“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?”
How Extended Warranties Work
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.
Parties to an Extended Warranty Contract
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:
- Purchaser/Owner. The person or entity who purchases the extended warranty and is entitled to its benefits, subject to contractual conditions.
- Principal/Obligor. The entity that assumes the risk in the contract and is financially responsible for the costs of repair, replacement, or maintenance. Some principals self-insure (keep the risk), while others purchase third-party insurance to reduce a portion (or all) of the risk.
- Service Contract Provider. The entity that actually delivers the warranty services – i.e., repair or replacement of the damaged product – to the purchaser of the extended warranty. This can be an unrelated third-party, manufacturer, distributor, or retailer of the product.
- Claim Administrator. A third-party provider who provides program design, pricing, underwriting, billing, and claims administration of the service contracts. Insurance companies like AmTrust Financial typically fill this role.
- Dealer/Seller. The dealer, retailer, or other party that sells the service contract to the consumer and is usually free to set the retail price to whatever the consumer will pay. As a consequence, sellers usually keep the largest portion of the premium, even though they have no financial or legal obligation to the purchaser of the extended warranty.
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.”
Overview of the Extended Warranty Industry
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:
- New and Used Automobiles. Representing 41% of the total premiums for service contracts, most contracts are purchased from the automobile dealership at the time of sale. While each of the major auto manufacturers has a captive program, the largest provider of automobile extended warranties is The Warranty Group of Chicago, Illinois. Insurance companies such as USAA also offer automotive extended warranty options.
- Mobile Phones. Mobile phone service contracts account for almost a quarter of the total warranty premiums. In addition to manufacturers of cell phones like Apple and Samsung, retailers such as Best Buy and wireless carriers such as Verizon and AT&T offer more comprehensive plans with coverage for theft, loss, and damage. Surprisingly, almost one in five mobile phone owners drop them in the toilet, according to Digital Trends. Third-party providers like SquareTrade, Protect Your Bubble, and Mobile Rhino are considered some of the better extended warranty plans by Gadget Review, an independent reviewer of technological products and services.
- Computers and Consumer Electronics. Accounting for 18% of total premiums, extended warranties for computers – especially tablets and laptops – are sold by major retailers including Walmart, Best Buy, and Staples, as well as the online retailers of Dell, HP, Acer, and Lenovo. Third-party providers are especially active in the electronics segment of extended warranty plans.
- Home Warranties and Appliances. The smallest segment of the industry (8.5% of premiums) is for service contracts covering the contents of the home, such as appliances and heating and cooling systems. American Home Shield dominates the home segment, while retailers like Sears, Home Depot, and Lowe’s account for the majority of appliance warranties.
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.
Questions to Ask When Buying an Extended Warranty
According to the Federal Trade Commission, factors to consider when buying an extended warranty include the following:
Is the Product Likely to Need Repairs?
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-.
What Are the Limitations of Coverage?
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.
Does the Warranty Provide Extra Coverage?
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.
How Are Claims Handled?
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.
Who Is Responsible for the Contract?
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.
Is There a Better Option?
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.”
Extended Warranties You Should Avoid
Consumer advocate groups are almost unanimous in their caution about purchasing an extended warranty contract for the following products:
- New and Used Automobiles. According to Consumer Reports, automobile extended warranty programs account for thousands of complaints with the Better Business Bureau. Michelle Corey, head of the St. Louis Better Business Bureau, says complaints about extended warranties in the St. Louis area are “nothing short of astounding.” Consumer advocates are especially critical of third-party auto extended warranty programs since they may limit who can perform repairs, often require lengthy approval before repairs can be made, and require the owner to pay the costs of repair before being reimbursed for the repair work. Ron Montoya, senior consumer advice editor for Edmunds, warns, “A number of these third-party (auto warranty companies) are fly-by-night operations that go belly-up within a few years, costing consumers hundreds of dollars in out-of-pocket repairs and leaving them without coverage.”
- Mobile Phones. Glenn Derene, electronics editor for Consumer Reports, claims extra-cost insurance or warranties rarely pay off due to their monthly insurance premiums of $10 or more and deductibles of $100. “Skip the extended warranties, as well. They have similarly high up-front costs and service deductibles.”
- Computers and Consumer Electronics. As a rule, according to Consumer Reports, extended warranties are poor buys, especially for computers. They do allow for some exceptions where technical support is included with the warranty or if theft and accidental damage is covered.
- Home Warranties and Appliances. Home warranties top the list of consumer complaints received by Angie’s List, primarily due to the differences between what customers expect and what the service plans actually deliver. There are exclusions – lack of maintenance, improper installation, excessive wear – as well as limitations. For example, repairs or replacement for a $12,000 boiler may be limited to $1,600.
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:
- Over-predict failure rates of products
- Do not understand a manufacturer’s repair or replacement policies
- Undervalue the cost of a warranty plan versus the benefit they might receive from the warranty
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?