Warranty Week estimates the U.S. service contract industry generated $40 billion in revenue in 2016 with $17 billion from vehicle service contracts and $23 billion from all other products and devices. Personal Safeguards Group estimates U.S. consumers spent approximately $33.4 billion on new and used vehicle service contracts (at retail prices) in 2016. The numbers are hard to pin down, in part, because of the different ways contracts are classified and revenues reported. Sellers report revenue from retail sales whereas administrators report revenue from wholesale sales, and insurers report gross written premium. Warranty Week attributes slightly more than half the total volume to ten major players and the balance spread among 140 administrators and 33 admitted insurance companies. Any way you measure it, it’s a big industry, and getting bigger.
On the heels of the Extended Warranty and Service Contract Innovations Conference held last month in Nashville, and coming off several projects for clients pushing the traditional limits of protection plans, I thought it was time to reconsider what’s next for the industry. Where is the industry heading? Not necessarily the road or roads ahead but the general direction of all the roads and the common markers found along the way.
I identified five major trends that are surfacing in the industry. Each was very much in focus at the Conference and I am seeing evidence of them developing in real time.
Five major trends
- Prediction and Prevention
Personalization refers to two trends that are intertwined as one, like the two strands of DNA. One strand is social media and the new direction of marketing and messaging. There is a continuing and accelerating movement to social media as the dominant channel for reaching prospective customers. It is a very personal medium and it requires the level of interaction and response one expects from one’s closest friends and family. It is forcing marketers to rethink their messaging and develop new capabilities for conversing with customers. The thing about conversing with customers is they get to talk back. Customers are shouting their expectations, frustrations and unbridled opinions about the products and services they receive. They complement and complain. They demand answers. They document in painstaking detail the responses they receive. The other strand is products and services. Parsing the tweets and posts leads to an inevitable conclusion – customers want personalized products or, at a minimum, products that meet their personalized needs. Personalized messaging and personalized products and services will dominate the new landscape. Customers want what they want, how they want it, when they want it, and where they want it.
Pricing will be squeezed. Inefficiencies and friction will be forced out. Fat commissions will fall away. The information gap in the extended warranty space is closing fast. Customers are learning the component parts of pricing and coverage. Extended warranties and protection plans are one of the last insurance-related consumer products with sales expenses at 3 and 4 times the cost of the underlying risk and administration. Markets are imperfect but they are self-correcting and the time is coming when new competitors will market protection plans far more efficiently. Many have tried. Many have failed. But some are beginning to gain traction and as they do the speed of price compression will be astonishing.
Even as prices fall due to compression, payment terms will evolve toward a subscription. Investors in extended warranty companies have long been attracted by the upfront collection of premiums for longtail risk. While sellers profit from big commissions, insurers and reinsurers profit from investment income that begins day one on reserves that won’t pay claims for months or years. The premiums collected upfront on vehicle service contracts are nearly always financed. The premium is rolled into the auto loan when plans are purchased together with the vehicle. But, when plans are sold later, such as via direct marketing, they carry a high cost for premium financing and payment processing. The days of upfront payments for protection plans might be numbered. The new payment model will look more like a subscription. The terms and conditions of plans will have to change and so will the reserving models. After-sale policies and plans will be rewritten to earn and renew monthly on subscription.
It is becoming increasingly difficult for providers to be vertically integrated. Even the top ten go outside for some of the services they require. Many, if not most, administrators and underwriters find their internal systems for contract and claims management cannot keep pace with innovations offered by third-party platform designers. Their go-to-market strategies are hindered by their antiquated marketing methods. They are tied to poorly documented proprietary source code that is increasingly difficult and expensive to maintain. They are slow to develop new products and add new features. They are flat-footed and standing on the sidelines watching social media pass them by. Their talent pool is shrinking. For many, the only way to keep pace is to partner with other specialized organizations. Many manufacturers are following the same route. General Motors is a case in point. GM partnered with Warrentech/AMT Warranty to underwrite and administer the Chevrolet-Buick-GMC and Cadillac Protection Plan. To launch the new Plan, GM partnered with GM Financial. Later, GM established its own specialized field force to install the program and train F&I managers at GM dealerships. GM partnered with MaximTrak Technologies to get an interactive F&I platform to streamline menu selling, enable electronic contracting, reporting, and compliance management.
Prediction and Prevention
The core value proposition for every extended warranty is peace of mind. An extended warranty is a promise to repair or replace a broken or failed product. Buyers of extended warranties know that products break and can be expensive to replace or repair. Their concerns are well founded and reinforced by well-trained sales reps schooled in the art of seeding fear of the uncertain financial consequences of a mechanical or electronic breakdown. Much of that is about to change. Predictive technologies are chipping away at uncertainty. Already there are onboard sensors and sophisticated monitors to detect problems with components long before they result in failure. Extended warranties and product protection plans, whether insured or not, conform to the basic principle of insurance. To be covered by insurance an accident or breakdown must be unexpected and unforeseen – a fortuitous event. Providers will not want to pay for breakdowns that could have been prevented. As predictive technology improves and more and more systems and components are monitored there will be a big shift from break/fix contracts to preventive maintenance contracts. Protection plans will morph into service plans and maintenance agreements.
The U.S. service contract industry continues to grow. There are ten major players but the industry is still highly fragmented. New entrants are challenging the status quo. Consumers are getting wise to the ways the industry has traditionally extracted profits. Competition and technology are driving down prices and the rise of subscription-based services is changing the way people think about paying for products and services. At the same time, machines covered by extended warranties are getting smarter. They are signaling when they need repair – before they break – taking the uncertainty out of the equation. The direction the industry is headed is becoming clear. How companies will get there remains to be seen.
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