Saturday, December 1, 2018

Is It Worth it to Buy a Warranty?

I used to work at a company that sold extended warranties for electronics such as phones & tablets so I'll share a way of thinking about warranties.

A warranty is just a form of insurance. It is insurance for if your product breaks. It protects you from the negative experience of that event. Most people buy warranties because they fear what they would do if their device breaks. If you drop your phone or one day your phone fails to turn on for some reason that can be a hearbreaking and costly event.

Is it worth it to buy a warranty for your phone? One great way to think about it is to take  step back from the situation. Let's say you don't have one phone anymore but instead you own an entire factory of phones. So, now you have to ask if you would buy a warranty for every phone. This pulls one away from the emotional thinking of covering their specific phone because one phone does not have more meaning than another phone. This turns it more from an emotional question into a profitability question.

And now you are looking at expected value. Over the long run would you come out ahead when the warranty pays out vs the amount you spent to buy the phone?

Even before making estimates, you could ask your intuition and it'd probably be right. An insurance company makes money by paying out less money than the risk of insuring the thing. In order to do that it has to win the information game. It needs to properly access the risk of the payout event to happen. And they don't have to be exactly right because they can limit their risk by charging a little bit more for the insurance. And if getting this information is the core of the business, you can be that there are some pretty intelligent people working on that problem.

So you have to ask yourself if you have an information advantage over this insurance company. You don't have more information than the warranty company on the risk of the product malfunctioning for the average person. But you do have more information on your self and if you are average! Do you have a dog or kid that will chew up your phone if left unattended? Are you highly emotional and throw your phone whenever you are angry? In this case you might be in a category where it would be more profitable to own the warranty than to not. *Although if this is true you still have a net loss as you pay deductibles on phones and buying warranties. You may want to adjust your habits and protect your phone more*

And the last part of having a warranty is peace of mind. Even if a warranty is -Expected Value, a lot of people dread the fact of paying $500 or more for a new phone and they would sleep better if they bought that warranty. This would be a valid reason to buy. Back to the example of the factory of phones. If I was the owner I'd be fine not buying the -EV warranty for my thousands of phones where but I'd certainly get fire insurance for my factory burning down and losing it all.