You are in a racing club. Once a month the club meets at a track and you get to drive race cars. Your membership dues cover the club's insurance of the cars, but there is a deductible of $2,500. Any person that wrecks a car is responsible for paying the deductible. You can get secondary insurance to cover your portion of the deductible. This insurance is $25 per month. You tell your significant other about it and the response is "No, lets just put $2,500 into an account and we can draw interest on it. If you get into an accident, we'll have the $2,500 to pay for it, but we'll get the interest off the investment." Which scenario would actually earn you more money?
The earning interest rate for this problem is 5%, and inflation rate is 1.5% (Please don't analyze the reality of the interest rates used.) Analyze this problem in 2 ways 1) No claim is made for at least 100 months and 2) 1 claims is made after 75 months.
Other areas of interest (but not being asked here) would be:
-Is one situation better than the other from the start? If not, at what point does each situation equal each other.
A) Placing $2,500 into an account to earn 5%
B) Paying the $25 per month premium and investing $2,500
There are other situations that could "solve" this situation, but as in real life, there are almost an infinite number of possible solutions. You could also analyze this problem from the standpoint of "You have a client that asks what he should do for the most protection and best return on his money."
I write this because it is similar to a real-life situation that has come up between my wife and I, although I don't belong to a racing club, but that would be cool.
J Allen Morris
**I'm pretty sure I'm right, but then again, I'm just a guy with his head up his a$$.