Where the GAP auto insurance market stands & where it is going

A new vehicle starts to depreciate as soon as it is driven off the car dealer’s lot. According to the Insurance Information Institute, a car’s value can go down 20%-30% in the first year and continues to decline over the time of ownership.

GAP insurance, or “guaranteed asset (or auto) protection,” ensures that vehicle owners won’t incur a loss if the vehicle is damaged beyond repair (total loss), such as in an accident or flood, or if the vehicle is stolen and never recovered. GAP coverage pays the difference between what the insurer pays (settlement amount) and the amount still owed on the borrower’s loan.

The settlement amount is based on the car’s actual cash value at the time of the incident: the cost of the vehicle when it was new, minus depreciation for age, mileage, physical condition and other factors.

As an example:

• Car age at the sale (in months): New
• Car Depreciation Level: High
• Loan Term: 60 months
• APR: 2%
• Car Value: $40,000
• Loan Amount: $48,000
• Loan to Value (LTV): 120%

A look at the current GAP insurance marketplace 

Supply chain issues are influencing today’s GAP Insurance Marketplace. The global microchip shortage has brought new vehicle production to a halt during the pandemic. The lack of new car availability has created an overall vehicle supply shortage. Additionally, we have seen higher vehicle demand, driven primarily by higher household savings due to federal stimulus during the pandemic, low interest rates and tax credits. The decreased supply and increased demand have driven up the price of used cars.

The higher used car values are, the higher the insurer’s settlement amount and the lower the GAP payment is, reducing the average severity of a GAP claim. Additionally, if the settlement amount is greater than the outstanding loan balance, a GAP claim will not be filed, driving claim frequencies down. Because of these factors, we are currently observing lower overall claims and favorable loss ratios on GAP.

How the market can change

As long as new car production lags behind, supply will not meet consumer demand and used car values will remain high leading to strong GAP loss ratios. However, we know this is not sustainable. It is a fair assumption that in 2022 or 2023, chip production, and correspondingly, car production, will move closer to pre-pandemic levels. As that occurs, used car values will come down, which will drive insurers’ settlement amounts to be lower and GAP payments will rise sharply.

As customers finance their vehicles, the overinflated vehicle values correspond to the amount financed. For example, a used car that was worth $10,000 prior to the pandemic is now worth $14,000, and customers have to get a loan for $14,000 to finance the vehicle. If car values revert to pre-pandemic levels, that $14,000 vehicle could drop in value immediately, causing a much larger difference between a consumer’s outstanding loan balance and vehicle value. This could lead to tremendous losses for a GAP program.

GAP risk is a long-term commitment, tied to loan terms (on average six-seven years), so there needs to be thoughtful consideration to ensure that you are pricing your GAP program now for the impact of a future return to normalcy. 

Frank Amendola is senior vice president, underwriting, for AmTrust Warranty and Specialty Risk.

This piece originally appeared on the AmTrust blog and is reprinted here with permission.

Opinions expressed are the author’s own.

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