12.1.2 Issue: Extended warranties

What is an extended warranty?

An extended warranty is a prolonged warranty offered to consumers to protect their purchase of a consumer good.

The warranty normally relates to the reliability of a good used under conditions of ordinary consumer use. It covers problems that may arise some point after the date of purchase. Should the good prove defective or malfunction within a certain time after the purchase, the person extending the warranty is liable to provide the customer with a replacement of the good, repair it, or refund the purchase money (not a common practice). Such warranties usually do not cover "Acts of God", damage caused by the purchaser, or commercial use.

In New Zealand such warranties are typically related to electronic items. The extended warranty may be offered by the retailer or the manufacturer or a “warranty administrator” (i.e. a third party). Extended warranties are sometimes known as extended guarantees.

Extended warranties are an additional cost on the price of the good being purchased. Warranties are generally sold for a fixed price but can be for a percentage of the item's retail price. As an incentive to sell extended warranties, store retailers can be paid commission on each sale.

What is the issue?

The National Consumer Survey 2009⁷⁵ found that only one third of New Zealanders know that extended warranties generally do not provide more protection than provided by the law. This highlights a large degree of misunderstanding about these warranties. Many consumers are likely to be purchasing extended warranties without realising that they probably already have protections under the Consumer Guarantees Act and may therefore have spent their money unnecessarily.

There are warranties that do offer benefits beyond the Consumer Guarantees Act. For example, they might provide for an on site repair service, or they might cover some forms of fair wear and tear. There is no problem with this kind of benefit being offered to the consumer and they can be useful products. It is also possible that some consumers have difficulty exerting their Consumer Guarantees Act rights with a retailer but feel more comfortable in making a claim under an extended warranty where they feel they are much more likely to get the desired outcome.

However, many of the rights typically offered by an extended warranty are currently already provided for in the Consumer Guarantees Act (repair, replace or refund). The consumer may be no better off by purchasing an extended warranty. In such cases, retailers are effectively extracting an economic rent from consumers by relying on consumers being unaware of, or having insufficient confidence in, their rights under the Consumer Guarantees Act.

Some extended warranties that are purchased for multiple years state that during the first year after a sale, the consumer must deal with the manufacturer where there is a malfunction. This effectively means that what was promoted as a 5-year extended warranty is actually only a 4-year guarantee.

Other issues with warranties include the expiry of the warranty once a claim is made. For instance a 5-year warranty may have a clause saying the warranty expires if the provider repairs or replaces a good covered by the warranty. If such an event happens in the first year the consumer effectively misses out on 4 years worth of warranty. While this will usually be stated somewhere within the warranty, the consumer will normally presume a 5-year warranty means 5 years of coverage. This situation is potentially compounded further if the repair does not work properly or the replacement item also develops a fault.

In 2005, the United Kingdom introduced the Extended Warranties on Domestic Electrical Goods Order 2005 under its Fair Trading Act. The Order was made following an investigation by the United Kingdom Competition Commission which concluded there was a “complex monopoly situation” in the extended warranties market that was not in the consumer interest. The Commission reached this finding on the basis of the following points:

• almost all extended warranties are bought at the point of sale. Few consumers consider extended warranties before their purchase, and have little opportunity to consider alternatives in the shop
• extended warranties on offer at the point of sale are nearly always from one provider, usually the retailer
• there is generally no information available on the reliability of electrical goods or the likely repair costs
• there is generally no information available at the point of sale on the prices, terms or conditions of extended warranties from alternative providers⁷⁶.

It was considered these points allowed profits earned by retailers on extended warranties to be substantially in excess of what should have been expected. Accordingly, the decision was taken to introduce regulation of extended warranties.

The Extended Warranties on Domestic Electrical Goods Order 2005 places obligations on retailers to:

show the price of the extended warranty alongside electrical goods, in store and in their printed advertising material (including websites)
provide consumers with information about their statutory rights, cancellation rights and details of the warranty, including whether or not the warranty provides financial protection in the event of insolvency and terminates if a claim is made
give consumers 45 days to cancel the extended warranty, including providing a written reminder of this right and the right to cancel at any time and receive a refund from the retailer, and
offer to any consumers, who do not wish to purchase a warranty immediately, quotations stating that the extended warranty remains available on the same terms for 30 days if the consumer chooses not to buy it at that time. Any discounts tied to the purchase of the extended warranty would also be available for 30 days.

The United Kingdom Office of Fair Trading undertook a review of the Order in 2008. It found the Order had encouraged positive impacts on consumer decision-making. The review found there was a rise in the number of consumers who shopped around for extended warranties. It also found that the number of consumers purchasing extended warranties at the point of sale fell from 82 percent to 68 percent. It was noted that 4 percent of consumers used the cooling-off period⁷⁷.

The United States has warranty law under the Magnuson Moss Warranty Act 1972. This Act requires retailers providing warranties to disclose the terms and conditions of the warranty offered in simple and readily understood language. This includes information such as the length of the warranty, what elements of the product are covered (e.g. parts or accessories), a description of any legal remedies available to the consumer, and what the warranty provider will do if a defect or problem occurs.

The circumstances which promoted the introduction of the Extended Warranties and Domestic Electrical Goods Order 2005 in the United Kingdom would appear to be similar to those that are occurring in New Zealand. New Zealand consumers are entering into extended warranty contracts. This is either due to ignorance (National Consumer Survey 2009, two in three consumers believe an extended warranty gives more protection than the Consumer Guarantees Act), or because the retailer is actively promoting the extended warranty. The latter is backed up by a Consumer NZ mystery shopper exercise. Conducted in October 2007 at the premises of three major retailers, it found there was strong emphasis on selling extended warranties, confusing or misleading sales patter and a distinct lack of knowledge of the Consumer Guarantees Act and its proper application to retail situations.

A retailer omitting to inform the consumer that they already have consumer protection rights available to them under the Consumer Guarantees Act and then attempting to “sell” those rights to the consumer may be deliberately misleading the consumer (which could be a breach of the Fair Trading Act).

Options to address issues associated with extended warranties

The following are possible approaches to addressing the problems associated with extended warranties:

A. Disclosure to the consumer

Providing information to consumers about the details of an extended warranty provides them with the opportunity to make an informed decision about the purchase of the warranty. Additionally, requiring the publication of information about the warranty may improve competition in the marketing of both goods and extended warranties.

B. Disclosure in advertising – price and rights

The Warranties on Domestic Electrical Goods Order 2005 in the United Kingdom requires retailers to display the cost of an extended warranty in both advertising and on the item being sold. This information must also be included in any website that the retailer administers which is related to the good being sold.

An approach could be to include similar requirements, as well as reference to the statutory rights under the Consumer Guarantees Act.

The benefit of such an approach is that a consumer is provided information about the extended warranty before they become emotionally committed to the purchase of the good. If the information highlights to the consumer the extended warranty only affords them limited benefits, they may be less likely to buy an extended warranty when they do decide to purchase the good.

There is also the question of whether there should be any punishment or detriment for the retailer if it does not comply with the disclosure requirements. Given the Fair Trading Act is the legislation which deals with trader behaviour and also may govern disclosure of information to consumers (and the Consumer Guarantees Act is self-enforcing), it would appear that it may be most appropriate to amend the Fair Trading Act to provide for the enforcement of any extended warranty law. (This would mean enforcement by the Commerce Commission, although consumers and other private parties can also make claims under the Act.)

C. Cooling-off period

Another possibility could be to provide the consumer with the right to “cool-off” and obtain a refund of the money paid for an extended warranty. Giving consumers a cooling-off period which allows them to cancel the purchase of an extended warranty is a means of remedying the situation where a consumer has purchased the warranty without the knowledge of the existence Consumer Guarantees Act rights to only then discover those rights are the same they just purchased.

A cooling-off period also allows the consumer time to recover from any “pressure selling” that may have occurred regarding the extended warranty.

The effectiveness of this approach would depend on consumers being aware there is a cooling-off period, suggesting there would need to be disclosure of its existence in the information provided by the retailer with the extended warranty.

A cooling-off period would be similar in nature to the cooling-off period under the Door to Door Sales Act 1967 and the Credit Contracts and Consumer Finance Act 2003.

When an extended warranty is cancelled under a cooling-off period, the consumer could be entitled to a full refund of the cost of the warranty.

For clarity, the consumer should be unable to cancel the purchase of a good in addition to the cancellation of the extended warranty under the cooling-off period (unless other reasons under the Consumer Guarantees Act allow for the cancellation of the purchase).

D. Right to buy the extended warranty at a later date

A reverse of the cooling-off period is the option to extend the timeframe in which a consumer may purchase an extended warranty for the good they purchased. For example, if a consumer purchases a television on Monday, they could go back to the retailer before the following Tuesday to purchase an extended warranty related to the television.

The reasoning is that the consumer then has seven days to consider if they wish the television to be covered by an extended warranty with the benefit of having had the opportunity to read the required disclosure about their consumer rights (as proposed above) and any additional benefits the warranty may offer. This would allow the consumer to make a more informed decision as to whether they need the warranty, rather than by having to “take it all in” at the point of sale.

Questions

Footnotes

75 National Consumer Survey 2009 – http://www.consumeraffairs.govt.nz.

76 http://www.berr.gov.uk/whatwedo/consumers/fact-sheets/page38190.html.

77 http://www.oft.gov.uk/shared_oft/reports/Evaluating-OFTs-work/oft1024.pdf.