Extended Warranty Education - GAO Report on Risk Retention Groups

United States Government Accountability Office
GAO Report #GAO-05-536
"Common Regulatory Standards and Greater Member Protections Are Needed"

This report was delivered to the Chairman, Committee on Financial Services, House of Representatives by the United States Government Accountability Office (GAO) on September 14, 2005. The report contains 120 pages on Risk Retention Groups and opinions on the regulation needed to protect the consumer.

Below you will find highlights extracted directly & without edit from the GAO report. Specifically we have highlighted areas pertaining to service contract's (extended warranties) backed by Risk Retention Groups (RRG's).

You may also view the report in its entirety at the GAO website, www.gao.gov and type "risk retention group" in the search field. Provided is a link to the entire document on the GAO website: http://www.gao.gov/new.items/d05536.pdf

Highlights

• Page 1 -
  "In 1981, in response to recurring shortages of liability insurance, Congress passed the Product Risk Retention Liability Act, now known as the Liability Risk Retention Act (LRRA), which authorized the creation of risk retention groups (RRG)..."

• Page 7 -
  "...LRRA does not require RRGs to disclose to prospective claimants, those who submit claims for loss, that the RRGs would not benefit from guaranty fund protection should they fail. This can be of special consequence to certain claimants - consumers who purchase extended service contracts from the insureds of RRGs - because contracts issued by these insureds take on the appearance of insurance when, in most cases, they are not."

  "...In addition, enhancing the availability and contents of the guaranty fund disclosure would provide RRG insureds, as well as consumers who purchase extended service contracts from RRG insureds, a better understanding of the lack of guaranty fund coverage."

• Page 26
  "...Few (eight) indicated that they believed LRRA's regulatory safeguards and protections, such as the right to file a suit against an RRG in court, were adequate. Further, some regulators suggested that some domiciliary states were modifying their regulatory requirements and practices to make it easier for RRGs to domicile in their state. We found some evidence to support these concerns based on differences among states in minimum capitalization requirements, willingness to charter RRGs to insure parties that sell extended service contracts to consumers, or willingness to charter RRGs primarily started by service providers, such as management companies, rather than insureds."

• Page - 45
  "Willingness to domicile vehicle service contract (VSC) providers:

  Several states, including California, New York, and Washington, questioned whether RRGs consisting of VSC providers should even qualify as RRGs and are concerned about states that allow these providers to form RRGs. VSC providers issue extended service contracts for the costs of future repairs to consumers (that is, the general public) who purchase automobiles. Until 2001, almost all of these RRGs were domiciled in Hawaii but after that date, all the new RRGs formed by VSC providers have domiciled in the District of Columbia and South Carolina.75 The Hawaii regulator said that the tougher regulations it imposed in 2001 (requiring that RRGs insuring VSC providers annually provide acceptable proof that they were financially capable of meeting VSC claims filed by consumers) dissuaded these providers from domiciling any longer in Hawaii. In addition, one of the leading domiciliary states, Vermont, refuses to domicile any of these RRGs because of the potential risk to consumers. Consumers who purchase these contracts, not just the RRG insureds, can be left without coverage if the RRG insuring the VSC provider's ability to cover VSC claims fails. (We discuss RRGs insuring service contract providers and consequences to insureds and consumers more fully later in this report.)"

  "75 - Since April 1995 Hawaii chartered seven RRGs to insure VSCs, approving the last such charter in December 2000. As of June 2005, only three of these RRGs remained domiciled in Hawaii. Since January 2001, South Carolina has chartered six RRGs to insure VSCs, with the most recent charter approval in April 2002. Since January 2004, the District of Columbia has chartered three RRGs to insure VSCs, with two of these three RRGs in 2005 redomiciling from Hawaii."

• Page 62 - 63
  "Lack of Guaranty Fund Protection Also Has Consequences for Consumers Who Purchase Extended Service Contracts"

  "Lack of guaranty fund protection also can have unique consequences for consumers who purchase extended service contracts from service contract providers. Service contract providers form RRGs to insure their ability to pay claims on extended service contracts - a form of insurance also known as contractual liability insurance - and sell these contracts to consumers.105 In exchange for the payment (sometimes substantial) made by the consumer, the service contract provider commits to performing services for example, paying for repairs to an automobile. Service contract providers may be required to set aside some portion of the money paid by consumers in a funded "reserve account" to pay resulting claims and may have to buy insurance (for example, from the RRG they have joined) to guarantee their ability to pay claims.106 However, potential problems result from the perception of consumers that what they have purchased is insurance, since the service contract provider pays for repairs or other service, when in fact it is not.107 Only the service contract provider purchases insurance, the consumer signs a contract for services."

  "105 Contractual liability insurance is liability assumed under any contract or agreement. Extended service contracts are also known as "extended warranties."

  "The failure of several RRGs, including HOW Insurance Company RRG (HOW) in 1994 and National Warranty RRG in 2003, underscores the consequences that failures of RRGs that insure service contract providers can have on consumers:"

  "106 The amount placed in the account by the service contract provider may or may not be based on actuarial standards that provide some assurance that the account would be sufficient."

  "107 Responses to our survey indicated that only eight states regulate vehicle service contracts as insurance in their states although others reported that they did so under certain conditions. However, we did not perform any additional audit work to compare how the regulation of vehicle service contracts as an insurance product could differ from the regulation of other insurance products in these states. Moreover, our survey only addressed the regulation of vehicle service contracts, not other types of service contracts."

• Page 64
  "In 2003, National Warranty Insurance RRG failed, leaving behind thousands of customers with largely worthless vehicle service contracts (VSCs). This RRG, domiciled in the Cayman Islands, insured the ability of service contract providers to honor contractual liabilities for automobile repairs. Before its failure, National Warranty insured at least 600,000 VSCs worth tens of millions of dollars. In 2003, the liquidators of National Warranty estimated that losses could range from $58 to $74 million.109 National Warranty's failure also raised the question of whether RRGs were insuring consumers directly, which LRRA prohibits - for example, because the laws of many states, including Texas, require that the insurance company become directly responsible for unpaid claims in the event a service contract provider failed to honor its contract.110 The failure of National Warranty also raised the question of whether RRGs should insure service contract providers at all because of the potential direct damage to consumers. Several regulators, including those in California, Wisconsin, and Washington, went even further. In response to our survey, they opined that LRRA should be amended to preclude RRGs from offering "contractual liability" insurance because such policies cover a vehicle service contract provider's financial obligations to consumers. 111 At a minimum, regulators from New York and California, in separate interviews, recommended that consumers who purchase extended service contracts insured by RRGs at least be notified in writing that the contracts they purchase were not insurance and would not qualify for state guaranty fund coverage."

  "109 The loss estimates, from June 2003, and the number of contracts insured, from March 2004, are based on the most recent loss estimates made available by the liquidators of National Warranty."

  "110 In response to our survey, 17 states reported that in the event a service contract provider fails to pay or provide service on a vehicle service contract claim within a certain number of days after proof of loss has been filed, the contract holder is entitled to make a claim directly against the insurance company. For example, the Texas code provides that if a service covered under a service contract is not provided to a service contract holder not later than the sixtieth day after the date of proof of loss, the insurer shall pay the covered amount directly to the service contract holder or provide the required service. Tx. Occ. Code § 304.152(a)(2)."

  "111 The regulators provided these opinions in response to our question on whether LRRA should be amended or clarified. In addition, one other state - Texas - recommended that Congress clarify whether RRGs should be permitted to offer contractual liability insurance."

• Page 67
  "...Further, consumers who purchase extended service contracts (which take on the appearance of insurance) from RRG insureds likewise have a right to be informed about these risks. The numerous comments that regulators received from consumers affected by RRG failures illustrate how profoundly uninformed the consumers were."

• Page 69-70
  "To better educate RRG members, including the insureds of organizations that are sole owners of an RRG, about the potential consequences of selfinsuring their risks, and to extend the benefits of this information to consumers who purchase extended service contracts from RRG members, Congress may wish to consider the following two actions:"

  "• Expand the wording of the current disclosure to more explicitly describe the consequences of not having state guaranty fund protection should an RRG fail, and requiring that RRGs print the disclosure prominently on policy applications, the policy itself, and marketing materials, including those posted on the Internet. These requirements also would apply to insureds who obtain their insurance through organizations that may own an RRG; and"

  "• Develop a modified version of the disclosure for consumers who purchase extended service contracts from providers that form RRGs to insure their ability to meet these contractual obligations. The disclosure would be printed prominently on the extended service contract application, as well as on the contract itself."

• Page 77

  "...Finally, our survey also included questions about RRGs consisting of businesses that issued vehicle service contracts (VSC) to consumers because this type of arrangement is associated with two failed RRGs."