Extended warranties not really insurance
Ruling on The Brick ensures plans will remain lucrative
Ever wonder about the mechanics behind those extended-warranty programs that seem to be popping up at every big-box retailer? The protection, sometimes aggressively promoted by eager salespersons, extends the manufacturer's warranty by several years, offering the consumer peace of mind should his new 50-inch plasma TV not function properly for as long as promised.
Details behind the operation of such a program were recently revealed in an unusual Alberta insurance tax case involving the Brick Protection Corp.
During the years in question, Brick Protection offered various protection plans which typically extended the manufacturer's warranty by two to 15 years for consumers who purchase appliances, electronics, home furnishings and other merchandise from The Brick.
The protection plans were contracts between Brick Protection and the consumer, but sold by Brick employees to the consumer at the time of the initial purchase of the retail goods. Brick Protection would charge the consumer for the plan and then pay the Brick a commission of 50% on all gross sales of protection plans within 10 days.
Under the terms of a plan, if a product purchased from the Brick was deemed defective in workmanship or materials during a specified number of years, Brick Protection would either repair or replace it.
The prices charged for the various protection plans were set by the Brick, taking into account what purchasers would consider a reasonable price to pay versus the retail price of the product (typically 10% to 15% of the retail price), as well as the expected repair costs to ensure the plans "provided sufficient margin."
For some plans, data from past claims was used to ensure that "the pricing was more than sufficient to cover repair costs."
In July 1994, the Alberta Treasury issued notices of assessment to Brick Protection. The notices covered the period of 1987 through 1993 and assessed "insurance corporation tax" of over $700,000. On top of that, it added $335,000 of arrears interest and over $110,000 in penalties.
The issue in the case was whether Brick Protection was an insurance company carrying on the business of insurance in Alberta during the tax years 1987 through 1993 and thus liable for this special tax.
After an extensive legal analysis and review of the jurisprudence, the judge found that the protection plans were "classic manufacturer's or distributor's product warranties" and that while "structurally very similar to insurance contracts, these types of agreements have historically fallen outside the realm of insurance law."
The judge determined that the main distinction between a warranty and insurance is that a warranty covers the risk that the specific product being purchased fails during normal use due to some inherent fault or weakness. By contrast, insurance covers the risk of "unforeseen events or perils," which are unrelated to an inherent weakness of the product itself.
As a result, the court concluded that Brick Protection was not in the business of insurance and thus was not liable for the more than $1.1-million in insurance tax, arrears interest and penalties.