Profit participation: Finding the right fit for auto dealerships

F&I profit participation programs have evolved since they first started to become common among auto dealerships in the 1970s. Today, with options to benefit all types of dealers, these programs are more valuable than ever in helping increase revenue. With the right portfolio, properly managed, profit participation can be a key income generator that helps your business more easily navigate the ups and downs of sales and repair/service streams.

However, while the vast majority of dealers today are in some kind of profit participation program, misunderstandings of the different program structures can result in some businesses not taking full advantage of the best choice to maximize their potential benefits.

Recognizing that no two businesses are exactly alike, Zurich offers several profit participation structures and we work with our customers to find the right fit for their unique needs. The process starts by asking some key questions, including:

• Where does your dealership stand in terms of cash flow versus long-term wealth-building, now and in the foreseeable future?
• Is this business more focused on growth or stability?
• What level of tax risk is appropriate or comfortable for you and your business?
• What is best for your business in terms of domestic versus foreign investment?

Zurich takes a consultative approach to finding the right structure for customers, providing the dealer with all the details they need to make the decision that’s best for their business.

Producer-Affiliated Reinsurance Company (PARC)

While there is no “one size fits all” answer for profit participation, there may be a “one size fits most” option: a Producer-Affiliated Reinsurance Company (PARC), also called a Controlled Foreign Corporation (CFC).

The vast majority of dealerships qualify for the PARC structure. It provides dealers with a lot of flexibility. It’s easy to set up and it has the minimal amount of tax risk associated with it, as it files an annual corporate tax return to the IRS. Overall, the flexibility can benefit the dealer in a number of ways. The dealer can access funds for loans with the surplus or profit that develops from that program. Dividends, declared at the request of the shareholders, typically get favorable tax treatment on a capital gains basis. Additionally, assets in trust are invested monthly, which can give the dealer investment income from the time it is ceded into the company until the time claims or dividend distributions occur. 

Zurich customers have a choice of investment portfolio options: 100% bonds, 90% bonds/10% S&P 500 Index funds, or an 80% bond/20% S&P option. Historically, Zurich customers have done quite well in the PARC program, getting good returns from largely low-risk investments. Since contracts in the program may not experience claims due to manufacturer warranty coverage, asset balances can be significantly enhanced with investment returns.

The PARC structure does have a maximum premium limit of $2.85 million per year; participants exceeding that would be subject to significant tax penalties. However, that premium threshold can go higher if more than one PARC is set up for the same dealership group. This is done fairly often for family businesses, which are so common in the industry.

If it’s a large dealership group with multiple family members involved, each individual may be able to justify setting up their own PARC. That strategy would afford the family the ability to capture significantly more reinsured premium generated from the dealership group.

Non-Controlled Foreign Corporation (NCFC)

If a PARC is not a good fit for the dealership, Zurich offers another reinsurance profit participation program: a Non-Controlled Foreign Corporation (NCFC). The NCFC is a corporation domiciled typically on an offshore island. As the name indicates, however, with the NCFC, the dealer is not a common shareholder and has limited control over the corporation. Unlike the CFC model, the dealer is not an officer nor a director for the company. The NCFC does not file an annual tax return in the U.S. and is responsible to pay excise tax.

The advantage to a NCFC is not having an annual premium limit. This can be a big benefit for a dealership constrained in the number of CFCs they can justify setting up.

Non-reinsurance programs

Zurich also offers two non-reinsurance profit participation programs: a Dealer-Owned Warranty Company and a Contingent Commission (Retro) plan.

A Dealer-Owned Warranty Company is exactly what the name indicates. It’s a warranty company — a service contract provider registered in the states where the dealership conducts business. Unlike the reinsurance plans, a Dealer-Owned Warranty Company is a domestic company and it can be a good option for dealerships focused on growth but wary of acting as a reinsurer. Zurich acts as an administrator for the program, but the dealership owns the business and is contractually obliged for warranties on the F&I products they choose to sell under those agreements. The plan can be appealing for dealers, as they retain all underwriting profits and investment income related to the products.

However, the minimum capital needed to launch a Dealer-Owned Warranty Company can be significantly higher than either a PARC or a NCFC. And although there is a tax-deferral period in initial years of operation, earnings are subject to considerably greater taxation when that period ends. This structure has some additional tax risk as it will eventually be subject to corporate tax rates and there are no guarantees on what the tax rate will be when the entity becomes taxable.

Finally, the Contingent Commission (Retro) plan is the most straightforward, with the dealer participating only in the bottom-line profit. Distributions for Contingent Commission (Retro) are recognized as ordinary income, not at the tax-beneficial capital gains rate enjoyed within the other programs. What’s appealing about this structure is that it requires no upfront money and has little risk beyond sales fluctuations.

Zurich is clear in communicating both the benefits and risks of our profit participation programs to help dealers select the best structure to support their business objectives. Shared success is always our aim.

Contact your Zurich representative to discuss our profit participation programs.