Extended Warranties
Thaler and Sunstein recommend paying smaller, affordable losses yourself rather than buying extended warranties. Their On My Own Account sets aside the premiums you save to cover occasional replacements; the choice depends on what a loss would cost you and what the policy covers.
THE IDEA
Extended Warranties
The general principle that underlies our advice about deductibles is that you want to “self-insure” as many risks as possible. After all, it is costly for the insurance company to sell you a policy and to process a claim. That makes insuring small risks a bad deal for the consumer, which is why you should almost always decline the opportunity to buy them.
Consider an example. We just checked online and found a nice microwave oven for about $100. The seller offers an extended warranty for an extra $10. Is that a good deal? Just ask yourself: When is the last time that your microwave oven stopped working? For us, that would be never. But you might ask: What if one of my kids stupidly puts something metal inside the oven and its wiring gets fried? We would say two things. First, it probably isn’t covered by the policy. Look at the fine print. And second, it is $100—not nothing, but not a whole lot. Buy a new one!
To make your life happier, especially if your spouse is likely to blame you on the rare occasions when you would have been better off having bought the policy, we recommend setting up a special mental account that we call an On My Own Account. It can be a real savings account at the bank or just a ledger or spreadsheet. Every time you do not buy the extended warranty, or trip insurance, or decline the collision damage waiver on a car rental (which is probably covered by your credit card anyway), or take a larger deductible on an insurance policy, deposit the money you saved into that account. On the rare occasions when such choices turn out to be unlucky, just deduct the cost from your On My Own balance. The money in that account will build up quickly if you follow our advice about deductibles.
When to use it
Deciding whether to purchase an extended warranty for a low-cost electronic device like a microwave or toaster.
Evaluating whether to buy trip insurance for a low-cost domestic flight.
Choosing to decline the collision damage waiver on a car rental when personal insurance or credit card coverage applies.
Selecting a higher deductible on home or auto insurance to lower premiums and self-insure the smaller risks.
FROM THEORY TO EVERYDAY LIFE
In practice
Microwave oven extended warranty
For a $100 microwave with a $10 extended warranty, Thaler and Sunstein favor paying for a replacement if needed. They question whether the warranty covers accidental damage and suggest setting aside the $10 instead.
Car rental collision damage waiver (CDW)
Before paying for a rental-car collision damage waiver, check whether existing insurance or credit-card benefits cover the rental and what exclusions or deductibles apply. Declining duplicate coverage can save money; an uncovered collision is a different decision from replacing a small appliance.
A MOMENT TO REFLECT
Put it to work.
What small risks do you currently insure that you could self-insure instead?
How would setting up an 'On My Own Account' change your behavior toward buying extended warranties or trip insurance?
Think of a recent extended warranty offer you declined or accepted. Was it a good decision based on the principle of self-insuring small risks?
CONTINUE THE CONVERSATION
Source texts
- Nudge The Final Edition (Richard H. Thaler Cass R. Sunstein)