Are Extended Warranties Keeping You Safe?

Most people don't buy a new car without hearing “how foolish it would be” to not protect their new investment from unexpected repairs. What soon follows is a sales pitch for an extended warranty.

Our analysis indicates that extended auto warranties (also known as extended service agreements) are a bad deal for consumers because of excessive sales commissions. In fact, extended warranties are the most profitable product car dealers sell. Therefore, if you choose to purchase one, we recommend you make it part of a package deal. Generally, about 60% of the cost of the warranty is paid to the auto dealer as commission for selling the warranty to the consumer. You should use this knowledge about the dealer’s sales commission to negotiate a lower price for your car. Remember, make it part of the deal up-front before you go into the dealer’s finance and insurance office to complete the paperwork. If you wait until then, you may not be able to renegotiate a lower price for your car.

Auto warranties in Florida are a huge business. As of December 31, 2008, consumers in Florida spent $3.1 billion on active auto warranty contracts. Yet a review of auto warranty financial filings made with the Florida Office of Insurance Regulation shows that for every dollar spent on the purchase of an auto warranty in Florida in 2008, 61 cents went to sales commissions and only 17 cents went to cover the cost of auto repairs. If you contrast this with your auto insurance policy that covers liability, medical payments, comprehensive and collision only 8.5 cents was paid in sales commissions and 67 cents was paid for repairs and other claims.

Auto warranty companies in Florida, and nearly every other state in the United States, are not subject to the same close regulation and oversight as other insurance companies. Consequently, the Florida Office of Insurance Regulation does not have the same authority over auto warranties that it has over other lines of insurance, i.e. it cannot make auto warranty companies reduce their rates if they are found to be excessive. Current law simply requires auto warranty companies to maintain their rates on file with the Office of Insurance Regulation (OIR). The OIR does not examine the rates to determine if they are excessive, inadequate or unfairly discriminatory, or if expenses are reasonable in comparison to services rendered.

In the U.S., auto warranty dealer commissions averaged $795 per new-car extended warranty in 2008, according to Superior Integrated Solutions, a dealer management consulting firm. Such sales contributed 14 percent to dealerships' bottom lines, according to CNW Marketing Research, which covers the automobile industry.

If you feel you must have an extended warranty, get copies of the various contracts offered by the dealer before you go in to negotiate the price of the car. These contracts are too complicated to try to review at the last minute after you’ve gone through the difficult process of purchasing your car. Also consider buying a warranty direct from the auto warranty company. Extended warranty contracts purchased directly from a warranty company may be more affordable and more comprehensive than the dealer’s offerings.

Do not make a decision to buy an extended warranty or service agreement based on price alone. The coverage offered under the various plans available in the marketplace varies widely. Be sure you understand the exclusions and limitations of the contract. Most contracts exclude damage for normal wear and tear. In some states, extended warranty contracts consider depreciation when paying a claim. For instance, if the company is paying a claim on a part that has a life expectancy of four years and it failed at the end of two years, the company may only provide coverage for 50% of the replacement part. However, under Florida Law, the Office of Insurance Regulation will not approve an extended warranty contract that contains any provision for reducing claim payments due to depreciation of parts. The only exception is for warranties on marine engines.

We recommend that you research the many extended service contracts available. Determine what will and will not be covered. What type of maintenance records must you have in order to verify that your vehicle has received proper maintenance in the event of a claim? Will you be able to obtain service at a dealership or service center of your choice? Will you be required to pay for repairs up-front and wait to be reimbursed later?

Since contracts vary, there may be many deductibles to choose from. Be sure you understand when the deductibles apply. Make sure the contract can transfer to the new owner if you sell your car. The ability to transfer ownership may help you sell the vehicle faster or for more money.

Research the make and model of the vehicle you are purchasing to determine the common types of repairs for the age of the vehicle at the time the repairs are typically needed. Review the warranty contract to make sure the most common repairs are covered. Is it likely that repairs will be covered by the manufacturer’s warranty instead of the extended warranty you are considering purchasing? What is the average cost of the repair? Consider these questions in evaluating the cost of the warranty compared to the odds that you will use the coverage. Be an informed consumer before you buy. Understanding the coverage and the options available will allow you to make a better decision.

You can also purchase an extended warranty after the vehicle has been purchased. However, please use caution when responding to a mail or telephone call solicitation from an extended warranty company. The Federal Trade Commission (FTC), the nation’s consumer protection agency, urges consumers to be skeptical of mail solicitation and phone calls warning that the warranty on your car is about to expire. The company sending the solicitation may give the impression they represent your car dealer or manufacturer. They use phrases like “Motor Vehicle Notification,” “Final Warranty Notice,” or “Notice of Interruption,” when trying to make the offer seem urgent – and to get you to call a toll-free number for more information.

These solicitations are from unrelated businesses that want to sell you an extended warranty. If you respond to one of these, you are likely to hear high-pressure sales tactics, as well as a request for your personal financial information and a down payment, before you get any details about the service contract. The best practice is to never provide your financial information to anyone until you have verified the license of the warranty company and have reviewed the product to make sure it fits your needs.

Always check with the Department of Financial Services to verify the warranty company is licensed in Florida. They can also tell you how long the company has been in business and if consumers have filed complaints. The Division of Consumer Services is available to assist you with these questions and can be reached by calling 1-877-693-5236.

The Insurance Consumer Advocate is appointed by Florida Chief Financial Officer Alex Sink and is committed to finding solutions to insurance issues facing Floridians, calling attention to questionable insurance practices, promoting a viable insurance market responsive to the needs of Florida’s diverse population and assuring that rates are fair and justified.