As consumer debt, now at approximately $2.2
trillion, continues to rise and debt financing periods are extended, various
forms of debt cancellation or debt deferral contracting gain more salience.
Perhaps the most common debt cancellation contract is that form common to automobile
financing, GAP insurance. "GAP" is an acronym for "Guaranteed Auto Protection."
by Tim Ryles,
Tim Ryles Consulting
In this article, I discuss what GAP is, what it covers, common exclusions,
how it is regulated, and certain sales/marketing methods to watch out for.
GAP contracts pay the difference between what a primary insurer pays in the
event of a total vehicle loss, including theft, and the outstanding loan balance
on the vehicle. (Approximately 2.5 million vehicles are totaled annually.) It
is a form of credit insurance similar to credit life, credit disability, and
credit property insurance. To illustrate, GAP operates in the following manner.
New, used, and leased vehicles and motorcycles are eligible for GAP. GAP
pays for losses up to a certain amount ($100,000 for example) and, unlike the
example above, it may not include the deductible. Further, the term of coverage
may be coextensive with the term of a loan or it may be of shorter duration.
A review of GAP policies shows remarkable similarity in both coverages and
exclusions. Notable exclusions include the following:
Readers will quickly note that "GAP" may still leave a gap in one's financial
obligations once the exclusions are applied.
GAP regulation is somewhat confusing and haphazard. Who offers it determines
largely how it is regulated. If a national bank, credit union, or other federally
chartered depository grants the loan, GAP is typically not considered insurance
for regulatory purposes. Further, to place state depositories on an equal footing
with their federal competitors, state banking regulators have adopted rules
allowing state depositories to offer GAP contracts free of insurance regulatory
interference. A June 17, 2004, opinion of the New York Department of Insurance
Office of General Counsel provides a detailed analysis of why financial institutions
offering GAP contracts are not regulated by state insurance departments.
As part of a credit transaction, GAP is subject to federal Truth-in-Lending
laws and Regulation Z of the Federal Reserve Board. If the purchase of the GAP
plan is not a condition of the loan, if it is voluntary, and if the borrower
acknowledges in writing that the purchase price and the program are disclosed,
the amount paid for GAP is placed in the "Amount Financed" category.
Automobile insurers, however, offer GAP policies and are subject to all of
the form and rate filing requirements state insurance codes.
Automobile sales and service are perennial sources of consumer complaints
and abuse. Typically, the areas of controversy entail Truth-in-Lending, Lemon
Law violations, odometer rollbacks, bait and switch, loan packing allegations,
force placed insurance, and selling previously wrecked vehicles without disclosing
vehicle history. Here are some reasons we may soon add GAP to the list of auto
First, as indicated above, GAP does not always completely fill the gap between
one's financial obligation and the primary insurer's settlement. Consequently,
any representation that it pays "full cost" or all the difference between what
one's primary auto insurer pays and the outstanding loan obligation could be
false. Similarly, if a federal or state exempt depository institution represents
GAP as insurance when in fact it is not, that, too, would be a misrepresentation.
Second, vehicle dealers who offer GAP work with an insurer in much the same
way as they do in selling other forms of credit insurance. One important difference,
however, seems to be that traditional types of credit insurance, while expensive
and of dubious value to many consumers, nevertheless comply with all insurance
form and rate filing requirements. This includes prohibitions on varying the
premium for the insurance.
In contrast, GAP arrangements with vehicle dealers may include a rate that
apparently consists of the insurer's rate on file with regulators but may also
be accompanied by a "suggested retail price" to be charged by the vehicle dealer.
When a GAP contract is sold to a borrower, the vehicle retailer remits the insurance
company's filed rate but pockets the difference to cover administrative or other
acquisition costs. For example, an arrangement may list the insurer's "amount
to be remitted" to the insurer as $90 and the "retail price" as $495, a difference
of $405. If the car dealer succeeds in selling the GAP for the $495, the dealership
pockets this $405.
While this practice may be characterized as an "administrative fee" or some
other designation, it looks a lot like a commission on a premium for insurance
to me. By definition, "premium" is consideration for insurance and includes
Third, since the $495 figure is merely a suggestion, the actual price may
be more or less than $495 depending on the negotiating skills of the buyer.
Since consumers are not accustomed to negotiating insurance costs, one can pretty
easily predict the outcome of the negotiations: the buyer loses. Of course,
under state insurance laws, it is an unfair trade practice for any selling agent
to charge a premium higher than that on file with state insurance regulators.
It is also an unfair practice to charge like risks different premiums for the
same coverage or unlike risks the same amount for the same coverage (it is called
"unfair discrimination" in insurance jargon).
How much knowledge insurers have of the auto dealer practice of charging
what the market will bear while remitting a lesser amount to the insurance company
is an open question. Insurers participating in such schemes, however, may find
themselves defending allegations of rate filing violations, tax evasion, unfair
trade practices, and fraud.
Fourth, some of the GAP contracts I have reviewed contain binding arbitration
clauses under which borrowers forego all access to judicial remedies. Some states,
Georgia's arbitration statute for example, do not permit such agreements in
insurance contracts while other states, Louisiana for example, prohibit binding
arbitration provisions in insurance contracts.
Fifth, a GAP contract may include a provision for resolving a claim in the
event that a debtor's primary insurance is not in effect. (Indeed, an underlying
primary insurance policy is not necessarily a condition of signing up for GAP.)
GAP policy language may dictate specific sources that will be used to determine
actual cash value, such as Kelley's Blue Book or the National Automobile Dealers Association
Guide, should a total loss occur. Some states, however, have specific
regulations governing procedures to be followed by insurers in determining the
value of a totaled vehicle that are at odds with the GAP policy's procedures.
Sixth, GAP policies may stipulate that the borrower is subject to the laws
of a foreign jurisdiction, even though the product is purchased in the buyer's
home state. Such a provision, common in credit transactions, may place heavy
burdens on the borrower.
Seven, many GAP contracts are single premium policies, i.e., the premium
is paid in full up-front for GAP. However, at some point the borrower will pay
down the loan to the point at which the gap disappears. Despite the fact that
the GAP policy may cover the entire period of the loan, as a practical matter
it ends at the point at which the gap disappears. That's why it makes more economic
sense to buy GAP on an annual basis, not all in one premium.
Eight, with respect to cancellation provisions, state insurance laws governing
conventional forms of credit insurance, such as credit life, generally stipulate
how refunds of unearned premium are determined. The regulatory gap between traditional
credit insurance and GAP, however, is illustrated by a provision in an Alabama
policy. According to the policy, "The insurance provided herein may be canceled
by You upon written notice to the lender or to US stating when thereafter such
cancellation shall become effective. Return premium, if any, will be computed
using the Pro Rata refund method after first deducting the applicable Certificate
fee as fully earned."
Since "Certificate" is capitalized, one might reasonably expect a definition
somewhere in the policy, but there is no definition. One is left guessing whether
the unearned premium refund is based upon a "Suggested Retail Price" or what
the insurer actually received. If the latter is the case, the unearned premium
provision is almost farcical.
In my opinion, then, there are significant gaps in GAP policies and regulation.
Fortunately, some auto insurance companies now offer GAP directly to consumers.
Until consumer protections catch up with GAP, buyers are probably best advised
to ask their insurance agents about purchasing GAP as a rider to their auto
insurance policies instead of buying from a vehicle dealer. In pursuing GAP
coverage, however, consumers should take the initiative to inquire about its
availability since there is no mandate to offer GAP endorsements. Washington
State, for example, allows insurers to sell GAP but does not permit insurers
to advertise its availability.
The advantages of buying directly from insurers are that the cost is relatively
cheap, insurers may not deviate from the rates they have on file with departments
of insurance, and a buyer does not forfeit important consumer protections.
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