The automotive industry, just like any other, has had its share of ups and downs. Yet, even amid market and industry fluctuations, I would estimate a large percentage of dealers are currently participating in the underwriting profits of reinsurance. This overwhelming participation is not without its implications, especially considering the constantly shifting economic landscape. So, it’s not surprising that one of the most frequently asked questions is, "Should automotive dealers be reinsuring their Guaranteed Asset Protection?"
In prior, stable market environments, customers tended to negotiate better deals, resulting in lower profit margins for each car sold. Additionally, low interest rates meant customers owed less on their cars. However, the economic landscape over the last two years has been anything but normal. The pandemic, inflation, inventory shortages and increased demand have significantly escalated car prices, more so for preowned cars, which sometimes sell for more than newer models. The combination of high car prices and higher interest rates could potentially result in astronomical GAP claims. The fallout from this is evident when a car is totaled or stolen; the primary insurance company often falls short of paying off the entire loan. Dealers participating in underwriting products, GAP being one of them, could be at risk of handling claims several times larger than in previous years.
The GAP Reinsurance Dilemma
Dealers who opt out of reinsuring their GAP face no risk; they write it, take the upfront profits, and do not partake in potential future underwriting profit. For those who opt into reinsuring their GAP product, if market conditions remain consistent with used-car values staying high, they stand to make underwriting profits. However, the market's volatility could quickly turn the tide. If used-car inventory levels stabilize and used-car values decline due to falling demand, there could be a big GAP problem, wiping out any potential underwriting profits. Essentially, the profits dealers hoped to enjoy would not be there.
Risks, Solutions, and Customized Solutions
The risks are high; a dealership can stand to lose up to 100% of its GAP premium. If a dealer writes a $1 million GAP premium and the losses amount to $1.5 million, they lose the $1 million, and insurance covers the rest. For dealers with dealerships in multiple locations within the same state, there may be variables that require one store to opt for reinsurance of certain products, when another store does not participate.
Dealerships must evaluate every opportunity or scenario, looking closely at the franchise, the market and socioeconomic factors. An expert with a finger on the pulse of value projections and markets can be invaluable, providing assessments and recommendations tailored to each dealership's unique circumstances.
GAP isn't the only concern. As an example, windshield protection products also pose a risk in some states. And then there's the matter of differing sales tax rates across states. Dealerships operating in multiple states might be advised to reinsure some products in states with zero sales tax versus states where high sales taxes are imposed.
Without a one-size-fits-all solution, it's about having the right product mix. Advisers can help by monitoring market indicators, guiding dealers to reassess their portfolio and develop a strategy for reinsuring products.
The Importance of Vigilance
With no crystal ball at hand, the automotive dealership's future lies in preparedness, vigilance and the ability to adapt to changing circumstances. No one has seen the shock waves yet; used cars still have a shortage, and book values are high. As markets and conditions fluctuate, one thing is certain: A strategic, flexible approach to reinsurance can be the difference between riding out the storm and being swept away.
Dylan Doran is is president of WFIS, a Vanguard Dealer Services Company.
