This is a two-part series. First, we are going to explore how extended warranties work. The next post will focus on the cost vs. value. With this information you can make the decision that is right for you.
There are numerous factors to consider when and if to purchase an Extended Warranty—first, the cost; second, the term; and third, what is covered.
First, let’s review what “extended warranty” means. It is an agreement between you and the contract administrator to repair your vehicle when a covered component malfunctions. Why do we talk about the administrator? That is because many people believe they agree with the dealer to fix their car if something happens. That is not the case. When it comes to extended warranties, the auto dealer is only the third-party seller and has no further obligation to assist you if there’s a problem. This distinction is necessary. The dealer does not make the final decision in your claim.
Considering the distinction about the administrator, “extended warranties,” a.k.a. Vehicle Service Contracts (VSC), have benefits. A VSC can moderate the financial cost of owning a vehicle. Edmunds.com breaks the true cost of ownership down into the following categories: Insurance, Maintenance, Repairs, Taxes & Fees, Financing, Depreciation, and Fuel.
VSC’s cover one part of the equation: Repairs. Edmund’s number is based on the statistically averaged repair cost and the age of the vehicle. Cars are more expensive and proprietary than ever. Dealerships spend hundreds of thousands of dollars on diagnostic equipment to isolate and diagnose what is causing the problem within the vehicle. If there weren’t a need for this, dealers would not do it. Cars do break down.
As auto industry insiders, here are three things we look at when buying a VSC:
As a third-party reseller of the VSC, the dealer uses our fear of a breakdown to make a significant amount of profit. Most finance managers mark up the cost of their VSC from 100-300% of their price. In other words, the cost to the finance manager for the VSC is $1000, and they sell it to the customer from $2000-5000. Not all cars are equal, based on complexity and equipment; therefore, the cost does vary. A repair bill for a Range Rover will be more than a Toyota Corolla, resulting in a significantly higher cost of a VSC for Range Rover.
This simple equation is where Edmund’s true cost to own is helpful. It tells you your expected repair cost over five years of ownership.
The VSC term is often overlooked when purchasing. New car buyers will usually buy a VSC for thousands of dollars, not necessarily understanding what they are buying. For example, a fairly standard manufacturer warranty is for 3 years and 36,000 miles “bumper to bumper” and a powertrain warranty (engine, transmission, and drivetrain) for 5 years, 60,000 miles.
Why is this important? Suppose a dealer sells you a 5-year VSC with 100,000 miles of “bumper to bumper” or exclusionary coverage for your new car for $3000. In that case, the warranty administrator only covers two years and 64,000 miles on the components of the vehicle and 40,000 miles of coverage for the major powertrain components. This is because the manufacturer covers the vehicle through their warranty for a portion of the VSC term.
Is $3000 worth the risk for the limited time of coverage?
How long do you plan on owning your vehicle? How many miles do you drive? Many customers living in urban areas have no use for a VSC. They change their vehicle our every five years, don’t put many miles on their vehicle, this customer doesn’t have the risk profile of the car breaking down enough to have a VSC be worth it. That is where most administrators make their profit. The manufacturer pays for repairs under warranty, and the administrator keeps most of the risk premium embedded within the contract.
Please understand, administrators are not making massive profits on VSC buyers. They have an actuarial table that manages their risk to ensure the policies they right are profitable. But most administrators run and an average of 80%+ loss ratio. Meaning they pay out over 80% of the cost of the contract. Dealers are the ones who make the lion’s share of the profit with no risk. They are the third-party reseller, zero obligation to help you in a claims battle, they make all the money. When we buy insurance we are paying someone else to take the risk. The problem with VSC’s is that we don’t really get that. We’re lining the pockets of someone who has next to no risk involved. That’s why Breeze Protection, because the money doesn’t go to the dealer, it goes to the company that’s taking on the risk. And the customer saves in the end because they are buying directly through Breeze.
There are three standard coverage options available to consumers: Exclusionary, Powertrain Plus, and Powertrain.
Exclusionary Coverage: This type of coverage mirrors the manufacturer’s “bumper to bumper” warranty coverage. An exclusionary VSC tells you what is not covered, wear and tear items that are part of vehicle maintenance. These include brake pads, wiper blades, tires, and fluid replacements (oil changes).
Powertrain Plus: This is a stated component coverage, meaning the component must be listed on the contract as a covered part. For example, power window motors must be included in the fine print to be covered by the agreement.
Powertrain Coverage: This coverage only covers state components within the engine and transmission, often overlooking seals and gaskets that might leak due to the age of the vehicle.
Understanding these coverages and paying attention to what you are buying is critical to ensuring the coverage you receive meets your needs. Often, coverage is limited because of the age and the vehicle’s mileage.
What to do?
Extended warranties purchased through a dealership can add thousands of dollars to buying a car. Financing the VSC with the vehicle will certainly take the sting out of the initial price, but often high-mileage drivers end up paying for a VSC that no longer covers their vehicle because their loan is longer than the coverage period.
As cars become more complicated, VSC’s have become an effective solution for customers to mitigate this risk. Unfortunately, not all customers use their VSC. Like auto insurance, you don’t always use it, but you are delighted to use it when you have it.
In 2022 there are also options outside of the dealership’s markups. One solution that we’ve seen is Breeze Protection. This option is unavailable at dealerships, so they sell their product directly to the consumer without expensive dealer markups. Additionally, Breeze has eliminated mileage limits and makes it convenient for the customer by providing coverage with a low monthly payment. Breeze has transitioned the VSC from an expensive upfront cost to a low subscription rate as long as your vehicle is covered. Many plans start at under $20 a month.