Is an Extended Warranty Worth the Cost? – When to Buy or Avoid
“Would you like the AppleCare Protection Plan for your computer?” asked the salesman. I had just purchased a new 27-inch iMac at my local Apple store. The plan, available for $169, would extend the manufacturer’s warranty from one to three years and would include technical support, as needed. The cost seemed reasonable, especially since I was spending more than $2,000 for the iMac. I had to ask myself, “Will I need the extra protection?”
An extended warranty is an agreement or contract to repair, replace, or maintain an identified vehicle, residential or other property due to operational or structural failure from a defect in materials, workmanship, and, in some cases, normal wear and tear. It is generally sold as an add-on product, and covers a specific duration of time in return for the premium paid. Extended warranties sometimes offer additional service options or more flexible terms than the manufacturer’s original warranty.
While appearing to be a type of insurance, the National Association of Insurance Commissioners ruled in 1995 that extended warranties were not insurance, but extended service contracts. While the extended warranty industry has been regulated by various state insurance boards, the Consumer Financial Protection Bureau (established under the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010) is expected by many in the industry to replace the various state regulators for a more consistent approach.
The sale and administration of an extended warranty or service contract requires a combination of separate functions, although a single entity may perform several in some cases. Parties include:
Effectively, an extended warranty extends service after the manufacturer’s warranty expires. For example, the iMac that I purchased has a limited manufacturer’s warranty of one year. The AppleCare Protection Plan – Apple’s extended warranty – extends the company’s basic one-year limited warranty an additional two years and adds telephonic customer support during the warranty period. Under the terms of the extended warranty, Apple will repair or replace the damaged hardware with parts of “equivalent functionality” or refund its original price if the failure is not due to “normal depletion of consumable parts such as batteries” or “damage resulting from abuse, accident, modifications, unauthorized repairs, or other causes that are defects in material or workmanship.”
Being asked to add an extended warranty to a purchase is commonplace these days, whether buying consumer electronics, household appliances, or automobiles. Even homes and their furnishings, new and used, can be protected by an extended warranty. Manufacturers and retailers, recognizing the huge profit potential in extended warranties, aggressively pursue their sale. The sales pitch starts with a point-of-sale placards in the product display area and continues through checkout when the cashier offers to include the extended coverage in the sale.
Extended warranties are very lucrative for the companies who offer them, with profits estimated to be 50% to 60% of the premium, according to a report published on ResearchGate. Warranty Week, the newsletter for warranty management professionals, estimated that Apple’s extended warranty sales in 2015 brought in about twice as much money as went out for claims. And The Motley Fool claims that the national retail chain Best Buy makes more than half its profits from extended warranties, more than they make from selling electronics and appliances.
According to the Global Warranty and Service Contract Association, extended warranty premiums were almost $41 billion in 2015 and covered the following:
The Service Contract Industry Council, the national trade association of the extended warranty industry, claims to represent manufacturers, insurers, retailers, providers and administrators of service contracts accounting for 80% of all appliance, consumer electronics, home, and vehicle service contracts sold in the United States.
According to the Federal Trade Commission, factors to consider when buying an extended warranty include the following:
For example, the Mac desktop that I replaced was more than five years old and still going strong – I bought the new one for its higher performance power, intending to donate the old iMac to my daughter’s school. If my new iMac proved to be as durable as the old, the likelihood that I would need repairs or a replacement during the three-year extended warranty term was unlikely. In addition, Computer Reliability Report ranks Apple products very high: an A-.
Most warranties have limitations to protect the manufacturer in certain events. For example, the iMac is sold with a one-year limited warranty that covers “defects in materials and workmanship when used normally.” Spilling coffee on the keyboard or dropping and breaking the screen is not be covered, since the damage was accidental.
Some extended warranties require compliance with specific maintenance that is provided by the manufacturer or its representative to maintain the protection. In the case of my iMac, the warranty restricts service to “a representative of Apple or an Apple Authorized Service Provider” to keep the warranty fully in force. It is important to remember that oral promises or explanations of warranty protections are generally unenforceable – so be sure to get any spoken promises about your purchase in writing (and dated) to ensure you have the protections you seek.
In the instance of my Apple iMac purchase, the limited warranty that accompanies the new computer would extend to a new buyer if the sale occurred during the first year following my purchase. However, other manufacturers may limit the warranty to the original buyer.
Furthermore, the three-year term of the extended warranty is misleading since it is actually the manufacturer’s original limited warranty, plus a two-year extension – the deception is intended to make the purchaser of the warranty think the coverage is greater than it is.
Finally, according to Consumer Reports, products seldom break within the service plan term. According to CreditCards.com, the four major card companies – Visa, MasterCard, Discover, and American Express – may double the manufacturer’s warranty up to 12 months for free, but you should expect major exclusions, as well as required documentation for coverage.
Warranties generally include detailed instructions about reporting and processing warranty claims. For example, some companies may require extensive documentation to process claims, including original purchase documents and service records.
Some manufacturers may limit their liability to specific types of repair, replacement with a refurbished equivalent product, or reimbursement adjusted for depreciation. Labor charges and shipping costs may cost extra. Finally, the process may extend for weeks before being reimbursed or your product is repaired.
Many manufacturers and retailers rely on third-party processing companies to handle claims. Reputation of the manufacturer is important and an indication of the potential difficulties you might face replacing or fixing a defective product.
The options include buying a warranty from an unaffiliated third party or foregoing an extended warranty altogether. According to Consumer Reports, more than half of purchasers of extended warranties for automobiles do not use the warranty before it expires, and those who do spend more for the coverage itself than they save in repair costs. Extended warranties are priced to return maximum profits to the sponsors. Accordingly, William Duckworth, professor of business intelligence and analytics at Creighton University, claims that if a warranty costs “under 10% to 15% of the purchase price [of your product], you’re probably getting a pretty good deal.”
Consumer advocate groups are almost unanimous in their caution about purchasing an extended warranty contract for the following products:
The major benefit of an extended warranty is the customer’s peace of mind. As the price of a product increases, the purchaser’s concern about its reliability also increases. According to a study by Pranav Jindal of Penn State’s Smeal College of Business, “Consumers view paying for repairs as a loss. Consumers feel it hurts three to four times worse than paying the price of the product itself. This hurt drives consumers to buy extended warranties.”
Professor Jindal also recognized that consumers:
At the same time, Kevin Rupkey of Bankers Warranty Group claims that extended warranty plans are valuable because “they not only protect against the high cost of repairs, but they also provide the consumer with a one-source resolution to a product failure.” In my case, having spent more than $2,300 for the new iMac, purchasing the additional protection for $169 or $85 each for years two and three seemed reasonable and made me more comfortable. At the same time, I do not buy the extended warranty coverage on my cell phone.
Do you buy extended warranties for the products you purchase?
Categories: Insurance, Money Management, Spending and Saving
Michael R. Lewis is a retired corporate executive and entrepreneur. During his 40+ year career, Lewis created and sold ten different companies ranging from oil exploration to healthcare software. He has also been a Registered Investment Adviser with the SEC, a Principal of one of the larger management consulting firms in the country, and a Senior Vice President of the largest not-for-profit health insurer in the United States. Mike’s articles on personal investments, business management, and the economy are available on several online publications. He’s a father and grandfather, who also writes non-fiction and biographical pieces about growing up in the plains of West Texas – including The Storm.
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