Solving the Industry’s Conundrums, One Question at a Time

Kirk A. Borchardt

2040 Alameda Padre Serra, #102Santa Barbara, CA 93103

(805) 963-2983

(former partner of Lord Bissell & Brookand former President and Chief Executive Officer of

Dealers Assurance Company)

INTRODUCTION

Question 1: Can we reinsure prepaid

maintenance contracts?

Question 2: Can an administrator issue

administrator-obligor limited warranties?

PRELIMINARY THOUGHTS

1. Do we really want answers?

2. Friends or enemies?

• Internal Revenue Service

• State insurance regulators

Dealer

Consumer

Policy Issuer

DORC

QUESTION 1: Can a dealer-owned reinsurance company reinsure prepaid maintenance plans.

1. There is nothing illegal about it.

2. How to book the business for tax purposes (953(d) electing companies).

• Insurance underwriting income, or

• Investment income (IRC Section 834(b)).

Reinsuring prepaid maintenance contracts

3. Principal tax issue – do we have insurable risk? Helvering v. Le Gierse, 312 U.S. 531 (1941).

• The policy insures the consumer’s credit risk of the issuer.

• The consumer shifts the risk of price increases in the cost of services.

• Performance causes economic loss to the issuer, which is spread over many exposure units.

4. No direct IRS ruling on point, but . . .

Reinsuring prepaid maintenance contracts

• Private Letter Ruling 200042018 – compared VSCs to prepaid maintenance

• Revenue Ruling 68-27 (1968) and Jordan v. Group Health Association, 107 F.2d 239

(D.C. Cir. 1939) – HMO prepaid service agreements

5. Why be bullish?

• Business risk vs. insurance risk

QUESTION 2: Can an administrator-obligor issue an A-O limited warrant covering a used vehicle?

• Normal evolution of the business

• Structure may involve a licensed A-O and include the insurance backing

A-O Limited Warranties

1. State regulatory risks – is it legal?

• Common law view – contracts issued by manufacturers, distributors, and dealers

• Regulatory support for VSCs and VPPs

• Florida challenge

A-O Limited Warranties

2. Mitigating factors

• The industry has evolved

• Using a licensed A-O with insurance

• Safety in numbers

• No direct charge to the consumer

A-O Limited Warranties

• Magnuson-Moss Warranty Act (15 U.S.C. 2301 et seq.) authority for warranty providers other than the manufacturer or dealer:

“It is not a requirement of the Act that an agreement obligate a supplier of the consumer product to a written warranty, but merely that it be part of the basis of the bargain between a supplier and a consumer. This contemplates written warranties by third-party non-suppliers.” 16 C.F.R. § 700.11(b).

A-O Limited Warranties

3.Federal income tax issue – can the limited warranty be viewed as an insurance contract, like a VSC.

• Private Letter Ruling 201438022

1) Complicated facts2) Warranty is “intertwined” with the product3) Insurance must be separately purchased

A-O Limited Warranties

4. PLR 201438022 ignores facts in Amerco Inc. v. Commissioner, 96 T.C. 18 (1991).

• Insurance purchased by U-Haul that specifically insured the renter. 1) U-Haul paid the premium2) Customer could not decline the insurance3) Insurance “intertwined” with lease

Warranties as Insurance: Does TAM Signal New IRS Position? Adam Fisher and Mark Smith, The Insurance Tax Review (March 2015)

A-O Limited Warranties

5. A private letter ruling request is in the works on this specific issue with clean facts.

• The ramifications of a positive ruling will be widespread and phenomenal.

• The industry would have to ramp up lobby efforts to secure authority under state law.