Have you ever purchased a service contract (sometimes referred to as an extended service plan or extended warranty) for your home, car, or consumer good? Most states regulate sellers of service contracts and require that the entity selling the contract has adequate financial capacity to pay for future repairs on the service contracts that they are selling to consumers.
Certain states require sellers to put up cash deposits (or cash like securities) with the state, maintain a contractual liability insurance policy, utilize a surety bond, or maintain a combination of different securities. Each state has different regulatory schemes, so you should contact a specialist in the warranty space while you are applying for various licenses to ensure that you follow all laws and regulations.
How is a Service Contract different from a Warranty?
A warranty is included in the purchase price of a product and there is no separate consideration charged to the consumer by the retailer. If you are purchasing a service contract, there will be consideration transferred for the service contract. Service Contracts can be beneficial because they are designed to provide protection after a manufacturer’s warranty expires. In some instance, a service contract may cover breakdowns which a manufacturer’s does not. It is important to fully read an understand the terms and conditions of the service contract you are purchasing. It is also a good idea to retain all documents related to the purchase of your service contract.
Why should I consider using a surety bond instead of a cash deposit for my Service Contract Provider license?
When you are making your application to the various state licensing departments to obtain a service contract provider license, you may be asked to provide financial security. In some cases, you will be able to put up cash, a letter of credit, or a certificate of deposit with the state to secure your obligations under the service contracts that you will be issuing. As a new business, you may not want to tie up cash. If you were to utilize the surety bond instead of a cash deposit, you only need to pay a percentage of the bond amount (known as the premium) each year. The surety company will underwrite you both from a business and personal perspective to ensure that you can fulfill your obligations under the bond.
How are Service Contract Provider bonds underwritten?
Since Service Contract Provider bonds guarantee that the business selling the service contract will have the funds to cover promises made under the service contract, the surety company will want to make sure that the business has ample resources on hand to cover the potential obligations. The aggregate limit of bonds needed by service contract provider business can get quite high as many companies operate in multiple states. Therefore, underwriting requirements may vary based on how many bonds and the size of the bonds that the company is requesting.
The underwriter will likely ask for the following:
- Personal and corporate financials
- Credit authorization
- Types of service contracts being sold
- Length of service contracts being sold
- Sales and claims history
Depending on the initial information received, the underwriter may have additional questions in order to approve or decline the bond request. Furthermore, some bonds have very unfavorable provisions, such as forfeiture language or lack of cancellation language which make the underwriting process more difficult.
Does Lexington National help Service Contract Providers become licensed?
Yes. Lexington National writes Service Contract Provider bonds through licensed insurance agents. In some instances, you may find out from the agency that you are trying to become licensed in that a bond cannot be used for financial security and that you must secure a contractual liability insurance policy, also known as a CLIP. Lexington National can also underwrite and provide CLIPs.
If you have questions about Service Contract Provider bonds, please contact us by completing the form below.