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Credit Card Balance Protection

Today I had to renew my credit card and as a good marketer my RBC tried to bring me into their scam. They tried to force me into their Balance Protection product.

In general insurance is only worth it when it covers events that are very unlikely and which, if they happened, they would pretty much ruin your life or the life of someone you care about. For example, life insurance if you have dependents, fire protection insurance, disability insurance. Those all protect you against things that are unlikely to happen but if they happen and you don't have insurance, someone's life gets ruined.

Insurance does not make sense for things that are cheap, or events that are likely. You shouldn't insure a television (aka buy an extended warranty). Balance protection insurance most likely lies under this category.

To understand why I say this, let's review how the insurance company makes money. Imagine a world where every house costs $100K and the chance of a house fire is 0.1%. Thus, the "expected cost" is $100K x 0.1% = $100. That's not very much. The problem is the risk. If your house does burn, you lose your life's savings. So the insurance company comes along and offers to insure your house if you pay them $120. The company does this for 1,000 houses. One of those houses does burn, so the insurance company received $120,000 and paid out $100,000 for the one house that did burn. The other $20,000 is profit.

The point of the example is that the insurance company will always charge you more than the "expected cost" of the event. You are guaranteed to lose money "in average". In this sense, you are always "over-paying". For events that are unlikely and would significantly hurt your life, this extra cost is worth it. For things that either happen very often or are low cost, insurance isn't worth it.

Let me give you an example of the latter: Suppose that you know with 100% certainty that you are going to lose $100. This is a high-probability event. Would you pay $120 to be insured against the certain loss of $100? Of course not.

Were do you draw the line?

Well, that's a personal choice. It depends on how risky something is for you and your tolerance for risk. But the basic principle is intact. Decide how you want to define "unlikely" and "significant cost" and make sure you only pay insurance for things that are unlikely and would incur a significant cost.

You may want to check this link for more statistical information:

http://www.cbc.ca/marketplace/blog/credit_balance_insurance.html