In many countries around the globe, such as the United Kingdom and Australia as well as in Europe, shortfall insurance is often a required investment. Such insurance covers the difference between the vehicle loan and the market value of the vehicle in the event of an accident, resulting in the vehicle being written off. Usually, such cases mean the vehicle is damaged beyond repair. The term often used to describe a vehicle in this state for insurance purposes is “total loss.” Shortfall insurance is normally secured at the beginning of the loan contract as a condition of the loan.
Also known as gap protection, shortfall insurance is designed to protect both the creditor and the debtor in the event of a total loss. Effective policies that cover the vehicle owner's loan contract in such an event will almost always pay the difference between the vehicle's assessed value and what is owed the creditor, thereby protecting the debtor from financial difficulties in paying for a vehicle he or she can no longer use. The policy will also protect the financial entity making the loan from a default, therefore ensuring payment and mitigating expenditures associated with collecting on a default loan or, even worse, risking uncollected funds.
Shortfall insurance is taken out in addition to comprehensive insurance on the vehicle. This means in the event of an accident, if the comprehensive policy pays enough to cover a total loss, the gap coverage will not usually kick in. Thus, comprehensive insurance is the first payer. Additionally, depending on the level of coverage selected and options offered by the insurer, a shortfall policy may also pay out additional expenses, such as registration expenses for a replacement vehicle or associated insurances costs. It is important to note, however, that the sum that equals the difference between what is paid out on the comprehensive policy and what is owed on the loan installment gets paid directly to the finance company in most cases.
Premiums for shortfall insurance are usually only paid once at the beginning of the loan contract, covering the insured for the duration of the loan agreement of the shortfall contract. Maintaining comprehensive coverage in all circumstances is usually a requirement, however, for the shortfall insurance to remain valid. Pending a lapse in comprehensive coverage, the insurer may cancel the shortfall insurance, which thereafter may or may not be reinstated at the discretion of the insurer.