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

by Freddy Tran Nager, Founder of Atomic Tango + Not Much of a Gambler; photo by maks_d on Unsplash…

iDon’tCare

I don’t care to gamble, not counting my 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 techno-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

What’s the key difference between an extended warranty and Las Vegas gambling? In Vegas, you’re betting to win. With an extended warranty and other kinds of insurance, you’re betting to lose. Plus, Vegas has better drinks.

Vegas plays on our hopes and dreams, while the extended warranty promoters play on our fears. (I call that “pulling a Fox News.”) Interestingly, Vegas-style gambling is illegal in most states while betting-to-lose extended warranties are everyday business. And we’re talking BIG business — as in $59 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 one tasty payoff. 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 handle all the hassles.

But if you’re a consumer, take your money and bet on something else.

Many credit cards will freely extend warranties when used to buy the product. 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 you would earn by keeping it in the bank. And if you were to invest that money in a stock… like, say, Apple’s… you could make even more with that money — perhaps even enough to buy a brand new computer. No guarantees, of course, but the same could be said of an extended warranty.
2. What if you need the money later on? If you invest your money in a liquid asset (like stocks), you’ll have access to it in case of emergencies. But you’re highly unlikely to get any refund or much resale value for an extended warranty.
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 it — I’ll want a new one. (Or I could just buy that used one on eBay.) Instead of buying an extended 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 extended 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 property-insurance holders in New Orleans discovered after Hurrican 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 be a heavy hit, 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 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.
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, 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. So estimate the odds of your product incurring repair costs that exceed the warranty price and deductible, and 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 Lexus’s parent company, Toyota. 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 these 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 that 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 ever had a rim destroyed by a 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 my MBA program, the school tried to sell me education insurance, which would cover my loans in case I got sick or pregnant and couldn’t complete the program. This is the exact same MBA program that would later teach me smart investing and the concept of time value of money, so I think they were testing my business acumen. Back then, I was a healthy male in my 30s, and since I didn’t participate in cliff diving or bomb defusing, the odds were slim that I’d suffer something debilitating. 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, couldn’t a computer company, car dealer, or MBA program truly have 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?

Possibly — but I wouldn’t bet on it.