Your GAP program seems fine. Members buy it when financing. Claims get paid. What else is there to know? That’s what we thought, too. Then we saw some fluttering in the wind. Flags. Bright red ones. 7, in fact.
This article will fly these 7 GAP Red Flags high for you to see.
If this seems too far “in the weeds” for you right now, that’s ok, too. We have a range of Guaranteed Asset Protection articles on every aspect of the product. Already up to speed? Then grab a flag and let’s go! Yes, you get to wave a flag around. Isn’t this fun?
GAP Topics With Possible Red Flags
- Actual Cash Value (ACV) Definition
- Loan to Value (LTV)
- Prior Debt
- Claims Reporting
- Delinquent Payments
1. Actual Cash Value (ACV) Definition
According to IRMI: In property and auto physical damage insurance, ACV is one of several possible methods to establish the value of insured property in determining the amount the insurer will pay in the event of loss.
In simple terms, it’s a tool the insurance company uses to figure out how much to pay.
ACV is typically calculated one of three ways:
- The cost to repair or replace the damaged property, minus depreciation
- The (damaged/stolen) property’s “fair market value”
- Using the “broad evidence rule,” which calls for considering all relevant evidence of the value of the (damaged/stolen) property.
How does that impact a GAP settlement? I mean, don’t they just pay the difference between the insurance claim and remaining loan balance? Sometimes. It depends. Let’s look at two strategies that impact how this seemingly simple process ends up.
If the “right” factors align, your borrower could be stuck with far more balance than they expected. And that becomes your institution’s problem, both in collections and member satisfaction.
Here’s the two methodologies used by GAP providers and what they can mean for your claim settlements.
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Primary Loss Methodology
Insurers may differ in how they determine ACV and this can have a dramatic effect on their total loss payouts to insureds. When determining claim amounts, most GAP providers use the “Primary” method.
This Constructive Total Loss is the difference between the Primary Carrier’s payout (less any tax and fee refunds), and the unpaid Net Loan Balance (up to a stated maximum amount or percentage of LTV).
In other words, when you think of GAP, this is the methodology your mind expects.
Greater Than Loss Methodology
Turns out, there’s more than one way to calculate a GAP claim. Some GAP providers use a more conservative method called “Greater Than” Loss. Let’s discover why this might create issues for your members.
This methodology allows the GAP payout to be based upon the greater of the published ACV (NADA or Kelly Blue Book) or the Primary Carrier’s actual payout. Experience shows that in 80% of claims paid, Primary Carrier payouts are less than the published ACV.
What does that mean for your borrowers? Their worst insurance nightmare: Claim amounts which do not pay off the outstanding balance. In other words, shorted claims. A phrase no one wants to hear.
Here’s a claim example to show how much could be left on your members’ shoulders:
Fortunately for the borrower, this claim was paid using the Primary method. They were still liable for a $295 storage fee, but that was the extent of their responsibility. Had their GAP provider used Greater Than methodology, the borrower would be liable for $2,230.33.
($295 storage fee + $1,935.33 in shorted claim)
Where Greater Than is More Common
“Greater Than” loss methodology is rare in credit unions like yours. Of course, there are exceptions, but the vast majority use Primary Loss and keep borrowers happy.
Where it is more common is on GAP sold by non-franchise used car dealers.
Be aware of this possibility, as your institution will likely experience a higher percentage of shorted claims (and payouts) from these policies.
We thought GAP was simple. Then we dove deeper. Turns out, there’s a lot more to know. Good thing we put it into a 5-step Cheat Sheet! Download now!
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2. Loan To Value (LTV)
You’re all about making responsible auto loans that help your borrowers. Typically, GAP with a 125% LTV limit is sufficient.
But not always.
Some GAP administrators offer 150% standard. Does the extra 25% make a difference? It can, by empowering your lenders with the flexibility to make responsible loans exceeding a 125% LTV limit. Yet how many are in that range? More than you’d expect.
22% of all GAP claims submitted last year would have been shorted, if not for having the 150% limit, according to data shared with us by a GAP administrator.
In those cases, with a strict 125% LTV limit, your institution may not immediately be “made whole”. This also means borrowers would be responsible for paying off a loan balance on a car they no longer have.
I’m sure you can agree that’s a scenario none of us want.
3. Prior Debt
This GAP benefit helps minimize risk for lenders and borrowers when existing debt is rolled into a new loan. The GAP waiver covers the total amount of the new loan, including this “prior debt”. Why would this be necessary?
Sometimes car loans go “underwater” for reasons including mechanical failures or an under-insured crash settlement. In these cases, the borrower has little choice but to purchase another vehicle. However, they still have debt from the previous loan.
Used properly, the prior debt benefit can assist borrowers in financing a newer, more reliable vehicle, while increasing loans and income for the lending institution. Plus, it’s doing right by the members during a tough time.
Be aware, this strategy is not without risk. Rolling existing debt into a new loan increases LTV, so make your best judgments on keeping it below or near your 125% (or 150%) limit.
4. Claims Reporting
If you’re dealing with a total loss, it’s a major life event. And an interruption to your daily routines, especially if that loss stemmed from a crash. Of course, the main concern is the health of any affected. Not on submitting a claim report to your insurance.
The majority of GAP providers accomode for this reality. Typically, they allow the borrower sufficient time, up to 365 days, to get a handle on life again before filing a claim.
Not all GAP providers are so understanding. They require borrowers to:
- Report the total loss to their insurance carrier within 5 days of knowledge of the loss
- Provide the proof of loss for GAP within 30 days
- Present the original paper GAP agreement in order to file a claim
- As ancient as it sounds, some providers make borrowers keep the paper copy of their GAP waiver. It’s good practice to suggest this to borrowers, even if your provider isn’t so antiquated. For those, they can scan it for digital archiving.
Do you know how long your GAP provider allows for filing insurance claims and proof of loss?
You’re likely familiar with this feature after a challenging first half of 2020. As financial hardships spread along with COVID-19, Skip-A-Pay became a useful tool to keep loans from going delinquent.
How does Skip-A-Pay work?
Pretty much as it sounds. The institution grants a certain number of skipped payments per calendar year or loan term. These may be complimentary or used for a fee (which generates non-interest income for your institution).
GAP Skip-A-Pay is similar, though it is part of your agreement with the provider. Without this coverage, in the event of a GAP claim, it is calculated based on the outstanding balance at the time of loss. It assumes that loan payment went unpaid (as the term was extended).
In this case, the borrower would be responsible for that difference.
With Skip-A-Pay included in your GAP coverage, the GAP payout assumes that skipped payment was made. Therefore, this results in a higher GAP payout, and less chance of a shorted claim. Everyone’s happy.
How many Skip-A-Pays?
Most GAP providers include 2 Skip-A-Pays in their program. A few offer additional Skips as a premium add-on. Check with your provider to see what you have, and what’s available. I’ve seen GAP claims with 3 or 4 skips included.
That translates to important savings for the borrower and financial security for your institution.
Then, there are GAP programs which do not offer any Skip-A-Pays. None. Zilch. Look at your loan records. Do you have any borrowers who have skipped a payment? Is their GAP policy going to pay out what everyone assumes? Without Skip-A-Pay, maybe not.
Example GAP Claim
What does a couple of Skip-A-Pays do for a GAP claim? Let’s take a look at a real example. This policy included two Skips on a loan with bi-monthly $180 payments. You decide how it worked out for both the credit union and borrower:
Everyone’s paid up. At least the financial side is fine.
6. Delinquent Payments
The current situation has a lot of people worried about the impacts of delinquent payments. There’s no way to avoid it without massive assistance programs; many more are coming. How can GAP help members and your institution in these tough times?
When a borrower is more than 30 days late on a loan payment, it becomes “past-due” or delinquent. Many institutions add a late fee to the original amount, and some report that late payment to the borrower’s credit report.
Given that late payments will become far more common over the course of 2020, I wonder the impact of their presence on credit reports. But that’s a discussion for another article.
The effect of a delinquent payment on GAP is similar to Skip-A-Pay. In this case, the loan term isn’t extended. However, the missed payment remains in arrears until both the payment and late fee are paid.
A GAP claim made on a delinquent loan would not include this debt in the payout calculation. Therefore, it would leave a balance due for the borrower. The borrower who already couldn’t afford the payment. That’s a recipe for downward financial spiraling, bad for everyone.
Understanding that “life happens”, the majority of GAP providers cover up to 2 delinquent payments. Claims made to them would include these past-due amounts, so everyone is made whole.
Do all providers? Well, sometimes cheaper isn’t better. There are GAP providers which offer zero delinquent payment allowances. Think about what that could mean for your borrowers and collection teams.
How much trouble can come from trying to promote your GAP offering? Turns out, quite a bit.
It may not be part of your GAP contract, but compliance applies to your marketing as well. Who’s up for playing fast and loose with compliance regulations? Yeah, not me, either.
For one costly example, Santander Bank was charged by the CFPB for “Unfair, Deceptive, or Abusive Acts or Practices” (UDAAP) in relation to their marketing of GAP. What was the punishment?
Over $11 million in fines, plus the negative publicity, and unwanted damage to their brand.
Good thing no credit unions engage in the same practices. Except…they do?
Our staff did some digging. On just the first two pages of a search for “credit union GAP”, our staff noted 14 of the 20 credit unions visible included non-compliant marketing similar to that which was used by Santander.
If that ratio remains consistent across the industry, it means 70% of credit unions are vulnerable to the same kind of compliance violations as impacted Santander Bank. The fixes are simple. Will you take 10 minutes to potentially save millions?
Great GAP Guards Growth
GAP is a major risk reduction tool for auto lenders. It’s an incredible value per dollar protection product for borrowers. Offering it is in everyone’s best interests.
Unfortunately, not all GAP programs are created equally. Some programs provide the standard benefits, but fall short then it comes to “going the extra mile” for your members. Others actively help them, while enhancing and increasing your loan production.
Is your institution about doing “just enough” or “above and beyond”?
Most importantly, no masks nor social distancing required!
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