Month-to-Month Vehicle Service Contracts

Vehicle service contracts have traditionally been sold as a single pay product purchased at the time of vehicle purchase. While the typical retail charge for the vehicle service contract (VSC) can be in the thousands of dollars, the availability of the vehicle finance contract provides a ready source of funds to pay the full cost.

However, there are many excellent marketing opportunities for a service contract where a finance contract is not available to pay this cost. These include:

• Follow-up sales after delivery of the vehicle
• Service drive sales
• Direct market sales
• Inability to finance the service contract with the lender

Currently, the typical approach in these situations is to use a finance company that specializes in VSCs to finance the cost over a period that is usually one-half or less of the time term of the VSC.

Month-to-month (monthly pay) VSCs are an alternative product for the above scenarios where special financing is otherwise needed. This product may also appeal to customers who do not want to pre-pay the cost of the VSC.

A month-to-month vehicle service contract provides one month of coverage for each monthly payment. The contract is generally renewable to a predetermined mileage and/or time limit and the monthly rate may be guaranteed for some or all of the term. The contract can be designed to renew at lower coverage levels and/or a higher price level as the covered vehicle ages, thus making longer terms more attractive to the administrator or underwriter.

Month-to-month VSCs are not likely to replace single pay VSCs in situations where funds are available to pay the total cost upfront for one obvious reason— cash flow. With a single pay contract, all parties involved in the transaction (dealer or seller, administrator, insurer, agent, etc.) get the money upfront instead of waiting for their share of the monthly payments. Most, not all, of the parties involved prefer to collect upfront.

Another disadvantage is that in some states an obligor can offset claims against cancellation refunds for a single pay VSC. This money is not available in a month-to-month VSC, so it must be considered in pricing.

There are advantages to the obligor for month-to-month over single pay contracts. In the case of cancellations, the refund due to the consumer will be much smaller since there is very little unearned exposure. This eliminates most of the unearned portion of the fees paid to every other party involved in the sale of the VSC and the possibility that that party won't be around to pay its share of cancellation refunds.

Another advantage is the ability to non-renew or adjust rates due to the experience of the service contract. For example, a problematic vehicle could be surcharged or non-renewed if there is a persistent issue of claims.

Currently, there are two approaches to determining claim eligibility under a month-to-month VSC— time only and time plus miles. Using time only, a vehicle is eligible so long as the monthly payments are made through the date of claim, subject to the overall mileage limitation. If eligibility is determined by time and miles, then each monthly payment extends the vehicle eligibility by one month and a certain number of miles. In this case, it is important to have some mechanism to make a reasonable estimate of miles driven per month at time of sale and to get updated information from the customer after initiation of the month-to-month VSC. If the customer is and continues to be a regular service customer, this information will be readily available at the time of sale and for adjusting the miles per month purchased in future months. If not, this information can be obtained by having the customer provide regular updates using an online form.

The time only approach is simple to explain and easier to administer at time of claim because a customer won't be in a position of needing to make extra payments to extend mileage eligibility in the event that he didn't purchase enough miles per month. However, the time only approach does create a subsidy of high miles per month drivers by low miles per month drivers. A simplistic example illustrates this point.

If the overall term and mileage limit for a month-to-month VSC is 72 months and 72,000 miles from time and mileage at purchase and the monthly charge is $40, a customer that drives 3,000 miles per month will exhaust the coverage in 24 months and pay a total of $960, but a customer that drives 1,000 miles or less per month will exhaust the coverage in 72 months and pay a total of $2,880.

A third approach that is not exactly month-to-month is providing coverage for the customer's maintenance interval. The service contract can be sold at the time of regular vehicle maintenance and designed to cover the time and miles to the next regular maintenance visit.

This month-to-month product design is very new, so there are issues to overcome for it to be viable in the long term. These issues include: adapting administration systems to capture monthly payments and make appropriate adjustments to determine claim eligibility and obtaining regulatory acceptance. The possibility of anti-selection will probably lead to a slow roll-out of this product within each market to ensure that customers will make enough monthly payments to cover any potential shortfall caused by early claims.

The month-to-month VSC has tremendous potential to favorably increase VSC sales to the many customers who are not able or would not prefer to finance their contract. In time, systems will be updated, regulators will be taught its value to consumers and the month-to-month VSC will become one of the standard products offered by VSC administrators.