What’s the Metric?

By Michael Benoit

With dealer finance compensation continuing to get squeezed by the regulatory pressure the Consumer financial protection Bureau is imposing on fi nance sources, dealers will be looking for other ways to generate revenues. New-cardealers can only earn a sliver of margin on a vehicle sale — as many would tell you, not enough to cover the overhead related to acquiring and selling the car. So, dealers have always looked to other sources to make up for the losses they incur in selling a car — good business judgment, floorplan lenders, and reality demand it. That’s why dealers don’t sell just cars, and why the sale of related products and services is so important. In two words, dealers are looking for “better margins.” Better margins are what pay the bills and employee salaries, fund retirement plans, and build wealth — activities that make the motor of a capitalist society hum.

Ancillary products — or “add-on products” as the CFPB and Center for responsible lending would call them — are one source of business that generates profits for a dealership. There are perhaps more than 5,000 of these products in the marketplace. Like anything, some are good, some are bad, and some are just right. The question that cannot be answered is, “Good, bad, or just right for whom?”

While the CFPB’s public attention to ancillary products to date has been focused largely on the credit card market (and primarily on debt- and identity-protection products), it seems as though the agency dislikes fi nancing of these products. The number of banks and other financial services providers that have stopped selling these products “due to regulatory pressure” or as a result of consent orders is proof enough. The bottom line is that despite an active market, these products are being driven out of financial institutions, thus eliminating access to what consumers may see as valuable.

There is a real danger when government starts to impose its views of what’s good for citizens through regulation or
legislation. “Value” is, and always has been, a subjective determination, made individually based on one’s specific
circumstances. To regulate value runs the danger of crossing the line between education and advocacy. Education through regulation informs; advocacy through regulation assigns value. The food and drug administration learned where that line is drawn when its cigarette labeling rules got struck down a few years ago. Whether done overtly through written regulation or through one-off regulatory actions, our government cannot — and should not — impose its views of “value” on citizens. In the case of auto finance products, leave that argument to industry and the CRLs of the world.

Here’s an illustration of how government run amok in our little world might go. Let’s say that regulators decided that service contracts have little or no value and should be discouraged. A prime credit customer buying a new car in Southern California might “value” a vehicle service contract differently than one in New York or Washington, D.C. Given the amount of driving one is likely to do in Southern California, a driver may easily hit the mileage cap that triggers the factory warranty’s expiration long before his financing is paid off, making a service contract attractive. On the other hand, that same customer living on the East Coast might reach the end of the warranty term long before he reaches the mileage cap, making a service contract unnecessary.

But whether the service contract has “value” can’t be determined by geographic location or credit tier. The California customer may live a mile from work and rack up few miles for other purposes, while the New York/D.C. driver may have a long commute or take a lot of car trips. What metric could regulators use to write a rule or take action against an institution to achieve its goal of discouragement? There isn’t one. The only accurate metric is the consumer’s subjective choice.

While the CFPB can’t directly force dealers to stop selling anything, it can apply pressure through the finance sources
(as we’ve seen in the fair lending arena), making them jump through hoops that add time and cost to the funding process. Many finance sources have been subject to inquiries about dealer profit margins on ancillary products (which the finance sources don’t know) and how the products are sold (which they also don’t really know).

GAP coverage and credit insurance may be first in the crosshairs. The CFPB is particularly interested in loss ratios on these products — something relatively easy to determine with credit insurance but nearly impossible to determine on GAP products — and the only reason I can think of is because it thinks that loss ratios are indications of “value.” Loss ratios are good as a window into profit, but not so good for valuing a product for any given consumer.

For example, I place high value on term life insurance for which I hope my insurance company never gets a claim. I probably pay more for it than I would if I’d lose a few pounds, but I’m not buying it for the price or the profit the insurer will make. Forget that states regulate insurance premiums, and assume for a moment they don’t. If my premiums, no matter how much I choose to pay, were pure profit to the insurer, I’m a happy camper because I’m still alive and providing for my family. I’m buying peace of mind. What metric could government use to tell me how valuable my life insurance is to me? There is no such metric.

What metric do you use for the credit insurance or GAP purchaser who is also buying peace of mind? There really isn’t one. In fact, the CFPB has as much as acknowledged that solid and consistent metrics are hard to come by in its refusals to provide its fair lending metrics to Congress, stating that they are based on the particular facts and circumstances of the financial institution.

Beware the government that tries to dictate a product’s “value.” At best, that’s advocacy, and at worst, the nanny state. Ensuring that consumers have sufficient information to make informed decisions through accurate and impartial disclosure is fair game — and a good thing for consumers and the economy.

Michael Benoit is a partner in the Washington, D.C., office of Hudson Cook LLP. He is a frequent speaker and writer on a variety of consumer credit topics. Michael can be reached at 202-327-9705 or mbenoit@hudco.com. Nothing in this article is legal advice and should not be taken as such. Please address all legal questions to your counsel.