GAP is optional consumer protection that generally covers the difference between what the car is worth and what the consumer owes on the car after a total loss. There are two types of GAP protection: (1) GAP insurance; and (2) a two-party GAP waiver. Both GAP insurance and two-party GAP waiver have coverage limits, although GAP waiver typically has much higher coverage limits that often apply to both the amount owed on the financed vehicle and negative equity from a trade in vehicle that is included in the amount financed.
GAP insurance is an agreement entered into between the consumer and a third-party insurance company. It functions as insurance coverage to generally cover the “gap” between the amount a customer owes on their car and the car’s actual cash value in the event of an accident. A car’s actual cash value is the car’s monetary value at the time of the accident, not the car’s original price. GAP insurance is not available from many auto insurance companies and, when it is available, it often is limited to consumers with a qualifying credit profile who are purchasing new vehicles or used vehicles below a certain age. GAP insurance also typically does not cover negative equity from a trade in vehicle and may not cover the auto insurance company’s deductible. In addition, GAP insurance must be added to coverage should a customer switch insurance companies because it does not transfer from one insurance company to another. The creditor is not a party to a GAP insurance agreement.
A 2-party GAP waiver, on the other hand, is a contractual agreement between the consumer and the creditor which remains with the finance contract through maturity unless it is cancelled pursuant to the agreement. A GAP waiver is typically designed to be an addendum to the retail installment sale contract or lease. In a retail installment sale transaction, the dealer, as the initial creditor, is initially obligated on the GAP waiver. When the retail installment sale contract is assigned, the holder steps into the dealer’s shoes and becomes obligated on the GAP waiver. Under a GAP waiver, the holder is obligated to “waive” the amount owned as specified in the agreement.
States typically dictate whether a creditor may sell and finance GAP. Historically, states generally permitted creditors to sell and finance GAP insurance, while only some states permitted creditors to sell 2-party GAP waivers as non-insurance products. In recent years, many states have enacted GAP waiver laws or adopted regulatory positions that expressly permit creditors to sell and finance non-insurance GAP waivers.
State GAP waiver laws typically impose disclosure and other substantive requirements for offering a GAP waiver, including limitations on GAP waiver terms, cancellation and refund requirements, and in a limited number of states, form approval requirements, licensing or registration requirements. The failure to comply with these requirements when offering a GAP waiver may, amongst other things, result in the GAP waiver being subject to regulation as insurance or may subject any GAP waiver charge to being treated as a finance charge. For example, in Colorado, a creditor may not exclude a GAP waiver charge from the finance charge unless certain conditions are met.
GAP insurance and GAP waivers are also subject to regulation under federal law. TILA requires the financing agreement to include certain disclosures in order to exclude GAP charges from the finance charge. Specifically, in order for a GAP charge to be excluded from the finance charge under TILA, Regulation Z requires the following conditions to be satisfied: (i) GAP is not required by the creditor, and this fact is disclosed in writing; (ii) The fee or premium for the initial term of coverage is disclosed in writing. If the term of coverage is less than the term of the credit transaction, the term of coverage also must be disclosed; and (iii) The consumer signs or initials an affirmative written request for coverage after receiving these required disclosures. Any consumer in the transaction may sign or initial the request. If a dealer fails to prominently disclose that the purchase of GAP is voluntary and not required for credit, the cost of the item is considered a part of the “finance charge” for TILA purposes and the APR must be calculated to reflect that fact. A dealer must also disclose if it will retain a portion of the premium or charge.
Finally, when marketing and selling GAP, dealers must be mindful of complying with state and federal standards governing unfair, deceptive, or abusive acts or practices. The sale and marketing of voluntary protection products (VPPs), including GAP, have been an area of focus for government law enforcers, including the Consumer Financial Protection Bureau and the Federal Trade Commission. While the agencies have not issued any guidance to date that directly impacts the ability of a creditor to sell GAP, issues of focus include fair lending, marketing and advertising of products, and the techniques used to sell GAP. This has resulted in enforcement actions involving deceptive claims about the benefits of GAP, failure to disclose material product exclusions, limitations, or qualifications on the benefits, violations of TILA, and billing for services not provided. Another area of potential risk with respect to GAP is high penetration rates as evidence to challenge the voluntary nature of the products. In other words, penetration rates in the high 90th percentile, while not per se evidence that the product is not voluntary, could invite heightened scrutiny around sales practices.
Most states have unfair and deceptive acts and practices statutes, and/or unfair insurance trade practices statutes, which may also govern the sale of GAP and/or disclosures made in connection with those sales. Many of these statutes offer appealing private remedies for plaintiffs seeking redress for alleged transgressions, including “payment packing” or “packing.”
“Packing” describes the sales practice of deceptively increasing a consumer’s credit obligation (and in turn, increasing the dealer’s and creditor’s profits), by padding or “packing” the amount financed through the sale of unnecessary, unrequested and/or unwanted products. Other packing practices may include overcharges to consumers eligible for GAP coverage, sales of GAP to consumers ineligible for coverage, and/or sales of GAP products that provide less or more than the coverage desired.
To the extent GAP is marketed honestly and the cost of the GAP is transparent to the consumer, dealers can reduce these compliance risks. [The National Automobile Dealers Association, in conjunction with the National Association of Minority Automobile Dealers and the American International Automobile Dealers Association, recently issued an optional Model Dealership Voluntary Protection Products Policy to assist dealers in offering a professional, transparent, and consumer-friendly VPP sales process. You should consult your attorney on compliance issues relating to the GAP products you offer.