New home construction is at its lowest level in years and the average price of existing homes continues to fall. Yet those who own a home continue to upgrade and replace their appliances and heating/cooling systems, and that is what's keeping their manufacturers open for business.

While the homebuilders saw claims peak in 2006, the home appliance and HVAC system manufacturers saw claims rise for an extra year, peaking in 2007 at a level of $2.087 billion. Claims then fell 11% in 2008, but slipped only 1.2% in 2009. In 2010, however, claims in this sector fell 12% to $1.613 billion, as a tough market deteriorated further.

To compile this warranty claims data, we're tracking 20 current and 27 former manufacturers of household, personal, and kitchen appliances and/or heating, ventilation and air conditioning systems. Since 2003, they each have included warranty expense reports in their quarterly and annual reports, in keeping with the FASB Inquiry Number 45 accounting rule.

Lag Time for Claims

The claims totals represent the amounts these manufacturers actually spent on product repairs and replacements. So it's no surprise that there's a bit of a lag time between when a product is sold and when it needs warranty work.

Accruals, meanwhile, are the amounts they set aside at the time a product is sold, in order to finance expected future claims for that product. In this respect, accruals represent what a company's planners believe will happen, while claims represent what actually happens. So while there should always be a lag time between a sale and a claim, there should be no lag time at all between accruals and sales. They should always rise and fall as a couple.

In Figure 2, the peak in accruals is still in 2007, but the gain in 2006-2007 is much less noticeable. And the decline in 2008-2010 is much more gradual, with a 74.% reduction in accruals in 2008 followed by a 2.9% reduction in 2009 and a 3.4% reduction in 2010.

As was detailed in the May 19 newsletter, the homebuilders saw claims peak in 2006 while accruals peaked in 2005. Their suppliers saw their warranty expenses peak a year or two later, as is detailed in this week's newsletter and in last week's. This suggests there is a lag time between the moment when a market peaks for its prime contractors (or OEMs, in PCs and autos), and its sub-contractors or suppliers.

Steady As She Goes?

The thing is, in terms of warranty costs as a percentage of sales, it's hard to find any evidence of a peak in anything. Instead, the makers of appliances and HVAC systems have remained within a tight range for several years. Since at least the middle of 2005, they have been paying out or setting aside roughly 1.3% to 1.7% of their product revenue to cover their warranty expenses.

Figure 3 shows these ratios over the past eight years. The highest claims and accrual rates came towards the end of 2006 and the beginning of 2007, with another peak in late 2009. The lowest claims and accrual rates came in the third quarter of 2003. If anything, the high and low bounds of the range seem to have tightened up in recent years. And the lowest claims rates since early 2006 were seen in the middle of last year.

In other words, there is none of the recession-induced divergence between claims and accrual rates that we've seen in other industries, nor the soaring claims rates that typically accompany falling sales totals. Instead, it looks like warranty costs were kept under control -- not too high, not too low -- for the duration of the downturn.

Volatility in Warranty Reserves

There is, however, some unusual activity in the warranty reserve fund totals for the appliance/HVAC industry. As can be seen in Figure 4, the total has risen in four years and has declined in four years (the 2002-2003 balance, not charted, grew 6.3%).

In 2005-2006, as accruals grew by 18%, reserves grew by 11%. In 2007, reserves fell 5.6%. The declines were -2.2% in 2008 and -3.8% in 2009. But there was a surprising 1.8% increase in the year-end 2010 balance. The cause of this is most likely the fact that industry set aside $61 million more in accruals than they paid out in claims last year.

However, the warranty reserve balance was also affected by the upwards changes of estimate registered by some of the industry's largest players, including Whirlpool Corp., United Technologies Corp., and Ingersoll-Rand plc, as well as the downward changes of estimate registered by Rockwell Automation Inc., Lennox International Inc., and others. And then there was the acquisition by Jarden Corp. of Aero Products International, Inc. (makers of the Aerobed), which added $5.2 million to that company's warranty reserves late in the year.

Figure 1 and 2 present claims and accruals, respectively, measured in dollars. Figure 3 presents these dollar amounts as a percentage of product revenue. And Figure 4 presents the resulting warranty reserve balance.

Capacity to Pay Claims

In addition to these metrics, we're going to calculate the reserve balance as a multiple of monthly claims payments. If a company has a warranty reserve of $10 million and is paying out $1 million per month in claims ($3 million per quarter), then its warranty reserve capacity would be 10 months. If reserves were to increase to $12 million and claims were to increase to $2 million per month, the capacity of the reserves would drop to six months. And so on.

In the appliance and HVAC industry, it turns out that most of the companies have claims and accrual rates slightly below the average for all manufacturers, but keep reserves slightly above the average. This, no doubt, has lots to do with the longer durations of the warranties they issue. In 2010, for instance, while all manufacturers averaged a warranty reserve balance equal to around 17 months of claims payments, appliance and HVAC manufacturers kept a balance above 20 months.

One can see from the data in Figure 5 that this was not always the case. For one year, in 2007, appliance and HVAC manufacturer allowed their warranty reserves to drop to only 16 months, slightly below the average for all manufacturers. In that year, seven of the top 10 warranty providers in the industry allowed their reserve capacity to fall, with only Trane Inc., Ingersoll-Rand, and Manitowoc bucking the trend by allowing their reserve capacity to rise.

Big Bump in 2007

Whirlpool, for instance, had a huge spike in claims paid during the second quarter of 2007. Though it also raised accruals, by the end of June 2007 the company had a warranty reserve fund balance of $284 million and was paying out $93 million a month in claims. So that's a reserve capacity of only 3.1 months!

By the end of 2010, Whirlpool's reserve capacity was back up to 6.5 months, and was close to seven months by the end of the first quarter of 2011. In Figures 6 through 9, we're including data for not only the eight years from 2003 to 2010, but also the just-arrived data from early 2011.

As can be seen in Figure 6, Whirlpool had what gentlemen would call a "warranty event" in mid-2007. But there was also a curious spike in accruals in early 2010, which unlike the 2007 event was not confirmed by a spike in claims. In fact, Whirlpool is now enjoying some of its lowest claims and accrual rates ever, if one dismisses the sudden and temporary drops seen in those metrics at the end of 2004 and 2005.

In other words, take out the spikes and the troughs, smooth over the bumps in the road, and look at the trend. Whirlpool, as it approaches its hundred-year anniversary later this year, has found a way to reduce its warranty expenses even as post-recession sales continue to rebound. That's worth a celebration.

Aerospace or Air Conditioning?

United Technologies is one of those conglomerates that's difficult to place into a single industry category. Its Sikorsky, Hamilton Sundstrand, and Pratt & Whitney units place it in the aerospace industry. Its Otis Elevator unit is a major supplier of building materials, specifically elevators and escalators. And its Carrier unit is the world�s largest manufacturer and distributor of HVAC systems.

Because of this unique structure, we included United Technologies in the Aerospace Warranty Report as an avionics and jet engine supplier. And now we're including it again as an HVAC manufacturer. But we're including the entire company's warranty data in each instance, so we're probably inflating the totals significantly.

Besides United Technologies, the only other significant warranty provider that's half in/half out of the appliance/HVAC industry is NACCO Industries Inc., which we track as an automotive company (for its forklifts), but which could also be tracked as an appliance company (for its Hamilton Beach and Kitchen Collection brands). So its absence from these totals in some ways compensates for the double-counting of United Technologies.

United spent more than Whirlpool on warranty claims in 2008 and 2010, though Whirlpool outspent United in 2006, 2007 and 2009. Considering that Whirlpool is strictly into appliances while United is about 60% in HVAC/elevators and 40% in aerospace, there's no doubt that Whirlpool is the largest appliance warranty provider in the U.S. But Carrier is still the largest HVAC warranty provider.

Another Bump in the Road

In Figure 7, we've detailed the claims and accrual rates of United Technologies over the past 33 quarters. Ironically, UTC also had a "warranty event" three years ago and a spike in accruals in early 2010 which was not confirmed by a spike in claims. And it had a sudden and temporary drop in both claims and accruals in 2003. But as with Whirlpool, if you smooth over those bumps, you're left with a steadily downward trend.

Except for that 2003 anomaly, United Technologies had never reported a claims rate below one percent until 2010. Its accrual rate, meanwhile, dipped below one percent in both 2007 and 2009. But in early 2011, it's back up again, over 1.4%, as it was at the beginning of 2010.

The problem, of course, is that we have no way of knowing how much of this good news comes from the aerospace side of the house, and how much of it is elevators and HVAC. All companies that follow FASB Inquiry Number 45 accounting rules usually release just one set of warranty numbers for their entire product line worldwide.

An HVAC Pure Play?

If there's a "pure play" left in the HVAC industry, it must be Lennox International. Carrier, Trane, and York are part of much larger companies. Goodman has gone back to being private. Rheem has always been private, so we have no warranty data for that company either.

The only thing in the Lennox product line that might not be HVAC is its fireplaces and wood-burning stoves. But then again, those are heating systems, no?

As can be seen in Figure 8, Lennox has always kept its warranty expenses within a narrow range. Except for upward bumps in 2006 and again in 2009, the company's claims and accrual rates have generally remained within a range of 0.9% to 1.2%. And this is significantly below the industry average as seen in Figure 3.

The household and personal appliance makers drive up the industry average seen in Figure 3, and also cause its volatility. In contrast, the HVAC companies are known for their steady warranty metrics and larger-than-average reserves.

In Figure 5, we saw that appliance and HVAC companies together have kept anywhere from 16 to 25 months of claims payments in their reserves. In contrast, a company such as Lennox has averaged 36 months of claims in reserve for the past eight years, with the ratio dipping below 30 months only twice.

Commercial Food Handling Appliances

Finally, we wanted to check in with the Middleby Corp., the parent company of an assortment of commercial cooking brands. If Lennox is a "pure play" in HVAC, then Middleby is its equivalent in terms of restaurant and food service equipment.

As can be seen in Figure 9, Middleby had generally declining warranty expense rates until 2009. And we think it's no coincidence that Middleby completed its acquisition of TurboChef Technologies in January 2009.

We last covered TurboChef in a September 25, 2007 newsletter, pointing out how the company did so well, and how the company's commercial ovens were so popular at sandwich shops such as Subway, that the units were wearing out long before their warranties expired. The result was a 48% claims rate in 2005.

And then we included a snapshot of Middleby in the October 22, 2009 newsletter, checking in to see how the first six months had gone after the acquisition. And we found that indeed, TurboChef's legacy of high repair rates had transferred over to the new parent. By the second quarter of 2009, Middleby's claims rate has jumped to 3.8%, while its accrual rate rose to 3.9%.

Figure 9 above adds another 21 months to that story. And it looks like Middleby is once again getting its warranty costs under control, and is once again seeing both its claims and accrual rates decline. But its most recent accrual rate -- just above three percent -- is really only back to where it was in early 2005. And its claims rate, at 3.7%, is back to 2004 levels.

Eighth Annual Product Warranty Reports

Here are the links to the online editions of all eleven parts of this series:

• Top 100 Warranty Providers of 2010
• 2010 Warranty Totals & Averages
• Automotive Warranty Report
• Aerospace Warranty Report
• Computer Warranty Report
• Disk Drive & Semiconductor Report
• Telecom Equipment Warranty Report
• Medical & Scientific Equipment Warranty Report
• New Home Warranty Report
• Fixtures, Furniture & Building Material Warranty Report
• Appliance & HVAC System Warranty Report

Readers needing more detailed snapshots of individual companies in either a PowerPoint or Excel format are invited to view the list of charts and spreadsheets available on the Warranty Statistics page.

Warranty Week Joins Facebook

By the way, Warranty Week recently joined Facebook, and we've begun posting links to our weekly newsletters on the page called "Warranty Week." If any of our readers are Facebook users, we encourage you to "like" the page and to write on its wall. If nothing else, it's a good way to get around the spam filters and corporate firewalls that sometimes impede delivery of the email and web editions of this newsletter.