Think Guaranteed Asset Protection is Simple? Misconception.
Guaranteed Asset Protection (GAP) is two things: A risk-management tool and non-interest income generator. But why does it even exist?
During the 1980s, high-interest rates along with increased rates of vehicle depreciation spurred the introduction of GAP coverage. With interest rates rising (not to mention the challenges of depreciation), is it any less valuable today?
Yet now, GAP is a commodity. It’s a product you offer, with the result being a certain level of income generated. The guarantees and inherent risks of the program are bypassed, perhaps due to that first misconception: GAP is simple.
Offering GAP without recognition of its misconceptions (and how to address them) can unknowingly wreak havoc for your borrowers and even subject your institution to regulatory action and fines.
That’s no fun. And definitely not what you would expect of a commodity offering.
Our firm, GreenProfit Solutions, offers GAP through a major industry provider. Of course, we realize that our solution is not a fit for every institution. We aim to help you learn and, if you decide to use another provider’s solution, walk away happy (and protected).
The objective of this article is to highlight five common misconceptions (“GAP is simple” was your freebie) so your institution can leverage your GAP program to meet and exceed its goals.
Misconception #1: Most used cars qualify as “Clean” under NADA
FALSE. In 2008, NADA estimated that 50% of used cars qualified as “Average”, not “Clean”. “Rough” and “Average” were added to their rating system after reviewing the data. They also make a value distinction between “Clean” Trade-In and “Clean” Retail.
What do you assume as the default condition? Most institutions use “Clean Retail”. This allows them to accommodate a higher value vehicle for the borrower and also increase loan volume.
However, at least 50% and as high as 90% of used cars (the latter data point was provided to us in anonymity) your institution finances are not Clean Retail. What’s the difference look like in dollars? From the chart above, “Clean Trade-in” means a $2,350 disparity. If the car is actually “Average”? The gulf grows to $3,350.
If there’s a claim, what does this mean for your borrowers? For your institution? Let’s dive deeper into the numbers with the next misconception.
Misconception #2: LTV limit of 125% means that borrower gets 125% of the value of a car at loan origination or at date of loss if they total vehicle.
FALSE. LTV (Loan to Value) limit is the maximum amount financed that can be fully covered under the GAP waiver. Any amount remaining in the loan exceeding the maximum LTV gets deducted from GAP settlement amount.
“Our institution has a 100% maximum LTV so 125% more than covers any potential loss”. Sound familiar? Santander Bank agreed. They were incorrect. And it cost them a lot of time and money.
125% LTV limit may cover losses. Of course, if you use the wrong designations as is common, it, well, doesn’t. That LTV determination may be flawed by 20%, 30%, or more.
Who gets stuck paying the non-covered difference? And how do you think they feel about it?
There’s even more reason to worry that 125% LTV isn’t sufficient. With depreciation increasing across the industry, claim payments are falling. Your GAP may not cover the gap. Here’s a recent actual claim which illustrates the difference in the 125% and 150% LTV cap:
In fact, according to statistics from Frost Financial, 26% of claims using 125% LTV were “shorted” (did not cover the deficiency).
So, what does this “125% LTV will be fine” misconception mean?
- More “shorted” GAP claims leaving borrowers liable for the difference
- Poor customer experience
- Increased collection challenges for your institution
- Potential regulator action for misleading borrowers on coverage
Misconception #3: GAP does not pay if the borrower does not have primary insurance on date of loss.
FALSE. GAP coverage is still available but the ACV (Actual Cash Value) or NADA value of the vehicle on date of loss is assumed as the primary settlement. This is just one of many advantages of your institution’s GAP over GAP Insurance included as an option within the borrower’s automobile insurance policy.
Your institution’s GAP is technically NOT insurance (and should not be referred to as such anywhere). It is a Waiver issued to the borrower, alongside your finance agreement, which activates if the financed vehicle is totaled. A Contractual Liability Insurance Policy (CLIP) protects your institution’s liability.
GAP Insurance is a different product, offered as an add-on within an auto insurance policy. Typically, there’s no LTV maximum. Instead, in the event of a loss, the policy will pay out a percentage of the ACV amount (generally 20%). This may or may not cover the outstanding loan balance. Finally, if your borrower lapsed the policy, they receive no coverage for damage nor GAP.
Misconception #4: Damage to vehicle determined to have occurred prior to date of total loss by the primary carrier is deducted from GAP amount.
FALSE. In the event of a totaled vehicle, the primary insurance deducts for condition and prior damage from before the loss event. However, GAP only deducts if damage has been previously reimbursed by the primary insurer.
Here’s an example: Your borrower has an insurance claim on their car. Their insurance appraiser deems the damage sufficient to “total” the vehicle. They then present a settlement amount. Any damage their appraiser lists as “pre-existing” is deducted from this payout.
GAP considers all damage as part of the total and will include that as part of their deficiency claim to the borrower up to the LTV limit. This is different from “other debt”, or borrower debt, which may be rolled into the current waiver. In certain circumstances, it can prove helpful, however, it is not offered by all GAP providers.
Misconception #5: Used vehicles financed at less than 100% of NADA retail don’t need GAP.
FALSE. Two main reasons why:
- Accelerating depreciation means vehicle values typically drop faster than loan balances
- Primary settlements on date of loss are rarely at NADA value.
There are also a number of other factors which may make GAP coverage helpful, even on less than 100% NADA Retail value vehicles. Here are just a few:
- Condition adjustments
- Local market comparisons
- Use of Trade-In values for settlement amounts
The following is an actual claim based on a loan with an 83.3% LTV:
Bridging Your GAP
What can your institution do to minimize risk to you and your borrowers? Here’s our recommendations:
- Whenever possible, use “Average” designation when determining valuation
- Ask your provider about increasing LTV limit to at least 150%
- Ensure your staff understands the difference between GAP insurance combined with an auto insurance policy and your institution’s GAP protection
- Use updated tracking of your collateral protection program to minimize loss
- The prevailing wisdom is that anything more than a 20% down payment means GAP isn’t necessary. It’s wrong. Train staff to look deeper to prevent future shortcomings for both the borrower and institution.
We write regularly about GAP along with other financial industry programs. Stay ahead of your competition and ensure best practices across your range of services. Subscribe to this blog to get regular updates.
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