August 6, 2009

Used Auto Warranties:

Signs of life are beginning to appear in the used auto industry as partnerships are formed and annual sales increases are claimed. One of the latest deals is struck between the makers of electronic contract and tax form software and a veteran administrator of service contracts sold by used car dealers.

As if to confirm the hopes of those who dream that the bottom of the economic trough is now behind us, automotive service providers are going back to work, once again announcing deals and forming alliances. A great example of this is a partnership announced last month by Wolters Kluwer Financial Services and Penn Warranty Corp., under which the latter's vehicle service contract offerings will be integrated into the former's workflow solutions platform aimed at used car dealerships.

Wolters Kluwer, which acquired a company called AppOne two years ago, is now building a stable of third-party service providers that will be offered to independent auto dealers alongside the company's traditional electronic forms, contract templates, and compliance services. Penn Warranty, which also specifically targets independent auto dealers as its target market, is one of four vehicle service contract providers to sign up for AppOne's Product Marketplace.

Have We Met?

Jude Tuma, Penn Warranty

"If you look at the partners," noted Jude Tuma, president of Penn Warranty, "you'd think it makes sense on so many levels that the question is how come we didn't do this sooner?"

Lee Domingue, founder and CEO of AppOne Services Inc., said it was simply that they didn't get a chance to talk about a formal deal until recently. His business development executives met some of the Penn Warranty folks at an industry conference, and discussions began about the possibility of deepening their relationship. They'd already been selling to some of the same dealerships, so they were already acquainted. Now they've decided to deepen that relationship.

"We're excited about Penn coming on board, and being able to allow dealers to make it very easy to sell their product all the way through trying to find the right warranty for the customer," Domingue said. "Now the warranty fits the vehicle, the pricing is all automated, and the forms are all done in a PDF format. The warranty remittance for the premium gets done, and the policy is enrolled. It makes it all very simple."

Penn Warranty Corp. was founded in Wilkes Barre PA in 1988. It was acquired in 2007 by Geminus Capital Partners LLC, a private investment firm based in Philadelphia, at which Tuma is the founder and managing partner.

Tuma said what attracted him and Geminus to the auto warranty business was the large yet highly fragmented nature of the industry. "If we take just the independent dealer marketplace," he said, "we're talking about 40 million vehicles that change hands every year." Assume a percentage of those buyers that are amenable to a service contract purchase, and you have a huge potential market. "Now, not all of them are sold through our distribution channels, which are car dealerships and auctions -- there are also private party transactions -- but it's such a large marketplace that, regardless of the downturn, there are still opportunities in it."

Through its relationships with independent auto dealerships, Penn Warranty sells vehicle service contract at the Elite, Gold, Standard and Basic levels. Basic doesn't cover power windows or power seats, and has mileage restrictions. Standard doesn't cover the air conditioning unit and doesn't include emergency roadside assistance services. Gold doesn't cover items such as the power steering pump and the wiper motors, and Elite covers all of that plus more.

Flying Under the Radar

"The company has always maintained a very low profile," Tuma said. Since it was founded 21 years ago, it has focused on the administration of service contracts sold by independent auto dealerships, so there was little need for Penn Warranty to get any visibility outside of the dealer community. "And it's since stayed that way," he added. "Even today, we are still predominantly in the independent dealership marketplace."

Tuma said it's difficult to say how many independent dealers sell Penn Warranty contracts, because some sell one every day while others sell them only occasionally. "In the 22 states that we do business in, at the end of the year, if we take those that have been active over the past 12 months, we're probably talking four to five thousand dealerships," he said.

Tuma said some of the dealerships that already use the AppOne platform have already been selling Penn Warranty contracts to their customers. "This was the first time we actually sat down and formalized a relationship and created targeted marketing and integration capabilities between our two systems to smoothen out that process," he said. That, in turn, is expected to make it easier to wrap an extended warranty contract into a financing package, making it easier for a customer to sign on the dotted line for one monthly payment.

Interestingly, Penn Warranty customers can take their vehicles to any Pep Boys location for repair work covered by their service contracts. Officially named The Pep Boys -- Manny, Moe & Jack, the company now operates over 560 automotive parts supply stores and repair locations in 35 U.S. states plus Puerto Rico. Under terms of the deal announced last November, any warranty work done by Pep Boys on behalf of Penn Warranty contract holders will be direct-billed to Penn Warranty.

"If you look at the partnership we have with Pep Boys, we are creating value for us as a company, and hopefully a tremendous amount of value for Pep Boys," Tuma said. "There are few other repair facilities that are as well-known as Pep Boys."

Tuma said there are two big central questions at the core of the automotive service contract business: how to market the service contracts and how to pay repair claims. AppOne is the key alliance at the marketing end, and Pep Boys is the key partner at the repair end of the business.

"We are very excited about those two opportunities," he said. "They're both phenomenal organizations."

Meanwhile, AppOne, Tuma said, is already deeply involved in the provision of services to used auto dealerships, such as the preparation of loan documents and financing deals. So being a part of that platform is expected to increase the number of sales opportunities for Penn Warranty contracts.

Sales Are Up!

Rather shockingly, Tuma said the volume of service contracts his company sold over the past few months is actually up from the levels of a year ago, suggesting that the worst could be behind them. Yes, he said, contract sales volumes are now up, year over year. We asked the question three different ways, just to make sure he wasn't mixing it up with a decreasing rate of decline or some other not-as-bad-as-it-was-at-the-bottom metric. He said it again: the number of contracts sold per month in the last few months is ahead of the comparable number from a year ago.

"But we have noticed that customers would opt for lower coverage than they did in the past," he added. In other words, instead of buying contracts at the Elite or Gold level, many customers are instead choosing to buy less expensive contracts at the Standard or Basic level.

As far as the percentage of used car buyers who are also buying service contracts, Tuma said he's not sure what the trend is, because his staff is one step removed from the point of sale. And independent dealers, being independent, after all, are free to sell other people's contracts. So just because Penn Warranty doesn't get the sale doesn't mean that a contract wasn't sold. But given that his contract volumes are up while vehicle sales are not, the best explanations are either that Penn's market share is going up or the appeal of vehicle service contracts is increasing.

So does a recession increase or reduce the appeal of vehicle service contracts? "I think it increases with a tough economy," Tuma said, "simply because that customer purchasing the used vehicle for $10,000 understands that the vehicle will have wear and tear, as expected. And at some point that vehicle will need some repairs. For the risk-averse customer, the service contract provides him or her some downside protection in case something goes wrong with the vehicle."

On the one hand, Tuma said, consumers want to reduce cost. On the other hand, they want to increase protection. With service contracts, he said, this plays out as an increase in sales, but a reduction in coverage. It's a compromise of sorts -- buying some protection but trying to save money on the purchase. "That gives them some protection, but not the best protection they could get," he said. It's like increasing the deductible on an auto insurance or a homeowner's policy in order to reduce the premium.

So Is the Recession Over?

"It's anybody's guess as to how soon we'll see a recovery," Tuma quickly added, because nobody really knows how soon the banks will resume financing or how soon the consumers will resume shopping. "But we believe we've seen the bottom of the downturn in this sector. And based on the numbers we're seeing, the decline has definitely tapered off, and we're expecting things to take off to their pre-2008 level, especially in the used car market."

A lot depends upon the lenders, he said, and whether they ever restore their loan approvals to pre-2008 levels. But then again, we're talking about used car loans, which were always considered to be more risky than new car loans, and therefore weren't as decimated by the credit melt-down last year.

It wasn't like the mortgage industry, where lenders seemed unprepared to deal with home prices that didn't always increase or to encounter borrowers who couldn't or wouldn't repay. And it wasn't like the new car industry, where half the buyers simply disappeared -- qualified or not. Then again, although it's been a long time since anybody in the new car business reported a sales increase, that's exactly what Ford Motor Co. announced for the month of July.

Lee Domingue, AppOne

Domingue said he also thinks the deepest point of the trough is now probably behind us, but he seemed to think that we'll be going along the bottom of a relatively flat bathtub curve for at the rest of this year. Then, hopefully, in 2010, the big year-over-year increases will begin to register. Financing, he said, will be a key part of that scenario.

"We've found that the greatest need for these [used car] dealers is financing," Domingue said. "The financing is what sells the automobile. Most folks are going to finance. So what ends up happening is it's been very difficult for the used car independents specifically to obtain lending sources. It's always been tough, but over the last two years it's been really difficult."

Workflow Automation

What AppOne has focused on with its workflow platform, Domingue said, is the automation of the paperwork and the interaction between the independent dealers and the lenders, making it easier for the dealers to secure financing for their customers. And now, he said, AppOne is making it easier for those dealers to sell vehicle service contracts and wrap that purchase into the overall financing package.

"Let the dealer sell his car," Domingue said. "That's what they know how to do. Let's make sure that the consumer is getting the proper disclosures, that the dealer is staying in compliance, and that when the lender buys that contract from them, all the terms and conditions are conforming to the lender's approval. That ensures that they stay out of trouble as well."

Domingue founded AppOne in 1997 in Baton Rouge, Louisiana. Even by that point, Domingue had already spent decades engaged in management, sales, consulting, brokering, financing and leasing activities within the automotive industry.

In August of 2007, Wolters Kluwer Financial Services acquired AppOne, for an undisclosed price. In June of 2009, Wolters Kluwer Financial Services formed a new Indirect Lending Business Unit, and made AppOne part of that unit. Domingue was named CEO of Indirect Lending. Chris Herndon, AppOne's Chief Financial Officer, was named Chief Operations Officer of Indirect Lending.

Wolters Kluwer Snapshot

Wolters Kluwer is an Amsterdam-based major multinational publisher, with approximately 20,000 people worldwide. But rather than publishing trade magazines or daily newspapers, the company specializes in high-value documents and publications aimed at the financial, accounting and regulatory compliance industries. Aspen Publishers, whose bestsellers include such titles as the State by State Guide to Human Resources Law, is about as close as the company comes to a title people might know.

Wolters Kluwer Financial Services is an information company aimed even more narrowly at bankers, brokers, dealers, and lenders. Regulatory compliance is a particular specialty of the company. Newsletters include Legislative Watch Update, a weekly state-by-state view of legislative actions that could impact the banking and finance industries, and Insurance Compliance Corner, a weekly newsletter on issues affecting the insurance industry.

CCH Inc. specializes in tax preparation software for professionals and companies. Its CorpSystem Sales Tax Office specializes in the accurate calculation of sales tax rates for a given geographic location. Other services include paper and electronic forms generation for property and casualty insurance companies, IRS Schedule D form generation software for stock traders, regulatory consulting services for financial institutions, and training services for employees.

AppOne�s main products include:

  • DealerOne, an automated online dealer setup platform that securely captures dealership application information for processing and underwriting;
  • RECON Score, a proprietary dealer underwriting and scoring model that predicts the level of risk associated with a dealer relationship;
  • DMSOne, a web based online dealership management system and portal specifically designed for the independent auto dealer;
  • BureauOne, a secure gateway for credit report access from all three national credit reporting agencies;
  • VehicleOne, an online interface for vehicle valuations, vehicle history reports and other related information;
  • RiskOne, a customizable rules based auto-decision and evaluation engine;
  • MenuOne, a real-time after-market products pricing and enrollment system;
  • ContractOne, a rules-based electronic forms printing and validation platform;
  • FundOne, an online funding and reserve report system; and
  • PortalOne, a private label loan origination portal system geared towards local and regional lenders and community banks.

Another Wolters Kluwer Financial Services operation, called RefundOne, also recently became part of the new Indirect Lending business unit. RefundOne is a system that can generate tax refund estimates for car buyers. That allows a dealership to use refund anticipation loans as down payments, first by collecting and passing basic tax return data to online filing services, and then when everything checks out, printing a check. The customer can then come back within a day or two and use the loan as a down payment for a used auto, or they can wait 18 to 24 days for the tax return to be officially accepted by the IRS, and then they can pick up the check and take it home with them.

Within the dealership management systems sector, the Reynolds and Reynolds Co. is a competitor. Automatic Data Processing's ADP Dealer Services unit is actually an AppOne supplier, providing the company and its DMSOne offering with some of its electronic business forms.

Domingue said AppOne created a "Product Marketplace" as a kind of business-to-business online shopping mall for the independent auto dealership workflow offering. Spaces in the mall were then offered to select extended warranty, guaranteed auto protection (GAP), and other insurance providers that wanted to make it easier for the dealers to sell their policies. AppOne in turn uses its software to make sure that all those contracts are priced properly, that all the details in them are accurate, that the coverages fit the actual vehicle purchased, and that everything is in compliance with relevant state laws.

Other Vehicle Service Contract Providers

Domingue said the AppOne workflow solutions platform is now in use by around 3,000 independent dealers in 48 states. Besides Penn Warranty, other vehicle service contract providers that are part of the Product Marketplace include:

  • Royal Administration Services Inc., an administrator in Hanover MA that sells service contracts through dealers under brand names such as Service Shield, People's Vehicle Protection, Capital Care, GEM Care Extended, Buyer's Choice, and Integrity Automotive Protection;

  • Warranty Solutions, of Denver, which was once part of General Electric but is now part of the Wachovia Dealer Services automotive finance operation, which since the end of last year has been part of Wells Fargo & Co.; and

  • Autosave of Farmington Hills MI, which sells an engine coolant additive, whose use also provides a five-year/100,000-mile engine and transmission warranty that's effective as long as that coolant is in use and as long as professional and verifiable oil changes are performed on the covered vehicle every four months or 4,000 miles, whichever comes first.

    Providing the Pipeline

    Domingue said his goal is simply to "provide the pipes" that vehicle service contract, GAP insurance, and other service providers can use to make their offerings available to used car dealers. But it's not as if those offerings have never been available before. Instead, it's never been easier to price and sell them, and then to print the paperwork for the customer to sign. And it's never been easier to wrap the price of those additional services into the purchase price for the car, and potentially the financing deal that pays for it all.

    And there's the danger: what's going to be allowed to go through those pipes? Is it going to be a contract pumped by some fly-by-night company that hangs paper and then collapses, only to reappear on some Caribbean island paradise, under the protection of a foreign monarch? (We'd suggest the Cayman Islands, but if we did some Caymanian search engine will link to this newsletter and then we'll get all sorts of abusive email from fugitive financiers and exiled hedge fund managers.)

    The used car industry doesn't need anyone to make it easier to swindle consumers, especially when it comes to extended warranties. And if Domingue gets his way, AppOne will never allow any swindlers to use its pipelines. That would be about as far away from the Wolters Kluwer heritage of regulatory compliance as one could possibly get.

    "We want to make sure that the warranty companies have been around a while, that they have people who know what they're doing, that their financial wherewithal within their operation is sound, and that they also are able to service and administer the claims, to make sure that the dealers and the customers are protected," he said.

    "We don't want every warranty company on there," he added. "That's not our goal. We want warranty companies that have the same ethics and integrity that we do. And we want to make their products available."

    Something else that Domingue also said he doesn't want to do is to acquire an extended warranty company and add it into the Indirect Lending Business Unit. "That's not a direction we have chosen," he stated. "We have the partners that are doing that. And we want to continue to partner with them. We know where we like to play, and that's just not anything that's been on our radar."

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