In August 2016, Chris Stoll of Allstate and I gave a presentation at the P&A Leadership Summit on GAP. At the time, we noted that GAP losses were up significantly and thought that the trend would continue, due to the underlying factors that are driving up GAP results. Attendees of this year’s conference are asked to join me for a session reviewing what has happened since our last meeting.
Before discussing the trends in GAP, it is important to realize that GAP is a very leveraged product! As the example below shows, changes in asset prices will have a much larger impact on GAP losses.
In this example, the value of a total loss settlement is shown at $15,000 with scenarios of +/-10%. The impact on GAP losses is about five times as much. So a used-car price decrease of 3% might have a 15% impact on GAP prices.
In the past, this has led to conditions which made GAP underwriting very profitable as well as very unprofitable. The instability is a feature of the product. We shouldn’t expect GAP pricing levels to be stable. Volatility and price changes are the norm for GAP insurance.
Recently, we have seen trends in asset prices, financing and the underlying used-car market.Asset prices: Information from Cox Automotive indicates that retention values for the latest three model-years have declined over the past two years, but at a moderate pace. Type of car is critical. Smaller cars have performed much worse than the pickup and SUV market. This is due to consumer preference as fuel prices have declined. Financing: Delinquency rates have increased for subprime loans but have been fairly stable for good credit scores. This is important because a tighter financing market will mean less negative equity financed and, ultimately, lower GAP losses. Underlying physical damage trends: These have remained at historic highs. Frequencies have increased likely due to an increase in miles driven in an improving economy as well as distracted driving. Technology and lighter, more expensive materials are driving up parts costs at a dramatic rate. As severities increase, physical damage insurers will declare cars as total losses and simply pay the market value.
Simply put, a lot of the cost of a car is being pushed from the engine to the outer edges as the replacement cost for these sensors, cameras, and lightweight materials are very high.
So what could stop GAP losses from increasing? The underlying trends still point to higher GAP losses in the future. Some events that might slow or reverse GAP losses would include:
- Tighter financing, which lowers the loan-to-value ratios on vehicles
- An increase in used car prices, which is somewhat unlikely in the near term with the large supply of late model vehicles in the vehicle supply
- An economic contraction which decreased physical damage frequency due to fewer miles being driven
- Better technology on crash avoidance
- A lowering of parts prices, perhaps due to increased availability of aftermarket parts for late model vehicles.