What’s a Vehicle Service Contract? 10-Second Review.
A Vehicle Service Contract is an insurance-backed product designed to protect the car buyer from the financial risk of covered mechanical breakdowns. Ok, that’s a complex-sounding explanation. Here’s a super-simple version:
A VSC may help pay for fixing a car if it breaks.
The first vehicle service contracts came about in the 1980s. You could only get them from dealers. Financial institutions were big fans since they helped reduce their risk of delinquencies while producing non-interest income.
A Glaring Need
Why would your credit union care about offering Vehicle Service Contracts? If you’re like many, your team sees it as a product which can be offered, but usually isn’t. I mean, it is complicated. And expensive. Plus, how many members actually have a need for it?
First, with a surge in used-car sales (which are also older), the number of people with factory warranty coverage will fall. That means more uncovered cars on the road, all vulnerable to the cost of repairs.
Second, you’re thinking about it as an upfront cost, you’re missing the value. It’s about being there for members when things go bad. In this case, if something expensive (and important) breaks on their car.
Thirty-nine percent of Americans don’t have enough cash to cover a $400 unexpected expense, according to the Federal Reserve Board. What’s an average car repair cost? About $500-600. That creates a worrisome situation for members, and increased risk for the credit union.
And if the repair is a bit higher than average? Say, $1000? 59% of Americans would be unable to cover it without going into debt.
Good thing you can do something about it.
Revenue Generation. An Opportunity to Protect.
Dealers sell Vehicle Service Contracts. Their mark-up is higher than your credit union. Thus, theirs cost more. So, you’re saving members money, helping protect them against unexpected financial hardship, all while generating non-interest income for your institution. Are you seeing a downside?
Our company, GreenProfit Solutions, offers a vehicle service contract program through a major provider. We believe it’s a best-in-class option for credit unions and their members.
Of course, we also understand that our solution may not be a fit for every institution. Our goal here is to give you the tools to choose the perfect program for your credit union and members.
Be aware VSC providers may have substantially different features, pricing, and even revenue return policies.
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Checklist for Choosing a Vehicle Service Contract Program at your Credit Union
- Insurer – CLIP or Mechanical Breakdown Insurance
- Terms, Qualifications, and Deductibles
- Refundable, Free look
- Offering Platform
1. CLIP or Mechanical Breakdown Insurance
This part is the icky due-diligence, so let’s get it out of the way first. VSC programs have two different coverage formats:
The most common is Contractual Liability Insurance Policy (CLIP). Such programs have these three parties:
- Insurance Carrier (and/or Reinsurance Carrier)
- Seller – That’s your credit union
The administrator is the company you see in your relationship. They service the contracts, including name changes, cancellations, transfers, and, of course, claims.
Administrators purchase a CLIP from an insurance carrier to insure a portion of their claim losses. In some cases, the carrier and the administrator are the same company.
A less common format, but required in some states, most notably California, is Mechanical Breakdown Insurance (MBI). In this system, the insurance company issues a policy directly to the member and is the sole contact for all servicing.
- Confirm the insurer’s A.M. Best ratings are at least “A-” Excellent.
- It’s important to know they could pay if things went really bad.
- Confirm the plan is “fully insured”.
- This term has varying definitions, depending on your state. Our own, Florida, permits the “fully insured” designation after the company posts a certain dollar amount bond.
VSC plans comprise 3 levels, moving from least covered to most covered.
- Powertrain – The most limited coverage. Provides coverage only for the parts that make the vehicle move.
- Examples: engine, transmission, drive axle, transfer unit, seals & gaskets, supercharger or turbocharger.
- Named Component – Everything named within the policy is covered. Anything missing, well, isn’t covered.
- Examples: Powertrain plus certain named parts of the air conditioner, brakes, cooling system, electrical components, front & rear suspension, fuel system, steering, and other parts.
- Named Exclusion – The highest coverage level. The list of what is covered is longer than what isn’t. Hence, the policy names the components excluded. Don’t confuse this with, “Bumper-to-Bumper” coverage. That’s offered by manufacturers on new cars, and sometimes on certified pre-owned models.
- Examples: Potentially dozens of non-covered parts. Of course, each is listed explicitly in the policy.
Some companies offer two levels of Named Component coverage. Others also offer Named Exclusion “Wrap” plans, which are specially priced and designed to complement coverage on vehicles with an original manufacturer’s warranty.
These exist to make it an easier sell when purchasing a new car.
Note: “Wear & tear” is a term used to exclude coverage on parts needing replacement at certain intervals. Think tires, brake pads, wiper blades, and the like. “Wear & tear” coverage can cover these components, with a catch. Their degree of wear must be beyond manufacturer’s tolerances and a reasonable expectation for the current mileage.
- As with any insurance, reviewing the exclusions is key.
- The fewer the exclusions, the better the member experience. (And the less out-of-pocket expense for them)
- Look at typical items like diagnostic time, fluids, and even tax.
- Get to that scenario by advising members to opt for Named Exclusion to ensure the most coverage and best member experience.
- It’s more up-front, but potentially way less down the road.
3. Other Benefits
Like many of your ancillary products, VSC plans include additional benefits outside the primary coverage. For example, all come with roadside assistance. These are common features:
- Gas/fluid delivery
- Lockout services
- Tire change
- Battery charge
- Car rental reimbursement
- Trip Interruption
- Members think of the primary benefits at purchase. However, these additional perks can provide massive satisfaction boosts (and truly help a member in a bind) when they are needed.
- Ensure any plan you choose has at least the basic benefits to assist members from being stranded, while also ensuring their car gets repaired in as short a time as possible.
The Ultimate Guide to VSC helps your credit union protect members while discovering the 3 (yes, 3!) forms of revenue possible with some VSC providers. Get your eBook now!
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4. Terms, Qualifications, and Deductibles
- Length of time the contract will be in force
- Generally dependent on the age of the car and the odometer mileage
Go-to rule: The lower the deductible, the higher the cost. Conversely, the higher the deductible, the lower the upfront cost.
This is one way to help a member afford a top-level coverage plan.
Some plans may exclude coverage on what they consider “exotic” cars, and most only accept passenger cars.
Sorry, you’ll need a different policy for your 18-wheeler (even if you do just use it for grocery shopping).
Be aware of surcharges built-in for items including:
- Lift kits
Many plans will also have an additional cost if the vehicle is for business use.
- Make sure that the terms, at minimum, cover your credit union’s longest available financing terms. If you’re going to cover the vehicle, best to know it’s good for the whole time you have a financial stake in it!
- Check the plan’s list of excluded cars. Some companies will exclude popular vehicles such as Audi, Mercedes, and BMW.
- Take a look at your loan data; if you finance a lot of these brands, perhaps worth looking for other providers.
- A low deductible or $0 deductible has a high perceived value, as members will assume that there are never any out of pocket costs. It’s not unreasonable. However, this may not be the case with all plans.
- Ask if there are potential “hidden costs”, like taxes.
5. Refundable & Free Look
Vehicle Service Contracts and Mechanical Breakdown policies are always refundable, regardless of the reason for the early termination. The refund is based upon time or mileage, whichever is greater.
The exception to that is during the “Free Look” period when the member can cancel and receive a 100% refund. Think of it as the money-back guarantee period. Free Look can run from 30-90 days depending upon the provider and state regulations.
In regard to the lien, this potential refund does serve as collateral, and, with most plans, can be collected in the event of a repossession.
Companies use a pro-rata formula (typically with a stated cancellation fee) to determine the borrower’s refund. If your credit union includes a markup in your pricing, your institution is also liable for a portion of this refund.
Here’s an example of how much:
- CU markup: $250
- Percent due member: 30%
- CU refund portion: $75
Some companies may offer a No-Chargeback option for a fee (or already have it built into their rates). This eliminates the need (generally after the Free Look period) for your credit union to share in the refund.
In these cases, all refunds would be paid entirely by the administrator.
- It makes sense to opt for the No-Chargeback plan. This will enable your credit union to generate the most revenue at the lowest amount of effort.
- However, it may cause increased rates, so review your institution’s philosophy and relationship with your borrowers.
- Having the VSC as collateral is important for risk management. Make sure the plan you choose does not assess paid claims against any potential refund.
Did the insurance company pay up? It’s the true test of any insurance/protection plan.
Members expect their vehicles to be repaired quickly and their claims to be paid.
Anything short of that and there’s friction for your members…and you.
Every VSC plan designed for credit unions states that they will make payments directly, via a major credit card, to any licensed repair facility in the US and Canada.
Be aware that some plans may require the vehicle be serviced by ASE Certified mechanics. If your plans have this requirement, advise members of how to find them (nearly all dealers and brand-name shops will have ASE Certified techs).
OEM, Remanufactured, “Used”, and LKQ
Ok, so the tech found the issue. Hooray, it’s covered on your member’s plan! What’s the holdup? VSC providers typically agree to pay a repair shop’s hourly labor rate.
However, some VSC programs only approve replacement with “remanufactured” parts. Yet the shop insists on using only OEM components, and may even tell your member their warranty wants them to use “used” parts. See where this is going?
OEM: This stands for Original Equipment Manufacturer. These are the same parts your car had off the lot. They’re expensive.
LKQ or “Remanufactured”: This stands for Like Kind and Quality. These are parts made to the same specs and tolerances, and carry the same warranties as the OEM parts. Remanufactured is another word for it.
Used: This is a random part scavenged from a junkyard. Could be fine. Could be not fine. Few shops will ever use this type of part, but some do imply that’s what is being demanded.
This situation can lead to uncomfortable conversations with the member.
It’s important to ensure your provider has a customer service number to handle such issues as they arise, and have a process to keep the credit union in the loop. Best to know when a member has an issue, and also that it’s been resolved!
Once claim issues get resolved, the administrator provides approval for the work. They pay the repair facility when the member picks up the car.
“Grey Area” claims
Sometimes claims don’t fit neatly into the plan terms. For whatever reason, though it’s not explicitly covered, it really should be. Most VSC companies have a separate fund to pay out on these types of claims.
Make sure the provider has a claims adjustor with the power to review and approve these amounts up front. Our VSC partner calls this “proactive approval”.
Otherwise, it becomes an automatic denial, ruffling feathers of all parties and frustrating your members.
Even if it does get approved in the end, the unneeded stress of the situation paints a bad image for everyone involved.
We’ve even seen this discourage loan advisors from mentioning their VSC program to borrowers!
- Discover the VSC provider’s policy on using remanufactured/LKQ and/or OEM parts.
- Ask if the contracts pay for diagnostic time. Not all do.
- Request the company’s average paid claim.
- Find out about “grey area” claims, and what their process, if any, is for handling them smoothly.
All plans provide your credit union with the opportunity to earn both interest and non-interest income.
Interest: A vehicle service contract can cost $1,500, $2,000, or more. When added to the loan, as is typical, interest is earned on each payment.
Markup: Your credit union will have a “net” rate, upon which the retail markup can be added (this amount is regulated in some states). For Mechanical Breakdown Insurance, the policy has a set filed rate, and the credit union receives a percentage as commission.
Profit-share: This is a rather new and profitable opportunity for the credit union world. It’s old hat to dealers, where it’s been in place for decades. How’s it work? At the end of each year, your VSC provider looks at your credit union’s claim experience (claims paid vs. reserves). Remaining funds are shared back to the institution.
Profit sharing can deliver substantial non-interest income far beyond markup. And there’s no risk to the credit union should claims ever exceed reserves.
- Ask if the program you are considering offers Profit-share.
The success of a VSC program begins with the staff. All companies offering VSC and MBI plans understand training is essential to create that comfort with the product. Their training manager will ask about previous challenges to ensure past mistakes are overcome.
Also, your production goals are important, as the training process can be tailored for your definition of success.
- Ensure your LOS can accommodate lengthening a loan term in order to keep the payment within the member’s budget.
- Consider offering some type of staff incentive. While not mandatory, we find that credit unions using them experience higher penetration rates.
- Ask about how you might be able to offer and remotely close without staff involvement
- This is most useful for selling as a product long after loan closing.
9. Offering Platform
Menus make choosing easy. Whether GAP or your other ancillary protection programs, simple is king. And a “menu-selling” system that integrates with your lending platform is ideal.
Share details about your Vehicle Service Contract, then seamlessly transition to other lending products, including GAP, Depreciation Protection, and Payment Protection.
All of the major providers have menu-selling systems. However, two require the menu have only their products. Is using one company for everything best for the credit union and members? Only you can answer that.
Besides simplifying the display of products, menu-selling makes price comparisons easy, too. The monthly payment updates as products get added, upgraded, or removed. Like your online shopping carts.
Make it easy to checkout now and book those loans!
- Ensure provider has seamless integration with your LOS
- Look to providers with a “menu-selling” system to simplify product offering
- Want member choice? Consider an “agnostic” platform, allowing you to offer products from a range of companies.
Let’s get it out of the way now: Any VSC program you choose will sell at a substantially lower cost than a comparable one from a car dealer. Simply put, their markup is much higher.
So, what determines the price of each? VSC providers underwrite risk in their own fashion. While new vehicles always share the lowest rates (as they’re also covered by a manufacturer’s warranty), that’s where the similarities end.
In a comparison, you may find that one provider consistently charges less for pre-owned imported sedans. Yet another has extremely competitive rates for domestic trucks and SUVs. Neither makes one better (or worse) than the other.
Terms and deductibles may also differ. It’s about finding the right combination of every factor for your credit union and its members.
- Prepare a cost matrix for due diligence. Request pricing from each company on a sampling of vehicles within your loan portfolio.
- Of course, cost isn’t everything. It’s about the overall value. A slightly more expensive plan that keeps members happier at repair times may be worth the tradeoff.
- Choose by factoring everything you learned from Checklist items 1-9.
Stay Protected On Your Learning Drive
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Take a look at our other content to help you choose and maximize your Vehicle Service Contract program:
- Best Financial Institution VSC Providers
- VSC Programs – Pros, Cons, & Finding The Best Fit
- Ultimate Guide to Vehicle Service Contracts [eBook]
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