Access to vehicles is often a requirement for employment, and as such the financial strain of procuring a vehicle can often result in individuals taking out a motor vehicle loan. The finance for vehicles, especially second-hand vehicles, is usually handled in-house by the vehicle dealers themselves, working as agents for the finance company (Lenders). As agents for the Lenders, these dealers are responsible for compliance with the CCCFA and FT Acts as it relates to assessing the customer’s repayment capacity and gathering the necessary documentation to fulfil the loan. However, their relationship with the loan is more intimate than just responsibility to legislation. The dealer often receives an “introducer fee”, which averaged $276 in the 2020 Financial Year, for initiating and facilitating the loan process, and the industry on the whole supports and utilises “flex commission”, whereby after the Lender sets the base interest rate for the loan based on the customer’s credit history, the dealer can add a variable percentage which they collect as a bonus. As dealers are normally exclusive agents for a specific lender, providing this kind of additional compensation model is a way to retain agents, and some lenders reported losing dealer agreements to other finance companies when they did not offer flex commission agreements. In this way, the dealer is incentivised to help the customer procure finance that may stretch their repayment capacity in order to receive these additional kickbacks from Lenders.
Alongside the finance itself are various forms of ‘add ons’, the main forms of which are Mechanical Breakdown Insurance, Guaranteed Asset Protection Insurance, Payment Protection Insurance, and then additionally some offer Repayment waivers. In theory, these products all exist to protect the customer in the event of ill-fortune or change of circumstance and are all sold by Insurers through the dealers at the point of sale. Once again, dealers receive a commission on these products. Insurers set the ‘wholesale’ cost of the products and the dealers then mark them up, the difference of which is retained by the dealer. While insurers expect up to 100% mark up in price by dealers, there is no limit on how much they can decide to retail them for, and in many cases the cost is not readily advertised, which makes it difficult for the customers to compare prices between competitors. In addition, there appears to be a limited investment by dealers to determine the suitability of each of the add on products for the individual customers, and while all the products are voluntary, the CC Report found that 14 of the 62 individuals interviewed were under the impression that the add on they had purchased was a compulsory component of their finance. One of the customers interviewed found that they were actually ineligible by virtue of their employment status to have claimed against the insurance that they were sold.
The concerns with affordability and customer repayment capacity are further exacerbated by the knowledge that all add on products comprise part of the loan principal and are paid off by the customer over the course of the loan, all the while incurring interest. This may mean, as it did for a customer in the review, that the total cost of fees, add ons, and insurance combined were more than the purchase price of the vehicle itself.
While the cost to the customers is evident and apparent, what is not clearly defined or understood is the value to those who purchase these products. We can readily assess the value of these products to the dealers who market and sell them and to the lenders and insurers who underwrite them. According to the information provided by the companies in the review, companies are paying out less than 10% of their annual premium retail in claims, with an average of 153,918 add on products sold annually netting wholesale premiums of an average of $82 million per year. This equated to an average retail premium total estimated at $142 million per year, showing the value to the dealers. Data collection on customer value in the products, however, is much harder to determine. While the claim to premium ration is low in all areas of add ons, the information provided by the insurers only listed the total number and value of approved claims. No information was provided about the volume of declined claims during this period, as the insurers do not capture information about their declined claims in a reportable format. Without this information we cannot know the percentage of successful claims, and as a result the total successful claim value as it relates to premiums cannot paint the full picture of the value of these policies.
It is evident that there is significant incentive to promote add ons to increase the commission of motor vehicle dealers, both from uncapped and unregulated retail premiums on the products themselves and using “flex commission” to increase the interest paid on the total principal loan. These incentives coupled with the pressures that customers are often facing to secure a vehicle can compromise the due diligence of agents to assess the loans for suitability to the customer before securing them. It is readily understandable, therefore, that Australia and the United Kingdom banned flex commission models in 2018 and 2021 respectively. With the changes to the CCCFA in December 2021, there is the potential that the industry may be forced to self-regulate their upselling of add ons in order to keep customers under their ‘responsible lending’ credit caps – after all it’s better to sell a vehicle with fewer bonuses than it is to price a customer out of buying the vehicle at all. There will also be further onus on lenders and their dealer agents to keep better records, gather and assess information more stringently, and disclose both their and the customer’s obligations to the loan – including what add ons are mandatory and which are upsold – more clearly.
The concern of our members who assist their communities with budgeting advice and help them untangle the consequences of poor financial decisions is evident and valid. We will be watching the industry over the next year to see if these changes to the CCCFA have made any impact on their reporting and performance and look with interest at the next steps the Commerce Commission will make following their report.