Reconciling refunds: Why aftermarket products became an afterthought

From the July issue: State and federal regulators are ratcheting up enforcement of ancillary product refunds.

In the past few years, auto lenders have faced heightened scrutiny related to the percentage of consumers buying ancillary products, how the products are offered, and what disclosures are provided. But compliance examinations of late have veered in another direction, seeking details on how aftermarket products — like service contracts and gap insurance — are handled when loans are terminated early or when vehicles are repossessed or deemed a total loss.

States are challenging the timing, responsibility, and amount of refunds, making it difficult for lenders to keep up, said Kelly Lipinski, partner at McGlinchey Stafford. The Consumer Financial Protection Bureau, too, is investigating whether lenders are appropriately canceling coverage and providing prorated rebates of premium amounts for any unused portions.

“It’s hard for lenders to remain compliant, because they don’t always know their obligations when it comes to a refund,” said Rich Apicella, executive vice president at F&I Express. Plus, there’s a lack of transparency in the market when it comes to communication between lenders, dealers, and the more than 500 aftermarket product providers in the U.S., he added.

“There’s a proliferation of companies out there and a proliferation of different products,” Apicella said. “That adds to the complexity of managing this [issue].”

In all, 46 states have regulations regarding ancillary product refunds, said Gary Peek, vice president and general manager at F&I Express. And aftermarket products continue to grow in popularity. According to data from investment banking firm Colonnade Advisors, it is estimated that post-OEM service contracts will jump 25% to 109 million by 2023.

As such, lenders must remain diligent on compliance, monitoring rules about communicating rebates and determining where the responsibility falls on relaying rebate notices, said Kenneth Rojc, managing partner of Nisen & Elliott LLC’s Automotive Finance Group. Then, he said, lenders have to answer several questions about the ancillary products in their portfolios: “‘Do I have an obligation to provide a refund? When must the refund be provided? How must that refund be shown in the context of a balance deficiency notice where credit is offered and the amount is known and the creditor has that amount in hand?’”

Specifically, the “triggering event” for a consumer refund is either repossession or total loss, Lipinski said. Once that event occurs, lenders must determine when a check needs to be issued or a credit applied. In some states, lenders have 60 or 90 days from the event to cut the check. Other states provide no specific timeline.

Then there are states with a 30-day window for refund. “That’s where the states are creating some challenges for the industry, because they’re expecting creditors to issue a refund within 30 days,” Lipinski said. “That is extremely impractical due to the process, which is you have to sell the car, you have to work with administrators — oftentimes they actually get the money — or [with] dealers to issue checks.”

With ancillary product rebates, though, examinations and subsequent enforcement actions taken by state and federal regulators are conducted privately, Lipinski said, noting that McGlinchey Stafford is dealing with an increasing number of refund cases.

Under the regulatory microscope

Though executives interviewed for this article said that data surrounding frequency of refund-related exams and enforcement is tough to quantify, these cases are top of mind for the CFPB, according to the regulator’s winter 2019 Supervisory Highlights.

Earlier this year, auto loan servicing examinations by the CFPB identified unfair and deceptive acts or practices related to calculating and disclosing deficiency balances in the context of ancillary products like extended vehicle warranties. The CFPB found that lenders were miscalculating rebates — which resulted in higher deficiency balances — and they failed to request refunds from service providers for eligible ancillary products after repossession or total loss. Furthermore, examiners found that lenders sent consumers notices that presumably showed final deficiency balances yet failed to include eligible rebates.

The CFPB noted mileage-related issues, too. “Examiners observed instances where one or more servicers used the wrong mileage amounts to calculate the rebate for extended warranty cancellations,” according to the recent Supervisory Highlights report.

“The miscalculation reduced the rebate available to certain borrowers and led to deficiency balances that were higher by hundreds of dollars,” which the servicers then attempted to collect, the report said.

The average unclaimed rebate, according to the report, is roughly $1,700.

Individual states — most notably Alabama, Colorado, Massachusetts, and Texas — have ramped up refund scrutiny, said McGlinchey Stafford’s Lipinski.

In Texas, the creditor holding the retail installment contract is responsible for ensuring that the refund is made, said Matthew Nance, deputy general counsel of the state’s Office of Consumer Credit Commissioner (OCCC). “Some creditors mistakenly believe that they are not responsible for the refunds,” he said. “We encourage creditors to pay careful attention to any debt-cancellation agreements that are part of the retail installment contracts that they take assignment of, and to have a procedure for making sure that consumers receive any required refunds.”

The OCCC has received complaints where consumers allege that their claims weren’t correctly processed or that their vehicles were improperly excluded from coverage, Nance added.

Similarly, Indiana requires lenders to keep track of rebates. “We require auto lenders, as the original creditor and seller of the gap or credit insurance product, to maintain records and track prepayment of accounts, including any retail installment contracts that they may assign to other finance companies or financial institutions,” said Lyndsay Miller, general counsel of the state’s Department of Financial Institutions.

How lenders react

Lenders should speak to in-house or outside counsel, along with compliance and risk management teams, to decide if they want to handle rebating internally or outsource it to firms that specializes in ancillary product servicing, Nisen & Elliott’s Rojc said.

Some nonprime lenders, due to their operational size and annual originations numbers, are able to put processes in place to curb the growing regulatory interest ancillary products are garnering.

Anderson Brothers Bank, for one, processes rebates in-house, canceling products as necessary while communicating and retrieving the proper rebates, said Senior Vice President Micky Watts. “We use a spreadsheet and just check all the boxes,” he said. “Did we send this letter? Did we cancel the check? Did we notify the consumer?”

The Mullins, S.C.-based bank typically sends 20 to 50 refunds a month. “We have one person that handles [rebates] for us,” he said. “We are small, so that works. The bigger you are, the harder it is — you just have to have a process from the get-go.”

The bank uses the same process for its loans in North Carolina and Georgia. “It’s money for us that we wouldn’t normally recover, and it’s good for the consumer,” Watts said. “It’s a win-win.”

About a year ago, Anderson Brothers tried using a third-party vendor and found that the refunds could take twice as long. “A process that might take 60 days when we manually do it took 90 to 120 days to get back — that’s too long,” Watts said.

Meanwhile, subprime lender Turner Acceptance also controls rebates in-house since they are “a sensitive area of operations,” said Andres Huertas, director of lending and marketing. Consumer Portfolio Services, too, manages ancillary product rebate procedures internally, using a process put in place more than a decade ago.

“It’s a real administrative function that the lender has to make a commitment to, because there’s real money involved and there are compliance issues involved, too,” said Executive Vice President and Chief Financial Officer Jeffrey Fritz. “In the event of a default or repossession liquidation, every account of ours that goes through that process goes to a work queue where someone is looking for an [ancillary product] at the time of origination. It’s prominently displayed and located in our database.”

Despite the upkeep required to manage ancillary product rebate procedures, Fritz insisted that the efforts are worthwhile to ensure that money is appropriately recovered. “We monitor to make sure that we receive the funds and they are applied back to the account,” he said. “It’s important for compliance purposes, of course, but it’s real money, too. It’s important to us, and it’s worth the administrative headache.”

Other lenders, meanwhile, turn to third-party vendors to manage refunds for ancillary products. F&I Express’s Express Recoveries platform has 40 lenders using its services, Apicella said.

Regardless of operational initiatives some nonprime lenders have taken, data that would serve to quantify the growing aftermarket compliance issue is largely unavailable in the public space, which keeps lenders in the dark as to big-picture concerns for the industry as a whole.

AFN reached out to nearly a dozen lenders, dealer groups, and industry associations for a dataset that cast a wide enough net to illustrate the scope of the problem, but none could provide data such as the percentage of loans originated with add-on products or the frequency at which loans are terminated early because of prepayment, repossession, or charge-off.

Communicating with dealer partners, however, may provide a glimpse into a smaller segment of the issue, even if it doesn’t envelop the entire scope.

California-based franchise dealership Carson Nissan, for one, typically sells 225 contracts per month; 69% of those contracts have one or more ancillary products attached to the vehicle’s financing, said Saif Kadri, the dealership’s sales manager, noting that around 20% of those contracts come back for refunds. “If the car is a repo[session] or total loss, we don’t touch the refund. The lender facilitates it,” Kadri said.

Similarly, Pa.-based Hagerstown Honda and Kia President Paul Ritchie told AFN his dealership chain sells 250 to 300 contracts per month, with an average of 1.7 ancillary products attached to the financing.

Still, Nisen & Elliott’s Rojc stressed that additional oversight by state and federal regulators should be enough to capture lenders’ attention.

“If the CFPB mentioned it in their winter 2019 Supervisory Highlights, they are signaling this is an issue they will be looking at in their exams— that should give sufficient alert to auto finance lenders to pay attention,” he said.