Extended warranties in the U.S. comprise a $40 billion industry issuing 250 million policies per year according to the Service Contract Industry Council (yes, Virginia, there is a trade association). Broad categories delineate the segment: automotive repair, home warranties and consumer goods like appliances and electronics.
Business is booming, with profit margins of as much as 50% or more, according to Bloomberg Businessweek. And just like Las Vegas, the odds are distinctly stacked in favor of the house, so for most consumers the best advice is to just say “no.”
Very few purchasers of follow-on service coverage benefit in the long term. According to the Federal Trade Commission, only 20% to 30% of consumers who buy them use them. And even where a claim is submitted, the cost of the repair is often less than the price of the service contract.
So, if extended warranty policies are not economically advantageous, why do so many consumers purchase them? Research suggests that the answer lies in our cognitive biases. That is, humans are not very good at estimating risks.
Consumers are often presented with a pitch for an add-on service contract after they have decided upon a specific product. Salespeople frequently have a financial incentive to sell extended coverage, and even online transactions often redirect the customer to extended warranty options before checkout. These interventions prompt the buyer to visualize an unlikely but potentially costly failure soon after purchase, an effect known as framing that often distorts rational decision-making.