Extended Warranties vs Las Vegas

July 4, 2016

Betting to Lose: Why Extended Warranties are a Rip-Off

by Freddy J. Nager, Founder of Atomic Tango, Warranty Not Included…

AppleCare Protection Plan

iDon’tCare

I’m not much of a gambler, unless you count my dismal dabbling in the stock market. So naturally, I look at any betting offer with skepticism and a deep lack of enthusiasm — even when it comes from my favorite technolust pusher, Apple.

Several years ago, Apple offered to extend the warranty on my MacBook Pro for three years for $349. Like most Apple creations, the pitch sounded irresistible, using terms like “peace of mind” (in bright red letters at the top) and “protect your investment.” The only things missing were the free drinks as I laid my bet…

Las Vegas = The Better Bet

The key difference between an extended warranty and Las Vegas gambling is that, in Vegas, you’re betting to win. With an extended warranty and other kinds of insurance, you’re betting to lose. And Vegas has better drinks.

Vegas plays on our hopes and dreams, while the extended warranty people play on our fears. (I call that pulling a Fox News.) Interestingly, Vegas-style gambling is illegal in most states while betting-to-lose warranties are everyday business. And we’re talking BIG business — as in $40 billion per year in the U.S.  And according to Warranty Week, The Newsletter for Warranty Management Professionals (there’s one sexy publication), most of that is profit:

“Not all that money goes to the actual administrators and underwriters of the policies, however. In fact, we’re estimating that roughly half is kept by the actual sellers — the retailers and dealers in the world of warranty.

That’s some tasty dinero. Who doesn’t like 50% commissions?

So if you run a business that’s selling big-ticket items, extended warranties are a sweet deal. You can slash your price on the actual product to entice buyers, then make it up with an extended warranty. You don’t even have to manage the warranty, since  underwriters will deal with all the hassles.

But if you’re a consumer, take your money and bet on something else. Many credit cards already extend your product warranty if you use the card to buy the product. (I use my American Express to buy all my electronics for that reason, and it has saved me on repair costs.) And don’t you have more worthwhile uses for $349?

Still thinking extended warranties? Ask these 7 questions:

  1. What’s the “time value” of your money? That $349 you’re giving Apple now is only the immediate cost. You’ll also lose out on the interest and other earnings from investing that money instead in, say, a stock that pays dividends. If you’re a savvy investor, you could make even more with that money — perhaps enough to buy a brand new computer.
  2. What if you need the money later on? If you invest your money in a liquid asset instead of a warranty, you’ll have access to it in case of emergencies. But try getting a refund or any resale value for a warranty you’ve already purchased.
  3. What’s the long-term value of the product? Most products lose much of their value the second you open the packaging (or, in the case of a car, the second you drive it off the lot). I spent about $2200 on my MacBook Pro. When I received the extended warranty offer, similar used ones on eBay were going for $1100, which means that my computer had already lost half of its value in less than 3 years. Do I want to pay $349 now to insure an $1100 machine? And what’s my MacBook Pro going to be worth by the time this extended warranty expires? At that point, I won’t even bother repairing my ancient MacBook — I’ll want a new one. (Or I could just buy that used one on eBay.) Instead of buying a warranty, I’ll just save my $349 toward a new computer.
  4. What’s the cost of repairs? I recently had another computer repaired for $100. That’s a lot of money, but it’s still less than the cost of an extended warranty. And keep in mind that warranties often don’t cover 100% of the repair cost. Many warranties include deductibles, so be sure to read the fine print. If your deductible is $100 for a repair that’s $100, your warranty is worthless.
  5. Will your warranty actually cover the damage? Getting companies to take your money is easy; getting them to pay out sometimes takes a lawsuit, as insurance-policy holders in New Orleans discovered after Katrina. Many policies have exclusions for “acts of God,” but if you’re religious, isn’t everything in the universe an “act of God”? In my most recent repair case, the problem was an “act of cat” (fur clogging the fan), and cleaning is not covered by most warranties.
  6. What can you afford to lose? I insure my car, because a major accident or theft would cost far more than I’d be willing to pay, but eventually, my car won’t be worth the extra coverage — I’d rather save the money for a new car. Same goes for a house, particularly if you live in natural disasters country, like here in L.A. And when it comes to your health, definitely insure that, because it’s priceless and surgery is ridiculously expensive. Plus, many hospitals won’t even admit you without insurance. (The health insurance industry, by the way, is a multi-trillion dollar empire that rivals Mordor in its smoky brooding evil — but that’s a topic for another blog.) So car, house, health, yes. But insuring something like an iPad makes no financial sense, even if you can’t afford to replace it right now.
  7. Most importantly, what are the odds of the thing needing repairs? One of the ironies of companies selling extended warranties is that they’re essentially saying, “Hey, you know that $2200 computer we sold you? Well, we didn’t make it all that well. In fact, odds are, it will blow a gasket within the next three years, costing you over $349 in repairs! So how’d you like some peace of mind?” To which I reply, uh, no, how’d you like a piece of my mind? With some products, particularly those built by a Shenzhen back alley sweatshop, the thing will probably die. Your challenge is to guess the odds of your product incurring repair costs that exceed the warranty price, and to seek out a gambling alternative.

Imagine you bought a new Lexus. It’s well-made, so let’s say the odds are 4-to-1 that you’ll have to repair it after your standard warranty runs out in 4 years or 50,000 miles. So rather than betting to lose now and waiting to see what happens in four years, why not go to Vegas tomorrow and find a 4-to-1 bet to win?

That way, if you guessed correctly, you’ll actually have something to celebrate. If you can’t make it to Vegas, you can buy stock in some company NOW. What’s more likely: your Lexus will cost more to repair than the price of the extended warranty, or shares of Toyota will be priced higher in 4 years? They’re both guessing games, but what’s more fun to bet on?

Incidentally, my MacBook Pro never did need repairs, but my Apple stock did really, really well.

Sometimes It’s a No-Brainer…

Sometimes, you don’t need to go through all five questions to make a decision. When my wife bought her VW Beetle years ago, the dealer tried to sell us “rim insurance” in case she hit a man-eating pothole and dented her tire rims. I nearly broke into laughter. My wife and I have been driving for over 50 years combined in such hazardous places as rural Texas and downtown L.A., and neither of us has had a rim destroyed by a man-eating pothole. We didn’t bother investigating what a replacement rim would cost — this is a Beetle, not a Ferrari.

If you think rim insurance is silly, when I enrolled in USC for my MBA, the school tried to sell me education insurance in case I got sick and couldn’t complete the program, I’d be off the hook for my tuition and loans. (Note: This is the exact same MBA program that taught me smart investing and the concept of time value of money. So I think this was a test of my business acumen.) Back then, I was a healthy male in my 30s, and since I don’t participate in cliff diving or bomb defusing, the odds were slim that I’d suffer something debilitating or get pregnant. And from what I’ve seen, universities are pretty flexible in enabling students to resume their educations when they’ve recovered from whatever ails them.

Now isn’t it possible that a computer company or a car dealer or an MBA program truly has your best interests at heart? Aren’t the extended warranties a sign that they really care about your investment, and just want to make sure you’re protected?

Sure it’s possible — but I wouldn’t bet on it.

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Freddy is the Founder & Creative Strategist of Atomic Tango. He also teaches at the University of Southern California (go Trojans!), shoots pool somewhat adequately, and herds cats. Freddy received his BA from Harvard and his MBA from USC.

2 Responses

  1. Speaking as a retailer, we’ve offered these extended warranties on MANY products. I can tell you that it is EXTREMELY profitable. I wish I could recall the ‘breakage’ figure (number of consumer participants who pay for the warranty but do NOT return to claim against it), but it was a massive %, similar to gift cards before the government stepped in and legislated that outstanding balances could no longer be held on the books as “profit”!

    • mm

      Great note about breakage. I have to look up how many people buy extended warranties and never use them — even if they need something repaired.

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