Jose Lugo did not hesitate when the salesman at a Fontana electronics store suggested that he purchase an extended warranty for his new $899 Pioneer laser disc player. The 27-year-old Santa Ana interpreter had saved for a year to buy the electronic equipment, and he wanted to avoid costly repairs.
While Lugo anticipated that his laser disc player might fail, he did not expect that his expensive warranty would malfunction. The Oklahoma City company that backed Lugo's warranty sought bankruptcy protection in July, leaving him with a useless $200 warranty and an $85 repair bill.
The shakeout in the intensely competitive electronics industry is leaving millions of consumers who bought extended warranties for peace of mind with financial headaches.
Last summer's demise of Oklahoma City-based EWC Inc. amid charges that its chairman looted the company socked 3.2 million consumers with an estimated repair tab totaling $55 million. The collapse of the Long Beach-based Leo's Stereo electronics chain later that month came as a powerful aftershock in Southern California, leaving thousands more consumers with useless warranties.
"A lot of people have lost a lot of money," said Curt Augustine of California's Consumer Affairs Department. He is among officials in several states who may seek legislation to protect consumers when warranty sellers fail. "It is an enormous problem," he said.
The extended warranty mess has not dampened sales. One of every three VCRs, camcorders and washing machines purchased this holiday season included an extended warranty, usually giving owners from one to five years' coverage on parts and labor beyond what the manufacturer provides. With expensive items, such as $2,000 projection TVs, four out of five consumers snap up warranties.
It is little wonder sales are strong. In the cutthroat electronics and appliance business, where failures and bankruptcies are routine, warranties stand out as an oasis of profit. Many retailers push them aggressively, sometimes using tactics that skirt the law. Most retailers make more on the warranties for an item such as a big-screen television than they do on the sale of the television itself.
One reason warranties are so profitable is that consumers rarely use them. Although consumers shelled out an estimated $10 billion last year for extended warranties, much of that money seems to have been wasted because appliances rarely break down. Studies have shown that fewer than one in five people who buy a warranty ever call to have their product serviced.
For people who, like Lugo, try to use their warranties, the loss is compounded as the roster of defunct chains grows. Pacific Stereo, Fedmart Stores, Gemco and Zody's are a few chains that have disappeared from the California marketplace over the last five years. The demise of Crazy Eddie's electronics chain in the East left 100,000 consumers with worthless extended warranties.
Since they were first offered 50 years ago by RCA on television sets, warranties have mushroomed from a sideline into a huge business, becoming as ubiquitous as TVs themselves. Virtually every company that makes or sells home or office equipment peddles extended warranties. Although most commonly associated with electronics, extended warranties are also sold for dishwashers, dryers, computers and fax machines. There are extended warranties for cars, and even for homes.
What few consumers realize is that only a handful of companies set aside funds to cover warranty repairs. This means that when a warranty provider goes under, there is usually nothing for the thousands of consumers who not only lose what they paid for a warranty, but get hit with repair costs, too.
Such was the case with EWC Inc. Although little known outside the industry, EWC was one of the nation's largest warranty companies. It sold extended warranties through 200 Southern California retailers, including Ken Crane's electronic stores. It also sold manufacturers warranties on such brands as Go-Video VCRs, Curtis Mathes televisions and Lennox Industries air-conditioning equipment.
Rather than set aside money for repairs, EWC used revenue from new warranty sales to pay repair bills. The strategy worked until a recession hit the electronics industry and put a crimp in new warranty sales. Unable to sell enough warranties to cover repairs, EWC's cash dried up. According to EWC's court-appointed bankruptcy trustee, EWC needed to sell 10 million to 12 million extended warranties to cover repair claims on the 3 million outstanding warranties--a target difficult to hit even in good times.
The company's weakened finances were not helped by its chairman's alleged habit of dipping into EWC's treasury to support a flamboyant lifestyle that until this year included a lavish annual Christmas party at his $1-million Oklahoma City gated estate. EWC's nationwide work force was flown in at company expense to attend a fete that last year featured palm trees incongruously transplanted in ankle-deep snow.
Trustee Gary Morrissey is suing EWC Chairman Barid W. Trice and several family members to recover $796,000 that he alleges they owe the mortally wounded company. Trice could not be reached for comment, but his attorney, Jerry Sepkowitz of Oklahoma City, said Trice concedes that he owes some of the disputed amount.
As in most other warranty-related bankruptcies, EWC's customers will not benefit from any settlement. As unsecured creditors, consumers are last in line to collect anything as EWC tries to sort out its finances under bankruptcy law protection. Many of these people will not learn that their warranties are worthless until their appliances break down and they, like Lugo, try to get them fixed. "I feel ripped off," said Lugo, who purchased his warranty at Space Video in Fontana.
No one knows how many millions of consumers have been victimized by the spate of bankruptcies in the electronics industry. The giants in the extended warranty business, such as Sears, Roebuck & Co. and General Electric, maintain that their customers have nothing to fear.
"You have to look at the reputation of the (warranty) seller," said Stan Knipe, vice president of product services for Sears, which is said to take in nearly $1 billion a year from extended warranties, also known as service contracts.
Some companies, including Ken Crane's and Go-Video, say they will absorb repair costs for customers who purchased EWC warranties from them. But many smaller outfits, such as Appliance Unlimited of Newhall, say they cannot afford to help out their customers. Royce Smith, owner of the one-store operation, estimates that it would take $100,000 to cover repair costs over the next five years.
However, most consumers tend not to use their warranties because their appliances do not break down. The life expectancy of a VCR or television set is closely guarded by the electronics industry, which computes longevity with the precision of a life insurance actuary.
Although she would not give away trade secrets, Suzanne Schneider, vice president of operations of the Torrance-based warranty company Elite Group Inc., said electronic equipment usually becomes obsolete and is replaced before it breaks down.
Consumers Union, the Yonkers, N.Y.-based publisher of Consumer Reports, advises consumers to pass up extended warranties unless the device being purchased uses a new and untested technology or is known to have a terrible repair history.
Bill McGuire, an editor at the magazine, suggests that consumers concerned about repair costs regularly deposit money into a repair fund. If the appliance never breaks, the repair fund can be used for other things.
It is hard for cautious consumers to say no to extended warranties. Sales people are instructed to pitch the extended warranties and remind consumers of how much repairs can cost. "We know if we explain it to our customers properly, some will buy," said Dick Stubbe, chief of the electronics division manager for Macy's California, the R.H. Macy's division that runs the Bullock's department store chain.
People who turn down extended warranties at the time of purchase find that the sales pitch follows them home. Sears and GE have telemarketing programs that prod consumers into taking extended warranties. Silo mails customers slick brochures that warn: "There's no such thing as a minor repair," and provide sampling of not-so-minor repair costs: $211 for a new microwave timer, $336.10 for a color TV picture tube, $122.50 for a refrigerator ice maker.
Rebecca Breverman, director of financial services for the Silo electronics chain, said the brochure is meant to "refresh the customer's memory" about how much repairs could cost and is not intended to alarm. "Whether it seems scary is a matter of interpretation," she said.
Law enforcement agencies have occasionally cracked down on overzealous sales tactics. Last year, Silo agreed to refund $49.95 each to Kansas consumers who bought unneeded one-year extended warranties on VCRs already covered by manufacturers' warranties.
Several years before that, Montgomery Ward, without admitting guilt, agreed to soften its sales pitch in order to settle federal false claims charges. The Federal Trade Commission in 1988 accused the department store chain of overstating the need for service on washing machines, lawn mowers and air conditioners.
There is a good reason why companies sell extended warranties so fervently. Because consumers use them infrequently, extended warranties provide a bonanza to retailers. For many struggling mom-and-pop appliance stores, EWC warranties were astonishingly lucrative. According to bankruptcy trustee Morrissey, EWC sold its warranties to retailers for $12 to $15 apiece. Electronics merchants in turn resold the warranties to consumers for between $50 and $100 each.
In the world of electronics retailing, EWC-like profits are not unusual. Two years ago, the Financial Accounting Standards Board, an obscure body that makes accounting rules, found that electronics chains that sold warranties for $300 spent no more than $50 and possibly as little as $12 for repairs.
Many retailers rely on warranties to make up for razor-thin profits on electronic equipment. Take the case of Leo's Stereo. Facing a cash crunch two years ago, Leo's started handing out bonuses for extended warranty sales. Revenue from warranties exploded fivefold, helping to prolong the life of the troubled electronics chain. According to Leo's annual report, it took in $10.5 million from warranties and repairs in fiscal 1990, about the same as it received from sales of such popular items as VCRs, camcorders and television sets.
John Howarth, former manager of Leo's now-shuttered Culver City store, felt guilty pushing service contracts so hard. "Most electronic goods don't break down," he said. "It was like taking free money. You sell a piece of paper and take money for it."
Among those persuaded to buy a Leo's warranty was Robert J. Brucato, a California Institute of Technology professor who paid $19.90 for a two-year warranty for a car stereo. When Leo's shut down, his car stereo was being fixed at a Whittier shop that refused to bill Leo's for repairs. Caught in the middle, Brucato had to pay the $118 repair bill to get his car stereo back.
Former Leo's executives declined to discuss the chain's warranties. Leo's bankruptcy attorney, Paul S. Aronzon of the firm Milbank, Tweed, Hadley & McCloy, said that a warranty is essentially backed by the "word of the company. . . . In bankruptcy, as with any other contract, there is no mechanism to enforce that promise."
Three years ago, then-Gov. George Deukmejian vetoed legislation sponsored by state Sen. Herschel Rosenthal (D-Los Angeles) that would have required warranty companies to maintain reserves for repairs or obtain insurance to cover repair costs in case of a bankruptcy. Now, Florida is the only state that requires extended warranty sellers to maintain reserves or insurance.
Although the Consumer Affairs Department is leaning toward a proposal to revive that legislation, retailers argue that it would be costly and in the end may do no good. When Florida regulators took steps against EWC Inc. last spring for maintaining inadequate reserves, the company left the state and emptied the escrow account that was set up to protect Florida warranty holders. The insurance policy taken to protect the escrow account, issued by an insurance company controlled by EWC's Trice, turned out to be as worthless as the EWC warranties.
Macy's Stubbe estimated that such legislation would raise the price of extended warranties by $1 to $2 each, making them more expensive for people who want them--such as William Fessler.
A Canyon County insurance salesman, Fessler has caution in his blood. He also has a houseful of extended warranties: There's one for his garage door opener, another for his washer, and warranties for his clothes dryer and his Ford Bronco. Though the EWC warranty for his stove top is now worthless, Fessler's trust in warranties is unshaken. "I still believe in them," he said. "I'd buy one again."
Before buying an extended warranty, keep the following things in mind:
Need. Though most manufacturers and retailers closely guard repair histories, Consumers Union says most electronic devices and appliances are fairly reliable. The publisher of Consumer Reports says an extended warranty should be considered only if the technology is new and untested.
Price. Consumers Union says that extended warranties generally cost between 10% and 12% of the item's purchase price. If a warranty costs more, it is overpriced, the group says.
The Seller. Know whom you are buying the warranty from and whether an insured reserve account is maintained for repairs.
The Alternative. Consumers Union says it is often cheaper for consumers who are worried about big repair bills to maintain their own repair fund in an interest-bearing account. If repairs are needed, the money is there. If not, the money is yours.