Last fall, at the F&I Reinsurance and Product Conference, GPW Actuarial Services shared some interesting data. Before the Great Recession, in 2007 and 2008, GAP losses peaked well above historical norms. In 2009, we saw significant reductions in GAP losses as financing tightened.
However, since 2014, we have seen a return to 2007/8 levels. Puzzling isn’t it? But there are several factors impacting GAP loss. Let’s look at how the slippery slope of lax lending has played into this. Consider this scenario: A buyer finances a car for 84 months at 110 percent of the $20,000 invoice, totaling $22,000 of financing. He consistently makes his payments, but a larger percentage of that payment is going to interest – not the principal of the loan. Then one day, he is in an accident and totals the vehicle. And suddenly, the value of the loan is greater than the total loss valuation of the vehicle. Voila! – GAP loss.
There is a belief that GAP pricing structures need to be overhauled. Originally, when GAP was introduced into the market, it was sold under a two-tier structure of 0-61 and 62-84 month terms. In 2003/4, a three-tier structure was introduced. This change reflected lender’s growing term flexibility and a zealous approach to the market.
Rather than basing GAP pricing on term, what if pricing was based on long term valuation or the type of vehicle purchased. We’ve clearly seen how loan length increases GAP exposure. By changing the pricing structure, we would lessen the impact of term and help mitigate some of the loss exposure.
We all know that GAP will remain a staple of the auto lender and dealer portfolio. 2017 may be a good year to re-evaluate how it is offered and make a few adjustments to lessen GAP loss.
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