Service Contracts and Extended Warranties: Building Customer Loyalty and Profits

14 February 2018 Manufacturing Industry Advisor Blog
Author(s): Ethan D. Lenz Morgan J. Tilleman

Purchasers of consumer goods are more discerning than ever before, and thanks to the internet, have access to more choices and more information every day.  Manufacturers that are perceived as producing high-quality products have an advantage in the markets of the future.  One way manufacturers have long signaled their quality is through providing product warranties against failure, breakage, or other problems.  Increasingly, however, manufacturers have recognized that traditional warranties are a cost center, rather than a profit center.  As a result, more and more manufacturers are offering extended warranties or service contracts that buyers purchase separately from the actual product.  Every reader who has made a major appliance, automobile, or electronics purchase recently will be familiar with the sales pitch for extended warranties and service contracts, and may even have purchased one for themselves.

Manufacturers can benefit from offering Service Contracts and Extended Warranties

Service contracts and extended warranties, if properly priced and structured, can be very profitable for the companies offering them.  Retailers have been aggressive in selling extended warranties and service contracts, which are typically offered by third-party warranty companies, with consumer goods, like electronics and appliances.  Warranty companies typically pay commissions to the retailer for each sale, and the retailer pockets a tidy profit with no further responsibility.    Manufacturers can capture their share of service contract and extended warranty profits, however, by getting into the business themselves; they already have brand recognition and customer engagement and can offer branded extended warranties or service contracts, unlike retailers or third party warranty providers.

Beyond increasing profitability, in the consumer space, service contracts and extended warranties appear to increase customer loyalty and purchase satisfaction.  In a 2015 survey conducted by Ipsos for The Warranty Group, it was reported that service contract purchasers have a “stronger emotional attachment” to the products they buy.  That survey also indicated that younger millennial purchasers were more likely to purchase a service contract than older purchasers.  Research by Assurant Solutions, a leading provider of extended warranty and service contract solutions, indicates that consumers that purchase extended warranties and service contracts are twice as likely to recommend the retailer where they made purchases.

State regulation of Service Contracts and Extended Warranties

Unlike traditional warranties, which are included in the purchase price of a product, service contracts and extended warranties for which a separate, identifiable price is charged are subject to state regulation.  Specifically, state insurance regulators in approximately thirty states have some oversight over providers of service contracts and extended warranties.  This regulation varies widely, from state requirements that service contract and extended warranty providers be licensed as insurance companies (for example, Georgia Code § 33-7-6(3) provides that service warranties are a form of property insurance) to requirements that providers register as service contract providers (for example, Minn. Stat. § 59B.03 requires all providers of service warranties to register with the Minnesota Division of Insurance and pay a $750 annual registration fee).  While many of the states that regulate service contract and extended warranty providers don’t follow it precisely, the National Association of Insurance Commissioners’ Service Contracts Model Act (MDL-685) (the “Model Act”) is one frequent source for state legislation on this issue, and any manufacturer contemplating its own service contract or extended warranty program should review this Model Act.

Manufacturers can offer Service Contracts and Extended Warranties with less regulatory hassle

When offering service contracts or extended warranties on their own products, manufacturers are often exempt from licensing and registration requirements to which other non-manufacturer service contract or extended warranty companies would be subject.  For example, in Utah, which requires service contract and extended warranty companies to register with the state insurance regulator (Utah Code § 31A-6a-103), a manufacturer offering service contracts for its own products is exempt from both the registration requirements and from oversight and regulation by the state insurance regulator (Utah Code §§ 31A-6a-102(3), 31A-1-103(3)(i) & (6)(a)).  In Utah, this exemption extends beyond the manufacturer to its affiliates and subsidiaries as well. Other states, like Kentucky, exempt only the manufacturer and not its affiliates and subsidiaries (see Ky. Rev. Stat. § 40-201a).  Yet other states, like North Carolina, provide an exemption for manufacturers and distributors, but not other affiliates and subsidiaries of a manufacturer (see N. C. Gen. Stat. § 58-1-15(2)(b)).

Unfortunately, not all states provide manufacturer exemptions from licensure or registration as a service contract or extended warranty provider.  Even in states where there is a manufacturer exemption from licensure or registration, manufacturers often must comply with state laws and regulations governing the form and contents of service contracts and extended warranties.  Accordingly, a manufacturer that seeks to offer its own extended warranty or service contract alongside its products (rather than allowing the profits to go to third-party providers) must plan on complying with varying state laws requiring registration or limited licensure with state insurance regulators in some states.  Despite these requirements, manufacturers face a lower overall regulatory burden in offering service contracts or extended warranties, compared to third-party providers.

Should you start a Service Contract or Extended Warranty business?

Manufacturers, particularly those with valuable brands, may be able to grow their revenue and profit by offering service contracts or extended warranties, either for the first time or in the place of a third party provider.  Manufacturers contemplating this approach often benefit from a number of exceptions from state regulations, which can mitigate costs of entry and reduce the regulatory risks that a manufacturer (as opposed to a non-manufacturer third party provider) faces from expanding its offerings to include service contracts or extended warranties.

If you have questions about manufacturer-provided service contracts or extended warranties, please contact Ethan Lenz, Morgan Tilleman, or your regular Foley attorney.

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