You are correct that GAP Insurance policies are not transferrable however in the circumstances that you describe (the dealer replacing the vehicle due to a manufacturing defect) the policyholder would be able to either transfer the remaining term of the policy to the new car or, if there was a price difference (increase) between the two vehicles, receive a pro-rata refund to use against the cost of purchasing a new policy for the replacement vehicle.It something I really wanted but due to problems with my car I didn't get it as the only drawback with it is, it only covers the car that you purchase so if for any reason (risk minimal) the car has to be replaced due to a serious mechanical fault you can not transfer the policy to the new car.
Of course, I'm talking about our policies and our procedures, but if the vehicle is being replaced due to a manufacturing defect, blame can hardly be attributed to the owner of the vehicle (the GAP Insurance Policyholder) and any Insurance company telling you otherwise is walking a very thin line as far as the FSA (Financial Services Authority) and their TCF (Treating Customers Fairly) Initiative would be concerned.
To clarify, if you decide to sell or transfer ownership of a vehicle covered by a GAP Insurance policy, then you're going to forfeit any remaining term of the policy and receive no form of refund.
On the other hand, if you purchase a vehicle from a dealer, take out GAP Insurance (from the dealer or a third party like ourselves) and the vehicle subsequently turns out to be defective. If the supplying dealer is accepting responsibility and replacing the vehicle (I guess this would effectively be under the Sale of Goods Act) then I can't think of any justifiable reason for any Insurance company to refuse to at least transfer the remaining term of the policy or not issue a pro-rata refund.