At long last, our tour of the vehicle service contract industry is coming to an end. Those weekly snapshots are turning into a tour guide, and the size and shape of the industry is coming into focus.

This week we're looking at just the underwriters of vehicle service contracts -- the insurance companies that guarantee to pay claims if the obligor doesn't or can't pay within a given period of time. Vehicle service contracts aren't insurance products, but they are backed by insurance companies. But mechanical breakdown policies are considered to be insurance, primarily because they're sold by insurance companies. Crazy, isn't it?

Right before your eyes, we're going to develop a simplified model of the VSC industry -- one which we hope will be not only easy to attack but also worth trying to improve in the next version. We think it's incredible that throughout 2008 and 2009, when the "expired warranty" scam was in full swing, not even those with subpoena power were able to answer one simple question: How big is this industry?

What Do You Think?

We're foolish enough to try. But then again, we've been probing and interviewing and gathering snapshots for almost eight months now, knowing how little has been made public elsewhere. And therefore we want to get the model right. So we want to continue the discussion long after these pie charts are published. Please click on the "contact" button at the top right of this page and tell us what you think. Privacy and confidentiality are assumed unless the reader desires their comments or opinions to be made public.

We started publishing details on the mathematical model last week, providing estimates of 6.2 million contracts sold by auto dealerships this year, for which consumers will pay about $10.6 billion. With an additional $560 million generated through direct-to-consumer sales, we pegged the 2010 U.S. VSC market at $11.175 billion. That figure is the amounts paid by consumers, or from an insurance point of view the gross premiums written -- the total amount of money generated by VSC sales.

Now comes the confusion. This week, we're going to measure the market a completely different way -- at the insurance level. In many states, some sort of contingent liability insurance policy is required before the administrator/obligor can do business. In some states, however, insurance is not required, and it's perfectly legal for a dealer or an administrator to self-insure the contracts they sell. But it's always a good idea to have an insurance company ultimately backing the contract, just in case one of those middlemen goes bankrupt.

Underwriter List

In the Feb. 11, 2010 newsletter, we listed all the insurance companies and risk retention groups we found who were backing service contracts of one kind or another -- everything from construction machinery to office equipment. That was an initial attempt to identify the major players in service contract underwriting, and to narrow the field down to just those who back vehicle service contracts.

Within just that vehicle side of the business, the two big changes since February have been the upgrade of AmTrust's Wesco Insurance Company from an A- to an A, and the upgrade of Ford's American Road Insurance Company from a B+ to a B++. It all sounds a bit Orwellian, but suffice it to say that an A- is the lowest high grade and B++ is the highest low grade.

GMAC and Ford are now both at B++, which complicates the ability of some dealers to help customers finance their extended warranties. Even if A.M. Best considers B++ to be good enough, some lenders do not agree.

We found some others at B++ or B+, but they were mostly smaller "captive" insurance companies or risk retention groups whose only customers seemed to be their owners: the administrators/obligors selling the actual service contracts. This type of arrangement is sufficient to pass muster in states that require insurance, in that it has all the right paperwork in place. But does it really provide honest-to-goodness protection?

Signing New Administrators

During the course of our VSC industry tour, we've come across three administrators that have added major players to their stable of underwriters. In the July 29 newsletter, we noted that Interstate National Dealer Services Inc. signed with Virginia Surety Company, a subsidiary of The Warranty Group. Back in February, Penn Warranty Corp. also signed with Virginia Surety.

This week, we're breaking the news that the Guardian Warranty Corp. is signing with American Bankers Insurance Company of Florida, a unit of Assurant Solutions. The new service contracts will be available to dealers beginning in mid-September.

Guardian also operates a risk retention group, the Global International Insurance Company Inc., which A.M. Best rates an A- (Excellent). The RRG currently underwrites most of Guardian's contracts, which earns it a slot in the list of Figure 1. And the company also sells self-insured service contracts in states that permit it.

Now Guardian can expand into states that require third parties to provide the insurance, while continuing to operate its RRG and sell its self-insured contracts. Make no doubt about it: third party insurance is expensive. But it's becoming a necessary cost of doing business, especially when poorly structured underwriters domiciled in places with sleepy regulators collapse and take their contracts with them to the bottom.

And just as we were about to go to press, AmTrust Financial Services Inc. announced that its subsidiary AMT Warranty Corp. has acquired the remaining 73% of Warrantech Corp. that it didn't already own. The company also announced that from 2007 through the second quarter of 2010, Warrantech generated over $224 million in written premium for AmTrust, which confirms our revenue estimates for the administrator and its underwriter rather precisely.

This also builds AmTrust into an even more vertically-integrated competitor of already heavily vertically-integrated underwriters such as The Warranty Group, Zurich North America, Allstate Dealer Services, and Assurant Solutions. The name of the game these days is to have a presence at every level of the service contract business: in the dealerships, at the retailers, as administrators, obligors, and of course, as underwriters. And what's done in the U.S. can then be replicated in Europe and South America.

Genuinely Fake Underwriter?

At the other extreme, we've also found other VSC-affiliated insurance companies that are too small to be rated by A.M. Best. And we found one that doesn't seem to exist at all. For instance, Genuine Warranty Solutions Inc., an Orwellian name if ever there was one, alleges that it's backed by an insurance company called American Capital Underwriting Ltd. We couldn't find a single confirming detail about the insurance company with A.M. Best, any of the state departments of insurance, or any of the insurance industry associations.

But as a detailed analysis that a gentleman posted last year on RangeRovers.net concludes, that "insurance" company seems to exist only in a Mail Boxes Etc. drop box located near Victoria Station in London. We've heard of "tight quarters" before, but that's ridiculous, even for Pimlico.

But back to our model. As mentioned, we're estimating the 2010 U.S. vehicle service contract industry at $11.175 billion. We're additionally estimating that $10.587 billion of that is backed by insurance, leaving $5880 million self-insured by the administrator/obligor, by an unrated RRG that they own, or by the selling dealer (or web site). That's a pretty good result: nearly 95% backed by insurance (though we're worried about the vitality of some of the carriers).

How We Got to $2.85 Billion

Next week, we'll go deeper into the administrators, obligors, and dealers doing the actual selling. This week, we simply want to lay out what we've found about the underwriters. but before we can do that, we have to explain why the pie chart below is only $2.85 billion in size. So let's work backwards through the model.

As mentioned, consumers will pay $11.175 billion for vehicle service contracts this year. Of that, $10.587 billion will be fully insured. Dealers and other agents will take around 46% in sales commissions. And then administrators will pay about 46% of what they're left with to insurance underwriters. That's the $2.85 billion.

Or let's look at it from the point of view of a single service contract. Let's estimate that the average VSC is priced at $1,850. It may be more. It may be less. But let's assume $1,850 is paid by the consumer.

The dealer takes an $850 commission and pays $1,000 to the administrator. Alternatively, the administrator charges the dealer $1,000 and the dealer applies an 85% markup. But let's assume that 46% stays with the dealer.

The administrator/obligor then needs to purchase insurance. The price per contract is going to be $460. We've seen insurance company bankruptcies where they were collecting $123 or $257 per contract, so let's call that dangerously low. And we're sure there are insurance companies getting $600 or even $700 per contract. But let's assume $460 is typical.

Which Way to Figure Percentages?

There are two ways to look at that amount. It's 46% of the administrator's $1,000. And it's also 25% of the consumer's $1,850. So while an administrator might claim that its underwriter demands 46%, the underwriting portion of the consumer's premium is only 25%.

Therefore, in an $11.175 billion market (with $588 million of it self-insured), we'd be looking for $2.85 billion in underwriting revenue. And if we disregarded the sales commissions and dealer markups, we believe we'd still be looking for $2.85 billion, albeit in a $6 billion market.

In talking to dealers, consumers, and insurance companies, along with countless requests for copies of contracts, we found 32 companies that were underwriting VSCs and were also rated by A.M. Best. We're considering A.M. Best to be the gatekeeper here: if they've never heard of you, you're not an underwriter. You go into the uninsured column.

In the pie charts below, we're going to label just the larger players. But we'll list all 32 of the companies right below that. In some cases, we'll use a familiar family name rather than the exact name of the insurance company. We hope, for instance, that people understand that Virginia Surety Company Inc. is wholly-owned by The Warranty Group, and that American Bankers Insurance Company of Florida is wholly-owned by Assurant Solutions. When we see one of those names on a contract, we'll put a check mark in the parent company's column.

We should note that both Assurant Solutions and AmTrust are longtime sponsors of this newsletter. Without the continued support of them and other sponsors, this market report would not have been possible. However, they have had no involvement with its preparation. We would expect them to be just as upset, relieved or joyful as the other 30 underwriters will be when they see the pie chart below.

Market Share in a Competitive Industry

As can be seen in Figure 1, none of the major players garnered 20% or more of the industry, though the top six have 63% of it. This somewhat mirrors the state of the personal auto insurance market in the U.S., which we examined in some detail the June 25 newsletter. Although six auto insurance companies had more than half the market between them, none had more than 20% by themselves.

All figures are for the U.S. only, and for 2010 only. And of course all are Warranty Week estimates, based on industry research. The irony behind the past eight months of tedious weekly articles about vehicle service contracts is that it masked a vigorous research project. Every snapshot was actually a spying mission. And from now through Christmas, we'll be doing the same for appliances, consumer electronics, computers and mobile phones.

Market Research Methodology?

So how do we get these numbers? Well, let's take The Warranty Group as an example. They're owned by a Canadian investment company called Onex Corp., and one day an executive from Onex gave a lunch speech in which he predicted that TWG would do $2 billion worldwide this year. That comment was quoted by a Toronto newspaper, which was picked up by our diligent headlines department.

Others have said that TWG is about half-and-half U.S. and international. And it's about half-and-half auto and non-auto. And so, after we made some additional adjustments for non-VSC revenue and non-underwriting revenue, we came up with $450 million for a 2010 U.S. VSC underwriting revenue estimate.

Repeat that process 31 times, spin, rinse, and dry, and you have Figure 1. But we understand that it's impossible to label it all correctly, even if we used fine print. In fact, that was one of the major criticisms of the market share report we published for home warranties in the December 22, 2009 newsletter. Labels fit on only the top eight, and percentages fit on only the top 12. What about the rest?

To prevent this problem from happening again, we're providing both the color-coded labels and the percentages for the smaller underwriters in the pie chart above. If we missed anyone, we want to hear about it. If we overestimated one of your competitors, we want to hear about it. If we confused Universal Underwriters with Universal Warranty, we want to know about it. All communications will be kept private unless a reader overtly requests the publicity.

Once again, we're not yet listing the administrators/obligors/sellers of the actual contracts, nor the brand names they use. That's news for next week. This week, we're counting just the underwriting revenue -- the insurance back end of a non-insurance product.

Some of these insurance companies are affiliated with VSC administrators, and especially in the case of mechanical breakdown insurance, they're sometimes also very close to the actual selling, employing or contracting with the licensed agents. And then there's the danger that we're confusing their administration revenue or perhaps even their sales commissions with their underwriting revenue.

Where Are the Administrators?

But that's for another newsletter to sort out. That's not here. So if you're wondering, where are the Interstates? Where are the National Auto Cares and the American Guardians? They're the customers of these underwriters, not the underwriters themselves.

This is the measurement of the vehicle service contract industry at the underwriter level. Next week, we'll do it all over again from the point of view of the premiums paid by consumers, and our model will be complete. But before we go, we wanted to show what else we've discovered: that even at the underwriting level, the VSC industry has followed the downturn and recovery of the automotive industry in general.

As Figure 2 details, we believe the VSC underwriting industry peaked in 2006 and 2007, when underwriters took in $2.97 billion and $3.15 billion, respectively, in a market worth around $13.1 billion from the point of view of premiums paid by consumers.

There was a downturn in 2008 and a deep trough in 2009. That comes as no surprise, given the recent downturn in vehicle sales. And as much as we're hoping for dealer lots to be nearly empty by New Year's Day, our 2010 estimates aren't even going to take us back to 2008 levels. So the recovery will stretch into 2011 and beyond.

The estimates in Figure 2 were compiled from a mixture of public sources and private gossip. Basically, it's five annual figures for each of the 29 underwriters in Figure 1 along with a few of the dearly departed.

Complaints & Abuse Welcome

So what's wrong with these pictures? What's impossible, what's unbelievable, and what's missing? Sometimes we feel like astronomers, looking indirectly for planets by measuring their gravity. In this case, we're looking for service contracts in the middle by measuring vehicle sales and underwriting revenue at the edges, looking at consumers, dealers and insurance companies for clues about the publicity-shy administrators. The mass in the middle must be the VSC companies. We hope.