When Cayman Islands-based underwriter National Warranty Insurance Risk Retention Group (NWIG) failed in June of 2003, Warranty Gold Ltd. ( www.warrantygold.com ) almost immediately ceased payment on claims on about 67,000 NWIG-backed policies. On Nov. 11, Warranty Gold itself filed for bankruptcy protection. Warranty Gold wasn't the only company impacted by NWIG's failure. In fact, some 5,000 auto dealers who sold policies under the Smart Choice brand name were suddenly confronted with the costs of honoring claims. Almost one million warranty holders were also affected.

Warranty Gold claims that NWIG, as the administrator and insurer of Warranty Gold extended service contracts purchased prior to June 6, 2003, is responsible for paying claims from monies deposited by Warranty Gold on behalf of its customers, and, if those funds prove insufficient, to pay all additional claims from the insurance paid for by Warranty Gold. NWIG's liquidators, on the other hand, say this is simply not the case. Moreover, the most recent news suggests Cayman and US regulators and their representatives continue to work through the thorny issue of whether NWIG or its members are responsible to the ultimate consumer service contract holder.

Unfortunately, the difference and division of responsibility between NWIG and Warranty Gold is not so clear in this complicated situation. The fact is that Warranty Gold and others sold the warranty contracts underwritten, and often administered, by another member of the same Risk Retention Group (RRG). In this RRG, NWIG functioned as group member, service contract underwriter and, often, administrator. RRGs take in premiums and insure their members against the underlying warranty costs. An RRG administrator can not write a contract directly with a consumer. Therefore, there were always two separate contractual relationships: one between NWIG and its members (e.g., Warranty Gold), and one between these members and their clients.

So how was even the most studious consumer to know about the risks of RRGs and/or NWIG? Many extended warranty companies wouldn't dream of having anything lower than an A-rated carrier as their underwriter, and several give out this piece of advice repeatedly. However, the insurance carrier rating agency, A.M. Best, rated NWIG as A- (Excellent) until March 7, 2003, and then downgraded NWIG twice before its liquidation.Unfortunately, unlike a bond or a promissory note, an extended warranty cannot be traded on the open market or sold for pennies on the dollar to an investor that speculates in distressed companies. A person who buys an extended warranty is stuck with it for the duration, whether the underwriter's rating climbs or falls in the interim. Further, one should be aware that some RRGs are younger than the policies they back, so their number-crunchers lack the multi-year data that would help them to price risks prudently.

Once NWIG's liquidation process began in June, Warranty Gold quickly switched underwriters to the Dealers Assurance Company. Their A.M. Best rating also is A- (Excellent). Warranty Gold went on to claim on its Web site, "You can feel confident that proper reserve amounts are being set-aside today with a direct insurer that has the financial stability to pay claims in the future."

What should auto warranty buyers take away from the joint NWIG and Warranty Gold collapse?

1. As with insurance policies, investigate the credentials (and assets) of the administrator, underwriter and re-insurer. In this case the RRG underwriter and administrator may have lacked the sophistication to adequately price the required payouts on the underlying service contracts. Further, unlike RRGs which are governed by the laws of the state in which they are formed, NWIG was an offshore RRG governed, at least in part, by the laws of the Cayman Islands
2. National Warranty was both Administrator and Underwriter for the policies of its Risk Retention Group. Further, the close relationship between contract seller, administrator and underwriter may have added to the problem.