Transforming Business Pain into Profit with Reinsurance Strategies

Pain. Lots of things in business can cause us pain. This article is designed to teach you a way to turn some of that pain into profit. 

In 1994, I started a company to help used car dealers with some pain they were experiencing. You see, their product — used cars — tend to break down. Why? Because they’re made in Detroit, not in Heaven. And because they break down, it is important that the dealers stand behind their product. That is accomplished through the use of warranties. 

Now, not every car breaks. Every car, however, has the potential to break. And, in order to be a good, reliable car dealer, it is a “Best Practice” to give your customer peace of mind that, should there be a problem, the dealer has a plan in place to get the customer back on the road. 

For many car dealers, that plan consisted of reaching out to a third-party warranty company, purchasing a warranty, and then turning around and offering it to their customers. 

We’ll call that company Joe Blow’s Warranty Company.

I’m telling you this story because, as you can see, there are some similarities with your HVAC contracting business. The pain is real. 

Let me explain what happens when you buy a warranty or service contract from a third-party warranty company. 

Let’s say, for demonstration purposes, that a warranty costs you $600. You sell a job, with a warranty, then send in $600. 

Joe Blow Warranty Company receives that $600. They take $100 out for overhead expenses, and put $500 in an account to pay claims. This is considered the premium. The premium is not taxed. 

In fact, Uncle Sam says you can put up to $2,900,000 away each year in premiums and pay no tax.

In this example, in one year, you send in 1,000 of these warranty contracts. Joe Blow Warranty Company stacks that cash up like firewood.

That’s $500,000 dollars. 

Now, what you think you paid for is a solution to the pain. The plan is: you submit a claim, and Joe Blow Warranty Company pays the claim. And maybe, that’s what will happen. I am sure that you have experienced the good and bad of that pain.

But, $500,000 dollars of claims? Not hardly. 

In fact, I can assure you that if that were the case, they would cut you off. So, let’s say they paid out 20%, or $100,000 in claims.

They made $400,000 in underwriting profit.

Now, the truth be known, what usually happens is your guy, Bubba, doesn’t do exactly what he was supposed to do during installation, and you have to send him or someone else back out to fix it. 

A “callback.” 

Now, who pays for callbacks? Do you submit a claim for callbacks? Or, do you normally have to pull someone off a paying job to send them on the callback? 

You most likely eat it. Pain!

Let me reassure you, there is a better way, and not just for car dealers, but for you too.

It’s called Reinsurance. It’s what smart car dealers do.

What the Heck is Reinsurance?

Just like what many car dealers have been doing for decades, reinsurance is setting up your own warranty company.

Your own, as in you own it. You’re the stockholder.

That means moving forward, instead of you buying a warranty or service contract from Joe Blow’s Warranty Company, you buy it from your warranty company.

Just like with Joe Blow, you sell your product, you add a warranty, and upsell a service contract. But, instead of sending it to the pit of no return, you send it to your own warranty company.

I know you will think of many ways you can use your own warranty company, but for illustration purposes, let’s revisit the above example. 

$500 x 1,000 = $500,000 - $100,000 in claims, leaves $400,000 profit for the stockholder.

Who’s the stockholder again? You.

You can expense out of your home services company the cost of the warranty and service contract, which means you don't pay taxes on that money. And eventually, when it earns out (expires), all of that profit belongs to you.

Yep! 

Only your claims and callbacks are paid out of your warranty company. The premium collected can be reserved indefinitely with no tax consequences. Underwriting profit can be invested within the reinsurance company. Tax is only paid on the underwriting profit.

You can borrow from your reinsurance company. Borrowing money does not create a taxable event. 

There are no employees. No overhead. There are no salaries or commissions to pay on the profit earned. Only you the stockholder benefits.

Who can own a warranty company?

If you own a business that provides a warranty, you can expense out the cost of that warranty from your primary company and send it to your own warranty company. It’s really not complicated. 

Maybe you just need someone who has been doing this for over 30 years to help you with it.

Reinsurance, it’s not just for car dealers anymore.