I am about to do some depraved, awful things to the extended warranty industry. I’m sure you can handle it, but in the event Retire29 has reached anyone under the age of 18, I feel it necessary to provide due warning before I lay utter waste to the concept of cryptic, aggressive, mis-priced, 3rd-party insurance contracts on everyday consumer products.
Ashley Furniture’s Montage Furniture Services
It all started a few months ago. My wife and I enjoy nice things, and as we approach middle age, we find it preferable to own fewer, nicer things that last a long time as opposed to cheap, replaceable junk that barely makes it home. In short, we prefer to shop at Ashley Furniture. Ashley is the Red Lobster of the furniture industry—a middle-class Mecca. The showrooms have some semblance of class (e.g. carpeted floors, recently dusted, bums haven’t made house in the beds), but the costs are still within even a frugal man’s budget.
On this particular day, we found ourselves at Ashley to get a nice bedroom set for Toddler29. Her furniture was bestowed upon NewBaby29, and we wanted to get her something that would last until we kick her out of the house. Indeed, Ashley had the perfect set—a sparkly white five-piece set. Cute enough for a 3-year-old, but subdued enough for a teenager.
Author’s Note: Only in the furniture industry can a “five-piece” set be advertised as a headboard, footboard, rails, dresser, and mirror. That’s a two-piece set in my book: (1) Bed & (2) Dresser. Is somebody requesting the “No Headboard” option? I saw one “five-piece” bed at a lesser-than-Ashley outfit that was calling each rail its own piece. Dafuq?
The price for the “five-piece” set was tolerable—around $800. We added a bedside table for $199, so I was figuring an after-tax price tag of about $1,100. You can imagine my surprise, then, when the salesman returned with a FULLY COMPLETED sales ticket for almost $1400. Yes, that’s Hundred, with an H.
Taken aback, I remark to the salesman, “Hmmm, this was more than I expected. Can you go over the prices again?”
“Absolutely, the set was $799, the bedstand was $199, and then we have the protection plan we talked about, which was $299.”
At this moment, I’m vaguely recalling a brief exchange an hour earlier about some warranty program Ashley offered, but the details were sparse. I foolishly assumed whatever he was speaking about was just Ashley’s store policy—like Craftsman’s Lifetime Warranty or Aldi’s Double Guarantee. I respond, “I’m not sure I want that. I have a sort of constitution about not buying extended warranties. They tend to not pay off.”
“Totally understand, but this one you just can’t live without—ESPECIALLY with that young daughter of yours. Take a look at this pamphlet.” The salesman hands me a pamphlet for the MFS Protection Plan. I instinctual think that “MFS” must mean “Mutha F*ckin’ Scam” but the small print indicates it is actually “Montage Furniture Services”—a third-party warranty provider. The salesman continues, “It covers everything for five years. Say that your daughter is upstairs painting her nails and she gets polish on the furniture. They’ll send out a repairman and clean that right up. Dings, scratches, you name it—even if they’re caused by you—are covered.”
“I don’t know about this,” I respond skeptically. “$299 is like one-third of the cost of the furniture. I’ve had some of these plans before and there always seems to be some fine-print loophole which prevents payment of my claim.” Although I’m speaking aloud to the salesman, all that’s running through my head is: what kind of parent leaves their 3-year-old alone with nail polish?
“MFS has an A+ rating with the Better Business Bureau. And there’s no fine-print. Everything is covered. Feel free to Google the company. It’s one of the highest rated in the industry. I don’t recommend this plan to everyone, but for those with young kids, it’s really a no-brainer.”
Riiiiiiight, of course you don’t recommend this to everyone. OF COURSE you aren’t hard-selling this plan to all of your customers. How lucky of me to have such a conscientious salesman.
Of course, I’d been on Google since the moment the pamphlet made its way into my hands minutes earlier. Google tells no lies, and I quickly see the universally-scathing reviews and the 1.2-out-of-5 stars currently held by MuthaF*ckin’ Scam Montage Furniture Services. A swift glance through the reviews confirms my all-too-obvious assumption that MFS could’ve been the subject of Grisham’s The Rainmaker—a company that will endlessly drag their feet through the claim’s process until the rubberstamp denial.
“Yeah, I’m looking through this and it sure seems like folks aren’t too happy with this plan. I’m afraid I’ll have to pass.”
The salesman’s face noticeably sags under the weight of my decision. “Well, alright. Let’s hope nothing goes wrong,” he says as we walk toward the cashier area. He hands the updated sales ticket to his associate and in a you-won’t-believe-what-this-guy-just-said tone he says, “he’s declining the extended warranty.” His associate, clearly the last line of defense in this little circus, says (and I’m dead serious), “even with that young daughter? What about if she’s in her room polishing her nails?!” (That actually happened).
Having gotten through that spectacle, I drive home trying to envision a set of circumstances that would result in me regretting my decision. Any small damage—nicks, scratches, stains—I would certainly repair myself with a little paint, and sandpaper. On my darkest days I’ve even been known to bust out the old Sharpie marker to fix little bits of damage—a victimless crime.
The hassle and frustration of filing a claim, working the “process,” and taking time off work for the we-arrive-between-noon-and-four repairman would make me just suck it up. Any major damage (like water or fire) is probably related to some other issue that would involve my homeowner’s insurance. The furniture manufacturer has its own (free) coverage on manufacturing faults. So, other than some massive nail polish disaster, I don’t know what MFS would be good for.
Chevrolet’s JM&A Warranty
Last month, we finally exchanged our barely-used little red Corvette for a new-to-us Chevrolet Traverse. The trade-in was about 60% of the sale price, and with today’s rock-bottom rates, I decided to just take a loan rather than pay the balance with cash that is currently returning 7+% in corporate preferred stock.
The car buying process itself was actually quite pleasant. The salesman was a decent guy who was straight with us about what would be the most economical car, and after a bit of haggling we ended up buying a certified used vehicle for almost $5k below blue book. We plan on driving this baby into the dirt, but in the event we need a new car, I’d have no qualms with going back to this same salesman.
The real circus began after we gave our thumbs-up on the purchase. Dusk had settled when I made my way to the financing office to finalize the paperwork, go over my financing options, and (I’d soon find out) fight valiantly against the world’s most hilarious-yet-devious warranty pitch.
Remember, the Traverse was already certified by Chevrolet. So, I already had pretty decent 20k bumper-to-bumper protection and another 60k of drivetrain protection offered in clear black-and-white by the service center up the street. Clearly, such frivolities didn’t matter to Julio, my finance rep.
Julio begins his spiel while I completed the standard demographic information on a few title, registration, and financing forms. At this point, I’ve already gotten credit approval. This part, I thought, was them telling me what my rate and payment would be.
Julio slides an iPad in front of me with four columns, each showing a set of services and at the bottom of each is a monthly payment amount, “so here are you payment options.” He begins, “but before we get into that, we should discuss which service option would be best for you.”
“Service option?” I respond hesitantly as I accept the brochure for “JM&A Warranty Services.”
Julio continues the soft sell. “Our extended service plans. It’s a fact of life that things go wrong on a car. So this plan pays for itself. You don’t want the worry and frustration of dealing with repairs, so think of this like an insurance plan on maintenance—and on your sanity.”
Of course, there’s no clear price tag for this “insurance.” The cost is nested with the 48-month financing payment. This is no accident, obviously. Any number, when divided by 48, is a much smaller number. Thankfully, I’m able to do a quick =PMT function on my phone to carve-out the actual finance payment to arrive at the remaining warranty portion, and I let him know. “Well, Julio. It looks like this warranty runs me about $3,800 all-in. That sounds like an awful lot. Especially when I’ll have the dealer powertrain warranty for the first 60,000 miles.”
“Right, right. About $3,800….but you’ll be spending at least that much on maintenance.”
“Will I? I mean, I understand that might happen, but it probably won’t. I mean, JM&A is a profitable entity, so in the aggregate the claims they pay must be less than the money they receive. They would not be in business if they regularly paid out more than they took in.”
“Well, I’m not sure about all that, but let me tell you a story….” Julio goes on to describe how JM&A recently paid $2k for his own repair.
I pry a bit, “That’s nice, but based on that, they still made a profit on you. I mean, you paid more than $2k for the coverage. So, you’d need some more stuff to go wrong before you turn a profit on your warranty—and it looks like you’re an exception to the rule. I’m looking through Google and JM&A has less than two-out-of-five stars. It sounds like most people get screwed in their claim based on fine print.”
“Last year, JM&A paid out over $15 million in claims. I can assure you they aren’t a scam.” (Distracted Author’s Note: This reminds me of those stickers on lottery machines, ‘Over $200 million in winnings paid out last year!’ Yeah okay, against a billion in tickets sold.)
“I’m not claiming that JM&A makes no payments. But $15 million in claim outlays is meaningless without the context of how much they took in. So, how much do they take in?” (Authors Note: This is getting to the concept of “loss ratio,” which we’ll discuss later.)
“I don’t have that information, but $15 million in payments is a lot. But at any rate, if things don’t work out, you can always cancel during your warranty period and get a refund.”
“A refund? Of the whole amount?”
“No, the refund is prorated for what is left in your coverage, by miles.”
“I tend to not buy things with the expectation of returning them. While the return option is comforting, I can only imagine I would take advantage of such an option AFTER I’ve been denied a claim. And, most likely, the greatest benefit of this coverage is the later years—when things start to go wrong and after my dealer warranty. So, cancelling the plan midway means that I’m still paying for the most useless time period, the beginning.
And then, the final salvo…
“Alright, I can see that you’ve done your homework. How about this, if you get the plan, I will decrease your interest rate from 2.79% to 1.99%. Now, you’re paying for maintenance instead of interest. Check that out, I just made the maintenance plan FREE.” (Julio toggled between the two options below).
Oh. My. God.
I’m taken aback by the number of things wrong and misleading with what just occurred. Let me explain.
- A borrowers interest rate should be based on one thing—the risk of the borrower not paying. It shouldn’t be based on “if they have the warranty.” Explain to me how throwing another payment at me lowers my risk of repaying the loan?
- “Paying for maintenance instead of interest?” Are you kidding me? The TOTAL interest I would pay over the life of the 2.79% loan is about $750—and that assumes I keep the loan to term. If the APR drops to 1.99%, I’ll then pay about $644 in interest. Total interest savings of….$106!!! Not quite as much as the $3,800 I’m paying for “Potential Maintenance.”
- So, if I’m only saving $106 in interest, but adding $3,800 in warranty costs, then how are the payments the same? This is made possible through a key, unmentioned-by-Julio factor called “adding one more year of payments.” The fact that he tried to sneak that little ditty by me was unnerving enough to make me give a long-overdue “no.”
“No thanks. I see you added a year to my loan, as well, which is really how the payments stayed the same. The interest savings is almost nil. What you said was misleading. I’m not getting the warranty.”
What is a Warranty?
First, some history. The concept of a warranty (or its sinister relative, the “extended service contract”) is nothing new. Warranties date back to ancient Babylonia, where the Hammurabi Code specifies such warranties as:
“If a builder builds a house for someone, and does not construct it properly, and the house which he built fall in and kill its owner, then that builder shall be put to death.”
Or, somewhat more humanely:
“If it ruin goods, he shall make compensation for all that has been ruined, and inasmuch as he did not construct properly this house which he built and it fell, he shall re-erect the house from his own means.”
Warranties are not altogether bad; it’s only certain kinds that I take issue with. To illustrate, let’s be clear as to the types of warranties:
Warranties can come from several sources:
- Manufacturers provide a guarantee over construction or material defects. This is quite common in new home or furniture construction. In the U.S., the Magnuson-Moss Warranty Act codifies in law the principle that a product should be suitable for the purpose for which it’s sold. In other words, Whirlpool—by law—cannot sell you an oven that doesn’t heat food.
- Retailers, as a sign of good faith and being the supplier of the product, usually provide returns and refunds which are limited guarantees (Note: the sole exceptions to this rule are ornery beauty supply shop owners). Service providers, like retailers, will similarly provide some level of guarantee of both their work and the product itself (carpet or tile installers will usually come back to your home to repair work). “Certified Used” cars are another type of warranty—provided by the car’s retailer rather than the manufacturer.
Both of these types of warranties have an implicit cost; while there is certainly some dollar figure paid for the warranty, that amount is inseparable from the product itself. In short, I’m glad these warranties are out there.
I take issue with those third-party warranties or extended service costs. Sometimes these warranties (or extended service plans) are also offered by the retailer, so it’s not always an MFS or JM&A outfit involved. These service contracts are peddled on top of every other warranty, and you’ll usually see that called out in the fine print of the contract (e.g. the service contract or warranty coverage will only begin at the point where manufacturer or retailer warranty ends).
I take issue with these types of warranties for three primary reasons. First is the sales practice of these products. Second is grifters and shifters behind the contract. And third is the obvious fact that they make no financial sense.
A Bad Financial Deal
Let’s be clear, a warranty is just another form of insurance. You pay up front for some peace of mind and to cover the unlikely event that whatever insurable event you prefer to avoid ultimately comes to pass.
As a rule, insurance of all kinds has a negative expected value. It must be this way, otherwise insurers simply wouldn’t exist. To ensure it remains a going-concern, insurers manage what’s called a “loss ratio,” which is a simple formula of: Loss Ratio = Claims Paid / Premiums Taken. Insurers also have a “net profit”-esque formula called “combined ratio” which also accounts for overhead: Combined Ratio = (Claims Paid + Underwriting Fees) / Premiums Taken.
It doesn’t take a rocket scientist to understand the idea that if claims are continually higher than premiums, the insurer will eventually go bankrupt. Thus, all insurers operate at some average loss ratio below 100%. The lower the ratio, the more premiums are kept as profit, and the worse the deal is for consumers.
For instance, health insurers by law (from the Affordable Care Act) must pay out at least 80% of claims toward patient services (i.e. loss ratio cannot be above 80%). Homeowners insurance loss ratios are lower, around 66%. Even lower than that, between 40-60%, is auto insurance. Notice a trend? As the insurance product becomes more discretionary, the worse the deal is for the consumer. Extended service contracts have loss ratios even lower than all of those, about 20% according to one expert’s estimate. This should ring alarm bells for most of us. Some quick math tells us that a $3,800 extended service warranty will, on average, pay out around $750 in claims.
A Strongly Incentivized Poor Product
The retailer is highly commissioned and incentivized to sell these contracts which are effectively nothing more than expensive peace of mind. Consumer Affairs does some great research on this, so if you want some informative reading, Google “Consumer Affairs and Extended Warranty.” You can imagine what you’ll find, but the general themes are:
- The salesman flat-out lied about what was covered.
- The warranty company continued to claim that are warranty was voided due to unauthorized customization or enhancement, even when all we did was routine oil changes.
- “Our heat went out in January (in Quebec), but the home warranty company wouldn’t send a technician out for two weeks.”
- They simply never answered the phone.
- Payout limits that are lower than the premium.
- Warranty prices that are out-of-whack with the actual product cost. Earlier this year I bought an outdoor antenna so I could watch the local football games. The antenna cost $60. When I went to check out, I was offered the “service plan” for a low price of $29.99. LOL.
- The company went bankrupt, and all contracts were voided.
- The company had us get an unreasonable number of estimates, and we still felt like we were negotiating those already-lowered rates.
When you buy these contracts, the salesman will usually get around 50% of the sale price, the administrator (claims processor and handler) will get around 20%, and the underwriter (the ones on the hook for the payouts) will get 30%. So, the sales rep is highly incentivized to peddle this bullshit to you, and to utilize some pathetic tactics in the process. Most often, this tactic will include some form of opting-out, rather than opting in. Remember the pre-filled form at Ashley that already included the service contract?
We all have our stories when it comes to service contracts. Six years ago I bought my current car. I had no idea, but I also bought the service plan for $755 (the car cost $20k). The $755 covered powertrain breakdowns for, get this, 1,500 miles! That’s fifty cents per mile! Perhaps even crazier was that I actually made a relatively successful claim. After buying the car, I noticed a hard-shifting between 1st and 2nd, so I took it in. The torque converter needed replacing. After three estimates and dozens of phone calls, a $1,200 repair was reduced to about $600. Buried in my contract was some fine print that said the contract did not cover fluids, liquids, oils, belts, hoses, or other parts that degrade with normal use. Well hell, turns out that “normal use” is a highly subjective term, and I still ended up paying for over half the repair bill. And even then, after all was said and done, I still paid more in premiums that I received in claims.
In sum, the common theme in all of these contracts is that the warranty provider has significant discretion on what and when they choose to pay. They can, and often do, simply say that the consumer misused or altered the product, or didn’t “perform proper maintenance.” They can do this because the contracts are written to give them all the power. All the while, some poor schmuck is sitting on the other end of the phone, in a cold house or busted car getting yelled at by his wife.
These companies are bad people; please avoid them.
When you Need Insurance
Don’t generalize this advice as a reprimand on all insurance. Necessities that you cannot afford to replace should be insured. However, we, as a society, seem to cast the net for “Necessity” and “afford” far too wide. We now insure our phones, our Blu-Ray players, our furniture, our air conditioners, our computers, our….basically everything. We can normally afford to replace these items, but because humans are so loss-averse, we’d often rather cough up some acceptable amount of money to offset the remote chance we pay some larger amount of money down the road.
This constant push for “Insurance on Everything” has scared us into thinking we need it. We almost always do not.
Thanks for reading!