The 'GAP' in GAP insurance means Guaranteed Asset Protection. It's an appropriate acronym, because GAP insurance is designed to bridge the gap between the amount you paid for the car and the figure your insurer will actually pay to you in the event of it being stolen or written off.

Hang on a minute: insurers won't pay out the full replacement cost of my stolen or written-off car?

That's right. If you buy a new car and it's then stolen or written off, your insurance might only pay you the car's current market value, not the figure you paid for it.

And the difference between those two numbers could be massive. Three years into its life, an average car will have lost about 60% of its original value. In the first year alone around 40% of its value will have disappeared.

So, a one year old car may still feel like a new car to you, but from the insurer's perspective it might not be, which may explain why people buy GAP insurance for cars younger than three years old.

If you're buying a car on finance or on a big personal loan, you need to be especially sure that you're covered somehow, either within your existing policy or through GAP insurance, as the outstanding payment will still need to be sorted out.

It's not all bad news. It is true that many new car insurance policies will replace a brand new car if it's written off in the first year, so it's always best to check with your insurer before taking out GAP insurance. In this scenario, you may want to buy GAP insurance for the second and third years of ownership. There may be a requirement to buy that GAP cover in the first six months of the car's life, however, so get yourself organised with quotes. GAP insurance is actually available for cars up to 10 years old.

You will usually be offered GAP cover in the dealership where you're buying the car. Car dealers can't sell you GAP insurance on the same day they sell you a car. They must wait for at least two days before offering it to you, and they are obliged to explain to you the total cost of the policy, the main benefits and exclusions on it, and the fact that you're not tied to them. Alternative offerings from outside insurers, brokers or comparison websites can often be cheaper. As with anything, it makes sense to shop around.

There are quite a few different GAP varieties, but here are the five most common.

• 'Finance' GAP insurance

As noted above, most of the more comprehensive insurance policies should have cover to pay off any outstanding finance if your car is written off. If yours doesn't, you can graft this basic finance GAP cover onto it.

• 'Return to invoice' GAP insurance

This is a popular GAP cover choice as it simply pays out the difference between the price you paid for your new car and the amount you get from your main car insurance policy in the event of a total loss declaration.

• 'Vehicle replacement' GAP insurance

This level of cover goes beyond simply boosting your funds to the amount you paid for your new car. It will give you enough money to get a brand new, straight replacement to exactly the same specification. That's handy, because manufacturers tend to increase their prices every year – but it's an expensive option.

• 'Return to value' GAP insurance

A bit like 'return to invoice' cover, except that but it boosts your funds to whatever the car was actually worth at purchase, rather than to the price you paid for the car. It's a good option for dear second-hand vehicles.

• 'Lease' GAP insurance

If you've leased your car and it's written off or stolen, this cover helps you to pay off the rest of the contract plus whatever early settlement fees may apply.

Things to be aware of

When buying GAP, be aware of cover length, excesses, exclusions, and the claims and cancellation processes.

One common drawback of a cheap policy is that you are constrained by a very short claim period, which could prevent you from claiming if your car is stolen and not recovered in as little as 30 days.

Another potential banana skin is 'pre-approval' which prohibits you from accepting an offer from the car's main insurer without the consent of the GAP insurer. By continually rejecting the insurer's offers a GAP company can delay its payout.

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