New Car Replacement or Gap Insurance: Which One Should I Choose?

Insurance companies operate within a regulated industry. But, it is still a free market environment. So, they are constantly looking for ways to differentiate and add additional value for their customers; also, so they can take other companies market share. This competition is, ultimately, to the benefit of the consumer. It is the catalyst that creates new product offerings or policy endorsement options that can better protect your assets and financial security.

When it comes to car insurance, a lot of people are looking for the cheapest way out the door. Compounded on top of that is the fact that some coverages are only available when you purchase a brand new vehicle and others may only be available when the vehicle is first added to the policy – i.e., immediately after you buy it. So, given the nature of car insurance and a typical buying experience, it becomes pretty obvious why many consumers are unaware of, or confused about, some of the coverages and endorsements available to them.

Two of those coverages are Loan/Lease Gap Insurance and New Car Replacement Cost. These coverages are sometimes confused with one another, but they change the policy in different ways and respond in different loss situations. Below is a brief description of each:

1. New Car Replacement Cost

Buying a new vehicle can be as stressful as it is exciting, especially if you stop long enough to realize that once the vehicle is driven off the lot, its value immediately depreciates. The vehicle can no longer be sold as “new”, and although buying a car from a dealer has its benefits, you pay for them in the price of the vehicle. What this rapid depreciation does to your car’s value, and the subsequent discrepancy between the dealer’s pricing and the vehicle’s “Actual Cash Value”, can leave you with a gap in your insurance plan.

Standard Coverage is Based on Actual Cash Value

Many people do not realize that a standard auto policy is going to value your vehicle based on an Actual Cash Value (ACV) calculation that is based on comparable vehicle values in your area. This means that if you wreck a brand new vehicle just one month after you buy it, your claim payment could realistically be a couple thousand dollars less than the cost of buying another new vehicle off the lot.

Depending on your financial situation, this may be very detrimental to your cash flow or your ability to replace a lost vehicle. Insurance companies offer products to help eliminate this potential coverage gap for insureds who buy new vehicles. One of the most common optional coverages to see offered on car insurance policies is New Car Replacement Cost.

How New Car Replacement Cost Works

The pricing and details of this endorsement may vary from company to company, but typically the endorsement changes the valuation basis of the vehicle and how your claim settlement is calculated. Instead of assessing the value of your car relative to its depreciation, the insurance company will pay what it costs to replace your vehicle with a new model of the vehicle that was just totaled.

By definition, property claims settled on a Replacement Cost basis allow the insured to receive new property to replace the old property that suffered a loss; versus actual cash value settlements that account for the depreciation of the damaged property, prior to the sustained loss.

2 Things to Know About New Car Replacement Coverage

There are two main things pertaining to New Car Replacement on an auto insurance policy that must be remembered. The first being that most companies will limit the timeframe that they will settle a claim on a Replacement Cost basis to just 3 years. Secondly, this coverage typically needs to be added at the same time that the new vehicle is added to the policy.

In other words, you typically won’t be able to add a vehicle to your policy and then a year later decide that you would like to have New Car Replacement Cost. So, consider the cost of the endorsement and whether or not an ACV loss settlement for your new car is something that you can financially manage. You can always elect to remove the endorsement before 3 years, if you decide you would like to save premium dollars.

2. Loan/Lease Gap Insurance Coverage

Loan/Lease Gap Insurance Coverage sometimes gets lumped in with New Car Replacement Cost. Even some agents misrepresent this coverage and what it provides. As mentioned, your vehicle experiences immediate depreciation as soon as it leaves the dealer lot. Since finance companies will still offer vehicle loans to car buyers who are purchasing pre-owned vehicles, Loan/Lease Gap coverage does not only apply to new vehicles; just new-to-you vehicles.

How Vehicles Often End Up With Insurance Gaps

To understand this coverage, consider a situation in which you buy a used vehicle that has low mileage for its age. Perhaps the vehicle is 5 years old and only has 40,000 miles. Typically, most people using a vehicle for commuting to and from work will put between 12,000-15,000 miles on their car annually. Of course, this will also vary with your geographic location. You likely had to pay a little extra for that vehicle that was below the average mileage for its age.

That vehicle does, in fact, have a higher actual cash value and so the dealer pricing will be increased as well. The potential issue arises if you drive significantly more than the average person does each year. If this is your reality, your vehicle will experience more rapid depreciation in its actual cash value. The likelihood of an insurance gap may be increased if you did not put a significant down payment on the vehicle at the time of purchase, or you chose a longer loan term.

An Example of How a Vehicle Could End Up With an Insurance Gap

Here is an example: Imagine you have just purchased a Nissan Maxima that is 3 model years old and has 30,000 miles on it. The sticker price on the vehicle was $25,000 and you put $1,000 down. With taxes, tags, and interest, the price out the door was about $27,000, and you chose a loan term of 72 months to make each monthly payments lower and more manageable for your cash flow. But, instead of the 10,000 miles per year that the previous owner put on the vehicle, you put 20,000 miles per year on the car for the first two years that you owned it.

Now, the same vehicle that had below-average mileage for its age two years ago, now is 5 years old with 70,000 miles, pushing it into the high end of “average” mileage. To make matters worse, the extended loan term you chose means that you are paying the vehicle off at a slower pace than you are depreciating its value with the increased amount of annual miles you are driving.

What Happens When There is a Claim on a Vehicle with an Insurance Gap?

If you were to experience a total loss to the vehicle in an accident, your car insurance company will calculate the vehicle’s Actual Cash Value. The lending bank, which will be listed as a loss payee or lienholder on your policy, will receive the check first, in order to satisfy their financial interests in the vehicle. If the actual cash value of your vehicle is less than the amount you still owe the bank, you will still be financially responsible for the difference. The loan collateral (your car) no longer exists to secure the loan, and so the bank will look to collect the difference in claim payment versus the outstanding loan balance from you, personally. This could be a couple of hundred dollars, a couple of thousand dollars, or the loan balance could even be less than the ACV of your vehicle if you have been paying off the vehicle quickly.

How Gap Insurance Works

How Loan/Lease Gap Coverage eliminates any doubt in these situations is by paying the lending institution the difference of the vehicle’s ACV and the remaining balance on the loan or lease. The value of this coverage should be carefully determined with the help of your independent insurance agent. If you put a large down payment on your vehicle, you plan to drive it less than the “average” annual mileage or you have selected a shorter term loan, Loan/Lease Gap Coverage might not be a wise purchase for you.

If your vehicle’s value is depreciating slower than the rate at which you are paying off the loan, you are probably better served to save some premium and decline purchasing this endorsement. However, as with New Car Replacement, you want to consider if your driving situation may change before your loan is paid off because Loan/Lease Gap Coverage can typically only be added immediately following the purchase of your new car.

Many drivers aren’t aware of how their car insurance policy will pay out in a claims situation. Many incorrectly assume that they will be compensated in the amount it takes to purchase a new car just like the one they lost. Unfortunately, it doesn’t always work out this way and many of those same insureds weren’t even aware that endorsements were available that would have helped to close some of these potential coverage gaps.

When customizing your car insurance policy and evaluating whether it is worthwhile to add these coverages to your auto policy, you should consult with an experienced independent agent so they can help you to determine the cost/benefit of these insurance add-ons. If you’re planning to purchase a new or new-to-you vehicle, contact Ruhl Insurance at 717-665-2283 or 1-800-537-6880 to get more information about the coverages and endorsements available to you.

Disclaimer: Information and claims presented in this content are meant for informative, illustrative purposes and should not be considered legally binding.