What are the Three Viable Options for an OEM or Retailer Service Contract Program

For a new program, there are three basic options for structure and approach. Each option includes many details, and this summary provides a high-level overview of those options.

Build

Building your own in-house program involves establishing an obligor company (the entity authorized to issue service contracts) in states that require one. This generally includes:

  • Filing for a license where required.
  • Demonstrating how you will financially back the service contract, where required.
  • Creating and filing terms and conditions where required. 
  • Ongoing state filings and audits in some states.
  • Ongoing actuarial and financial reviews with some states.
  • The costs to obtain initial licensing are well into six figures, including legal support and state fees, for a 50-state solution.   This varies depending on how many states require licensing, which in turn varies by product type.
  • Approximately 30+ states will require an insurance policy to back service contracts, or bonds and cash reserves (reserves are typically 40% of the contract’s retail selling price, plus an additional 5% held by the state), or some states offer a financial guarantee exemption if the company has over $100m in net worth. Each state has its own requirements.
  • This process typically takes 3-6 months for 46 states and an additional 6-18 months for the remaining states. 
  • In this scenario, you bear all the risk, retain all the program’s profit, and perform all functions. 
  • Some states may offer different levels of exemptions for certain requirements. These exemptions are not consistent and vary by state. You should conduct a 50-state legal review to identify what exemptions exist for your business and which sections may apply.

Buy

This is a straightforward option. You are given a wholesale cost from a third-party obligor, who assumes all risk for claims and generally retains any underwriting profit.

This is often a more expensive option, since the obligor faces true underwriting risk and will typically require a conservative pricing model to compensate for it.  The advantage is that the OEM/Retailer simply buys, marks up, and resells the program.

You may need an administrator license in a handful of states, depending on how you handle claims, or the third-party may serve as the administrator.  You may need to work with the obligor to develop a set of terms and conditions for your products and determine who would pay for the costs of the creation and filing of the terms and conditions, since it is not likely that any shelf product would work.

The obligor may set a minimum writing term and/or a minimum revenue level. This option assumes you generate enough revenue for the obligor to enter into an agreement.

Partner

This is a hybrid model and is very common among well-known Original Equipment Manufacturers and Retailers.  It provides the best scenario for controlling the products, controlling the customer experience, and retaining underwriting profit. The program has to be large enough for a third party to engage with, since it’s a fee-only model.

In this model, the OEM/Retailer partners with a third-party obligor that already has insurance coverage and complies with applicable state laws. The initial costs are relatively low and depend on the program’s size, scope, and scale. 

The OEM/Retailer may need to pay a one-time fee to have a set of terms and conditions developed and filed for the obligor, depending on the program size and structure.   This cost varies based on the level of effort required to create the terms and conditions and the number of states that require filing (by product type).

The OEM/Retailer may also need to get an administrator license in some states. Using a third party for this process is fairly easy and efficient.

The OEM/Retailer will need some level of underwriting or actuarial data to validate rates and reserves.

The obligor may request a written term and a minimum premium (fee).  The premium (fee) is calculated as a percentage charged against the claim reserve amount.  The term ‘premium’ may refer to the claim reserve, the insurance policy fee, or both; this varies depending on the program’s structure. 

Premium (fee) is calculated using a ground-up build to determine how much to set aside for future claims (claim reserve), then applying a percentage to the claim reserve to arrive at the premium (fee).

A properly structured program has a low cost to the client and allows the client to realize underwriting profit when the contracts are earned.

Contact Mike Frosch, president of Meramec Secure, Inc., for a no-cost discussion of the details of each option and how they would fit your business. Book a Zoom Meeting: https://calendly.com/mike-frosch