Working in the F&I industry stays interesting because of the great products that our industry continues to develop to meet the needs of the public.
In developing a new product, there are, of course, many issues regarding policy language, pricing, marketing, systems, etc. We want to focus on some general considerations when developing a product from a pricing and accounting standpoint.
Do I have any claims experience?
Obviously, if you have related claims experience it can be of tremendous help in determining the potential exposure for your product. If so, you will need to adjust the claims experience for any changes in the product. For example, if you are adding a new feature to an existing product, you might be able to use the frequency of claims for the current product and adjust the average claim for the new feature.
You should also bring the claims level in your historical database to current levels by applying the expected inflation costs from the time the original products were sold. For example, if you are looking at experience on 2009 sales for a product you plan to introduce in 2012 you will have 3 years of inflation to consider.
Be extra careful if you are considering pricing coverage based on the historical behavior of insureds. A classic example is a “refund program” which refunds a portion or the entire price if the buyer does not make a claim. Historical experience may show a low percentage of non-claimants. However, buyers will not file small claims if there is a financial incentive to avoid doing so.
Therefore, the percentage of contracts without claims on a refund program are much higher. Assume that buyers of your product will adjust their behavior based on their financial self interest.
How is the product marketed?
Similar products can have vastly different claims experience depending on how they are marketed. Will the product be marketed to new buyers or to current owners? Is the product marketed at the dealership or direct marketed? What is your expected pricing?
The amount of money that a consumer pays can impact claims consciousness as well. A low price product will have lower awareness. A product that is automatically added as part of the sale will have even lower costs.
How am I going to earn the premium?
This is a critical assumption for evaluating early experience. Claims occur on F&I products at vastly different rates depending on the product. Some products (even profitable ones) have an initial surge of claims as the buyer may seek to repair some preexisting issues that cannot be fully excluded. Never assume that exclusions can prevent all claims.
To evaluate the experience correctly, you must earn the premium in the same ratio as the claims flow. You may need to earn premium differently for accounting and refunding than you do to evaluate the program. While earnings are necessarily subjective, be careful to use your best estimate.
How do you react to results?
Everyone who develops a product expects it to succeed. Don’t let your prior assumptions blind you to the results in your book!
Most F&I products are relatively high frequency/low severity products which reach credibility in a short amount of time. If you are earning your exposures correctly (see above), your results should be actionable in a few months. Plan on frequent monitoring after the product launch to ensure that the program is performing to your expectations.
Divide the experience into months or quarters by policy inception date and examine the experience of the most mature contracts carefully. For example, if you expected a “claims surge” for the first months of a product are you seeing the claims from your oldest contracts dropping? If not, you may need to reevaluate your assumptions.
If an insured makes a claim, will they be in a better financial position?
Most insurance products operate on the premise that the insured will not be better off financially after a claim. For example, auto insurance will pay the actual cash value of your car. In theory, you could go out and buy the same model car with similar mileage. You cannot buy a brand new car.
Some products such as GAP insurance actually improve your financial situation. If you have a GAP claim, the negative equity in your vehicle is erased. A similar example occurs in homeowner’s insurance with “replacement value” which pays for the replacement value of your house and contents. If a fire destroys your house, you will receive new furniture and clothes – not the old stuff you had.
These insurance products work because the vast majority of people do not wish to have a fire or a car wreck even if it improves their personal balance sheet slightly. However, you can expect that these types of products will have higher claims because there are always a few people who will use the product to their advantage.
Will the claims be correlated with the economy?
For most products, this is not true. Car repairs and vehicle accidents are examples of random events. While certain people and certain vehicles may be more likely to have a claim, in general the claims among similar risks are random.
However, this is not true for all products. Some products will show a higher propensity of claims due to the economic environment. This type of risk can occur when insuring the underlying value of an asset (such as GAP or residual value insurance). If the used car market shows a big drop in prices, then the likelihood and severity of claims will increase across the board.
If your product is correlated with the economic environment, be prepared for a wide range of results depending on the conditions of our economy.
Conclusion
New products are what make the F&I business one of the most exciting places in insurance for product development. While the considerations listed above may give you pause, we encourage our industry to continue to develop products which meet the needs of all participants by providing peace-of-mind to the buyer with and an adequate return to the underwriter and business partners.
