the portion your credit union could stand to earn.
While never guaranteed, it’s highly likely this category can generate 200-300% more income beyond markup and interest.
Providing Member “Peace of Mind”
Remember those unexpected expenses stats from above?
Changing the numbers paints an even more worrying picture: Dropping the amount down slightly, and still 40% of Americans cannot afford an unexpected $400 expense.
The average mechanical breakdown repair bill? $500-600, according to AAA.
A VSC reduces member anxiety of a vehicle breakdown also breaking the bank.
Then, if one does occur, it helps ensure the vehicle gets repaired as soon as possible.
Knowing the money won’t come out of their pocket (less deductible) provides massive peace of mind in their daily vehicle needs.
No more “what if” getting in the way of driving to work, the doctor, or bringing their kids to school.
Can Save Members Money
VSC costs more than your other protection options.
However, it may be far less at your credit union than at a dealer. Markups there can be as high as double net cost.
|Net cost: $1200||Credit Union member cost: $1450||Dealer customer cost: $2400|
There’s a flip-side, though. Depending on state regulations, despite having set retail pricing, dealers may offer VSCs at a lower cost than your credit union.
Dealers earn on the sale of the car, financing (if it’s with them), and other ancillary benefits. Given these additional profit sources, they have the flexibility to sell VSC at cost and still be in the black in the overall car purchase.
Vehicle Service Contract Cons
Price – It’s Expensive
Let’s get it out of the way: VSCs are expensive. Car prices keep rising. Repair costs, both in the parts and labor, keep rising.
Therefore, VSC costs keep rising.
The average cost of a credit union VSC in 2018 was between $1800 and $2000. (Source: CU Certified Auto)
Of course, it’s only a negative at the moment of sale. If anything on the car ever breaks…
May Exceed Member Budget
Adding $1800 (plus the potential cost of credit insurance and GAP) may drive payments beyond the member’s budget.
A common strategy is keeping monthly payments the same and extending the term.
This has the positive effect of lowering payments, but also of keeping the loan “underwater” for a longer period of time. This adds risk for the member as well as the credit union.
Credit Union LTV
The addition of VSC to the loan can negatively affect LTV (Loan to Value).
Typically, credit unions do not add in this cost when calculating LTV, as it is considered collateral. However, that collateral can depreciate at an accelerated rate as mileage increases.
In other words, it’s worth less as the car gets driven. To add more risk, some VSC programs deduct claims from the refundable amount. This hurts the real collateral value while further increasing risk on you, the lender.
How would you feel about a VSC program that deducts claims from the refundable amount?
Complicated to Offer
Credit insurance and GAP are easy to explain.
GAP pays most or all of the difference between your loan balance and the amount your insurance company pays if your car gets totaled.
Credit life coverage may pay off your loan in the event of your death, disability, or illness.
VSC gets complicated fast. Here’s three reasons why:
1. Coverage Level Confusion
VSC have two types of coverage: Named Component and Named Exclusion. Here’s what they mean:
- Named Component: This form of coverage provides a list of vehicle components and systems. If it’s on the list, it’s covered. Can’t find it? No coverage. The lowest level covers only basic powertrain. It’s common to have a second and third level, each adding coverage to a longer list of components.
- Named Exclusion: This is your best coverage. As the name implies, the list only excludes parts. Everything not specifically mentioned is covered.
2. Universal Exclusions
Sound easy? Just wait.
There are “universal” exclusions, which may include if a member skips regular maintenance, normal wear & tear, and even claim denials when a non-covered part causes damage to a covered part.
There may also be exclusions for diagnostic time, fluids, and belts. Plus, make sure to remember your deductible!
Oh, and some programs don’t cover taxes.
3. Many Parties to Please
A VSC claim brings several parties to the same table. Sometimes, they’re not on the same page. Here’s one example we hear about a lot:
Some VSC companies require repair facilities to use remanufactured LKQ (Like Kind and Quality) replacements to reduce cost.
Your members aren’t getting shafted; these parts are guaranteed to meet or exceed OEM (Original Equipment Manufacturer) specs.
However, some franchise repair shops will only use OEM parts. They’re typically more costly, which pits shop against provider, with both the member and the credit union in the middle.
To this example, we work with VSC providers which cover use of OEM parts if the shop requires them. But it’s not the only challenge which can arise, and it can be a delicate series of relationships to manage.
We encourage you to learn your VSC provider’s policies on repair shop relations.
Member Service Noise
VSC can be a complex product, with many moving parts. Not unlike the vehicles it covers! Oh, the puns!
From the perspective of your members, they have a reasonable expectation that if something breaks on their car, they can bring it in and get it fixed. With little or no out-of-pocket costs.
And definitely no hassle about what kinds of parts get used. If issues arise, take one guess who they are going to call (or tweet) first.
Is your team trained and empowered to address these questions?
Staff Anxiety in Offering
If your staff doesn’t understand it, they’re not going to offer it.
Simple as that.
And if word spreads through a branch about a member with a bad claim experience, do you think any loan officers there will bring up VSC again?
Then you have the normal challenges of high cost and a perception of it being unnecessary by some of your staff (seriously, ask them if they think a VSC is worth it).
These all present training challenges. Once again, we work with providers who perform their own staff training to get everyone on the same page.
When were your staff last trained in your VSC offering?
Getting You Back on the Road
So, that’s the Pros & Cons, the highs and lows of VSC for your credit union and members.
Do you see the tangible benefits for both?
We tried to be as open and honest as possible because you deserve quality information before making any decisions.
Now, the power is in your hands. Take everything you’ve learned back to the rest of your team.
Sit down (or go on a walking meeting) and discuss how to maximize the good while minimizing the bad.
A few final notes: Depending on provider, VSC programs can greatly differ. In our experience, many, if not most, of the “Cons” from above are addressable with the right program match.
Is it ours?
We’re always here to help you come to a confident conclusion.
If you’re still in the research stage, whether for a new program or due-diligence on an existing one, take a look at our other VSC-focused content:
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