The UK extended warranty market is at a crucial stage. Customer take-up is stagnant, new EU legislation is pending and the market has come under increasing scrutiny. Richard O'Donoghue reports

The motor extended warranty market for private cars experienced sales of 2.4 million in 2001 - an increase of 3.8% on the previous year. Sales of extended warranties on new cars have been stagnant over the 1997-2001 period. This is a result of many new vehicles coming with a three-year warranty as standard. Therefore, it is harder to convince customers of the need for an extension.

However, growth in 2001 was significantly higher than average as a result of it being a record year for new car sales.

Growth in the used car warranty market is increasingly driven by a desire among dealers and manufacturers to realise the profit potential from sales of extended warranty. This has led to a gradual rise in policy take-up. Furthermore, the popularity of the `nearly-fairly-new' market segment, fueled by the fleet sector, is another important driver of growth, especially as many vehicles would have been covered only by an original one-year manufacturer's warranty.

It will be necessary for motor extended warranty providers to offer more than just warranty in their range of products and services.

This is for two main reasons: first, margins on sales of extended warranty are falling, in particular on new vehicles; therefore alternative products are increasingly attractive as a way of generating new revenue streams. Second, insurers, in particular the smaller, independent players, need to be increasingly adaptable and add more value to their product and service offering in order to take advantage of new business opportunities.

The value of the brown and white goods extended warranty market was £828.1m in 2001. Retail sales of brown and white goods are the key driver of growth in the extended warranty market, since most policies are sold at the point of sale. Sales of extended warranty policies on brown and white goods achieved a volume of 9.2 million in 2001.

Some industry executives interviewed by Datamonitor feel that the market for warranties on white goods was mature, even to the extent of being a `dog' market. They felt that take-up is not improving, leading to flat growth, since penetration of white goods is high in UK households and, in some circumstances, take-up is declining as products have become more reliable.

As a result some players are pursuing other growth areas such as small domestic appliance replacement policies. Replacement plans are proving popular and have become a growth area. Replacement plans for small brown and white goods are not just an opportunity to increase income from add-on products for retailers, but also provide an opportunity for insurers to administer or underwrite such schemes.

In its 1998 report, Datamonitor estimated that in 1997 the market split between insured and self-insured business was 55% and 45% respectively. Research in 2002 suggests that this has now changed to 34% insured, 66% self-insured. This represents an average annual decline of 4.2% in the value of insured business, while the value of the self-insured market has grown on average by 18.3% between 1997 and 2001.

According to FSA returns, insurers are fighting over a smaller and smaller market. The total market value from insurers that included extended warranty business in their FSA returns shows that since 1997 the market has declined by an annual average of 15.9%. Of the companies that are included in the FSA returns, most are providers of service plans to retailers and manufacturers rather than direct players, which suggests they are competing for a declining number of clients, as manufacturers and retailers increasingly opt to self-insure their warranty schemes.

Datamonitor forecasts that the extended warranty market will grow, but with certain lines continuing to stagnate. Growth in the motor sector will be off the back of an increase in the penetration of policies for used cars, as dealers increasingly seek to maintain their profit margins with sales of add-on products and offer a more complete package of benefits. Policy sales of extended warranty on new cars are anticipated to decrease as longer base warranties become standard.

The future of the market for extended warranties on brown and white goods is closely linked with the health of the electrical retail sector. Current forecasts for private consumption in the UK show a marginal decline, suggesting a slight slowdown in sales of electrical appliances. Growth in sales of extended warranty policies can also be anticipated to slow. Sales of cover on brown goods are likely to experience stronger growth than on white goods due to the injection of new, expensive product lines into the brown goods market. Alongside the electrical retail sector, a key factor in the future of the brown and white goods extended warranty market is the impact of regulation under the FSA and the possibility of investigation by the Competition Commission, both of which may prompt a greater transparency in pricing.

Richard O'Donoghue is a financial services analyst with Datamonitor.

Datamonitor's report `UK Extended Warranty 2002' is £1,995. For details phone 0207 675 7487.