Survey: Why car buyers get service contracts

Consumers buying expensive vehicles and those with plans for lengthy ownership or whose finances make them unable to afford more than a $500 sudden expense are among the most likely groups to purchase a vehicle service contract, new research has found.

High-mileage vehicles or driving habits also can boost the odds a consumer buys a finance and insurance product, according to a June paper by retired Federal Reserve Senior Economist Thomas Durkin, Federal Reserve Principal Economist Gregory Elliehausen and Mississippi State University Professor Thomas Miller Jr. Their work was funded by the Voluntary Protection Products Coalition and drew upon polling in January and March of 1,200 consumers.

The Federal Trade Commission last year argued consumers are being hoodwinked into buying various F&I products and proposed auto retail regulations to improve transparency and curtail dealership deception.

The "length and complexity of motor vehicle transactions has created an environment ripe for deceptive or unfair conduct," the FTC's rule-making proposal states. "Consumer complaints suggest some dealers have added thousands of dollars in unauthorized charges, including for add-ons consumers had already rejected. These issues are exacerbated when pre-printed consumer contracts automatically include charges for optional add-ons, when consumers are rushed through stacks of paperwork or when asked to sign blank documents.

"This provision would help protect consumers from unfair or deceptive charges buried within lengthy contracts or stacks of paperwork," the proposal adds.

But Durkin, Elliehausen and Miller's polling found — as they had hypothesized — customers who buy service contracts have the kinds of vehicles, plans and financial vulnerability that make the coverage relevant. The study also found buyers overwhelmingly know the contracts are voluntary, understand their terms and cost and are satisfied if they buy one.

"Dealers typically offer service contracts as part of the vehicle sales process, but the sales process itself does not appear to govern the outcome," the authors wrote. "Further, although many vehicle buyers are offered the product, only a minority of vehicle buyers actually purchase it, the rest presumably believing either they do not need it, or it is not cost-efficient for their needs."

Shoppers appear to buy the coverage with an eye to their specific situation, such as a high-price or high-mileage vehicle, they said.

The paper finds "evidence about purchases of service contracts is consistent with demand variables in a normal model of demand for the product rather than any finding of ad hoc explanations like excess sales pressure placed by sellers upon buyers," the authors wrote.

Paul Metrey, senior vice president for regulatory affairs for the National Automobile Dealers Association, told Automotive News the results mean "the market is functioning in an efficient manner here, and that consumers are really making choices based on their circumstances that are rational."

The polling found 58 percent of households among the 1,200 individuals polled had bought a vehicle in the past four years. Overall, 25 percent of the owners had purchased vehicle service contracts, a proportion that rises to 29 percent when only dealership sales are considered. (Among franchised dealerships, contract penetration ran 51 percent on new-vehicle deals and 56 percent on used-model transactions, according to 2021 data by NADA.)

Trends also show which future customers in the F&I box are more likely to agree to the coverage and why.

Thirty-nine percent of those who couldn't cover more than a $500 emergency expense bought a service contract. Thirty-seven percent paying at least $45,000 for their vehicle bought the coverage, compared with 16 percent with vehicles that cost $25,000 or less. Thirty-five percent of those who financed their vehicles through the dealership purchased contracts, compared with only 14 percent who paid cash.

Thirty-four percent buying vehicles they planned to keep at least 10 years attached a service contract, but the penetration rate was only 14 percent for buyers who planned to keep a vehicle no more than four years. Thirty percent of coverage buyers expected to put more than 20,000 miles on their vehicle every year.

Other trends focused solely on consumers who bought vehicles at dealerships.

"Reasonably, the purchase of service contracts would be more common in dealer situations," the authors wrote.

Only 16 percent of buyers in the lowest income quartile added a service contract — but 26 percent of lower-income buyers at dealerships bought the coverage.

Service contract penetration was dismal if the vehicle had more than 95,000 miles — only 6.8 percent. However, 25 percent of those high-mileage vehicles bought at dealerships were protected by the coverage.

A customer interview can help a finance manager identify shoppers in demographics more likely to want a service contract or other F&I product.

"If we spend all of our time getting that information, asking those questions, it leads to a very quick close and [an] effective presentation," Phil Parlovecchio Jr., regional finance executive for F&I product provider Zurich North America, said at a June training seminar.

Zurich recommends the interview include questions such as how long a buyer plans to keep the vehicle, their expected annual mileage, whether the car will be kept in a garage at home and at work and the quality of the roads they'll drive. (It also recommends confirming key transaction details at this time, ranging from the monthly payment to the trade-in vehicle's mileage.)

The idea is to determine why someone would buy an F&I product, Parlovecchio said.

"If you are going out to buy something, you're buying something because of what it's going to do for you and your life and how it's going to better your circumstance or your situation, right?" Parlovecchio said. "So we have to build the value over costs in terms of our presentation. ... So doing that through the interview, asking those questions is getting through the why."