GAP Claims & Sales Tax: Challenges for Borrowers and Institution

Sales Tax Road Sign
(Last Updated On: September 11, 2020)

Keep GAP simple.

In a total loss, GAP helps pay the difference between the primary insurer’s settlement and any outstanding loan balance. Insurers normally pay the Actual Cash Value (ACV) or Fair Market Value (FMV) of the vehicle the moment just prior to the incident.

There, done. Why does this article keep going? Is there some complexity not yet considered? A complication that could put both borrowers and institutions at a loss?

You’re so good at this.

Our topic: Sales tax.

According to Insure.com (1/30/2020), 34 states require car insurance companies pay the sales tax after your borrower replaces their totalled vehicle with a new or used one (see list at link).

However, even in those states, insurers may not offer to pay the sales tax upfront as part of the original settlement. They may wait until the purchase of a replacement vehicle. Bottom line: There’s consistency in inconsistency.

Let’s add another bit of complexity. For some insurers, there is a 30-day time limit for requesting reimbursement of these costs. That clock starts ticking when your borrower purchases a replacement vehicle.

Miss that deadline and they may lose rights to any further reimbursement.

Seems challenging, but manageable enough. Which makes it as good a time as any to dive into the ways sales tax can be reimbursed. Of course, they vary by state.

Is Your State Regulation A, B, or C?

Hallway of Doors
Pick your door, ahem, state.

Assuming you’re in one of the 34 states where insurers pay sales tax, there are two ways it can be reimbursed. If you’re not, choose option C:

  1. The insurance carrier will reimburse the sales tax by including it in the total loss settlement. Keep in mind that this amount is “usually” based upon the ACV or FMV amount.
  2. The insurance carrier will reimburse the sales tax only after it receives proof that a replacement vehicle was purchased, and within the 30 day window.
  3. The insurance carrier is not required to pay sales tax. While most carriers won’t pay out what’s not mandated, there have been instances where carriers were cited by their regulators for making these payments.

How does this connect to your GAP program and replacement vehicle financing? Stick around as we build the house of understanding together. Just two more sections of confusion. I mean, clarification.

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State Regulation Variety…and Challenges

States may have similar regulations, however, their requirements for fulfillment can differ by a lot. Here are two states with unique regulations:

Missouri: Requires insurers to pay sales tax, title, and registration costs, but not with their initial claim settlement. Instead, the buyer is required to complete and file an affidavit with the state to waive these costs on their replacement vehicle.

Ohio: Insurers here will not include sales tax in their claim payment. Instead, buyers must submit proof of purchase of a replacement car to their insurer for reimbursement of these charges.

Other states, such as Arizona, Kansas, and Minnesota, require insurers to include future sales tax as part of the total-loss settlement check. Under this arrangement, the insurer will calculate the sales tax as a percentage of the total settlement.

Yes, if your institution operates in more than one of these states, your policies need to account for local regulations. And if that wasn’t enough complexity, there’s one more category that determines sales tax payment…who files the claim.

First or Third Party Claims

Know the Rules Written on Chalkboard

Regulations concerning first and third party claims can differ considerably when it concerns sales tax or other associated fees. You’ll have access to a reference at the end to bring everything together.

What’s the difference between a first and third-party claim? It’s all about who files the claim, which is partially determined by who is at fault and also by who’s handling the loan.

Assuming a borrower is at fault in a crash (or if the vehicle is stolen), they file a claim with their insurance company. This is a first-party claim.

If your borrower is filing a claim with another insurer, such as another driver’s insurance, then it is considered a third-party claim.

Then there’s CPI and VSI claims. Since you’re the lender, your institution files as a first-party claim with your insurer.

So, to clarify:

  • First-party claim if borrower files to their own insurance company
  • Third-party claim if borrower files to another insurance company
  • If your institution files on someone’s behalf, it’s a first-party claim

Couldn’t be clearer, right? Who’s on first?

Abbott and Costello Who's on First

Where does GAP fit in?

As an institution, your concerns are twofold:

  1. Your institution is made whole after a claim.
  2. Your borrower is made whole to the terms of their policy.

GAP administrators must find the delicate balance between serving the institution and borrower, while also aiming to achieve these two goals. Then, there’s the added challenge of speed. No one wants to be waiting for funds, so the GAP administrator must pay quickly.

For most claims, GAP pays the remainder between the outstanding loan and the primary insurance settlement. As long as it is within given LTV and maximum amounts, it should be simple.

Yet, as we have seen, an insurance carrier can “temporarily” short a claim, leaving responsibility for paying off the outstanding loan balance on the borrower. This isn’t just an issue for your GAP administrator; it’s a worthwhile concern for your institution.

When do you look to “make whole” the loan? Is it a matter of waiting for the member to purchase a new vehicle? Do you notify them to complete needed forms? Expect the GAP administrator to just handle it all?

Knowing that there may be more dollars coming from the insurer, it seems reasonable to just pay ahead. However, this may put them and your institution out of compliance. We’re not looking for anyone to get in trouble.

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Credit Union & Bank GAP Expectations

Pulling Dollars Out of Wallet

Put simply, your financial institution wants your ancillary insurance products to pay when triggered: Quickly, accurately, while keeping everyone in compliance.

When a borrower suffers a total loss, your process includes waiting for insurance proceeds. Once that arrives, you compare to the outstanding balance. Is there a remainder? Does the borrower have GAP? If so on both, it’s time to file a claim with your GAP administrator.

Upon receipt, your partner checks to see the claim is valid and within policy limits, then pays out the appropriate amount. A reasonable assumption is that this will pay off your loan. Your borrower thinks the same thing.

Imagine everyone’s surprise when it’s short by $500, $1000, or more.

Who is to blame? Well, no one. The insurance carrier did not include sales tax in their initial claim payout. Thus, the GAP waiver paid everything except that amount. And now lots of people are frustrated.

What’s the “proper” action in this situation? Most GAP administrators follow their agreement and do not include the sales tax credit in their claim payment. This is especially true if the primary did not do so. However, some administrators understand:

  • Your institution wants to close out this loan
  • Leaving a balance may cause a negative borrower experience
  • Keeping loan open may have a negative effect on your borrower qualifying for a new loan
  • The process of following up and qualifying for additional sales tax claims may not be guaranteed

Those GAP administrators will take these factors under consideration and include the assumed sales tax as part of the GAP claim payment.

Making Whole Without Profiting?

Roll of Dollars on Pile of Money

One rule of insurance is to make the insured “whole”. The other, equally important aspect, is that an insured should not “profit” from an insurance claim.

Could this happen in the above situation? Let’s assume your GAP administrator includes sales tax in their claim payment. Then, your borrower follows the state-appropriate process and gets sales tax reimbursed after purchasing a replacement car.

It’s possible that final payment from the insurance company could be pure profit.

What happens then? Could the GAP administrator seek the amount back from your credit union? Or your borrower? Beyond addressing who is actually the lienholder (is anyone?), it’s a tricky thing to recoup. So, yes, the borrower could profit and that’s just reality.

At the time of publication, we are aware of no regulations which would forbid nor prevent this occurrence. And given the other challenges facing GAP administrators, it isn’t likely they will pursue your institution or borrower for repayment.

What’s the law in your state?

Lady Justice and Law Books

Discover each state’s laws on requiring sales tax to be paid as part of total-loss settlement. This also includes third-party claims, for your reference. Document is prepared by the law firm Matthiesen, Wickert & Lehrer (We have no connection).

Summary

Insurance laws regarding vehicle total-loss can be complex. In some states, it’s a real challenge. For those institutions operating in a number of states, this can be a regulatory minefield.

We share this information not to confuse or scare, but to ensure you are best equipped to navigate applicable laws responsibly. Keep in mind that GAP exists mainly to eliminate any outstanding loan balance. As we see in this article, that can go beyond what we expect.

Make sure you select a GAP administrator to partner with that takes the right steps for both your institution and borrowers. We work with Frost Financial Services and vouch for their commitment.

Because our Learning Library is about honest due diligence, check out the Best GAP Providers. Then be sure to Subscribe to the Learning Library to get the latest insights on GAP and other topics which matter to you.

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Joe Winn - CU Geek

Blogger. Speaker. Part-time Jedi.

Focused on helping your bank or credit union grow in the face of emerging challenges.