August 7, 2008

Flat Rate Extended Warranties:

For shoppers, the choice at the cash register is to say yes or no. The competition is between administrators vying for exclusive contracts with the retailers. But now there's a new choice, for consumers to go home and buy their extended warranties over the Internet.

It's been a few years since anybody took on the task of trying to change the way business is conducted within the extended warranty industry. Not since Wal-Mart and Target debuted discounted extended warranties to match their discounted merchandise has anybody so threatened the status quo.

GreenUmbrella.com Inc., a new online service launched by credit report giant Experian plc, aims to sell service plans directly to consumers at a flat rate of $9.95 per month, no matter how many products they want to cover.

Online sales by dot-coms have been offered before by independent vehicle service contract administrators, but are a relatively new phenomenon in the home electronics, computer, and appliance industries targeted by GreenUmbrella.com. Monthly pricing is a trend that's been seen promarily within the mobile phone industry, and is sure to worry actuaries everywhere as it spreads to other product types. But one single monthly premium to cover an unlimited number of items, as GreenUmbrella.com offers, is a completely new concept.

Some say GreenUmbrella.com is too expensive, costing potentially as much as $358.20 if a single product is covered for the maximum 36-month term. Others say it's too cheap, given the real possibility that premiums won't cover the cost of repairing failure-prone items such as laptops.

Eliminating the Middleman

Apparently, it's the magic of the Internet that allows GreenUmbrella.com to charge only $9.95 a month. But if that's the case, it won't be long before other companies launch their own online plans. Banks, utilities, airlines, or even copy shops -- anyone with a strong brand name and a Web site -- could team up with an extended warranty administrator and begin to compete with those allegedly aggressive in-store salesmen.

Manufacturers might get into the act too. After all, why can't Dell sell an extended warranty for an Apple computer? Retailers might even begin to poach one another's customers, urging them to buy their warranties online after they finish shopping elsewhere for the best price on the merchandise. They might even devise a set of terms and conditions that allow them to offer subscription plans for only $5.95 a month.

In any extended warranty transaction, there are usually going to be four participants: the buyer, the seller, the administrator, and the insurance underwriter. With traditional sales channels, prices tend to be higher because the seller is collecting a lucrative sales commission in return for exclusivity. It's then up to the administrator to do all the work, registering the sale, arranging for repairs, and paying claims.

In a traditional retail setting, the buyer has only two choices: to buy or not to buy the service contract. Retailers are frequently criticized for pushing too hard to close the sale, but industry averages suggest that despite all this pressure, three out of four buyers usually say no. Now, thanks to online alternatives such as GreenUmbrella.com (and SquareTrade, and soon others), the customer can choose instead to say no and then go home and buy coverage online.

In the automotive sector, online service contract sellers frequently attribute their lower prices to the way they "cut out the middleman" and sell directly to consumers. But almost as frequently, these dot-coms go out of business after discovering how expensive automotive extended warranty claims can be, especially when the repairman has no incentive to hold the line on claims costs. So one day, customers who thought they got a great deal paying half-price for a vehicle service contract find the administrator's phone has been disconnected and all unpaid claims are being referred to a bankruptcy court in the Cayman Islands.

Mike Balducci, general manager of GreenUmbrella.com, says that won't happen here. "We're not just a fly-by-night dot-com," he told Warranty Week. "We're wholly-owned by Experian, and we operate within Experian Interactive, and Experian is committed to making this work."

Corporate Structure

Experian may be new to the game, but the claims administrator that stands behind the company is one of the veterans. Backing up Experian is The Warranty Group, formerly the Aon Warranty Group and before that Pat Ryan & Associates Co., which since 1964 has sold extended warranties for automobiles and later for electronics, appliances, and computers.

In this instance, GreenUmbrella.com is acting as the sales agent, while The Warranty Group is the administrator and its wholly-owned insurance affiliate -- the Virginia Surety Company Inc. -- is the underwriter. GreenUmbrella.com, based in Irvine, Calif., is owned by Experian Interactive, a unit of Dublin-based Experian plc. The Warranty Group is owned by an investment arm of Toronto-based Onex Corp.

Experian, a US$4.1 billion company, is one of the three leading credit reporting agencies, the others being Equifax and TransUnion. The company's databases hold information about the credit status of more than 460 million consumers and about 35 million businesses around the world.

Experian Interactive, which sells some of that information online, also has branched out into other aspects of electronic commerce. Its Internet properties include Experian Consumer Direct, Experian CheetahMail, AutoCheck, Affiliate Fuel, ClassesUSA.com, PriceGrabber.com and LowerMyBills.com.

Service plans offered by GreenUmbrella.com are issued, serviced and administered by companies owned and operated by The Warranty Group. In most states, the service plans are issued and serviced by an entity called National Product Care Co. But in Arizona, Florida, Wisconsin and Oklahoma, the service plans are administered by Service Saver Inc. Both are wholly-owned by The Warranty Group, and both are underwritten by Virginia Surety.

Onex acquired The Warranty Group from Aon Corp. in late 2006 in a transaction that valued the company at US$800 million. Onex is also the current owner of Allison Transmission, Hawker Beechcraft, Celestica, and numerous other acquisitions. Revenue in 2007 topped CA$23.4 billion, of which approximately US$1.3 billion came from The Warranty Group.

Virginia Surety, founded in 1927, handles underwriting for The Warranty Group in both North and South America. Underwriting in the rest of the world is handled by another unit of The Warranty Group called London General Insurance Company Ltd., which was founded in 1899. A.M. Best, an insurance company rating agency, gives a grade of A- (Excellent) to both underwriters.

The point of all this background is that both companies are large, established and well-funded multinational operations, not some fly-by-night dot-com run out of a spare bedroom. But still, how did they end up partnering on a flat-rate online extended warranty offering like this? Service plans may be The Warranty Group's core business, but Experian is a newcomer to this business.

Tradition vs. Innovation

"We had partnered with The Warranty Group on some of their other property and casualty insurance products," Balducci said, "and they approached us and wanted to discuss how we could partner on selling extended service plans."

However, The Warranty Group at least initially wanted to take a traditional approach, Balducci added, selling plans of defined durations for defined prices. "You would input the product you wanted to cover and they would tell you how much it was going to cost," he said. "I didn't think we could be successful marketing something like that."

Balducci and his team proposed a flat-rate subscription plan that would cover electronics, appliances, and computers from month to month. And while that approach may have been something new in extended warranties, it was a model that Balducci said he had seen prove itself in other markets such as Internet access and mobile phone plans.

That's not to say everybody was in favor of the flat-rate plan. While the marketing people loved the concept, some of the financial types didn't. "As we were dealing with some of the actuaries and finance people, there was certainly some skepticism," Balducci said. Some worried if the revenue stream would support the heavy marketing costs, while others worried if it would be sufficient to pay claims. "But we're pretty confident we can make it work."

Balducci said he thinks it was simply a matter of good timing. Both companies were in a position where they shared an appetite for new ventures, he said. "And having had a partnership with them in the past, we were comfortable working with each other," he added. "There was a level of trust there."

Shutting Off the Clock

Once upon a time, both Internet service providers and phone companies charged by the minute, resulting in mammoth monthly bills for customers who didn't watch the clock. And then along came carriers that changed the rules by charging a set flat rate for an unlimited amount of usage.

However, here we're not talking about eliminating worries about piling up per-minute charges. Here we're talking about getting rid of the per-product charges for service plan coverage. And while from a consumer's point of view that may greatly simplify costs, from an insurance underwriter's point of view it greatly complicates matters.

Let's face it, home electronics are not as unreliable as the salesman pushing those extended warranties make it seem. In many of today's digital products, there's few moving parts and little that's subject to wear. So whatever's going to happen will usually happen right out of the box. And the technology advances so quickly that the units are more likely to be discarded in perfect working order long before they reach old age.

Oh, that's just an old wives' tale -- an urban legend, you say? Actually, there's some unbiased math which suggests that warranty costs are just a minor problem for many top brands. Back in the July 3 newsletter, for all you Americans who were headed for the shore that holiday weekend, we detailed the real world warranty costs of Sony, Hitachi, Matsushita, and Canon, and three of the four had never reported spending more than 1% of their product revenue on warranty claims.

The only one that went over 1% was Sony, and we believe that had a lot to do with not only its battery problems, but also with its presence in the computer industry. Computer manufacturers traditionally end up paying out 2.5% to 4% of their revenue in warranty claims, as do many of the top appliance manufacturers.

Which is why it gets complicated when everything is flat rate. Can the underwriter make enough money off the people who insure electronics that don't break to pay the claims of people whose computers and appliances definitely do break? Even the extended warranty skeptics at Consumer Reports concede that laptops merit a service plan. Wonder what they'll think of a $10/month contract when they draft their next Christmas-spoiling annual report?

Difficult To Compare Prices?

The problem one faces when trying to compare $9.95 a month to more traditional pricing plans is that first you have to develop a model based on theories, opinions and estimates. In this case, GreenUmbrella.com is expecting its average customer to buy five to seven covered items per year. So that's simple, right? Multiply $9.95 by 12 months and divide by five and seven to figure out how much each product's coverage costs.

And then GreenUmbrella.com expects those five to seven purchases to cost a total of around $1,352, meaning that its $119.40-per-year coverage will add only 8.8% to the annual bill for the average consumer. So that's a bargain, comparable to the discount extended warranties offered by Wal-Mart and Target, right?

Not so fast. The way GreenUmbrella.com works is as follows. When you first sign up, you can register any covered items purchased within the last 60 days. As long as you continue to pay the $9.95 monthly premium, that coverage can last as long as 36 months per product. As you make new purchases, you can cover them by registering them on the GreenUmbrella.com Web site within 30 days of purchase.

Only two claims are allowed per customer within any 12-month period. The plan provides only secondary coverage, meaning that the customer must first try to collect from the manufacturer if the product warranty is still in force. The only significant enhancement versus the product warranty is that GreenUmbrella.com will cover items damaged by voltage spikes, which most manufacturers' warranties exclude.

In terms of a no-lemon policy, after three repair attempts, GreenUmbrella.com will replace the item, but the replacement unit will not then be covered. The plan also does not cover products that have an individual purchase price in excess of $5,000 or products that do not come with a manufacturer-issued warranty of at least 90 days. It does not cover floor models, refurbished units, items bought used, or gray market items sold "as is" at a bargain price.

The cost of removal, reinstallation, or in the case of a replacement, the disposal of the old unit, is not covered. Depending on the size and weight of the unit, repairs are performed either on an in-home visit by an authorized technician or as a carry-in to an authorized service centers. The Warranty Group, as a veteran administrator, has a plentiful supply of both. If the customer would rather mail the product back to the service center, they will have to pay their own shipping charges.

The following product types are eligible for coverage:

Electronics:

Alarm Clocks, Camcorders (Analog and Digital), Cameras (Analog and Digital), Car Audio (Radios, Amplifiers, CD Players, CD Changers, Equalizers, Speakers, Subwoofers), Car Videos (DVD Players and Video Monitors), Home Audio Components (Non-Portable: Amplifiers, CD Players, CD Changers, CD Players/Recorders, CD Recorders, Equalizers, Receivers, Tuners), Home Speakers, Home Theatres in a Box, Home Video Products (DVD Players, TV/DVD Combos, TV/VCR Combos, TV/VCR/DVD Combos, Digital Video Recorders, Digital Satellite Systems, HDTV Receivers), MP3 Players, Portable Electronics (PDA's, Satellite Radios, GPS, DVD Players, Telephone (Not Cellular)), Radar Detectors, Boom boxes, Televisions (CRT Projection, CRT Televisions, Front Projectors, LCD Flat Panels, Microdisplay Rear, Projection and Plasma).

Appliances:

Air Purifiers, Blenders, Bread Makers, Clothes Steamers, Coffee/Espresso Machines, Cooktops, Dehumidifiers, Dishwashers, Disposals, Downdrafts, Dryers, Electronic Can Openers, Electronic Tooth Brushes, Electronic Shavers, Floor Cleaners, Food Processors, Freezers, Fryers, Griddles, Grills, Grinders, Hair Dryers, Humidifiers, Ice Machines (Free-standing), Indoor Grills, Irons, Juicers, Microwaves, Mini-Refrigerators/Freezers, Mixers, Ovens, Portable Heaters, Ranges, Range Hoods, Refrigerators, Rice Cookers/Steamers, Rotisseries, Sewing Machines, Slow Cookers (Crock Pots), Steamers, Small Portable Appliances, Space Heaters, Toaster or Toaster Ovens, Trash Compactors, Vacuums, Vacuum Sealers, Waffle Makers, Warming Drawers, Washers, Window Air Conditioners, and Wine Coolers.

Computers:

Copiers, Desktop Computer Systems, External Electronic Computer Accessories and Electronic Peripheral Devices, Flat Screen Monitors, Laptop Computers, Monitors, Pocket PCs, Printers (Laser, Dot Matrix, or Ink Jet), Printers (Multifunctional), and Paper Shredders.

Source: GreenUmbrella.com

So let's assume there's someone out there that signs up for GreenUmbrella.com and registers one of each of these product types. That could be an actuarial nightmare for The Warranty Group. Surely, something will be breaking down at any given moment, and soon the technicians will be on a first-name basis with the customer. And $9.95 a month won't even begin to cover the cost.

Alternatively, let's assume our customer is closer to the average, and buys only five to seven units per year. Not only the premium repeats, but also the purchases. In year one they have five to seven covered units. In year two they have 10 to 14 covered units. And in year three they have 15 to 21 covered units. But that assumes they keep paying every month. Stop paying for just one month and everything older than 60 days is ineligible to go back on the plan if and when payments resume.

Or let's assume that the only item a customer ever buys is a $1200 Dell laptop. Dell's price for a three-year extended warranty is $300. SquareTrade would cut that price by 60%, charging only $120. But GreenUmbrella.com would cost almost $120 a year, or $358.20 for the full 36 months, if one were to attempt an apples-to-apples comparison. That's more than even Dell would charge. And there won't be a fourth or fifth year of coverage, which at least in the case of major appliances, are when failure rates escalate.

Like we said, in order to compare prices, one has to inject some theories, opinions and estimates into the pricing model. Depending upon those assumptions, GreenUmbrella.com could turn out to be a bargain for certain customers (and a nightmare for the underwriter) or GreenUmbrella.com could turn out to be an overpriced service that disguises its true cost by chopping into acceptably small monthly payments.

It's far easier to look at mobile phone extended warranties, and to compare the relative cost of monthly plans. After all, how many mobile phones can one family have? But even there one finds complications, such as the typical $50 deductible applied to a claim (GreenUmbrella.com has no deductibles), the tendency to find mysterious water damage that invalidates claims, and the tendency of carriers to sell handsets below cost and to insist on multi-year contracts to lock-in the customers who buy them. So even if there was a cheaper service plan available, it might also involve the pain of switching carriers or the penalties of canceling contracts.

Impact on Retailers?

And then there's the question of what other effects GreenUmbrella.com might have on The Warranty Group. As a newcomer to extended warranties, Experian has no market share to protect. However, The Warranty Group partners with other sales agents besides Experian, and they could feel genuinely threatened by a flat-rate online sales model.

GreenUmbrella.com's central pitch to the consumer is to say no in the store, go home and sign up. And once a customer signs up, they're probably going to always decline an in-store purchase, to spread the monthly cost over more items and improve their odds of collecting. For the same reason, they're likely to register items with GreenUmbrella.com that they would never have otherwise considered for extended warranty coverage (alarm clocks, anyone?).

Therefore, as the administrator for GreenUmbrella.com, The Warranty Group might find it's covering more units than if each customer was paying per item. And it might find attachment rates are dropping for in-store purchases, assuming that the buy-at-home concept catches on.

For SquareTrade and its underwriter, this is not so much of a problem. SquareTrade is backed by AmTrust Financial Services Inc., which like Virginia Surety carries an A- (Excellent) rating from A.M. Best. But both SquareTrade and AmTrust have a relatively small market share in extended warranties, and they don't have a long list of large and established retailers that are angry that their erstwhile partners are goring their oxen.

Then again, the non-automotive market share of The Warranty Group and its underwriters isn't what it used to be either. Ten years ago, its support of an online competitor to the traditional in-store retail model might have made many angry retailers depart the Aon Warranty Group for the more understanding arms of administrators such as Service Net Solutions, NEW Customer Service Companies, Warrantech, or the Warranty Corp. of America. The sad truth is that at this point, they've already left for other reasons. So The Warranty Group may also have nothing to lose by backing GreenUmbrella.com.

Representatives of The Warranty Group declined to respond to requests for comment.

Competitive Landscape

Usually, each retailer offers service plans administered by one company. So in terms of competition, the customer in the store really has a choice of one company's plans, though of course they are free to say no. The competition is really between administrators, each of which will do its best to entice the others' retailers to switch.

In the U.S., at least, for extended warranties that cover electronics, computers, and appliances, the vast majority of the contracts are sold by retailers backed by third party administrators and insurance underwriters. In Europe, some of the retailers are self-insured and are also in some cases acting as their own administrator. There are still a few retailers in the U.S. doing business that way, but most long ago turned to third parties. Some have taken a hybrid approach, managing their own repairs but contracting out the call center and insurance underwriting functions.

The latest trend is for the manufacturers themselves to sell their own brands of extended warranties. Some partner with their retailers, while others compete, waiting for the retailer to fail to close the sale before approaching the customer. Some manufacturers will even wait until the product warranty is about to expire before making their pitch by phone, email or postcard.

And then there are a small but growing number of companies, unaffiliated with either the retailer or the manufacturer, that are selling extended warranties direct to the consumer, primarily over the Internet. GreenUmbrella.com and SquareTrade are some of the first to give it a try. But even SquareTrade partners with some of the smaller online retailers, especially those that sell their wares on eBay, helping them to offer extended warranties on their Web pages.

Also, unlike GreenUmbrella.com, SquareTrade is selling the same old fashioned individually-priced contracts as do the retailers and manufacturers. And let's face it, all the major retailers (except Costco) sell extended warranties not only in-store, but also online (although with big ticket items such as refrigerators and washing machines, some retailers are finding follow-up phone calls to be more effective than radio buttons on Web pages).

Building Brand Awareness

The main obstacle for GreenUmbrella.com is simply making consumers aware that they can now choose to say no in the store and wait until they get home to buy an extended warranty online. Neither Experian nor The Warranty group has a very strong brand awareness among consumers, and frankly, GreenUmbrella.com sounds like the name of a top 40 pop radio hit -- not an extended warranty company. So Experian is going to have to spend quite a bit of money on promotions and advertising.

Balducci said it's in the budget. "We have to educate consumers that there's a now way to protect your stuff," he said. "If you're looking for that peace of mind that comes with an extended service plan, there's an alternative now."

So why hasn't such an alternative been there all along? Why has it taken 14 years since the Internet became a force in electronic commerce for online companies to mount a serious challenge to the dominance of the retailer in terms of extended warranties? It can't be a technical hurdle, because all of these retailers offer extended warranties on their own Web sites. So what is it?

"I go back to the monopoly of opportunity that traditionally the retailers have had on this opportunity, and the point-of-sale presence," Balducci said. Simply put, there's no competition at the cash register. And the cashier isn't going to mention the alternatives. "So it's going to be a challenge for us to market this. It's a different way to protect your purchases. And we're going to be up against retailers that have a vast majority of the market share, as well as the manufacturers that have an existing relationship with the customer."

Bottom line: It won't be easy.





AMT Warranty Corp.
Fulcrum Analytics
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