When you buy a 1000 dollar HDTV and are offered an extended warranty for 250 bucks a year, what thoughts go through your head? That you just made a heavy investment and that 250 bucks a year is a reasonable price for ensuring that the TV stays operable? If that’s your initial response, don’t fret; most people act like that. The truth is, that’s how places like Best Buy make most of its profits.
Think about it: The 250 dollar/year warranty only makes sense if you believe your HDTV has a 25% chance of dying completely (with absolutely no redeemable value), OR a 50% chance of losing 50% of its value EACH year. If that is your honest assessment of the reliability of the product, then you shouldn’t buy the product itself–there are much more reliable TVs than that. If that is not your honest assessment, you’re getting ripped off by the warranty.
Aside from the minor concavity in the “utility of money” curve due to people’s natural risk aversion, there is absolutely no reason to buy an extended warranty for products that SHOULD last. On the other hand, if you’re so risk averse with a 1000 dollar investment as to pay 250 dollars/year to insure a product that has a 5% chance of failing completely each year, you should reevaluate your instincts to make better use of your money.