Extended warranties: a simple expected-value test
Extended warranties sell peace of mind, but you can test the price against the likely cost of repairs.
Expected repair cost
Expected repair cost = chance of needing a repair x average repair cost
Suppose there is a 20% chance of a repair during the covered years and the average repair costs $150. The expected cost is 0.2 x $150 = $30. A plan costing $80 loses money on average. A plan costing $25 might be a fair deal. Real failure rates are uncertain, and that uncertainty is the weakness of the method.
What to read in the terms
- What is covered: parts, labour, accidental damage, consumables
- Deductibles and limits on number of claims
- Overlap with the manufacturer warranty or credit card benefits
- Who services the product and how long repairs take
Rules of thumb
- Plans make more sense for expensive products with costly repairs
- For cheap or easily replaced items, putting the same money in savings is usually better
- If you have an emergency fund, you can self-insure small repairs