Little value in extended warranties
By Terence O'Hara
By Terence O'Hara
You buy a $119 cordless phone system at Wal-Mart. As you're checking out, the cashier asks if you'd like to put another two years on the manufacturer's warranty. Cost: $29.
What do you do?
While consumer groups and common sense would urge you to resoundingly reject the offer, an entire industry has been built on the likelihood that you will act on impulse and say yes.
Each year, millions of people gladly pay an additional 10 to 50 percent of a product's original price to extend a warranty. These snap purchases help fuel a booming, $15 billion-a-year business and feed a lucrative profit stream for retailers that sell the warranties and companies that underwrite them. Many consumers do so because they say the plans provide them with peace of mind.
The decision to buy an extended warranty, however, defies the recommendations of economists, consumer advocates and product quality experts, who all warn that the plans rarely benefit consumers and are nearly always a waste of money.
"The things make no rational sense," Harvard economist David Cutler said. "The implied probability that (a product) will break has to be substantially greater than the risk that you can't afford to fix it or replace it. If you're buying a $400 item, for the overwhelming number of consumers that level of spending is not a risk you need to insure under any circumstances."
Extended warranties, first introduced in high-pressure fashion by big electronics stores in the late 1980s, have become a core product sold by all kinds of retailers, covering everything from bicycles to wedding jewelry.
The warranties, often marketed as service plans, are technically insurance products on which the premiums are paid in a lump sum at time of purchase. Extended warranties generally lengthen the coverage provided by the manufacturer's own warranty on a product. The plans are backed by an insurance company that promises to repair or replace the covered item should it break or malfunction. While terms vary widely, the plans typically last from one to three years.
In terms of service, most warranty providers use third-party contractors to repair broken items, and consumers do not get to choose who performs a covered repair. Many policies do not cover accidents or normal wear and tear — the most common causes of breakdowns in common household goods.
But most important, consumer advocates say, the vast majority of extended warranties are never used, simply because most products do not need a repair or, worse, the extended-warranty provider refuses to cover the repair or makes it such a hassle that it makes more sense to pay for it on your own.
"All you have to do is see how aggressively these things are sold at the point of sale," said Jean Ann Fox, director of consumer protection for the Consumer Federation of America, a Washington-based nonprofit of 300 consumer groups. "It's not a good buy under most circumstances."
Many consumers who normally would resist the hard sell on the warranties occasionally give in. Adam Weiner, 24, a computer engineer in Arlington, Va., recently bought a 37-inch Sharp LCD television for $1,644. He paid $450, or an additional 27 percent, for a five-year extended service warranty.
"I usually don't buy" extended warranties, he said. "But the (television) cost so much. It's impossible to buy a decent flat screen for less than a grand. I wanted to protect my investment."
Weiner's decision speaks volumes about how extended warranties play upon a basic human trait to avoid loss, even if it means sacrificing a possible future gain. In this case, the gain is all the other things of value that a consumer could buy with the money spent on a warranty. Even without knowing from experience that a product will break, many people insure it anyway, said Kevin McCabe, an economist and director of the Center for the Study of Neuroeconomics at George Mason University.
"I suspect that this behavior is in part due to our sensitivity to uncertainty in general," he said.
Then there's the obvious question that may not occur to many buyers.
"Why do I need an extended warranty on a phone I'm going to replace in two years anyway? Or one year?" said Greg Brue, a quality consultant and expert on product life cycles who runs Six Sigma Consultants Inc. in Albuquerque, N.M.
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QUESTIONS TO ASK
Things to think about when you're offered an extended service warranty: