The case at hand

As an example, we tried to get underneath the standard trends for the auto warranty industry. Not only did we size the industry and project the growth, but we looked at likely industry performance in a downcycle. 

Our approach

Our analysis of both short-term and long-term economic recession weighed the risk and demonstrated the upside to investing during a decline.

Does your operating partner or consultant provide scenario analysis to test the downside? We do. 

The Analysis

We analyzed both the baseline scenario (in which a temporary economic downturn is quickly mitigated by federal and congressional action) and the downside scenario (in which we enter a prolonged 2009-style recession, perhaps deepened by a failure to address the needs of small businesses).

Even in the event of a deeper, more prolonged recession, we anticipate a full recovery of auto sales by 2025. In either scenario, we see a strong case for investment in auto warranties.

Baseline scenario

The baseline economic scenario assumes a quicker recovery

In our baseline projections, a temporary economic hit from COVID-19 response is mitigated quickly by Federal and Congressional action. 2019 levels of economic activity resume by 2022.

Projections for new auto sales

• Job and income losses from nationwide COVID-19 directives point to an imminent, quick and sharp recession. The Baseline scenario assumes a quick recovery once the spread of the virus is brought under control, with selling rates picking up.

• Several automakers have idled manufacturing facilities and limited dealer activities.

• New light vehicle sales are projected to decline ~15%–20% in 2020. Auto demand slump will linger before reaching 2019 level by 2024–2025.

Projections for used auto sales

• Used car sales are expected to take a hit in 2020 as consumers shy away from big purchases.

• An affordability crisis will have consumers delaying new car purchases or trading down to used cars which are now better than ever. Used car sales decline much less than new car sales as a result.

• COVID-19 reopening should lift economic activity relatively quickly.

• Remote retailing practice, deferment programs, and steep incentives will likely buoy demand further, to reach 2019 levels by 2025.

Downside Scenario

The downside economic scenario assumes a deeper downcycle

The recession could last longer and hit harder, particularly if the small business crisis is not addressed. Economic conditions similar to the 2008–2009 financial crisis continue into 2021.

Projections for new auto sales

• The Recession scenario assumes an almost 20% drop in vehicle sales (just like the Baseline) but predicts a slower recovery by 2025 as the US experiences a major standstill. Sales are expected to show an unprecedented slump before the impact of fiscal and monetary stimulus gains traction.

• COVID-19 contributes to the slow recovery as it reappears strongly for the next few winters despite vaccines being developed.

Projections for used auto sales

• The impact of the recession will see used car sales plunge in the short-term as consumer sentiment remains dismal.

• Replacing cars may not be high on the priority list of vehicle owners, so they are more likely to still own the vehicle when the warranty expires. Vehicle owners are also more sensitive to unbudgeted expenses like car repairs in a downturn and therefore tend to be more receptive to the value proposition of extended warranties.

• A gradual recovery brings Baseline and Recession scenarios close together in 2025.

the case for investing

Learn more about our approach and how we find value

For more background on this case study and the tools we use in our analyses, see our previous installment, “The Case for Investing in Warranty & Specialty Insurance Businesses.”