I often read on the blogs when someone talks about their insurance
my ___________ (life, car, home, …) insurance is $______ a month.
I saved $_______ a month on my ____________ insurance.
So it seems that a lot of people pay their insurance by month. I’ve always paid my insurance in a single payment because insurance companies typically charge a small processing fee or service fee if you choose to pay by month. That service fee looks like a finance charge to me. No other business charges its customers by the number of times the customer pays. The reason the insurance company charges extra is because it extends credit to you if you don’t pay the entire premium when it’s due, the same way the credit card company charges you interest if you don’t pay the balance in full. What the insurance companies call service fee is really interest or finance charge in disguise.
I received the bill for my car insurance renewal last week. Here are my options:
- Make one payment for $736; or
- Make four payments of $184, plus a $4 service fee for each payment.
So if I take the 4-payment plan, I will pay $752 over 4 months, $16 more than the $736 premium due. That’s only a little over 2% of the premium. Not bad for making it easier on the budget? Not so fast. I decided to take a closer look at the embedded interest rate in the 4-payment plan. Here’s the insurance company’s cash flow for the 4-payment plan:
The interest rate turns out to be … … 19%! Wow, taking the 4-payment plan amounts to charging it on a credit card and paying 19% interest!
To calculate the interest rate, you need the XIRR function in Excel or OpenOffice. I made an Excel spreadsheet for this exercise. You can download it here. If your insurance company charges you a service fee for paying by month, plug in your own numbers and see what interest rate they are charging. If you don’t mind, please post in the comments the company, product and the built-in interest rate on their payment plans.