Scott On Money

One of the many things I was offered as I was trying to get the deal closed was gap insurance. Gap insurance makes up the different between what you owe on your loan and what your insurance company will actually pay you if you have a claim. In my case if my car was totaled or stolen I might be out $2000 for the lost value in the car (depreciation) $1000 for the deductible and $2000 for the taxes (I financed everything).

The dealer offered me gap insurance for $1600. Is this a good deal or not?

The quick answer that I had from how hard it was pushed was absolutely not. There is a way to look at this that gives you a better idea than just a gut feel. There is a little math but I promise you it is very simple.

Case 1: The car is stolen or totaled
I’m out $2000 for the difference between the cars value at what a new one costs.
I’m out $1000 for the deductible.
I’m out the $2000 I spent on taxes.
Outcome: -$5000

Case 2: The car is not stolen
Outcome: $0

Case 3: The car is stolen or totaled with gap insurance
I’m out $2000 for the difference between the cars value at what a new one costs.
I’m out $1000 for the deductible.
I’m out the $2000 I spent on taxes.
I spend $1600 on the gap insurance.
The gap insurance pays me $5000
Outcome: -$1600

Case 4: The car is not stolen with gap insurance
I spend $1600 on the gap insurance.
Outcome: -$1600

So now we need to decide what the chance of totaling the car or having it stolen are. I don’t know the statistic but I’m sure it is not more than a 5% chance.

Expected result = Chance of occurring * value (for each outcome)

For gap insurance we have:
Expected result = 5% * -$1600 + 95% * -1600 = -$1600

Without the gap insurance we have:
Expected result = 5% * -$5000 + 95% * 0 = -$250

First note that you will always come up with a negative number when doing these insurance expectations since you are paying the insurer to pay their staff, make a profit etc.

Second this is only an example. I didn’t bother with the details of this policy since it looked so bad. Be sure to carefully check the details of any insurance policy. You’ll be pretty upset if you pay for gap insurance, incur a loss, and they have an exclusion preventing you from collecting.

Finally check around. Your financer or insurance company probably has a far better deal than the dealer will give you.