published Wednesday, December 18th, 2013

Personal Finance: Leave the extended warranty at the store

Chris Hopkins

As Christmas shoppers queue up at the checkout line, one refrain is sure to be heard: "you really should consider adding our extended service protection". Correct response: "Humbug!"

Ever wonder why salespeople are so persistent when selling you an extended warranty? You probably already know the answer: it is extremely profitable for the store -- more profitable, in fact, than any of the products on display. Margins on extended warranties can exceed 50 percent, according to the Better Business Bureau. Your odds are better at a Vegas roulette wheel.

The concept of insurance is founded upon the principle of mitigating catastrophic losses too large to cover out-of-pocket. For most typical purchases like consumer electronics, that condition does not apply and therefore the cost of the insurance will substantially exceed the benefit.

Reliability engineers study the patterns of failure in new products, and model the expected outcomes. For common products like appliances and electronics, the vast majority of failures occur either at the end of a product's useful life through normal wear, or relatively early due to faulty components. Early-stage failures, called "infant mortality" in the quality assurance field, are almost always covered by the manufacturer's warranty. Once the infant mortality phase has passed, failure rates fall dramatically and stabilize for long periods of normal use. Graphing failure rates over time yields what is called a "bathtub curve", since it resembles the cross-section of Grandma's tub.

Consider the case of a large-screen TV. Most recognized brands carry a manufacturer's warranty against malfunctions during the first year. Virtually all premature failures occur within the warranty period, and the odds of breakage declines substantially thereafter until the set dies of natural causes. That is why most extended warranties expire unused (leaving the profits in the till at the retailer).

Even when a failure occurs under an extended warranty, the cost of repair is less, on average, than the cost of the warranty policy, according to Consumer Reports.

Another aspect often overlooked is the overlap period. Extended warranties usually begin on the date of purchase, overlapping with the manufacturer's warranty period. That means most three-year policies actually add just two years of additional protection.

An easy (and free) way to add extra protection is to charge the purchase on a major credit card. All four major issuers (Amex, Visa, MasterCard and Discover) offer extension of the manufacturer's warranty for up to a year, generally limited to $10,000. Not all cards qualify, so consult your card issuer for details, and retain your purchase receipt.

Is there ever a case for buying the coverage? Potentially yes, on very expensive items (like autos) for which a major failure would create a significant financial hardship. The odds are always in the dealer's favor, but this is true with all insurance coverage. If you can afford the loss, you are still better off statistically to pass on the extended warranty.

Cell phones are another category for which a case could be made, given the relatively high probability of loss or damage due to frequent handling and transport. Just don't fall for the expensive all-inclusive plan; just get basic protection in case you lose or break it.

For most of the other items in your Christmas shopping cart, just say "Bah!" to extended coverage.

Christopher A. Hopkins, CFA. is a vice president for Barnett & Co. Advisors. Email your personal finance questions to business@timesfreepress.com.

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