Cars are great for transportation, but they’re horrible investments. At no point is that more obvious than when you total your car in an accident. You bought that shiny new Ford Fusion for $20,000 a couple years ago, but you only got $10,000 from the insurance company for it. Even worse, you still owe $13,000 on the car loan.
What’s up with that?
Gap insurance could have made up the difference in this scenario, but increasingly there are other options available.
What is Gap Insurance?
Sometimes referred to as "loan/lease gap coverage" or "upside down insurance," gap insurance is a specialized form of auto insurance designed to do one thing and one thing only: make up the difference in what you purchased your car for and what the insurance company pays for it in the event it is totaled out in a claim. It’s traditionally sold for a single premium (usually around $300 to $700) by an auto sales guys at signing.
Yes, that auto dealer’s finance manager is an insurance agent too. Well, sort of. He’s usually licensed to sell that gap insurance and something else called "credit life," which I won’t get into here.
Understanding the Terminology Behind Gap Insurance
To better understand how gap insurance works, you should first understand some basic insurance terminology. Auto insurance is designed to repair or replace losses incurred to your vehicle in such a manner that you neither profit nor lose from the deal. This idea is called indemnification. Indeed indemnification is arguably the single most important concept behind all insurance, not just auto insurance. As an example, a major insurance company recently alluded to indemnification by using the slogan "gets you back to where you belong."
If it were all about indemnification then insurance would be easy. Of course it isn’t. There are other factors to consider as well. For example, insurers need to know what caused caused your loss. This is known in the industry as the "peril." Examples of perils common in car insurance include vandalism, theft, and auto glass damage due to "missiles"i.e. rocks).
Now stay with me here.
Some perils are specifically not covered by auto insurance. These are called exclusions. Common exclusions in auto insurance policies include intentional damage and depreciation. By definition, exclusions are specifically listed in your auto insurance policy.
So here’s where gap insurance comes into play. Everyone knows automobile values depreciate over time. Depreciation is a peril because it causes a tangible loss to your vehicle. However, because depreciation is an exclusion in your policy, it’s not covered by your auto insurance. Therefore this is the rationale for the existence of gap insurance. Stick with us and you’ll pass the insurance licensing exam in any state in the country.
Do You Really Need Gap Insurance?
Many people skip gap insurance because frankly they think it’s just another boondoggle the auto dealerships use to line their pockets. That isn’t necessarily true, however it’s also not necessarily true that you always need it. What is necessarily true is that you want talk to your insurance agent before you sign closing documents on a new car.
Chances are you’re going to finance that new car you just purchased anyway, which means you’re going to carry full coverage on the vehicle. You’ll do it if for no other reason than the bank will make you. Failing to do so will compel them to "force place" full coverage insurance on your vehicle. You don’t want to do that.
You do, however, want to see if your full coverage auto insurance includes gap insurance coverage as either an option or as a standard feature. Many companies offer this. In addition, an increasing number of companies offer options that allow you to replace a totaled vehicle with a new one within a certain time period.
Although the depreciation exclusion still exists on auto insurance policies, insurance companies are nonetheless sensitive to these concerns, not to mention eager to retain your business by offering more bells and whistles.
However, if your auto insurance doesn’t offer any of these features, then you’ll want to do one of two things, get another auto insurance company or go ahead and take the gap insurance. The only thing worse than being upside down in a vehicle is being upside down in a wrecked one.
