Auto insurance: installments or upfront?

[disneysteve]

I used to pay in full every 6 months, but the past couple of years I've been splitting it into 2 or 3 payments just for cash-flow convenience. I know I'm paying a little extra that way but it avoids having to pull money out of high-yield savings to make the full payment up front. It ends up costing me something like $20 each year to split it up. I'm okay with that.

[InDebtInDC]

What would you do?

Mathematically, if you could invest the lump sum amount - down payment amount and earn more than the surcharge amount over the life of the policy, then you are better off paying installments. If not, you're better off paying the lump sum.

If you have cashflow problems then you may not have a choice but to pay installments.

From my experience in the insurance industry, I would never pay a lump sum premium, no matter how much the surcharge is. This is because you may withhold payment any time and switch carrier. If you paid the lump sum you're at the insurance company's mercy and they get to decide how much, and if, to refund your money.


There is a lot more involved in dealing with insurance companies but that's outside of the scope of your original question.

[sweeps]

I've never had a problem getting a pro-rated refund when I've cancelled/changed a policy.

[disneysteve]

I've never had a problem getting a pro-rated refund when I've cancelled/changed a policy.

Me neither.

[InDebtInDC]

With all due respect, this is from my personal experience and I have seen hundreds if not thousands of insurance policies from all the major carriers. The average consumer will have personal experience with ten or twenty policies at most during their lifetime.

So of course my perspective will be skewed. So take what I say with a grain of salt, as you should with anything anybody says.



Back to the original topic, you're looking for the net present value (NPV) of the installments: Net present value - Wikipedia, the free encyclopedia

I used 30-year Treasury bond rates as the riskfree rate. As of today it's 4.69%. You have 8 payments in 1 year so the periodic riskfree rate is 0.58% per 1.5 months.

My calculated NPV for the installments is $1838.17. I checked this with several online calculators and we're consistent.


So what this means is you can either make the lump sum payment of $1828, or you may pay the first installment of $234.50 and deposit $1603.67 into an account that pays you 4.69% APY. When each subsequent installment is due, you withdraw $234.50 and pay. By the 8th payment. your account will be zero.

Based on this calculation, you save $10.17 with the lump sum ($234.50+$1603.67=$1838.17). If you can earn more than 4.69% with your account, then the numbers start favouring the installments.


In view of the issues I raised above regarding proration and cancellation, it has been my personal experience that a proration is always done in the insurance company's favour, and you'll like lose more than $10.17 if you cancel midterm. This is because it takes a while to get your refund, and they may deduct more money than you think. Some companies are better than other but generally this has been my experience.


If I were calculating this for my work (add 3 zeros behind each of your numbers), I would still tend to favour the installments even though it costs $10,174.03 more. $10,000 is a lot of money, but when you're looking at a $1.8 million insurance policy it's about 1/2 of a percent. I would recommend this option to preserve cashflow and maintain flexiblity with the insurance carrier. I would make the same recommendation to you since $10 is such a small number to preserve cashflow and maintain flexiblity.

[sweeps]

You should be using after-tax return. Few people can get 4.7% after taxes are taken out (unless you're taking on extra risk).

There could definitely be situations where you come out just a little bit better financially by making installments. But I prefer paying the 6 months and not worrying about again until then. Someone with cash flow issues, I can understand having to go the installment route.

[Scanner]

Sweeps,

Good point on the taxable interest.

I think it comes down to what I have often referred to as "opportunity cost" in business.

Sometimes I elect to hold onto the money because at least in my mind there's more perceived opportunity with it.

Now. . .my malpractice insurance is a different story - they charge a 15% interest if you don't pay the premium up front so I do now. I did used to finance it in the past because often in business I'd come up short come premium time.

But 2.5% is hard to turn down.

If the bill were in April, I'd probably pay the whole thing, just not November.

[InDebtInDC]

You should be using after-tax return. Few people can get 4.7% after taxes are taken out (unless you're taking on extra risk).

There could definitely be situations where you come out just a little bit better financially by making installments. But I prefer paying the 6 months and not worrying about again until then. Someone with cash flow issues, I can understand having to go the installment route.

I agree completely with taxable interest. If you want to be more realistic, calculate using municipal bonds that mature in 1 year. I estimate they pay somewhere between 3-4%.

For people who worry about making payments on time then they should pay the lump sum.

[InDebtInDC]

But 2.5% is hard to turn down.

As I calculated above for you, it's actually lower than 2.5% due to the "opportunity cost" you mentioned. It's closer to 0.5% if you factor in interest you could earn elsewhere with the money.