GAP Insurance - Covering the Gap
By E. L. Eversman, Esq.
People often ask me if diminished value and GAP insurance are the same thing. The answer is, "No", but the question raises some interesting issues. Essentially, GAP could be sold to cover diminished value losses, or insurers could sell separate policies or include riders to existing auto policies to cover diminished value losses. Those losses, however, are not what GAP is currently designed to address.
So what is GAP insurance?
GAP, or "guaranteed asset protection", insurance is coverage often required by leasing companies and financing institutions to ensure payment of your note or lease in the event your car is declared a total loss. The "gap" being covered represents the drive-off depreciation and other naturally occurring depreciation accumulated on the vehicle. Because diminished value is accelerated depreciation, and because diminished value traditionally does not apply to vehicles that have been declared a total loss, GAP insurance does not cover losses associated with damage caused to a repairable vehicle.
How GAP insurance works.
Here is how GAP insurance works. You buy a new 2003 Ford Windstar Limited for the manufacturer's suggested retail price of $ 34,000 and finance 100% of the purchase price. The dealership titles the car in your name, and in the majority of jurisdictions, the bank receives and holds the title to secure payment and prevent you from transferring title to the car until its lien is satisfied. You are driving your Windstar down the street three weeks after buying it, when another driver runs a red light and plows in to your new minivan, totaling it. At the time, you have only put 800 miles on the vehicle.
You might think, "I just bought this minivan. It should be worth almost exactly what I paid for it." But, now comes the ugly shock. What we call "drive off" depreciation, and which would be more accurately described as "prior owner" depreciation, will have decreased the Windstar's value by several thousand dollars. However, you still owe the bank the total amount financed - which appears as a deficiency when the check for the totaled minivan is applied. Enter GAP insurance.
GAP insurance is designed to cover that deficiency and pay off any amount remaining due on the finance note. Deficiencies GAP was created to cover are those typically associated with naturally occurring depreciation, but, in some instances, GAP may pick up unrecognized diminished value. Here's how.
In the Windstar situation, let's say that the minivan had been involved in a prior accident causing $3,000 worth of damage, and it was repaired. If you did not ask for and collect the diminished value caused by the first accident, when the minivan is totaled in the second collision, the decrease in value will be paid by the GAP insurer as part of your finance pay-off. That will happen automatically and you should not have to make a separate demand for payment of the diminished value from the GAP insurer. The reason this occurs is because GAP is paying the difference between the totaled value of the vehicle and your pay-off amount and does not typically make any distinction between the causes of depreciation leading to that "gap" in value.
Tension between insurers
Many people mistakenly believe that a vehicle is more likely to be totaled if they carry GAP insurance on the car than if they do not. Often, the opposite is true. When you purchase GAP insurance, you purchase an additional policy from either your auto insurer or from another company. If the GAP provider is the same, or an affiliate of your auto insurer, you have a situation in which (essentially) a single insurer is covering 100% of the financed value of the car. If the car is severely damaged, even though it would otherwise be declared a total loss, the insurer may refuse to total the vehicle and insist it be repaired instead. There is an economic incentive for the insurer to pay to repair a complete loss vehicle - if it prevents additional payments to satisfy any deficiency owed.
Even when different companies are involved, a tug-of-war sometimes occurs between the interests of the auto and GAP insurers. Obviously, the GAP insurer prefers not to pay out on drive-off depreciation, accelerated depreciation, or any "negative equity" a person may have financed. If the GAP provider becomes involved in the decision regarding the fate of your car, the odds that the car will be totaled significantly decrease.
So, is GAP worth purchasing?
Whether GAP insurance is worth purchasing depends on your circumstances. Your finance or lease company may require GAP insurance to be purchased as a term in the loan or lease contract. If you purchase a vehicle you know will suffer substantial initial depreciation and you live in an area in which there is a high likelihood of the car being severely damaged, then GAP is probably a good thing to buy. Remember, however, that GAP only pays if the vehicle is declared a total loss. Therefore, consider your circumstances, and always be actively involved with collision damage repairs to your car.
E. L. Eversman
The information provided in this column is for information purposes only and should not be construed as legal advice. You should always consult an attorney licensed to practice in your Country, State, and/or Territory as laws vary from Country to Country, State to State, and Territory to Territory. The author is delighted to share information but cannot be responsible for damage or adversity encountered by reliance upon that information and urges you to consult with local counsel.
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