Putting the “R” in Residential Salvage Recovery

By Paul Gross

The province of Alberta, Canada — not Saudi Arabia — is home of the world's largest oil reserves. The Alberta Department of Energy proudly proclaims its province is home to more than 330 billion barrels of oil reserves, while Saudi Arabia possesses the world's second largest reserve totaling 270 billion barrels. At current prices, those reserves are worth an incomparable sum of money. Yet, until the 1990s the same reserves remained untapped, only recently have companies begun to effectively extract those natural resources.

So what has changed? First of all, the price of oil has soared, so the economics and motivation for cultivating these resources has garnered the attention of the energy industry and consumers alike. Secondly, technology advancements have made the recovery possible, viable, and more realistic. It is not that these resources were completely untapped previously. Rather, it's just that there was makeshift effort at best to do so. Now for the first time, innovative companies have treated this like a real business and subsequently broken out of their rut of conventional exploration and recovery, dedicating real resources to recover the crude from the oil sands in a very scalable manner. According to the Alberta Energy & Utilities Board, production is now at 1.26 million barrels per day (BPD), a figure that is expected to increase to 3.19 million BPD by 2016. At $120 a barrel, that yields $379 million per day in found revenue.

It is simply amazing what the deployment of technology, focus, commitment, and a little ingenuity can do when companies set their eyes on a target and develop a plan to achieve it.

The “R” Is for Revenue

Remarkably enough, the insurance industry has its own untapped resource similar to that of the “oil sands.” The good news is that the resource can be very manageably recovered in much the same way the oil sands are today: through technology, focus, commitment, and ingenuity. It is estimated that there are approximately $20 billion dollars worth of personal property content losses that the insurance industry absorbs annually. Certainly some of these items are total losses and are completely destroyed, but often many of these items are barely damaged and represent a significant amount of retained value that insurance carriers can and frankly should recover.

In fact, the very existence of a professional salvage program can reduce the number of content items involved in a loss. If policyholders know that they can claim an item while still retaining the personal property (because the carrier doesn't have an effective outlet for it), then they will be economically motivated to stretch the claim in order to do so. The mere existence of a well-executed program will serve as leverage with the insured. As an example, we recently dealt with a loss that involved a juke box to which the insured attached sentimental value. They claimed the item and upon learning that we were going to recover the item for salvage, they offered the carrier $300 for salvage value. We proceeded to list the item through a series of distribution channels. Running a sophisticated auction, we were able to command a high bid of $1,500 for the item, which the policyholder ultimately agreed to match. The shear existence of the program got the policyholder to offer recovery value and then increased the offer by five-fold. Prior to having a program in place, the carrier would have gladly left the item with the policyholder just to eliminate the disposal charges associated with the item. The need for this type of program is exacerbated in states like Florida where RCV is stipulated by the state and a higher percentage of the losses will have retained value.

Currently market conditions are ideal for implementing this type of initiative. We are swiftly moving into a soft market; investment income is in the tank; and clever solutions that create a competitive advantage are at an all-time premium. Moreover, the world is going “green.” What could be “greener” than sparing our landfills from these salvageable items and thus eliminating the need to consume natural resources in the fabrication of replacements? This is recycling at its finest.

Untapped Residential Resources

While salvage programs are widely used on large commercial losses, there is no serious effort being deployed to recover residential salvage. Like the efforts prior to the 1990s in the oil sands, the efforts currently deployed across the insurance industry to recover optimal amounts from residential salvage are makeshift at best. Because this opportunity hasn't been treated like a real business, carriers often experience a combination of the following challenges (which then become excuses for not tapping this incredible resource):

• Negative recovery value – It is regularly reported that carriers spend more money, in storage, cleaning, marketing, pack-out, or shipping in the attempt to recover the retained value of the item than the actual gross recovery amount. In addition, because of ineffective marketing efforts, at times, money is spent without any recovery at all. This scenario means that the carrier incurs further expense in disposal.
• Conflict of interest – Of the programs currently in place, most of them rely on selling the items back to the policyholder, the contractor, or to fellow associates, which often leads to a conflict of interest and sub-optimized results. Whether it translates to under-appreciated recovery value, hard feelings with a purchase, or increased losses because of misaligned motives, these “internal customers” can cause considerable challenges.
• Efforts to sell junk – Another past challenge includes burdening the program, by attempting to sell junk. Clearly there are some items that just don't have any retained value. That being the case, efforts to recover revenue can lead to unnecessary costs absent any appreciable income.
• Accounting concerns – A loosely structured program can create a long sales cycle. As time passes, accounting for the recovered item and tying the revenue back to the original claim can create challenges with compliance to internal accounting disciplines. Aside from that, it can create failures in properly remitting sales tax to the local taxing authority, and, yes, even internet sales require sales tax remittance.

While these challenges are very real, the technology to overcome these obstacles exists. Given the size of the market potential, the motivation to recover the optimal value from these should prevail. By industry estimates, there is upwards of $20 billion in combined content losses on an annual basis. Provided that the ACV value of those items is half that amount and 50 percent of those items have actual recovery value of some sort, one can estimate that there is approximately $5 billion dollars worth of items that go largely “unrecovered” every year. Based on our internal experience, it is possible to recover 27 percent of that ACV, which means that $1.35 billion in top-line revenue exists with assets that are currently being disposed of. Even after expenses, hundreds of millions of dollars in found profits lay at your disposal. Could you imagine not having a salvage outlet for your auto physical damage program? Not that long ago, total loss autos were left with the policyholder because the salvage opportunity did not seem worth exploring. Is the industry making the same mistake with its residential content items?

The Trappings of a Successful Program

What measures can be taken to create an effective program? First, treat the opportunity like a real business and deploy a dedicated approach. What you get out of this program will be commensurate with what you contribute to it. Putting a few items on eBay and hoping for the best does not constitute genuine effort.

Next, you'll need to create a real “retail sales environment” if you want optimal recovery value against the ACV. While selling through wholesale channels may be easier, the majority of your recovery value will be eroded. Develop a retail web site as your sales portal with the capacity to accept credit card payments; automate the collection and remittance of sales tax in each taxing authority; calculate shipping; and select the most economical shipping method. Have a phone bank or call center available 24 hours per day, seven days per week to answer questions and make the sale when the customer is most likely to buy.

Another key to success is focusing on the net income, rather than the gross revenue. Often, shipping expenses and other costs can eat into your bottom line. In other instances, including “free shipping” can demonstrably increase the retail price that you can command. Be sure to have an expert analyze every sale.

Results illustrate that the only way to fairly value used content items is to create an auction environment. This does not equate to the exclusive use of eBay, which is typically the most expensive channel. Instead, depending on the item, feel free to select from a host of distribution channels, and allow the buyers to value the item via a “bid” environment.

If you are ready to bring residential salvage in-house, then make the most of your decision by employing proven techniques that will lead to success. Otherwise, leave the details to the experts and engage a third party in the recovery of millions of dollars of your “found money.”

Paul Gross is a founding member of the board of directors for the National Windshield Repair Association. He is also president and CEO of CodeBlue and Harmon Solutions Group. He may be reached at 757-589-9000; [email protected].

SALVAGE REPORT #2

Totaling It Out What to Expect in the Salvaged Auto Parts Market

By Greg Horn

Salvage parts come from a few key sources: Insurance claims, manufacturer “lemon buy-backs,” damaged rental vehicle sales, owner abandonment, and charity donations. Since owner abandonment and charity donations tend to supply the pool with primarily older vehicles of lower value, they usually end up in self-service salvage part yards like “Pick-N-Pull” and “Pick-A-Part.”

Because of this limitation, the latter two segments are not major contributors, and the majority of vehicles used for part replacements tend to come from insurance salvage and damaged rental sales, with a limited number of buy-backs thrown into the mix. This puts the supply of salvage parts in the system at the mercy of the number of total losses declared by insurers each year. But exactly where is the number of total losses headed? We'll take a look at the factors that influence the number of totals in a year and use these factors to predict where totals are headed.

The SUV Influence

For starters, an interesting phenomenon took place in the early part of this decade — sport utility vehicles (SUV) captured America's imagination. Everyone from vehicle enthusiasts to soccer moms seemed to enjoy the rugged looks, added space, and the greater visibility gained from sitting above passenger cars. Savvy manufacturers made short work and took notice of the praise coming from consumers. It didn't take long for virtually every automaker to jump on the bandwagon to meet consumers' demands and make SUVs in all shapes, sizes, and price ranges.

In less than half a year, however, SUVs went from the hottest sellers on the lot to the slowest moving, most heavily rebated vehicles due in large part to rising gas prices. In April 2008, for the first time in nearly a decade, new passenger car sales overtook new SUV sales.

But what does all of this mean for the salvage market? First and foremost, it's important to recognize that the characteristics of the insured vehicle have a significant influence on whether or not a vehicle is repaired or totaled. And when SUVs gained in market share, their high initial cost and equally matched elevated resale values in comparison to passenger cars meant that if SUVs were involved in accidents, more of them would be repaired rather than totaled. For example, the approximate average actual cash value of an SUV on U.S. roads in 2007 was $3,000 higher than the average passenger car, and it was over 2.5 years newer. Because insurers primarily factor in a percentage of actual cash value versus repair costs when making the decision to repair or total a vehicle, a $6,000 collision would total the average passenger car but not the average SUV on the road.

There was also a second scenario playing out at the same time as the SUV factor was affecting the market. At this time, customers were increasingly buying Asian nameplate passenger cars, which allowed Toyota, Honda, and Nissan to dominate the top 10 sales spots. And while domestic manufacturers were capitalizing on overwhelming sales of their SUVs and were devoting development capital solely to these models, they put the development of new designs and innovations for their passenger cars on the back burner. This reasoning left a “product gap” that allowed Asian passenger vehicles to prosper as top sellers. Why does this matter? This too is very important because Asian passenger cars retain more of their value and consequently are (slightly) more often repaired than their domestic counterparts.

Impact on Total Losses

Since this trend is reversing and passenger cars are now the largest selling vehicle segment again, will total losses bounce back and perhaps reach even higher levels? To answer this question, we need to look not only at the mix of the vehicles on the road, but also the features and options on the vehicle being totaled. Why? A higher equipment level or trim package on a passenger car means a higher ACV, and more sophisticated features such as multiple airbags or Xenon headlamps also increase the potential cost of repair, impacting the total loss equation in terms of the number of collisions occurring.

Since the late 1990s, the percentage of vehicle collisions resulting in a total loss has increased by double-digit percentages each year. However, in 2004 the occurrence of total losses stabilized and even began declining. What were the reasons behind this decline? In 2004, the majority of vehicles on the road were equipped with dual airbags, which significantly added to the cost of vehicle repair. And prior to 2004, each year, more and more dual-airbag vehicles have been involved in collisions, resulting in increasing totals. Once total losses achieved the majority, their percentages leveled, but then started a gradual decline because the majority of vehicles on the road were dual-airbag vehicles and were also SUVs with higher values.

As we look to the future, all of these factors that are influencing total losses bear watching. If fuel prices stay high (above $3.25 a gallon), consumer tastes will continue to favor more efficient passenger cars over SUVs. Just as consumers bought higher priced SUVs, they will likely buy “loaded” passenger cars, albeit with smaller power plants. Evidence of this phenomenon has already shown itself, and now manufacturers are responding to consumers who are demanding package features with four-cylinder models that were once only available with six cylinder engine packages. This adaptation will also increase the ACVs of vehicles involved in collisions, although not to the extent of the gap we saw when SUVs were in the majority. It is likely that the average ACV will climb 10-15 percent for passenger cars, which will dampen the likelihood of a total slightly but also will increase the need to accurately assess all options of the potentially totaled vehicle.

With all of the changes taking place in the industry today that are contributing to total losses and affecting the salvage supply, we can safely draw several conclusions. We should begin to see modest increases in the salvage supply because SUVs are no longer the majority vehicle on the road, their resale values have fallen, and passenger cars (which are totaled more often) are once again the best-selling vehicles on the road. However, since Asian nameplate vehicles with higher option levels are in the majority, they will have a slightly higher proportionate ACV than prior passenger cars that weren't equipped with all the bells and whistles, making them marginally more likely to be repaired. That said, will total losses as a percentage of claims increase? Yes, but given these factors, don't expect a dramatic increase.

Greg Horn is vice president of industry relations for Mitchell International, a provider of information, workflow, and performance management solutions to the automotive insurance claim and collision repair industries. He can be reached at [email protected]; www.mitchell.com.