Insurance Versus Warranty - What's the Difference?

When you are planning ways to protect the value of your assets, insurance is always something to consider. When you insure something, you are buying protection against the possible sudden loss of the value represented in whatever you are insuring. Each insurance "policy" is a contract between the insurance company and the person buying the insurance policy. There are four major areas for insurance of this type: Health, Home, Auto (and other vehicles such as boats), and Life insurance (such as term and whole-life).

There are two other types of contracts that customers get confused with the contracts listed above. The first of these is the life insurance contract that is primarily sold as a financial investment tool. While these still contain some form of life insurance, they are generally designed as a means of producing a guaranteed income stream later in life, or for reducing the impact of taxes when transferring estate wealth when the insured person dies. These are not the simple life insurance policies you get with term insurance. And they are more complicated than whole-life policies. Because of the use of this type of insurance contract in investment planning, it is not like the concept of insurance for day-to-day protection of the value of an asset like your house.

The other type of contract is more like a product warranty, yet it is sometimes called insurance. Examples of this type contract include appliance warranties, or extended car warranties.

In most states, there is a Department of Insurance that registers and regulates companies and their agents who are permitted to sell insurance in the state. This department is usually a part of the state's office that regulates businesses involved with financial matters. The purpose of the department is to make certain the residents of the state are being treated fairly when buying insurance, or making a damage claim. Before a company is authorized to sell insurance in a state, it must show that it is following accepted procedures for the industry and has the capacity to pay on claims presented to it.

The state watches over these insurance companies, but so does the Federal Trade Commission (FTC). The FTC has a great deal to say about the general practices of insurance companies -What type of policies they can sell. -What insurance company can merge with what other companies. -What evidence an insurance company can include when evaluating risk. -And so on.

If an insurance company fails to live up to the expectations of the state, or the FTC, there can be legal action brought against the company by the government. To the customer, this is good news. Still, we hear horror stories about having claims denied for reasons that weren't exactly clear when the contract was signed. One of the best examples of this is the claim for damages during hurricane Katrina. Insurance companies claimed the damage was caused by flooding and the policy didn't include flood insurance. Home owners claimed the damage was caused by wind, which led to the problems with flooding.

The government does get involved in protecting the interests of the customer. They also attempt to provide a fair environment for the insurance companies. There are probably still claims cases for damage caused by Katrina that are in the civil-court process.

The types of insurance I am talking about here all pertain to the retail market. There are other types of insurance for businesses to cover the value of inventory, workers' health, construction liability, etc. This business is also regulated by the state and federal governments.

Earlier, I mentioned the product warranty. This is also a contract for protection. Customers used to feel satisfied with the manufacturer's warranty that was included with the purchase of the item. But now we are seeing third parties who want to sell us warranties that continue after the manufacturer warranty ends. For example, you buy a major brand TV from Sears and they attempt to sell you an extended warranty from a company that is neither the company who manufactured the TV nor Sears. The business of these service contracts is not regulated by the state and federal governments like the business of insurance is.

The product warranty is a form of insurance if you look at what it offers you. You pay a known fee for a contract to take care of servicing your product if it breaks during a certain time period. This protects you from potential high-cost repairs needed if the item fails to perform as intended. They don't usually compensate you for accidental damage. More correctly, these contracts are called service contracts.

Companies who sell these contracts can specify what is included and what is not included in their warranty. They can cover the item for certain types of use and not others. They can set time limits on when certain types of failure are covered. Basically, the coverage and the pricing are designed with a preference for earning the company money rather than providing you with protection. Furthermore, no one but the issuing company is assuring the customer that there is a strong company standing behind the validity of the service contract. These are the important differences between a service contract and a regulated insurance contract.

When you hear someone selling an automobile service contract claiming to protect you from an outrageously high cost for replacing the transmission in your car, ask yourself how likely that repair is to be needed and if the cost estimate is correct. Ask if the contract is insuring you against something that the car manufacturer is already covering (Do you drive a Hyundai or Kia? Check out the warranty they already offer you.) Service contracts cost the buyer more than the costs of likely repairs. That's how the companies make money. That might be okay if all you wanted was to avoid a catastrophic expense. But most of these contracts won't cover many of the repairs you are assuming they will cover. And they are not an insurance product.

Copyright 2009, James W. Stone, all rights reserved worldwide

James W. Stone has been involved in new product development and marketing for most of his working career. He has degrees in Mechanical Engineering (BSME, Kentucky, 1976) and Business (MBA, Northwestern University's Kellogg Graduate School of Management, 1985).

Jim's current interests focus on the psychology and sociology that influence our daily decisions when we spend money.

Read more of Jim's articles at http://www.jameswstone.com