Recent developments following the investigation by the Financial Conduct Authority into GAP insurance have been widely reported, as has the underlying concern that policies sold at point of sale offer very poor returns for the consumers who buy them. But is this really a true reflection of the market in the future? At Glass’s, we suspect not for a number of reasons.
First, some background. GAP insurance was traditionally sold to cover the difference between the write-off value of a car and any outstanding finance. In the same way mortgage lenders often insist on similar policies to be taken out to cover against negative equity once a certain loan-to-value threshold is exceeded, applying the same concept for cars on finance is a sound one, and increasing PCP penetration especially has widened the consumer market.
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Back in 2009 when PCPs were just beginning to take off in the UK, the used market was characterised by volatile prices with double-digit monthly declines in 2008, followed by the reverse in early 2009. As a consequence many in the finance industry took a conservative view of future residual values, both at the end of contract and also for early termination. This led to a relatively high
initial/low final payment structure, with the balance being met by affordable monthly payments in-between.
Due to a combination of high demand and shortage of used car supply as consumers opted to buy used rather than new, residual values for cars strengthened to what was probably a peak during 2012. The upshot was that, coupled with conservative forecast valuations driving the structure of historical PCP deals, the risk that there would be insufficient equity in the vehicle on finance at any point in the contract was small, and so the providers of GAP insurance ended up with only limited risk.
Ironically, it is the success of PCPs in particular that could generate problems for the GAP insurance industry. By focusing on monthly costs and making the initial payment as affordable as possible, PCPs have become increasingly attractive to private buyers. This has all been possible because used car prices have been stable for so long, and so many market participants have become more optimistic with their forecast views as the good times appeared to last.
However, we are now entering a different pricing environment. Three-year-old used car supply – the typical PCP contract length – is increasing as the impact of historical new car sales growth is felt. Not only that but the apparent affordability of new cars to many consumers has already depressed late-plate prices, albeit not three-year-old values – yet.
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By GlobalDataGoing forward, all used car values are set to fall from their current levels, thereby increasing the risk of any financed vehicle being in negative territory.
If we get to a position that the residual value is less than the balloon payment on a PCP deal for a particular vehicle, it’s likely that the used values for that particular model will spiral downwards if the market cannot find ways to deal with the volume of returns, leaving the GAP insurers with an ever-increasing liability.
Furthermore, this could spread to other models in the same segment if such price declines bring into question the cost of owning a comparable vehicle.
As a consequence, and perhaps unexpectedly by some, the value of GAP insurance to consumers will increase as the market normalises back to a higher level of used car supply and thus removes the support of ever-increasing used values that have acted in recent years to safeguard against negative equity.
Richard Parkin is director, valuations & analysis at Glass’s Information
