The stretching of loan terms is one of the many auto finance trends driving payment-conscience consumers back into showrooms. It’s also allowing some providers, agents and dealers to test a new wrinkle on a core F&I product.
Since its introduction in the 1990s, guaranteed asset protection (GAP) has primarily been sold based on two- and three-tier pricing models. Within the past couple of years, though, some dealers have switched to a four-tier structure to match GAP pricing and coverage to current finance trends, including the uptick in approvals for auto loans of 63- and 75-month terms.
Data on 63- and 75-month terms wasn’t readily available from Experian Automotive, but the firm did note that the first sign of finance source loosening terms dates back to the fourth quarter 2010. That’s when the average term for new-vehicle financing reached 63 months. Last quarter, the average term on new-vehicle financing sat at 65 months, with the 61-to-72-month term band accounting for 41.7 percent of all new-vehicle financing during that period.
However, the segment that experienced the biggest increase in share was the 73-to-84-month band, which jumped 25.1 percent from a year ago to 19.5 percent of all new-vehicle loans.
Providers of debt-cancellation products say adoption of the four-tier pricing structure is still relatively low, but they add that dealerships that have made the switch are enjoying increased acceptance rates for GAP, as well as better profitability. They believe adoption levels will only increase if auto finance continues on its current path.
In the event of the total loss of a vehicle, GAP covers the difference between the depreciated value of the vehicle and the owner’s unpaid loan balance. A traditional two-tier model prices GAP based on the zero-to-61- and 62-to-84-month term bands, while the three-tier model uses the zero-to-60-, 61-to-72- and 73-to-84-month term bands. The price differences between these term bands often result in dealers making less profit on GAP at the higher term band.
Blake Norberg, development manager for C.D. Norberg & Associates Inc., a general agency based in Alabama, says the money his dealers were leaving on the table became more pronounced the more finance sources approved new-vehicle loans for 63- and 75-month terms. “What I found was that a lot of the banks will give you the same interest rate for 60 and 63 months, 72 and 75 months,” he says, acknowledging that the trend did help F&I offices move more product by keeping monthly payments down for customers.
But to help dealers capture more profit on GAP sales, Norberg has spent the last two years pushing his dealers in Mississippi, Georgia and Alabama to adopt the four-tier model — the product he reps offering a structure of zero-to-59-, 60-to-63-, 64-to-75- and 76-to-84-month term bands. Norberg likens it to a risk-based pricing program.
“Having risk-based pricing is the right way to go,” he says, estimating average profit for a four-tier structure to be more than $400. “You can still sell a lot of GAP and make a lot of money while at the same time being transparent to both customers and regulators. You’re also more credible as a finance manager.”
Norberg sources his four-tier offering from Mechanical Protection Plan, an administrator of debt-waiver products since 1990. Gerald Lamb, MPP’s vice president, has been with the company for 28 years. He says the firm primarily uses the two-tier pricing model because of its simplicity for dealers and customers, but he acknowledges that four-tier pricing is effective for certain dealerships.
“This four-tier model came about as a request from some dealers and agents,” he says. “They utilized this prior to us doing business with them. We did it more as an accommodation.
“When we do use the four-tier, it prices more effectively for the dealer and customer,” he explains. “If [dealers] do more new-car sales and longer terms, they have a pricing model for that segment. As a provider, if we continue to get the volume and penetration, that’s good.”
Lamb says only eight percent of his company’s GAP business originates from the four-tier pricing model, but he believes multi-tier pricing may grow in the future. In Texas, he notes, a new law went into effect last month that limits the consumer price on debt waivers to less than five percent of the amount financed. That could impact how MPP conducts business in Texas, which accounts for 42 percent of the company’s business.
“That could be a huge impact,” he says. “Maybe we don’t do four-tiers, but we’ll have to do at least three, so we expect multi-tier GAP pricing to increase for us.”
While dealers and product providers in Texas anticipate changes for GAP, others have already made the transition to the four-tier pricing model and achieved positive results. One such operation is Dalton, Ga.-based North Georgia Toyota, a family-owned dealership that retails, on average, 110 new and used cars per month.
Martin Wood, an F&I manager there, says the dealership made the switch from a three-tier to a four-tier pricing model two years ago on the advice of Norberg. The product currently penetrates at a rate of 40 percent.
“More and more folks are going to that 63-month option,” Wood says, noting that his department’s shift from the three-tier to four-tier model didn’t change how he presented the coverage to customers. “It’s just like going to the 72- to 75-month option. The banks have done it for the last few years with these term bands.”
He says the four-tier program does help his department retain more profit at the 63-month loan term because producers don’t have to compensate for any price increases by sacrificing profit. More than anything, his GAP pricing makes better sense to his customers.
“When you’re presenting GAP, it allows for everything to be more standardized,” he says. “When you can go from 60 to 63, the penetration level is good because the customer sees a constant. When they’re looking at pricing, the fluctuation is not that much.”
Woody Anderson Ford, an Alabama-based dealer group and another client of Norberg’s, switched its two Ford franchised stores from a three- to four-tier pricing model in late 2011. The reason: 85 percent of the store’s retail finance contracts approved by finance sources are for 75-month terms.
“It was just confusing to [customers] to switch 72 and 75 and charging $100 more,” says Chris Waggett, a 17-year industry veteran and F&I manager for the group’s 300-units-per-month Huntsville, Ala., store. “The reason it works so well for us is because we have a lot of banks that tier their schedule as far as financing goes.”
Waggett can attest to how matching the coverage term with the loan term has driven up GAP profitability. No longer does the F&I team have to concede margin because the finance source’s approval pushed the GAP term into the next tier. Waggett also believes the pinpoint pricing will play well should the dealership face legal or regulatory scrutiny.
“The dealership is at less risk,” Waggett says, noting that deductible coverage is what drives the product’s 24.8 percent acceptance rate. He says the structure also plays well in the accounting department. There’s less paperwork involved and the pricing model has eliminated that difference in pricing between 72- and 75-months loan terms, Waggett adds.
Other prominent figures and firms in the debt-cancellation segment are responding to current finance trends, including Tony Wanderon, a more than 25-year industry veteran. He was a partner and president of the original firm — founded in 1981 — Allstate acquired in 1999 and renamed Allstate Dealer Service in 2009.
Wanderon ran Allstate’s dealer business unit until he and the company parted ways in January 2011. He then founded Ponta Vedra Beach, Fla.-based Family First Dealer Services in February 2012. It opened as an administrator and marketer of guaranteed asset and trade-in protection. Wanderon’s firm added five new F&I products to its portfolio this year, including a four-tier GAP offering in February. The coverage now offers zero-to-60-, 61-to-72-, 73-to-76- and 77-to-84-month term bands.
The industry executive says finance sources introducing and approving 75-month term auto loans are what prompted FFDS to add the 73-to-76-month term band. “There wasn’t a lot, if any at all, loans that fell in between the 73-to-76-month term prior to 18 months ago,” he says. “Then it started showing up pretty prominently in the business that we write nationwide.”
Wanderon estimates that about 1,000 dealers have adopted the company’s four-tier program since the product’s launch. He believes it has the potential to gain even more ground. “It’s a competitively priced program and offers better coverage than most offerings in the market today,” he says. “And if you’re a dealer today paying an inflated rate for three tiers and you’re doing a good number of 75-month loans, it’s definitely worth looking at.”
The 15-store Ed Morse Automotive Group in Florida, which retails about 1,300 new and used vehicles per month, was one of FFDS’ early adopters of the four-tier program, and it is not difficult to understand why. For the first six months of 2013, 12 percent of the dealer group’s finance deals were within the 72-to-75-month term band, an increase of two points from previous years, says Senior Director Randy Hoffman.
“We have a large Toyota dealership and Southeast Toyota [Finance] has a 75-month term,” he says. “We were getting dinged for it.”
Hoffman says it took about a month to educate and transition the F&I staff to the new pricing model. Critical to the transition was getting producers to buy into the product’s pricing structure and how it was a better value to customers. Year to date, consumer acceptance of GAP has risen 5.7 percent and now penetrates in the mid-40 percent range. Hoffman estimates that the four-tier program has increased profits for the group by $20,000 per month overall.
“In today’s world, why would anyone want to pay more for a big brand name that, in the end, provides your customers with less coverage and a higher price?” Wanderon says. “Our goal is to always identify trends and respond quickly so we can save our clients time and money.”
The industry veteran says GAP had originally moved to a three-tier structure between 2003 and 2004, when finance sources moved to longer terms and higher advance limits. He describes the introduction of four-tier programs as an example of how much better GAP providers and administrators are able to respond to market trends. But he says the more ideal model would be if the product could be priced by risk rather than term band, noting that the longer term band is the riskiest for providers.
“Today, our industry can’t price by type of vehicle, interest rate or percentage of MSRP advance, and all those factors have a dramatic impact on what the cost of the program is. While the industry has come a long way, we are still mostly manual in the way we price and offer F&I-related products,” notes Wanderon, whose firm recently announced that it will merge with NAC (formerly National Auto Care), a provider and administrator of vehicle service contracts since its founding in 1984.
“At some point, I see us being able to do that — looking at interest rate, type of vehicle, percentage of MSRP. But at this point, three-tier has been effective and well received by all,” he adds. “I do think the four-tier has a lot of potential for our agents to stand out from the pack.”