Extended Warranties: Prudent Purchase or a Waste of Money?

Extended Warranties: Prudent Purchase or a Waste of Money?

WalletPop has broken a story about a suit being leveled against U.S. Fidelis and Credexx regarding allegedly abusive advertising methods resulting in consumers purchasing worthless extended warranties. Several states are suing both companies, saying the two companies tricked consumers into purchasing extended warranties (through alarmist voicemails and postcards announcing the imminent termination of coverage) that often did not cover what they claimed to.

This gets into the case of extended warranties, which are often borderline rackets. Devices that come with warranties do so, because if there was an error in construction, the device will fail early. No manufacturing process is perfect and some errors are inevitable. But the whole warranty system is set to correct these mistakes. The end of the standard warranty is set at the end of the period where manufacturing errors are likely to occur, whether it be one year or two years or something else. The idea is that if the device makes it past that date without a failure, then it was constructed correctly, and will continue to work for the expected life of the device. The company offers warranties because these early failures are easier to replace free of charge, than initiating a widespread recall or suffering a huge drop in public perception.

Extended warranties, however, cover the device in the period after the standard warranty ends. And as I said, if the device has made it through the life of the standard warranty without a failure, it is very likely to last through its expected life. So extended warranties cover the period of time when failures are highly unlikely to occur, and they always run out before the expected life of the device.

For example, a new computer usually comes with a one year warranty. If any failure occurs in this time, such as a broken power supply or cooling fan, then the computer was likely manufactured incorrectly. If no error occurs, the computer is almost guaranteed to last the expected life a computer, say between 4 and 6 years. So if you buy an extended warranty for another 2 years, you’re covering the time when the computer would be working fine. Inevitably, some failures do occur during this time, however as I’ve been saying, they high highly-unlikely.

These extended warranties exist, therefore, to try to bilk consumers out of more money. They feed on the fear of a failure which is highly unlikely to occur. However, companies often are able to get consumers to purchase this service through this fear. So the company receives a payment from the consumer, and then rarely have to pay out to fix any devices. The company sets the price of the standard warranty based on what it expects to pay out. The manufacturer will have data on how often errors occur, and will use this. The price of the warranty is usually absorbed into the normal price, and companies want to keep this low so they can sell more. However, extended warranties cost the buyer significantly more than the company expects to pay.

They are still a legal service to offer. Unless, of course, they are abusively advertised or don’t actually follow through on repair services, as U.S. Fidelis and Credexx’s services are alleged to.