What is a Profit Share

What is a Profit Share

A profit share is an arrangement with the insurance carrier or service contract obligor (provider) that allows the manufacturer or retailer to participate in any remaining funds in the claims reserve account after the contracts have been partially or fully earned.

A typical structure is to determine how much is needed to fund future claims and then add a small buffer. This is the claim reserve. Then you add the claim reserve and the fee (including taxes) a carrier takes and add that to the claim reserve to yield the gross amount the carrier receives.

If the future claim per item was determined to be $100 and you added a 10% buffer ($100/.90), the total is $111. If the carrier adds a 10% fee ($111/.90), you have a $12 fee plus the $111 claim reserve for $123. If the claims come in as expected, you will have approximately $11 per contract remaining in the reserve. This remaining amount is then subject to negotiating a profit share.

Profit shares exist when a program can support it based on the size of the program, the carrier fee, and underwriting performance.

For additional information on Service Contract, Limited Warranty, and Specialty Insurance Programs visit Meramec Secure.

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Example State Regulatory Statutes for Service Contracts

Example State Regulatory Statutes for Service Contracts

To form a compliant service contract administrator or provider involves a patchwork of state regulations. Many states have specific statutes that address registration, licensing, requirements for the customer terms and conditions, financial guarantees, and other items.

Some states have separate and distinct statutes by product type. For example, Florida has unique statutes broken into Auto, Consumer Goods, and Home Warranties.
- Florida Warranty Associations (634)

Here is a link to one state, Illinois, that generally follows the Service Contract Model Act that has been adopted by many states. Each state is different; this is just an example.
- Illinois Service Contract Model Act (215 ILCS 152/)

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What is Product Warranty Insurance

What is Product Warranty Insurance?

When a seller or manufacturer (OEM) wishes to offer a longer product warranty but does not wish to retain all or some of the liability, they seek options for Product Warranty Insurance. For a single defined cost, the company purchases coverage to transfer the risk to a third party obtaining balance sheet relief.

This is an easy solution to offer a longer limited warranty on a promotional basis or for selected products. The transaction is between the company and the third party, and the end customer has no impact. In most cases, the company still takes care of the customer experience and manages the claim process just like under the "normal" warranty term. The company doesn't need to pay an administration fee or processing fees or go through multiple layers. This streamlines the costs for the company.

Depending on the product type, coverage exists for parts, labor, or parts & labor. The term includes a limited OEM or seller warranty retention, and then the liability falls to the third party. The obligations for the warranty or service contract are insured by a contractual liability insurance policy or other structure.

Product Warranty Insurance Overview

Additional information on manufacturer warranty insurance is available at Meramec Secure.

Top Considerations when Forming a Service Contract Provider

Here are the Top Items to consider when you are evaluating building or in-sourcing a Service Contract Program:

Overall Structure
    Previous articles discuss the various elements of a service contract program, including the obligor (provider), the administrator, the financial guarantee, and the service entity. Options exist for structuring a program with some internal components and some outsourced ones. For instance, using a third party as the obligor (the company making the legal promise to a consumer) has many potential benefits, such as rev recognition and no need to file for a license in many states. Time to market is faster with this option and significantly less expensive in many cases.

Insurance Partner
    The most common method to satisfy state-level financial guarantee requirements for a service contract program is to use a Service Contract Reimbursement Insurance Policy from a licensed and admitted insurance carrier. Multiple good options exist for an insurance carrier; knowing which carriers are better at what programs and structures is extremely important.

Technology Partner
    Many options exist for managing a service contract program, and each provider has unique capabilities and expertise. Knowing the options that make sense is important, and performing a deep dive into the partners to find the right solution is important. Options range from in-house limited functionality solutions to large Enterprise solutions.

Legal and Compliance Partner
    It is important to understand each state's legal and compliance landscape for service contract programs. This includes support in creating the actual terms and conditions, understanding administrator licenses, understanding obligor licenses, understanding seller appointments, and many additional elements. Even if you use a third party for some elements, you should have visibility into the requirements and any changes.

Rate Development
    This includes understanding how to price your program and the various inputs necessary to build a model. Actuarial support may be necessary depending on the program, so knowing the right option is important.

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What are the Basic Elements of a Service Contract Program

The Seller
    This represents the entity making the solicitation and sale of a Service Contract. This includes Retailers, Dealers, and Marketers.

The Obligor (aka Provider)
    The Obligor (or Provider) is the legal entity that is issuing the Service Contract.

    Many states require some form of registration (licensing), form filing for terms and conditions, financial guarantees, officer and/or director biographical reviews, and other requirements. This is not a one-time event; ongoing reporting and license renewals exist in many states.

    This is on a state-by-state basis and varies on a product level. Examples include vehicle service contracts, ancillary auto products, home warranties, consumer appliances, and electronics products.

The Administrator
    The Administrator is the entity providing customer entitlement, claim adjudication, and payment of claims.

    Some states require registration of the administrator and some form of financial guarantee.

The Financial Guarantee
    Most states have requirements for how an Obligor (Provider) must provide for the financial guarantee of a Service Contract.

    Financial guarantees are intended to protect the Contract Holder from the financial failure of the Obligor (Provider).

    Financial guarantees may include cash reserves, bonds, a parental guarantee from an entity with substantial and defined net worth, or a service contract reimbursement insurance policy (contractual liability insurance policy).

The Service Entity
    The Service Entity is a company the Administrator utilizes to perform repair or replacement services in fulfilling the obligations of the Obligor in the Service Contract.

    Some states require registration of the administrator and some form of financial guarantee.

The Contract Holder
    The actual Contract Holder (or Consumer) that the Service Contract is issued to and who is the owner of the covered product.

Process Flow for Service Contract Elements

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What is a Service Contract Administrator License

Several states require a license or some form of registration to act as an administrator for service contracts. This applies if an entity other than the Service Contract Obligor (Provider) is administering claims. This varies by product type (auto versus consumer goods, for example).

For service contracts related to consumer goods, this process ranges from having the obligor submit an acknowledgment form that the administrator understands its obligations under the law ( New York Example ) to a full license ( California Example ).

The process may include a fee to the state, a copy of the terms and conditions from the obligor, a copy of the Service Contract Reimbursement Insurance Policy that backs the service contracts, a list of providers supported, registered agent information, and a completed application. The application includes company information and often includes shareholder information.

The overall process is easy to navigate with the right help. Many great firms exist to assist with the process, and often the obligor will help as well.

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What is a Service Contract Obligor

As you research Service Contract programs, you will hear the term Obligor (aka Provider) as a significant component of the Service Contract process. At the most simplistic level, the Obligor is the legal entity that is issuing the Service Contract and making the promise.

Many states have specific requirements for Obligors, including registration, terms and conditions design & filing, and demonstrating how the Obligor will provide a financial guarantee to back the Service Contract. Each state has its own requirements and varies on a product level, including vehicle service contracts, ancillary auto products, home warranties, and consumer appliances & electronics. Having proper compliance support is very important, and several great options exist to help you with compliance if you choose to form an Obligor.

Forming your own Obligor is not necessary if you wish to design an in-house program. Many structural options exist to take control of the consumer-facing elements while using a third party for the regulatory side and not impacting revenue recognition. This streamlines a program, removes unnecessary costs, and allows the Retailer or OEM to control the customer experience for enhanced lifetime value. It is important to pick the right third-party partner for your business based on mapping out your objectives and the third party's expertise.

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