One of the most memorable days for a vehicle owner is the day they acquire a brand new vehicle. Unfortunately, when a total loss to that vehicle happens it’s often not one of the greatest days, but a day filled with problems, namely a lack of funds to cover the loss. Many vehicle owners face the harsh reality that they still owe more on the auto loan than they receive from their insurance company. This article addresses the issue, and points out a solution to the problem.

Why the Problem Exists

An article (October, 8, 2002) in the Wall Street Journalpointed out that the value of used cars is plummeting, in part due to zero-percent financing and the glut of used vehicles on the market. For example, a Ford Taurus with a sticker price of $19,440 just two years ago commands a trade-in value of only $8,302, which is a whopping 57% depreciation. A Chevrolet Blazer with a sticker price of $29,120 yields a trade-in value of $12,701, or 56% depreciated.

Another article in USA Today (February 2004) stated that 40% of the time a consumer trades in a car they owe more than the car is worth. The article also stated that the average bank loan for a vehicle is 101% of the value of that vehicle — an immediate problem!

Yet another article in USA Today (February 13, 2008) stated that car loans are now stretching to 84-months. The article went on to state that even 48-months into the loan, the remaining balance of the loan exceeds the value of the car.

As if the decreased value weren’t enough, the real problem lies in the fact that the loan amount on many cars decreases only slightly in the first two years. For example, suppose the buyer of the Taurus above obtained a five-year loan in the amount of $15,000 at a rate of 8% interest. After two years the principal balance would be $9,705. On the Blazer a $25,000 loan would have a remaining principal balance of $16,176. With a 100% financing situation (not uncommon today) the Taurus would have a remaining loan amount due of $12,578 after two years while the Blazer would have $18,842 remaining. In the first half of the loan it’s entirely possible (if not likely) that the vehicle owner would owe more on the loan than they would receive from the insurance company in a total loss situation. Many refer to this as being “upside down” in the car.

In addition to causing a financial hardship on the vehicle owner, this situation places the insurance agency and company in a situation where they aren’t “the good guy wearing the white hat.” It is estimated by The Wall Street Journalthat 22% of vehicle owners owe more on the loan than their vehicle is worth, with the average excess amount owed being $2,163. That’s one huge check that the vehicle owner would be responsible for in a total loss situation.

The Solution

Both the personal auto policy (PAP) and business auto policy (BAP) have endorsements available to provide a remedy to this coverage situation. The endorsement is referred to as “GAP” coverage because it “fills the gap” between the amounts owed on a loan and the actual cash value (ACV) settlement paid by the insurance company for a total loss vehicle. (“GAP” can also be an acronym for “Guaranteed Auto Protection.”)

Under the PAP the endorsement is PP 03 35 – Auto Loan/Lease Coverage. Under the BAP the endorsement is CA 20 71 – Auto Loan/Lease Gap Coverage. It should be noted that many car dealers routinely make this coverage available to their customers, and in addition various web sites offer it on a direct basis. The advantage of the insurance agency offering the coverage is that it places them (as well as the company) in a positive light come claim time. Should the vehicle owner have a separate GAP policy they would be faced with the problem of filing two separate claims, one under the PAP/BAP and one under the GAP policy. Having one policy makes claim settlement easier.

Both the PP 03 35 and CA 20 71 contain substantially identical language. Shown below is language from the PP 03 35:

In the event of a covered total loss to a “your covered auto” shown in the Schedule or in the Declarations for which a specific premium charge indicates that Auto Loan/Lease Coverage applies, we will pay any unpaid amount due on the lease or loan for “your covered auto” less:

1. The amount paid under Part D of the policy; and
2. Any:
1. Overdue lease/loan payments at the time of the loss;
2. Financial penalties imposed under a lease for excessive use, abnormal wear and tear or high mileage;
3. Security deposits not refunded by a lessor;
4. Costs for extended warranties, Credit Life insurance, Health, Accident or Disability insurance purchased with the loan or lease; and
5. Carry-over balances from previous loans or leases.

In simple terms, adding the GAP endorsement provides payment for the difference in what the client owes the bank and what the insurance company pays as ACV of the auto. (Remember, that’s an average of $2,163 today.) Some of the “add on” coverages purchased by the owner such as extended warranty or credit life insurance would not be covered by the endorsement, nor would any overdue loan or lease payments. Some GAP endorsements limit coverage to a specified amount, for example 125% of the loan balance so it’s important to read the endorsement.

The cost to add the endorsement is small. The loss costs for the BAP is 7% of the physical damage coverage while under the PAP the loss cost is only 2% of the physical damage coverage. (Premiums will vary by company and state.) Note too that the endorsement is available for use when a vehicle is financed, or when leased. Paying off the terms of a lease could be a significant cost for some clients who have entered into a long-term auto lease situation.

Many consumers elect to purchase GAP coverage from the auto dealer. While not a “bad” choice, it may be an overly expensive choice. Dealers typically charge about $500 for the coverage and comparing that price to the cost under the PAP, the dealer’s cost is almost always higher, and at times significantly higher. The important point is for the customer to have the coverage from some source.

Summary

Any time a client finances a vehicle purchase, or any time they enter into a lease agreement the potential for significant out of pocket costs exists due to the client owing more on the loan/lease than the vehicle is worth. For a small premium charge adding “GAP coverage” can help mitigate the financial loss. Additionally, the endorsement goes a long way towards building a positive image of the agency and insurance industry in general.

This article contains copyrighted information of the Florida Association of Insurance Agents and is used with permission.  Please call Bush-Thompson Insurance at (904)278-4288 if you have any further questions about this article.  FAIA is not staffed to take consumer calls.

Copyright FAIA, 2/15/08, David Thompson