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Saturday, October 21, 2017

Dealer Musings (II): Ruggles on Gap Insurance

David Ruggles

Gap insurance is a by-product of the extension of car loans to longer maturities. Once only 3-4 years, loans now extend out to 7 years (and sometimes more). At current interest rates of 7.6% (quoted on a Chevy dealer website), at the end of 3 years the purchaser will have only paid $18,200 on a $50,000 loan. However, the resale value may only be $25,000 or 50%. So the purchaser will be “upside-down” on their loan by $7,000. Now there’s generally some sort of downpayment, but purchasers can add on extras that aren’t figured into the insurance value of the car but might be built into the loan. So if they total their car and are paid only the replacement cost (less deductible!), they’re in trouble. Or in this case, their truck in Texas was underwater, and their auto loan is, too.

Now consumers can be quite naive about this risk. That's not true of banks. If the borrower defaults and the bank repossesses the car, they’ll be out the “gap” between the balance of their loan and the wholesale value of the car (plus the out-of-pocket costs of hiring a “repo” specialist, and cleaning up and transporting the vehicle to auction). Hence “gap” insurance. (Of course the same issue faces anyone involved in vehicle finance.)

...don’t be surprised if some GAP insurers become insolvent...

According to Forbes and others, a million vehicles have been “totaled” by hurricanes so far this season. This begs the question, how many of the insurance payoffs will be deficient when it comes to paying off the outstanding loan against these vehicles? Many of these vehicles carry GAP insurance, to cover any difference between the lender payoff and the insurance settlement, less deductible, for a totaled vehicle that is collateral for the loan. And GAP coverage is generally “reinsured.” I’ll leave it to David Robertson, a true expert on this type of coverage, to explain the details, especially the “banding” inherent in most reinsurance coverage.

Bottom Line: Yes. Don’t be surprised if some GAP insurers become insolvent. And don’t be surprised if GAP coverage rates rise dramatically.

Some salient information follows. Many of the players are big, diversified insurance companies for whom an one sector going south, all the way to Texas, won’t threaten their viability. But gap insurance is a specialized product, and some of the players are small.

“State Farm Mutual Automobile Insurance, Allstate Insurance, Farmers Insurance Exchange, National Indemnity Company (an affiliate of Geico), the Progressive Group, and Metropolitan Property and Casualty Insurance (a unit of MetLife) are among the big companies that write a large portion of their auto insurance business in Texas.” Business Day