Piloting the Impact of Inflation on Reinsurance Earnings for Automotive Dealers

Inflation is a critical factor for automotive dealers who are invested in reinsurance programs, especially given the volatility of today’s financial markets. Combined with the instability of the equity market, this inflationary environment exposes significant risks to investment income within reinsurance portfolios. Dealer principals must adopt a proactive approach to ensure their profit participation structures remain robust in the face of these challenges.

Long-Term Impacts of Vehicle Service Contracts (VSCs)

When dealers sell vehicle service contracts (VSCs), terms typically range from 3 to 10 years. The dollars collected today are expected to fund potential claims far into the future, potentially as late as year 2035. With inflation rising, parts costs have risen nearly 100%, while labor costs have seen a 50-60% increase. These unprecedented cost increases raise a crucial question: Were these inflationary pressures adequately considered when actuaries set reserves?

Given the evolving landscape, dealers must stay mindful of their reinsurance position, particularly as it relates to inflation. Parts and labor prices are likely to continue their upward trajectory, putting pressure on reserves that were calculated years earlier under very different economic conditions.

Navigating Reserve Adjustments and Regulations

Another important consideration is state regulations regarding reserve adjustments. Some states impose restrictions on filings that prevent reserve adjustments, while others allow for them. In either case, it is imperative to work with an F&I agent who deeply understands the implications of rising costs. Your agent can provide crucial data to support reserve adjustments or offer insights into current pricing.

Proactive Strategies to Mitigate Losses

While rate increases may seem like the most direct solution to counteract inflationary pressures, several additional strategies can be implemented to mitigate potential losses:

1. Claims Retention: Dealers can retain claims within their own store, allowing them to control the labor rates applied to those claims. Claims for outside repairs may be subject to higher rates, whereas retaining the service in-house can reduce these costs. This also presents an opportunity to retain the customer for future service work.
2. Tie-Back Provisions: Implementing a 40-to-50-mile tie-back provision ensures that customers return to the dealership for service work. By keeping customers within proximity, dealers can mitigate the risk of external service costs rising unchecked.
3. Lower Labor Rates for In-House Warranties: Dealers can assign a lower labor rate to warranty claims than what would typically be charged for customer-paid repairs. For example, while a customer may pay $200 per hour for labor, the dealership’s warranty contract might allow a lower rate for in-house warranty work. This can significantly reduce long-term claims costs.
4. Incentivizing Shorter-Term Warranties: A proactive F&I agent can structure warranty programs to incentivize the finance team to sell shorter-term warranties. Limiting long-term contracts to six or seven years, rather than the maximum of 10, can help minimize future exposure to rising inflationary costs.

Portfolio Management: Keeping Pace with Inflation

Again, a dealer’s reinsurance portfolio must be actively managed to keep pace with inflation. It’s crucial to evaluate where reinsurance funds are held, the investment strategy in place, and whether the portfolio’s rate of return meets current financial demands. Key considerations include:

• Custodianship and Fiduciary Oversight: Is your reinsurance provider acting in your best interest? Do you have a clear understanding of who the fiduciary is, who holds the funds, and how decisions are made regarding investments?
• Investment Strategy: Is your portfolio’s investment strategy aligned with inflationary trends? Are there opportunities to adjust the balance between earned and unearned premium reserves to generate stronger returns?
• Management Fees and Targeted Returns: Are the fees associated with your reinsurance portfolio competitive? Does your F&I agent provide access to the best available deals, and is there transparency around your portfolio’s performance?

In today’s challenging economic environment, dealer principals must be diligent in ensuring their reinsurance programs are both resilient and adaptable to inflationary pressures. By leveraging proactive strategies—such as optimizing labor rates, managing claim retention, and ensuring that the portfolio management strategy aligns with inflationary realities—dealers can better protect their bottom line.

For more insight into building a reinsurance strategy that performs under pressure, connect with Dylan Doran on LinkedIn or by sending him an email at ddoran@ezvds.com.