1. Risk Management & Financing for
Warranty & ESC Programs
Michael Paczolt, FCAS, MAAA
Consulting Actuary
Milliman
August 2, 2012
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2. WHY
ARE
WARRANTIES
AND
SERVICE
CONTRACTS
IMPORTANT?
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3. What is your strategic position?
Market Standard
Below Above
Product innovation
Customer intimacy
Operational excellence
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3 Graphic from Business Analytics for Managers, Laursen and Thorlund

4. Where are warranties?
Operational Excellence
SCM
Inventory Mgmt
Finance
Lean
CPM
HRD Web
Pricing Campaign
Mgmt
Prod Develop
CRM
Product Innovation Customer Intimacy
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4 Graphic from Business Analytics for Managers, Laursen and Thorlund

5. “Whale” Graph
Earnings
Increased Sales
Acquisition Customer
Costs Retention
Time
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5 Graphic from Business Analytics for Managers, Laursen and Thorlund

6. WHAT
DOES
RISK
MANAGEMENT
HAVE TO DO
WITH WARRANTIES
AND SERVICE
CONTRACTS?
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7. Risk
 Uncertainty
Non-
Financial
Financial
 Possibility of loss
Investment Reputation
Supply Chain Brand
Warranty
Relationships
claims
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8. Probability Distributions
35%
Mean 95th
30% Percentile
25%
20%
15%
10%
5%
0%
$0 $10 $20 $30 $40 $50 $60 $70 $80 $90 $100
Millions
Expected Unexpected
Loss Loss
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9. Quantitative Risk Management
Expected Unexpected
Loss Loss
35%
Mean 95th
30% Percentile
25%
20% Pre Risk
Mitigation
15% Post Risk
Mitigation
10%
5%
0%
$0 $10 $20 $30 $40 $50 $60 $70 $80 $90 $100
Millions
Budget Risk
Savings Management
($5M) Savings
($25M)
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10. Diversification/Pooling
Mean
5th Pct
95th Pct
Claims
# of Polices
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11. Diversification/Pooling (Cont’d)
250%
200%
150%
Claims as % of Mean
100%
50%
0% 5th Pct
95th Pct
-50%
-100%
-150%
-200%
-250%
# of Policies
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12. Risk Management Objectives
• Efficiency
Pre-Loss • Tolerable uncertainty
Objectives • Legal requirements
• Ethical conduct
• Survival
• Continuity of operations
Post-Loss
• Profitability
Objectives
• Growth
• Ethical conduct
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12 From Foundations of Risk Management, Wiening

13. Risk Control
 Prevention
 Reduction
 Separation
 Duplication
 Diversification
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13 From Foundations of Risk Management, Wiening

14. Risk Management Team
 Risk Manager
 Finance/Accounting
 Advisors
– Legal
– Actuarial
– Broker
– Auditor
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15. Analytics
 Competing on analytics is the future
 Key to making educated decisions going forward
 Confidence and support of IT is critical
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16. HOW
CAN WE
MANAGE
THE RISKS
OF A WARRANTY
OR SERVICE
CONTRACT
PROGRAM?
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17. Risk Financing
 Insurance
 Self-Insurance
 Mixture
 Hybrid self-insurance
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18. Self-Insurance
Cost per
Unit
Sales
Year
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19. Insurance
Cost per
Unit
Sales
Year
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20. Insurance vs. Self-Insurance
• Peace of mind
• Reduce volatility
Insurance •
•
Financial reasons
Help with administrative/legal/regulatory issues
• Tax deductible premiums
• Loss incentive
Self- •
•
Control of claims handling
Cost savings (insurer profit & inv. income)
Insurance • Goodwill
• Synergy
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21. Types of Insurance
 Pro Rata $20m
$10m Insurer Insured
Share Share
 Excess of Loss
$0m
$20m
Insurer Share
$10m
Insured Share
$0m
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22. Selecting Insurance
 Price
 Trust
 Retention/Limits
 Financial Condition
 TPA
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23. Alternatives
 Risk Sharing
 Pools
 Captives
 Retro plans
 RRGs
 Capital markets
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24. Captives
Advantages Disadvantages
Self-Insurance Capital/Startup
advantages costs
Access to
Premium taxes
reinsurers
Potential tax
Solvency risk
savings
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25. Captives & Warranties/Service Contracts
Warranties, Extended Warranties, and Service Contracts most
likely qualify as 3rd party risk which help the Captive qualify as an
insurance company, resulting in a potential tax benefit
*Please consult a tax professional before doing so!*
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26. Leftovers
 Read insurance contract provisions carefully
 Include provision for access to claim and premium data
 Avoid silos
 Communication is key
 Control of call center is crucial
 Align incentives of all parties
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27. Contact
Michael.Paczolt@Milliman.com
312-499-5720
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