Double Blind

I received a letter in the mail from the Insurance Corporation of British Columbia (ICBC) which politely informed me that my automobile insurance was due for renewal in a month. I was rather shocked when I opened the letter and discovered that I will be paying less for insurance this year than I did in 2003. I paid $1196 in 2003, while I will be paying $1080 in 2004 for the same basic and optional coverage. Although I am in the 40% discount category this year (compared to 35% the previous year) even when you eliminate that difference, my insurance this year is cheaper. Since a generous estimation of the book value of my ancient vehicle is $2500, I am basically covered for people that decide to bump into me at sufficiently low velocities to cause two thousand dollars of damage or less. If my car is totaled, the insurance firm will pay me book value on the vehicle and I will have to find a new one.

What caught my attention, however, was the option that they gave people to pay in monthly installments, called “Autoplan12″. Instead of paying $1080 in one lump sum, I could pay 12 monthly installments of approximately $95. 12 times $95 is $1140 so thus the interest charge of using Autoplan12 would be $60 over the sum of a year. $60 over $1080 is approximately 5.6%, which is not a bad rate of interest, right?

This is an incorrect calculation! The problem here is that the payments are performed monthly, so you will not have the utilization of the full $1080 during the entire year. Every month, starting with the initial payment, $95 will be subtracted from your account until 12 payments have been made. So if you are starting with $1080 of capital, you deduct $95 for your first payment and then start earning interest on the $995 of capital you have left. You repeat this process for 11 more iterations and then all payments have been made. How much of a rate of interest must you achieve with your remaining capital in order to break-even with Autoplan12?

The answer is 12%. This is significantly higher than the paper napkin calculation above that somebody uneducated in finance would make. 5.6% is the typical interest rate you would receive on a 5-year secured loan (such as a mortgage), while 12% is extremely expensive even for an unsecured loan to a credit-worthy person. Despite the fact that I have more confidence in my investing abilities to pull a risky return greater than 12%, my decision to make the annual payment of $1080 was obvious since the 12% was risk-free.

I find it very good marketing on the behalf of ICBC to conveniently omit the fact that the interest implied in the payment plan is so ridiculously high. There is nothing illegal about it, nor should there be any laws that would make it illegal. People simply have to be better educated in matters of finance and I do not feel any sympathy for the suckers that do decide to take the Autoplan12 package.

This entry was posted on Tuesday, January 6th, 2004 and is filed under Best Of, Commentary. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.