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Warranties Are A Bad Deal!

All insurance contracts are a zero sum game.  Each one has a winner and a loser, and normally the winner is the party with more information.  To see why this is so, consider Batchelor Bob and Farmer Freddie who are buying new washing machines and considering extended warranty insurance.

The insurance company has a great deal of information on the machine, covering millions of tests back at the factory.  With normal usage by a typical family on average this machine will last four years and the warranty period is for two years. The premium is roughly three times the level of a “fair value” assessment.  This is a very profitable product for the insurer.

Batchelor Bob is single and washes his work shirts and some sports clothes once a week on average.  He probably doesn’t use the proper settings but his usage is much less than the typical family.  The insurance is a bad deal for the typical family and it is worse still for Bob.

Farmer Freddie has a wife and five children, two of which help out on his dairy farm.  They run the washing machine every day with heavily soiled items.  He knows he should really use an industrial strength machine because their last three washing machines all broke down within six months, and one of the kids keeps putting his farm boots in there.

The extended warranty is a good deal for Freddie, because his information is in this case more valuable than the insurance company’s information.  It is not the quality of the machine that is likely to determine the winner of this game, but the usage of the machine by Freddie and his family.

Some insurance is a legal requirement, such as car insurance.  Some insurance protects you from the impact of a big disaster, such as house insurance.  When you are offered other forms of insurance, ask yourself:

“Am I Batchelor Bob or Farmer Freddie?”

In other words, who has better information – the insurance company or you?  If the answer is the insurance company, you can be confident it’s a bad deal!

Monday 18 July 2011