In the early 2000s, manufacturer warranties were 36 months or longer and some manufacturers had begun to extend the base warranty further but limited the extended protection to the powertrain parts.
The original Limited Lifetime Powertrain Warranty (LLPW) concept was developed primarily for the Japanese makes. At that time, Toyota and Honda dealers were trying to hold the line on MSRP in the face of significant discounting by the American makes.
Also, they did not want to compete in a local market with other same-make dealers based on price. Having a program like LLPW would allow the Toyota/Honda dealers and others to have a distinguishing edge without compromising on the sticker price.
The idea of providing a complimentary extension beyond the new vehicle manufacturer’s base and extended powertrain warranty began to take shape. Given the manufacturer warranty protection, another extension had to be inexpensive. The marketing team got excited: "Should we go to seven years, 10 years? Wait, how about a lifetime powertrain warranty? What could be better than a lifetime extension?"
The idea went beyond the marketing team, but the wet-blanket actuaries and risk managers threw cold water on the deal. It wasn’t pricing that presented the challenge; in fact, with fairly reasonable contractual provisions, controls and requirements, the underlying loss cost for a new Toyota or Honda was only about $50.
The problem was risk management. The new-vehicle buyer is told that if he meets the manufacturer’s maintenance requirements (and keeps meticulous records of compliance), he has powertrain coverage as long as he owns the vehicle.
The actuaries could project the pattern of when the exposure to loss would likely decrease, but how would the risk taker ever know if a particular vehicle owner no longer had protection? No vehicle owner would send an email saying, “Oops, I have not changed my oil in a year, you can take me off the active list,” or even, “You can quit worrying about me, I sold the vehicle today.” When do you ever get to take the reserves down?
It was Chrysler’s entry into the LLPW market in 2007 that appeared to give the concept a real future. Chrysler needed a sales boost, so it chose to include it on most new Chrysler vehicles.
Recognizing the need to bring closure to the loss exposure and always looking for an excuse to become reacquainted with the customer, Chrysler added the “every five years, return to the dealer” inspection requirement.
Within 60 days of the fifth-year anniversary, and every five years after that, the customer simply had to return to a Chrysler dealer for a complimentary inspection. Without complying with the inspection requirement, all coverage and loss exposure ceased. Chrysler could hardly take any of the reserve down for five years, but at least at the five-year anniversary it had a clear count of the remaining exposure and a chance to spend some quality time with a customer about the time that customer might be considering a replacement vehicle.
With the “five year, return to the dealer” requirement in place, several insurers were willing to insure the promise with a contractual liability insurance policy if the dealer would provide the protection on a complimentary basis. The dealer price for a new vehicle was about $200; a lot of cost to put on every vehicle sold just for the benefit of an unknown number of marginal sales decisions, the opportunity to pick up some additional scheduled maintenance visits and a nice long chat every five years.
GM followed suit for a short period, then thought better of the idea. Chrysler continued its program until early 2009, leaving the concept to be offered occasionally by individual dealers.
Rick Case was featured in an Automotive News story regarding a dealership promise to extend the Hyundai/Mitsubishi 10-year/100,000-mile powertrain warranty to 20 years/200,000 miles.
Given the basic requirements to qualify for a claim under the protection, it is likely that the dealership cost for that contractual liability insurance policy from Protective was inexpensive.
How Does a Warranty Differ from a Vehicle Service Contract?
Warranties are regulated at the federal level by the Magnuson-Moss Act. The principal constraints placed on a warranty are that (1) there cannot be any identifiable charge to the buyer for the warranty promise and (2) the protection must be provided to all buyers.
Most warranties are manufacturer warranties. The original manufacturer can warrant its products from defects and promise to repair or replace any defective part or product. Anyone in the chain of distribution can warrant a product that the wholesaler/retailer/dealer sells.
Finally, Magnuson-Moss permits third-party warranties. A party unrelated to the manufacture or sale of the product can agree to warrant a product. In many cases, the LLPW is a dealer-obligor promise backed by a contractual liability insurance policy or, in some cases, an administrator-obligor promise backed by a contractual liability insurance policy.
Pricing for New-Vehicle LLPW Contracts
The underlying risk is the failure of one of the listed powertrain parts. For ease of understanding and administration, the powertrain coverage is defined and described as being identical to the definitions and coverage in the manufacturer’s warranty or the extended powertrain protection.
Loss frequency and loss severity are actually fairly straightforward to determine. For manufacturers, they know the loss frequency and severity for the manufacturer's base warranty, the manufacturer's extended powertrain warranty and likely have experience through at least seven years of ownership drawn from VSC loss experience. Projecting beyond seven years is a straightforward task.
For insurers, the experience associated with the manufacturer’s warranty period is not needed since that period is excluded from the LLPW exposure. The insurers have access to extensive VSC loss experience and could project forward through 20 years of ownership.
The challenge is projecting the loss exposure. Start with 10,000 sales this month. For every month over the next 240 months, how many vehicles still meet the requirements to qualify for a claim if a covered part fails? The conditions for staying eligible for five or more years are reasonably tough to meet:
Coverage is only provided to the original owner.
Coverage excludes any repair covered by the manufacturer’s warranty.
Coverage excludes any repair covered by an optional VSC.
And, most importantly, the owner must fully comply with the manufacturer's scheduled maintenance plan and must keep records to support that compliance. The easy way to comply is to return to your original dealer who has graciously consented to keep meticulous records for you.
The pricing for LLPW is complex, but the best news is that the probability of a claim in the first five years is limited. Many manufacturer warranties have powertrain coverage up to 5 years/60,000 miles and at least 30 percent of the buyers will have purchased a VSC, thereby taking the no-LLPW-claim window up to 7 years/100,000 miles. Vehicles are sold, stolen, totaled and taken out of service for other reasons. We are still waiting for the tally of customers who satisfy the “every five years, return to the dealer” inspection requirement to see how much exposure remains from the early adopters of the LLPW concept.
A few insurers continue to be willing to insure LLPW for new vehicles and several now have programs available on used vehicles. The challenges a dealership faces today are far different from the heady days of 2006-2007.
The per-vehicle cost of LLPW is daunting, but an occasional dealer is willing to take the plunge, at least for a while, to test the marketing power of the concept.