Ian answers: The offer of an extended warranty often comes as we are paying for our shiny new prized possession. The extended warranty, or service contract as it is sometimes known, typically involves paying a fee to lengthen the time period for which the new possession is insured against various breakdowns. To gauge if such protection is worthwhile, we can look at emotion – such as our desire to minimise feelings of loss – as well as crunching the numbers of the actual costs.
Even for those expert at maths, it might pay to consider these factors ahead of time to cut the chance of having to make a decision under pressure and when more vulnerable to emotion. Extended warranties may be worthwhile for some people in some circumstances.
How would you feel if your TV broke down out of warranty?
It is natural to be pleased when we’ve saved for a new TV, found the one we want and made it to the cash register. The thought of it not working properly can be unpleasant. Part of the attraction of extended warranties is that they play on this emotion, guarding against the possibility of loss.
This fear of loss is known to behavioural economists as loss aversion. It kicks in for all sorts of financial losses – on shares, property and other investments – and can influence the way we act, at times making investors reluctant to sell. Loss hits us hard, with research showing people feel the pain of losses more than they appreciate the joy of similar-sized gains.
So, in the case of the extended warranty, consider how much it is actually worth to you to extend the protection against your feelings of loss should the TV breakdown.
Crunch the numbers
Extended warranties can be sold either when the product is bought or some weeks or months after purchase. Some involve a one-off payment and others payments on a regular basis. Check the arrangement that applies in individual cases to work out costs.
If your TV is €500, an extra €50 for an extended warranty may seem small. However, this is a 10% price increase – or a much higher proportion of the price of a TV depreciated through use and age.
Moreover, this practice of adding extra costs during the sales process is known as drip pricing and is known to make it difficult to compare prices between sellers. A similar warranty may be available elsewhere at a lower price but this fact may not be obvious at first glance. The United Kingdom’s Office of Fair Trading said in February 2012 that a lack of relevant information for shoppers made it difficult to work out if extended warranties being offered were value for money, with several retailers pledging to improve practices. An OFT video offers some guidance on extended warranties.
A budget for breakdowns
So, Christian, your extended warranty could be money well spent, depending on your aversion to loss and the finer details of price and cover.
Some shoppers might want to guard against repeating past experiences with breakages and failures of similar products. Or perhaps the item covered is so essential that they can’t do without it, for even a short time.
An possible alternative for those who choose not to buy extended warranties is to save a similar amount into a special bank account to use if emergency strikes. It can be a type of own insurance – particularly when combined with traditional home and contents and other insurance provisions.