GAP – Where Are We?
Lee Bowron, ACAS, MAAA
John Kerper, FSA, MAAA
Navigating GAP exposures in 2023 is proving to be a challenge for those attempting to gauge potential future losses from GAP contracts. The foundation of all GAP claims lies in a total loss incident. Such an incident hinges on both a trigger event, which is a physical damage claim, and the subsequent classification of that event as a total loss by the insurance provider.
The present dynamics can be attributed to a myriad of factors, with particular emphasis on:
- Used Car Prices:
- The current dip in used car valuations is a predictable aftermath of the swift price escalation post-pandemic.
- As supply-chain situations improve, these falling prices can have repercussions on GAP losses, primarily impacting contracts from 2022 onwards.
- Although further drops in used car prices are anticipated, macroeconomic elements, such as the inflation rate, appear to cushion this descent. Furthermore, standard contributors to the used car inventory, like leasing and rental returns, are currently fewer than the usual rates, which may restrict the availability.
- Diving deeper, compact car valuations have seen the most significant drop, whereas pickup prices remain consistent. Highlighting another concern, electric vehicles’ pricing has seen a 25% depreciation since early 2022, as per Yahoo Finance data.
- Auto Financing:
- The auto financing landscape has been rattled with disturbances, and a rise in interest rates has influenced credit accessibility.
- An environment where credit is less available might result in diminished GAP losses because loans would likely start with less negative equity. From a GAP underwriters’ perspective, while the precise effects of financing continue to be ambiguous and will differ across portfolios, the current conditions can function as a buffer against the implications of reduced auto prices.
- Auto Insurance Market:
- It is essential to note that insurance providers have discretion when designating total losses. A drop in used car valuations can influence their decisions, making it more feasible to label a claim as a total loss since repairs might cost more than settlements.
- A surge is noted in repair costs owing to rising labor rates and technology integration like sensors, cameras, and advanced lighting systems in vehicle parts.
- On the brighter side, although severe accidents leading to total losses are still prevalent, long-term claim frequencies are on a downtrend.
Earning Strategy for GAP:
When assessing GAP, the reserve should be earned in alignment with the claims over the contract’s tenure. Traditionally used methods, such as pro-rata, may not present an accurate picture. A more nuanced approach suggests adopting the Rule-of-78s, but with a 25% to 40% reduction in term duration. While accounting standards might necessitate a slower GAP earning pattern for financial statements, this method offers a more precise measure for experience evaluation.
For a comprehensive study on this topic, refer to our detailed paper titled “GAP – Techniques and Challenges” available on the Casualty Actuarial Society website. Read here.
Conclusion:
GAP losses will persist as a focal point of unpredictability, influenced heavily by the undulating trends in used car prices and financing structures. Keeping abreast of current shifts is paramount to accurately estimate exposures arising from these contracts.
Kerper and Bowron LLC is an actuarial and insurance consulting firm. We specialize in evaluating property and casualty exposures, including extended warranty, vehicle service contracts, and other F&I products. For more information contact John Kerper (205-873-1488, john@kerper-bowron.com) or Lee Bowron (205-870-0595, lee@kerper-bowron.com).
