2. Solving the Industry’s Conundrums, One Question at a Time Kirk A. Borchardt 2040 Alameda Padre Serra, #102 Santa Barbara, CA 93103 (805) 963-2983 (former partner of Lord Bissell & Brook and former President and Chief Executive Officer of Dealers Assurance Company)

3. INTRODUCTION Question 1:Can we reinsure prepaid maintenance contracts? Question 2:Can an administrator issue administrator-obligor limited warranties?

4. PRELIMINARY THOUGHTS 1.Do we really want answers? 2.Friends or enemies? Internal Revenue Service State insurance regulators

5. Dealer Consumer Policy Issuer DORC QUESTION 1: Can a dealer-owned reinsurance company reinsure prepaid maintenance plans.

6. 1.There is nothing illegal about it. 2.How to book the business for tax purposes (953(d) electing companies). Insurance underwriting income, or Investment income (IRC Section 834(b)). Reinsuring prepaid maintenance contracts

7. 3.Principal tax issue – do we have insurable risk? Helvering v. Le Gierse, 312 U.S. 531 (1941). The policy insures the consumer’s credit risk of the issuer. The consumer shifts the risk of price increases in the cost of services. Performance causes economic loss to the issuer, which is spread over many exposure units.

8. 4.No direct IRS ruling on point, but... Reinsuring prepaid maintenance contracts Private Letter Ruling 200042018 – compared VSCs to prepaid maintenance Revenue Ruling 68-27 (1968) and Jordan v. Group Health Association, 107 F.2d 239 (D.C. Cir. 1939) – HMO prepaid service agreements 5.Why be bullish? Business risk vs. insurance risk

9. QUESTION 2: Can an administrator-obligor issue an A-O limited warrant covering a used vehicle? Normal evolution of the business Structure may involve a licensed A-O and include the insurance backing

10. A-O Limited Warranties 1. State regulatory risks – is it legal? Common law view – contracts issued by manufacturers, distributors, and dealers Regulatory support for VSCs and VPPs Florida challenge

11. A-O Limited Warranties 2. Mitigating factors The industry has evolved U sing a licensed A-O with insurance Safety in numbers No direct charge to the consumer

12. A-O Limited Warranties Magnuson-Moss Warranty Act (15 U.S.C. 2301 et seq.) authority for warranty providers other than the manufacturer or dealer: “It is not a requirement of the Act that an agreement obligate a supplier of the consumer product to a written warranty, but merely that it be part of the basis of the bargain between a supplier and a consumer. This contemplates written warranties by third-party non- suppliers.” 16 C.F.R. § 700.11(b).

13. A-O Limited Warranties 3.Federal income tax issue – can the limited warranty be viewed as an insurance contract, like a VSC. Private Letter Ruling 201438022 1)Complicated facts 2)Warranty is “intertwined” with the product 3)Insurance must be separately purchased

14. A-O Limited Warranties 4.PLR 201438022 ignores facts in Amerco Inc. v. Commissioner, 96 T.C. 18 (1991). Insurance purchased by U-Haul that specifically insured the renter. 1)U-Haul paid the premium 2)Customer could not decline the insurance 3)Insurance “intertwined” with lease Warranties as Insurance: Does TAM Signal New IRS Position? Adam Fisher and Mark Smith, The Insurance Tax Review (March 2015)

15. A-O Limited Warranties 5.A private letter ruling request is in the works on this specific issue with clean facts. The ramifications of a positive ruling will be widespread and phenomenal. The industry would have to ramp up lobby efforts to secure authority under state law.