7 Red Flags For VSC You Need to Know

Red Flag - VSC
(Last Updated On: August 28, 2020)

You don’t need me to tell you that Vehicle Service Contracts are complicated. No matter what you call them, VSC, MBP, or Extended Warranty, they provide valuable benefits. And yet, they’re a challenge to offer.

Despite that, you know they’re worth the effort, as a policy can:

  • Reduce your member’s risk
  • Reduce your credit union’s risk
  • Generate non-interest income

Given the average American would struggle to cover an unexpected $400 expense (that’s pre-COVID data), protecting them from high costs of vehicle repairs is essential. That car is more than a loan. For many, the crisis deepens without a usable vehicle.

It doesn’t take much from there to create a downward spiral of financial challenges. Your VSC program can avoid all those painful scenarios. Of course, we understand that it’s a complex product. That’s why we have a whole series dedicated to them.

Beyond those complexities, not all VSC programs are created the same. Contract provisions, exclusions, even policies can vary wildly. Not knowing these differences or being aware of alternatives can leave some claims shortchanged or even unpaid.

Coupled with an increased LTV and credit union risk, there are ample ways to negatively impact the member’s experience.

But that’s not going to happen at your institution, because we’re covering the 7 Red Flags in VSC programs. And I know you will take each to heart so your institution and members are protected.

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1. Refund Policies

Every state requires their vehicle service contracts to include a “free look” period. During this time, a consumer can decide to cancel the purchase, and, assuming there were no paid claims, receive a 100% refund. This is generally effective for the first 30 days.

Bowl of Pasta and Vegetables
Free as in free lunch. At least for the first 30 days.

So what happens if a member decides to cancel after their “free look” passes?

There’s two methods of refund, dependent upon the VSC administrator:

  1. Pro-rata refund, less any cancellation fee, based upon time or mileage, whichever is greater
  2. Pro-rata refund after deducting any paid claims

Most states allow the VSC administrator to set their cancellation terms. This gives you an option to choose which policy makes the most sense for your institution and members.

However, a few states, including Texas, require the administrator to pay the pro-rata refund, after deducting any paid claims.

Of course, by deducting claims, your member’s cancellation refund will be reduced. For your credit union, that means (and neither are good):

  1. The VSC collateral value cannot be guaranteed
  2. Since there is no collateral value, the cost of the VSC goes directly against LTV. It can then possibly reduce their qualifying amount or make it impossible for the member to purchase the VSC.

Be sure you know what’s required in every state you offer VSC so you stay in compliance. Plus, it helps you only present loans that meet your underwriting standards.

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2. Decreasing Benefits

At the time of VSC purchase, the contract receives a maximum benefit. This is based on the NADA Clean Retail, or, for some VSC providers, the lower NADA Loan Value. That becomes the maximum “out-of-pocket” the VSC contract will pay out in claims over its term.

Your eyebrow raise is noted. You’re right. It’s rare a vehicle will have so many high-cost claims that it reaches the maximum. However, there’s a practice some VSC providers use that makes hitting the limit more likely.

Most VSC policies stick with the initial maximum benefit amount. All the way through expiration (by time or miles), that’s the total claim amount they’ll pay. Some providers do things differently. They let that benefit value each year. What? How?

On each contract anniversary, those “decreasing benefit” policies recalculate that maximum spend using the car’s falling value. The new max is lower, and they repeat the process each year to minimize potential liability (and keep policy costs down).

YearMax BenefitAnnual ClaimsCumulative ClaimsBenefits
1$7050$1250$1250+$5,800
2$6225$1675$2925+$3,300
3$5150$920$3845+$930
4$4365$2175$6,020-$1,655
Vehicle: 2015 Hyundai Elantra (That negative amount is out-of-pocket!)

While this may be an effective cost-containment strategy, it does shift risk to your members. In some situations, their coverage may no longer be sufficient in the later contract years. You know, when the potential of mechanical breakdown is at its highest.

Let’s visualize the practice with another example:

VSC Decreasing Benefit Chart

The reason we include it as a Red Flag is so that you can proactively avoid member issues. Knowing the practice up-front lets you better compare pricing from competing providers and have a process in place if you choose a provider which does this.

3. Exclusions

This is the section that makes offering VSC policies so darn complicated. Why can’t it just be like the (unstated but real-life) Amazon return policy? Have an issue? Contact support. Get a replacement or refund. Oh, right. Because they don’t sell cars (yet).

All vehicle service contracts have exclusions. While there’s some variation on coverages, they include many of the same items. It’s important that your own team is well-trained on what those are and how to present the policy benefits (and exclusions) to members.

This goes beyond setting expectations into maintaining compliance. The work you put in here reaps dividends come claim time, especially if it’s a complex scenario.

The Not-Always $0 Deductible

Zero Deductible Icons

Yes, explaining terms can be difficult when presenting a $0 deductible plan. “So if I need a repair, it’s nothing out of my pocket? Great!” “Well, sometimes…” Now try explaining that to the member three years later, while they’re sitting at a repair shop.

Evidence shows that when faced with a breakdown, members remember their VSC contract has a $0 deductible. One, because $0 is easy to remember. Two, because some VSC providers (and thus, your credit union) prioritizes their $0 deductible in sales collateral.

Unsurprisingly, they expect $0 out-of-pocket. And that’s just not the case with all VSC providers.

Some VSC policies exclude costs of common items such as diagnostic fees, fluids, lubricants, filters, and even sales tax. Your member with a $0 deductible policy can be left with a paid claim and also a several hundred dollar bill.

Zero Deductible VSC Explanation

In that situation, it’s no surprise they aren’t happy. And who will they blame? Yes, those who sold them the policy…your credit union.

Make sure you use policies with clear exclusion terms and a $0 deductible that really is.

4. Repair Facilities

Mechanic Working on Car Engine

When their car breaks, people bring the car to their trusted, cheapest, or closest repair shop. Obviously, they have a VSC, so anyone will fix it and it’ll get paid. Right?

You know the answer. Or do you?

VSC companies have different definitions as to what type of facility qualifies to perform their repair work. There are three common categories:

  • ASE Certified: The facility has at least one mechanic who holds an ASE certification
  • Approved: Meets a VSC company’s standards
  • Licensed:  The facility has a governmental license to perform the work

Most VSC providers offer many options for your members to seek out repairs. That includes franchise and independent facilities. However, in rural areas, there are fewer choices. If that locale is common for your members, work with a VSC provider offering broader coverage.

Requiring ASE Certified shops is another limiting factor. It could affect those rural repairs, but, in our experience, tends to create the most friction with members who have relationships with local non-ASE Certified facilities.

Sidenote: In looking for appropriate image content in this section, I came across a site selling Fake ASE Automotive Certificates. It’s a thing. Tell members if they don’t trust a shop, go somewhere else and check ASE to ensure they are really certified.

ASE Certified Mechanic Working on Engine
A real ASE Certified Technician.

5. Parts

Who wants “aftermarket” parts to repair their vehicles? Don’t go giving me some broken or used components! Make the repair last with quality parts. New. From the manufacturer. How many member stories include that sentiment? Can you blame them? Of course not!

Ok, boys and girls, it’s lesson time! Today we’re going to discuss “Parts terminologies”. There seems to be some misunderstanding. So let’s get some clarification:

  • OEM: Original Equipment Manufacturer. These are new parts made by your car’s manufacturer.
  • Re-manufactured: Previously used OEM parts which are “rebuilt” and returned to manufacturer specifications.
  • Aftermarket: These parts are manufactured by companies other than the OEMs.

What’s LKQ?

There’s a perception that OEM parts are always better than anything else. Car dealer repair shops would love for you to feel that way! The reality is a bit different. Sure, those are the original manufacturer parts. Doesn’t mean they’re the only ones that work great.

Both Re-manufactured and Aftermarket parts are considered as “Like, Kind, and Quality” (LKQ). In most applications, they have the same fit, reliability, and guarantees as OEM parts. For most situations, LKQ equals OEM.

VSC companies prefer the use of LKQ parts as they are cheaper and sometimes more readily available than OEM equivalents.

However, repair shops, especially those part of franchise dealers, often refuse to use LKQ parts. Then the service worker tells your member that, “your VSC company wants us to use aftermarket parts, and that’s not how this repair facility does business.”

Guess who your member contacts next?

Yeah, educating members and staff about this policy is good, but there’s a better approach, and it’s this Red Flag. Keep members and repair facilities happy. One way VSC companies employ is to give shops the option of using LKQ or OEM parts.

Auto Parts

Does your VSC provider pay for OEM parts?

6. Labor Rate

All VSC companies stipulate that repairs are made using “published labor rates”. This includes two factors for the repair shop:

  • Flat Labor Rate: Per hour fee for doing work on the vehicle
  • Repair Time: For stated work, cited from a reputable published guide

The first varies based on the facility, higher at franchise dealers and lower at independent shops. We usually don’t see issues with agreeing on a labor rate. However, the repair time…

For the “reputable published guide”, the most popular source is Chilton’s. It provides a labor time (or range) for performing specific repairs on every brand, model, and trim for any model year vehicle. Yeah, it’s comprehensive.

VSC company adjusters use this guide to determine labor time, so the mechanic and adjuster are usually on the same page. Unfortunately, Chilton’s isn’t the only guide. Every manufacturer has their own OEM labor reference. Here’s where the Red Flag can fly.

ASE Certified Mechanic Talking to Customer
A real ASE Certified Tech with a fair labor rate.

It’s not uncommon for a Ford dealer, for example, to use their Ford OEM labor guide when calculating repair times. Then, there can be a variance between the guide your VSC provider uses and the one the shop prices the repair from.

In this case, there are two possible paths forward if the adjuster and facility cannot agree:

  1. Member pays the difference
  2. Member takes their vehicle to a repair facility in alignment with the VSC company’s covered rate

Either way, repairs get completed. However, it’s not a good experience for the member. In some way, they’re upset…with the place that sold them the VSC. Yep, your credit union.

Talk to your VSC provider to see if they have a “keep the mechanic happy” policy to ensure your members always get a great experience.

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7. Waiting Period or Pre-Existing Condition Exclusion

According to Statista, over 70% of vehicles sold in the US are pre-owned. Take a look at your loan portfolio. Your mix is likely similar. It also means your biggest market for VSC sales are used vehicles.

This is a challenge for VSC companies. When a policy is added to a new car, there’s a manufacturer warranty to offset claims shortly after purchase (and then for a few years). With used (excluding Certified Pre-Owned), the VSC company is “on the hook” after loan closing.

And besides a vehicle history report (How many of your loans include a 3rd party inspection?), your VSC provider doesn’t know the actual mechanical condition. Hopefully, all is fine, but how does the VSC company minimize early claims?

Plan structure and rates account for past claims experience. However, that isn’t enough to insulate the company from risk. To increase protection against early claims (and people buying a VSC just to get their car fixed), they set up two methods:

  1. Impose a Waiting Period
  2. Include a Pre-Existing Condition Exclusion

Either limits early, unexpected claims. Let’s look at both clauses to see the pros and cons of each. You can decide if either, or both, are Red Flags for your current provider.

Waiting Period

Hourglass on Table

A waiting period of 1,000 miles or 30 days, whichever comes first, is popular with several VSC companies.

Cons: Your members have no coverage during that period. Even if the breakdown has nothing to do with prior issues, they’re stuck. Which means they’ll come back to you…upset. Some may even cancel (since they’re usually within the “free-look” period).

Pros: After the waiting period, the VSC company cannot deny claims due to a pre-existing condition. It’s simply not a thing.

Pre-Existing Condition Exclusion

For the entire contract term, a pre-existing condition clause remains in effect.

Cons: Well, the downside is the exclusion itself. Even years into ownership, the member may find themselves facing a non-covered repair because the VSC company claims it is a pre-existing condition. Needless to say, they won’t be happy.

Pros: The benefits are solely in that time right after purchase. If something goes wrong in the first 30 days or 1,000 miles, and is determined to be a new issue, it’s covered. For the length of the term, there are no other Pros.

Take a look at your current or prospective VSC providers to see what they do. Balance the risk against costs and other factors that help you decide which is the best option for your members.

Flying All Your VSC Flags

This article focused on the Red Flags of VSC. Some are more common than others, and the cost-benefit analysis of each is up to you. Our mission is to make you aware of potential risks, not to tell you who to choose.

While you’re in the VSC world, we have a whole bunch of other flags to fly in a range of colors! In other words, the Learning Library has tons of helpful content regarding VSC programs.

A fitting next read uncovers 7 Myths of VSC Programs. Get a short list of Do’s and Don’ts (5, to be precise) for VSC marketing. And don’t forget the free You’re Special to Us video series, which introduces VSC (and more!) to members closing loans online!

The Learning Library is the industry-leading due diligence resource on over a dozen topics which matter to your institution. Subscribe today (choose your area of focus, so content is hyper-relevant) to keep the honest information flowing to your inbox.

Joe Winn - CU Geek

Blogger. Speaker. Part-time Jedi.

Focused on helping your bank or credit union grow in the face of emerging challenges.