GAP is on sale!
by: Rob Volatile
To understand what has taken place with GAP products nationally since 2015, you need to have a basic understanding of insurance. Insurance on its face is simply math based on the rule of large numbers. Actuarial folks are tasked with risk assessment based on all available data. Once the information has been examined, a pure insurance rate is calculated to cover the specific risk. After that the administrator establishes a per contract fee for legal insurance filings, risk management, claims administration and a myriad of other expenses. Once concluded (in the case of GAP) a “dealer rate” is established.
There is no such thing as a bad risk…just a bad rate.
Starting around 2015 many factors converged to create an environment where GAP losses began to accelerate. Up until that point, GAP losses had hovered at about the same number for years. Here is a list of SOME of the factors that created the accelerated losses on GAP protection:
- Increased finance terms
- Increased insurance “total losses” due to technology increasing the cost of repair
- Acts of God: floods / storms / etc
- Adverse selection: Selling GAP to the people that need it most instead of offering it to all customers
- Used vehicle price fluctuations
- And on and on
These factors created loss ratios that sometimes eclipsed 300%. A loss ratio is the number insurance companies used to measure the outcome of the original risk assessment. A simple way to understand loss ratio is based on $1:
- If $1 in insurance reserve is taken in and 60 cents is paid in claims the loss ratio would be 60%
- If $1 in insurance reserve is taken in and $1.50 is paid in claims the loss ratio would be 150%
Obviously, the goal of any insurance company is to do their best to keep the loss ratio below 100%. Remember that insurance companies make money on “the float”. The float is the investment of insurance reserve while it is waiting to pay a claim. This is how Warren Buffet made his fortune.
How is GAP on sale?
Basic math would tell you that if the money paid in claims is more than the money taken in by the insurance company then the customers are getting more than their dollars are worth. This is exactly the scenario that has and is currently taking place with GAP. So in conclusion, GAP is actually on sale since it will pay more on average in claims than the customer is paying in pure insurance premium.
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