May 13, 2010

50/50 Warranties:

Dealers who sell used vehicles sometimes can't afford or won't risk the cost of a limited warranty policy. So they ask customers to split the cost of repairs for the first 30 or 90 days. Some regulators say these types of warranties are unfair or misleading, but others say all that's needed is adequate disclosure.

As we continue our tour of the vehicle service contract industry, we're taking a little detour this week to take a look at a most intriguing hybrid between a warranty and a service contract.

In the used car business, as well as with used boats, motorcycles and power sports vehicles, buyer and seller sometimes agree to split the costs of repairs, under terms of what are called 50/50 warranties.

The Federal Trade Commission calls them split-cost warranty, and requires the seller to disclose what percentage of claims they will pay. But in some states such as Massachusetts, anything but a 100% warranty is against the law. And a group of consumer advocates once asked the FTC to outlaw split-cost warranties nationwide.

These 50/50 warranties are really more of a compromise between a warranty and no warranty at all. But when they're issued to a buyer as part of their purchase, they can take the place of a service contract, providing that crucial peace of mind to the customer. After all, the old joke about used car warranties is that if the vehicle breaks in half on the drive home, the warranty states that you own both halves.

Three Kinds of Splits

Split-cost warranties are nothing new, but their use is increasing as dealers look for better ways to attract and keep customers. Ashok Kartham, president of 4C Solutions Inc., said he's seen at least three ways his clients are splitting warranty costs with their customers.

First, there are so-called goodwill repairs, or "policy authorizations," in which the cost of a repair is deemed to be ineligible for warranty coverage, but the dealer and/or manufacturer aren't in the mood to completely deny 100% of the claim and thereby anger the customer. So in the name of good customer relations, the dealer, the OEM, and the customer come to some kind of informal arrangement where each pays a portion of the costs.

Second, there are service contracts sold in which both the premiums and the loss costs are split between the participants, in transactions involving reinsurance entities, underwriters, manufacturers, sales agents, and retailers. But this premium- and cost-splitting is usually done behind the scenes, and the consumer may not even be aware it occurs.

And third, there are split warranties that arise out of the sales process, particularly in relation to the sale of used goods that aren't otherwise covered by a warranty. The most popular are the 50/50 warranties seen in the used auto industry, where buyer and seller agree to split the potential future cost of repairs that might arise within the first 30 or 90 days of ownership.

"We have seen all three models," Kartham said. The company's 4CS iWarranty software package, part of its 4CS Service Suite, enables companies to manage and optimize all warranty-relates activities from manufacturing and sale through the end of an extended warranty period. So the input of all these warranty terms and conditions, including any splits in costs, will have to be configured in the client's software.

50/50 Warranty or No Warranty?

Kartham said he sees the 50/50 warranties as more of a compromise between a full warranty and no warranty at all. Or, in more precise legal terms, it's halfway between a limited warranty in which the obligor agrees to pay 100% of the cost of covered claims, and a case where a product is sold "as-is," without warranty, with all faults, etc.

"A lot of times it's being used on pre-owned products, where generally there may not be a warranty -- where they want to offer one, but there is a higher risk," he said. Particularly with mechanical products, the bathtub curve predicts that the incidence of failures will increase as the units age, increasing the risk of major repair costs. "So it's more like a risk sharing. It's a compromise between no warranty and some kind of coverage," Kartham said.

Another variation Kartham has seen is a limited warranty that includes some kind of deductible. This, he said, discourages small claims, whose cost would not exceed the deductible amount. therefore, the consumer is unlikely to submit the claims. Another variation -- a small fee paid by the consumer for a service call -- is used in the home warranty industry, both to discourage the small claims and to give the responding repair technician an instant source of revenue.

Kartham said he sees the incidence of all three (or four) warranty cost-splitting arrangements increasing, particularly in the case of 50/50 splits on used products. Part of the reason is competition from the manufacturers themselves, which are issuing limited warranties on their "certified pre-owned" inventory. Used dealers want to compete, but can't afford to cover 100%. So 50% is a good compromise.

"I would say it's on the upswing," he said. "I think it's a cost-saving measure as well as making sure the risk is shared. Customers understand that it's a used product, so it is outside the normal, standard warranty. But they do want some comfort level that there is a warranty."

Good Customer Service

John Lippis, the owner of Swedish Motorcar Service in Spokane WA, issues 50/50 warranties to cover both the used cars that he sells as well as the repairs he performs for his clients. He said he thinks 50/50 warranties are a fair way to split costs, share the risk, and keep the customer happy.

"To me, it is a way of cooperating with my customers," he said. "We specialize in long-term maintenance. Most of my customers stick with me for life. It's a way for me to cooperate with them on the cost."

Furthermore, Lippis said that if a customer comes back with a part that failed a few months outside of the warranty, he's likely to give them the part at cost and then split the labor costs with them as a further concession.

"The 50/50 warranty, at least in my business," Lippis suggested, "is saying that unforeseen and unfortunate things happen. Well, we're not going to leave you out there hanging out by yourself. It's a way I can participate in the risk." And so can the customer.

Lippis has been in the business since 1972, so he depends heavily on the business of repeat customers who appreciate his expertise. "I'm living proof that -- we're a very small business, but people will come back, because they know that we're trying to help them," he said.

Swedish Motorcar is primarily a repair center for Saab vehicles, but it also has a small operation that sells used Saabs. In such a sale, Lippis said, "a 50/50 warranty shows them that I've done everything I can possibly do to make that car right. And if I missed something, I'll split it with you. So it's my way of ensuring to them that I've done my level best."

Lippis said he can't afford to go to a 100% warranty, because frankly he doesn't manufacture the cars or the parts he uses to fix them. "We see defective parts all the time," he said. "I mean, I'm not making so much money ... and I have to invest all of the labor, and everything. I'm in the business of taking care of people's cars, and not in the business of selling them things."

Selling Peace of Mind

Steve Cyr, the store manager at the Port Boat House in Port Alberni, British Columbia, said the company has been providing 90-day 50/50 warranties on used items such as Yamaha boat engines ever since it opened its doors in 1980. He said he thinks it reassures the buyer that they're not about to purchase someone else's headache.

A 50/50 warranty, Cyr said, is neither a service contract nor a limited warranty. Yet it serves the same purpose: providing peace of mind to the buyer, who might otherwise be reluctant to buy a used product.

"What we're trying to do is say to people that yes, we have checked over this motor, we do believe it to be 100% operational as it leaves the dealership, and we believe that it's going to be a good-running engine for you," Cyr said. "But being a mechanical device, sometimes those things are beyond our control.

"And when those things do fail, as a used product, I don't think it's necessarily the dealer's fault. And I most certainly don't think it's the consumer's fault. But the bottom line is someone's got to pay. So we figured that a 50/50 split is probably the best way to do it."

It's better than selling a used product with no warranty at all, Cyr said. "I think it's a grave error to let people out with nothing and then when they come back, trying to deal with them," he added. "It shows that we have some confidence in what we're selling, to the point that we're willing to stand by it to a certain degree."

Used Motorcycles

Hamilton Motosport, located in Kingston, Ontario, provides a lifetime powertrain warranty to customers who buy its pre-owned Harley-Davidson motorcycles. "This ain't your daddy's ride," the company's advertising exclaims.

However, those lifetime warranties come with a bit of a twist: while all repairs to the engine, transmission and clutch will be covered, the bike shop and the customer are expected to split the cost of the repair equally. And to keep that lifetime 50/50 powertrain warranty in effect, Hamilton Motosport must perform all the routine maintenance.

"This allows for us to do the inspections, adjustments, fluid and filter changes, lubrications, tire and brake pad changes, etc., in order to best maintain the optimal operational aspects of the machine," the company states in the terms and conditions outlined on its web site. "The costs of such various services and maintenance aspects are the owners responsibility, at Hamilton's advertised or quoted prices."

Preston, an employee of Hamilton Motosport who declined to give his last name, said part of the reason behind the lifetime 50/50 powertrain warranty is to keep the customer coming back to the dealership. "That way, we can monitor the service on the vehicle," he said, and watch for signs of abuse or abnormal use.

So why not just give customers a 100% warranty? "That wouldn't be cost-effective to us," Preston said. "We have a small bike shop here. We try to look after the customers as best we can, but we really don't have the backing of a major motorcycle manufacturer. So that's why a lot of times we just don't have the ability to provide 100% coverage on our motorcycles. Down the road, if a major repair is required, that could run into the $3,000 range."

Explaining the 50/50 Split

Sometimes, it takes a bit of explaining to get the customer to understand a 50/50 warranty, he said. "They've never heard of it before. But once they understand it, they're fine with it," Preston added.

Mitch Pate, sales manager at Butler Auto Recycling Inc. of Pensacola FL, said he thinks customers understand exactly what's included in a 50/50 warranty by the time their salesman is finished explaining it to them. Customers are told that for the first 30 days after they buy the vehicle, or the first 3,000 miles of usage (whichever comes first), they and Butler will each pay 50% of the total cost of repairs.

"We give them a full sheet that explains it verbatim," Pate said. "What's covered, how we don't do any markup on parts, and that they're responsible for half the price of the parts. We give them that full sheet."

The terms and conditions spell out how not only are major mechanical breakdowns covered, but also such items as the alternator and air conditioning. It doesn't include power windows or the radio, but it does include the vehicle's computer and other electrical components necessary for the operation of the vehicle.

So why not provide a 100% warranty? Or, since it's a used car, why not provide no warranty at all? Pate said he sees the 50/50 split as a good compromise between the two extremes -- one that makes both buyer and seller share the risk, and share the responsibility.

"We really are serious about trying to make sure we're selling a good, dependable product," Pate said. "They're half-partners in this vehicle with me for the first 30 days or 3,000 miles. And that just gives them a little more peace of mind that we really are serious about this being a dependable vehicle."

Protecting the Dealer

"It really protects both of us," he said. "Nobody has a crystal ball. They could be one of the best and most respectful car owners on the planet, taking very good care of their equipment, and something bad could still happen. We do our best to make sure that the vehicles are in a good, sound condition before we sell them, but like I said, nobody has a crystal ball."

At the other extreme, he said, the buyer could be the kind of driver that immediately goes "rompin' and stompin'" through town, abusing their vehicle until it fails. One hot rodder, he said, floored the accelerator, spun the wheels, and left a trail of burnt rubber as he exited the lot going sideways. At least this way, they're still responsible for 50% of the cost if they run their acquisition into the ground and dare to make a claim.

"It kind of makes us partners in the vehicle for the time of the warranty, so that hey, maybe they're a little more likely to take better care of it. And if something does happen that's not their fault, we're going to come through and help out, and live up to our end of the bargain," Pate said.

Butler doesn't sell service contracts, and couldn't afford to cover 100% of repair costs, so a 50/50 split is the only alternative to no warranty at all. As its name implies, Butler Auto Recycling is primarily in the business of salvaging parts off vehicles that are otherwise destined to become cube-shaped. But if something in fairly decent shape comes in, it will be packaged for sale rather than being sent to the compactor.

"We were seeing cars coming in that needed just a bumper cover and a parking light," he said, but for one reason or another the insurance companies sent them in for salvage. Pate said the company's owner thought it made more sense to try to sell them instead of scrapping them, and so a new business was born.

Ironically, at first the rescued vehicles were covered by a 100% warranty for the first 30 days or 3,000 miles. But after a few "rompers and stompers" took advantage of that policy, Butler decided to change over to the 50/50 split.

Protecting the Consumer

Among regulators, the fear is that the dealers could be the ones taking advantage of the customers. But so far, most regulators have allowed 50/50 warranties to be issued, as long as the buyer is made aware of precisely what that involves. For instance, the FTC's publication, "A Dealer's Guide to the Used Car Rule," mandates the following disclosures:

Split-cost warranties are those under which the dealer pays less than 100% of the cost for a warranty repair. This type of warranty includes 50/50 warranties where the dealer pays 50% of the cost for a covered repair and the buyer pays the remaining 50%. Another type of split-cost warranty is one under which the buyer pays a deductible amount and the dealer pays the remaining cost for the repair.

If you offer a split-cost warranty that requires you to pay a percentage of the repair cost for covered repairs, you should include the following disclosures in your warranty document:

  • The percentage of the total repair cost you will pay.

  • The percentage of the total repair cost the buyer must pay.

  • How the total cost of the repair will be determined. For example, your warranty might state: "The total cost of a warranty repair will be the retail price ABC motors charges for the same job." As another example, your warranty might state: "The total cost of a warranty repair will be determined by adding the dealer's cost for parts to the labor cost. Labor will be billed at a rate of $______ per hour for the actual time required to complete the repair." As a final example, your warranty might state: "If the work is done by an outside repair shop, total cost of a repair will be the same price ABC Motors is charged by the outside shop. If the work is done by ABC Motors, the total cost of the repair will be the same price ABC Motors charges non-warranty customers for the same job."
If your warranty requires buyers to pay a deductible, your warranty document should disclose the deductible amount and the details as to when and under what circumstances the deductible must be paid.

Dealers offering split-cost warranties can require that buyers return to the dealer for warranty repairs. If your warranty includes this restriction, however, you should provide an estimate of the total repair cost before work is started. This will allow the buyer to decide whether to approve the repair or have the work done elsewhere.

Some states don't allow even that. In Massachusetts, for instance, it is impossible for a dealer to sell a used vehicle without a 100% warranty. The state's implied warranty of merchantability states that a product must do what it was designed to do with "reasonable" safety, efficiency and ease for a "reasonable" period of time. If the vehicle does not run properly, the seller is responsible for repair, replacement or a refund.

Banned in Boston

However, state laws don't define the word "reasonable." The state's guide to the Used Vehicle Warranty Law says this determination will depend in part upon the condition, age, and sale price of the vehicle.

This law has been interpreted in a way that makes it impossible for a used car dealer to sell a vehicle "as-is" or "with all faults." It also prohibits any sharing of repair costs, which must be 100% covered by the dealer. So 50/50 warranties are not permitted in the state.

Two years ago, this animosity almost went national. In 2008, a group of consumer advocates submitted comments to the FTC on the occasion of a regulatory review of the Used Car Rule.

The groups asked the FTC to amend the rule in order to "preclude 50/50 warranties or other dealer warranties where dealers represent they will split the cost of repairs with the customer, as qualifying as a warranty under the Buyer's Guide."

Signatories to that letter included the Consumer Federation of America; Consumer Action; Consumers for Auto Reliability and Safety; the Consumer Federation of California; the National Consumer Law Center; the U.S. Public Interest Research Group; and the Watsonville Law Center.

The groups also asked the FTC to prohibit what they called "misleading language" from the Buyers Guide regarding "as-is" product sales. What they said they'd prefer is something in plainer English, such as "The dealer will not pay any costs for any repairs. The dealer assumes no responsibility for any repairs regardless of any oral statements about the vehicle."

Had they'd gotten their way, and had the FTC completely outlawed split-cost warranties nationally, it's probable that many cost-conscious dealers, given the choice between 100% warranties and no warranties, would have chosen the latter.

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