Recent Publications

May 21, 2008
ALP: Extended warranties promise great profits, but beware of regulatory costs.
Christopher J. Karo

The sale of extended warranties (commonly referred to as “service contracts” in the industry) has become a profit center for many retailers of consumer products and automobiles. Extended warranties provide the promise of high profit margins at relatively little cost, in terms of both marketing and, ultimately, product repair or replacement.

In response to the growing number of extended warranty offerings in the marketplace, states have increasingly begun to regulate these contracts as a type of insurance product, requiring retailers to pay particular attention to the regulatory schemes of the states in which they do business. Before you decide to offer extended warranties, there are several important issues to consider:

• There is a difference between merely “selling” and “issuing” an extended warranty. Companies that issue extended warranties are obligated to perform the promised services or to pay for those services to be performed by a third party. In states that regulate extended warranties, it is primarily the issuing “obligor” that is responsible for meeting certain regulatory burdens, which can include registration, financial solvency, consumer disclosure, and record-keeping requirements.
  
  A service contract seller that is not obligated to perform or pay for promised services is generally exempt from these requirements in most states. However, there are a few states that require extended warranty sellers to be registered, like insurance agents or agencies.
  
  
• If you sell another company’s extended warranty, verify that it meets your state regulatory requirements. When you partner with a company that issues extended warranties, you should verify that the company is lawfully permitted to issue extended warranties in your state. Ask questions and verify the information you are given. Because extended warranties are typically regulated as quasi-insurance products, companies that illegally offer extended warranties in a state may be prosecuted as unauthorized insurers, and those selling their contracts can be charged with aiding and abetting an unauthorized insurer.
  
  
• Make sure your extended warranty does not provide insurance benefits. There is some leeway for extended warranties to cover more than just defects in materials or workmanship; for instance, coverage for accidental damage from handling, power surges, and road hazards are generally permitted. However, extended warranties that cover outside perils typically covered by insurance policies – such as theft, fire, loss, and damage – can transform your extended warranty into a full-fledged insurance product, which can only be issued by a licensed insurance company.
  
  Related to this point, the Kentucky Legislature recently passed HB 590/SCS which, in part, prohibits offering or providing “free insurance for damage, loss, or theft as an inducement to the purchase, sale, or rental of consumer goods or services” connected with consumer goods. This new provision of law does not affect extended warranty offerings by consumer product retailers or automobile dealers, assuming those companies comply with Kentucky’s statutes and regulations regarding the conditions under which extended warranties (referred to as “motor vehicle warranties” and “service contracts” under Kentucky law) can be offered. When offered in compliance with Kentucky law, extended warranties are specifically deemed not to be insurance. If, however, your extended warranty program does not meet Kentucky law, or you offer certain benefits as part of your program that fit the traditional definition of insurance, this provision may apply to your program.
  
  
• Be wary of state regulatory requirements for selling extended warranties over the internet. States that regulate the sale of extended warranties focus on offerings made to consumers who reside in their states. If you sell extended warranties nationwide via a website, you must determine which state regulatory requirements apply to your extended warranty offerings.

As the service contract industry continues to evolve and expand, the trend toward further regulation of industry participants, including retailers, will likely continue. Companies involved in any aspect of the industry are well-cautioned to review their activities in light of the numerous and differing state regulatory schemes applicable to the sale and offer of extended warranties.