When Your Car Warranty
Runs Out of Gas

When the air conditioner in Rick Hooper's 1999 Pontiac stopped working properly under Arizona's blazing July sun, he didn't worry. After all, he'd purchased an $874 service contract when he bought the car to cover the costs of repairs.

But when he sent the car to his mechanic, he got some bad news: The company that backed his extended-service contract, National Warranty Risk Retention Group, was in liquidation and couldn't pay the claim. Rather than pay $2,000 out of his own pocket, he just decided to sweat it out and roll down the windows.

Mr. Hooper is one of many consumers whose car-warranty claims are going unpaid by National Warranty of Lincoln, Neb. The company backed an estimated 900,000 to one million service contracts over the past two decades. Car buyers paid anywhere from $600 to $2,000 for the coverage.

The National Warranty debacle highlights a little-known aspect of the service-contract business. Even if you buy a contract from a longtime neighborhood car dealer, the contract is actually backed by an unseen insurance company. If this insurer runs into trouble, you're out of luck unless your dealer opts to pay for repairs to keep a customer.

Consumers bought vehicle-service contracts on nearly 30% of new vehicles sold last year and more than 40% of used vehicles, according to the National Automobile Dealers Association. An estimated 8.7 million such contracts are sold a year, putting the market for them in excess of $10 billion, according to Universal Underwriters Group, a competitor to National Warranty.

This isn't the first time an insurer of extended-service contracts has run into trouble. These contracts first became popular in the late 1970s and early 1980s, and several companies writing the coverage miscalculated the costs of repairs and ultimately folded. Among them: American Warranty Corp., a division of United Equitable Insurance and National Colonial Insurance Co. Industry experts say now that the industry has matured, such incidents are rare and insurers have built up a better bank of statistical data to make good estimates on claims.

National Warranty won't say how many claims are going unpaid, but frustrated consumers looking for advice are flooding car discussion boards like Edmunds.com . The Better Business Bureau in Lincoln has received 178 complaint letters related to the issue.

The Nevada Department of Motor Vehicles has received 104 complaints; in 78 of those cases, the dealer has agreed to pay for repairs. One lawyer in Las Vegas, Robert Gerard, says he's preparing a class-action suit on behalf of uncompensated claimants, though the liquidation is supposed to protect National Warranty from such legal actions.

When a state-regulated insurance company runs aground, state guaranty funds normally kick in. But because National Warranty is a so-called risk retention group, which is regulated by the federal government, customers can't tap state insurance guaranty funds.

The contracts backed by National Warranty had some of the lowest prices in the industry, according to competitors. That may be part of the reason the company got into trouble. If insurers don't charge enough then "they either have to make up the shortfall or they go out of business," says David Robertson, executive director of the Association of Finance and Insurance Professionals.

National Warranty got into financial trouble late last year when it didn't have enough money to pay claims and got into a dispute with business partners, says a spokesman for accounting firm KPMG, the company's liquidator. In June, National Warranty filed for court protection in the Cayman Islands, where the company is incorporated. Now, the company is being liquidated. KMPG says it's too early to tell how much money, if any, will be available to pay claims.

Consumers are typically advised to check the financial health of an insurer before they buy a contract, but that's easier said than done. Just months before it stopped paying claims, National Warranty was rated highly by A.M. Best Co., which monitors the financial strength of insurers.

Matt Mosher, group vice president for A.M. Best, says, "The rating opinion in our view was correct based on the available information we had at the time." He also points out that the National Warranty rating was downgraded as more information became available.

"Consumers are really out there on their own," says Robert Hunter, director of insurance at the Consumer Federation of America, who won't buy extended warranties on his own cars. "I think it's a very risky purchase," he says.

In some instances, dealers who sold contracts backed by National Warranty are paying for repairs out of their own pockets. Spady-Runcie, a Chevrolet, Oldsmobile and Cadillac dealership in Beatrice, Neb., says it has paid for several repairs that were supposed to be covered by a service contract. Other dealers are holding cars hostage.

James Glaziner, an auto-parts deliveryman, from the city of Orange, Calif., saw his car get repossessed after getting tangled up in National Warranty's financial mess. Mr. Glaziner says a Las Vegas car dealership, Bill Hurst Chevy, told him in May that his warranty would cover all of the $5,500 in engine repairs his car needed.

But, a week later, Mr. Glaziner's son Tim called to see if the car was ready and was told that the insurer had refused to make any payments while it was in liquidation. If Mr. Glaziner wanted the car, he'd have to settle the bill himself.

Mr. Glaziner refused, and the car was ultimately seized by Bank of America, which held his car loan.

"Why should I pay for something that was supposed to be guaranteed?" asks Mr. Glaziner who is talking to an attorney about getting the car back. Bank of America declined to comment. Bill Hurst Chevy didn't return calls.

How can consumers avoid such problems? One option is to buy a warranty directly from the manufacturer instead of an independent company. It may be more expensive, but chances are if the insurance company backing the policy drops out, the manufacturer will step in and cover the cost. "If they don't, they know it's going to hurt their brand," says Bob Kurilko, vice president of marketing for Edmunds.com.

© 2003   Dow Jones & Company, Inc.