Insurer’s problems force tough choices
By Donna Harris
Automotive News / June 30, 2003
Five thousand dealers who sold service contracts under the financially troubled Smart Choice program may have to choose between two evils – pay off hefty repair claims themselves, or tell angry customers to slug it out with insurers.
Either way, some dealers could lose.
According to DeltaGroup – a Dallas firm that markets Smart Choice – 5,000 dealers nationwide sold the contracts. Sales started in 1984 and recently were 15,000 per month, DeltaGroup says.
National Warranty Insurance Co., which insured the contracts, declined to say how many contracts were outstanding or to comment on any other aspect of the situation.
Agents and dealers say that National Warranty has stopped paying claims on its Smart Choice warranty. If reinsurers refuse to pay for consumers’ vehicle repairs, dealers who marketed Smart Choice may be liable for warranty claims worth tens of thousands of dollars.
The contracts, which can range from one-year to 10-year terms, cover repairs and parts for vehicles out of warranty. According to dealers, they sell a typical three- to five-year extended-service contract for $800 to $1,500. Some dealers may try to cancel the contracts because it may be cheaper to issue a refund than pay for a $6,000 engine job, says Kirk Borchardt, a Santa Barbara, Calif., lawyer who represents Smart Choice agents and their dealers.
But it’s not clear whether that’s necessary – or possible. Dealers have been in limbo since June 6, when Smart Choice administrator and insurer National Warranty Insurance Co. obtained a Cayman Islands court order protecting it from creditors. In July, the court is expected to determine whether the company should be liquidated. If declared insolvent, all contracts likely will be canceled. The company and possibly its reinsurers will be ordered to issue refunds, says Borchardt.
Insurance companies typically contract with reinsurers to spread the risk of unusually large claims. But it is uncertain whether National Warran- ty’s reinsurers will cover the losses, Borchardt says. If the funds are depleted, consumers may demand payment from dealers, he says.
Rex Moats, a lawyer for National Warranty, declined to comment on any issues relating to Smart Choice.
Judging by the experience of dealers in Las Vegas, Smart Choice seems likely to become a public relations disaster. Dealers in that city aggressively marketed Smart Choice. Now several dealers are holding customers’ vehicles until they pay for repairs. The customers insist the repairs should be covered, but the dealers insist they are not liable.
"The dealers are holding customers’ cars hostage," says Tom Jacobs, a spokesman for the Nevada Department of Motor Vehicles, which regulates vehicle service contracts. Last week, the department urged those motorists to file complaints. The department has received 50 inquiries, and 17 complaints were filed, Jacobs says.
Other Las Vegas dealerships are paying off repair claims, but they aren’t happy about it. "I am concerned we are going to be left holding the bag on 700 warranties," says Tom Downer, COO of the Fletcher Jones Management Group. "I won’t believe anything until I see some claims money."
Strong for years
For years, there had been little reason to worry. National Warranty, which is based in Lincoln, Neb., and incorporated in the Cayman Islands, had been in business since 1984.
The company was the underwriter for a number of extended service plans sold by dealers to consumers. National Warranty marketed Smart Choice to dealers through agents employed by DeltaGroup.
To protect itself from excess claims, National Warranty contracted with well-known reinsurers such as Signet Star Reinsurance Co. of Florham Park, N.J., and American Safety Insurance Group of Hamilton, Bermuda. only four months ago, National Warranty was rated A- by A.M. Best, a firm that monitors the financial strength of insurers. But dealers and agents suggest that National Warranty’s contracts were priced $200 to $300 below market, and it may have been too generous in paying for repairs. Some say it could have scrutinized claims more thoroughly.
Dealers face tough choices.
Customers could blame them for selling them a worthless contract. And if a dealership pays for the repairs as a goodwill gesture, it might be held legally liable for other contracts, says Mike Charapp, a Washington dealer attorney.
"The problem with starting to cover repairs is once dealers start eating repairs, where do they stop?"
That question worries Chicago dealer Jeff Jacobs, owner of Jacobs Twin Auto Plaza. When he started selling Smart Choice in 1996, the warranty looked rock-solid.
But in the last three weeks, Jacobs has paid $30,000 for customer repairs that should have been covered under the contracts. He stopped selling Smart Choice three years ago, but Jacobs still has 2,500 contracts outstanding. The company that insures Jacobs’ dealership has told him the claims are not covered under his general liability policy.
"You are more likely to get claims as the cars get older," says Jacobs, a multifranchise dealer with $150 million in annual revenues. Transmissions and engines can cost $3,000 to $7,000 to replace, he says.
If a dealer gets two or three such claims a month, he may end up spending $100,000 to $200,000 a year on repairs.
Says Jacobs: "This is a snarled mess with no easy answers."