Can Tesla benefit from its insurance business?

For most Tesla, Inc. (TSLA) investors, electric vehicle sales are the top numbers on the company’s balance sheet. But if CEO Elon Musk is to be believed, another part of Tesla’s business could account for a significant chunk of its profits. During an October 2020 earnings call, Musk suggested that the company’s insurance business, launched the previous year, could account for 30% to 40% of the overall future value of its car business.

Based on Tesla’s current valuation of more than $1 trillion, that means the insurance business could be worth between $300 billion and $400 billion in the next few years. To put those numbers into context, the upper end of that estimate is equal to twice the combined valuations of Tesla’s rivals Ford Motor Company (F) and General Motors Company (GM).

key takeaways

  • Tesla’s auto insurance, which is currently available in three states, is expected to make a significant contribution to the company’s bottom line going forward.
  • However, in its current form, the insurance product needs to overcome several problems to make a visible difference to revenue.
  • Tesla CEO Elon Musk has said the insurance arm could account for 30% to 40% of the company’s car business.

Tesla’s auto insurance business

With a value of $288.4 billion and average annual growth rates of 2.7% over the last five years, auto insurance is an attractive industry. Tesla entered the business in 2019 in California as a broker for policies underwritten by State National Insurance Company. The company has since expanded its operations, launching a similar product in Texas and Illinois. Tesla has also applied to offer insurance coverage to customers in Washington and launched an insurance brokerage firm in China in August 2020.

In addition to generating revenue for your business, providing auto insurance to customers helps the electric car maker solve two problems at once.

First, it lowers the overall cost of insurance for Tesla vehicles. A 2018 USA Today survey ranked the Tesla Model S as the most expensive car for auto insurance. Insurance costs for Model 3, Tesla’s mass-market vehicle, are also higher than the industry average.

Second, and this is related to the first, Tesla’s insurance business could also boost sales of its cars by lowering the total cost of ownership. The company has promised monthly premium discounts based on a driver’s “safety score.” Scores are calculated by monitoring “real-time driving behavior” that checks for actions such as aggressive turns, hard braking and unsafe following distances. For example, drivers with “average” safety scores save 20-40% on their insurance, while those with the highest safety scores can save 30-60%.

Monitoring driver performance also serves another purpose for the automaker. CEO Musk says it enables a “much better feedback loop” that connects manufacturing processes to car design, meaning the company can make changes to its car design based on data collected about behavior of the driver. Robert Le, an analyst at Pitchbook Mobility, says Tesla has “full access data” to vehicle features such as battery levels, autopilot and car lights.

To be sure, the concept of usage-based insurance, or UBI, is not new. Insurance companies like The Allstate Corporation (ALL) already offer similar products. Other automakers like GM and BMW have their own versions of usage-based insurance that offer discounts on standard rates and are much larger than Tesla’s offering.

In such systems, a device that reviews driving behavior for a limited period is usually installed in vehicles. Discounts are offered based on appraisals completed during the review period, as well as credit and vehicle type. Tesla, on the other hand, claims that its insurance product does not take into account age, gender, or driving history.

Can Tesla make a profit from its insurance business?

Tesla’s insurance business is not expected to pose much of a threat to insurance industry incumbents, at least initially. According to Tom Super, vice president of intelligence at JD Power, Tesla’s entry will have a “limited impact on the average car insurance consumer, including the premiums they pay.”

More importantly, he says that the success of Tesla’s insurance company depends on the sales of its cars. That statement is not surprising. The auto insurance industry operates on low margins, and scale is necessary to profit from the business. The electric carmaker trails its more established counterparts by a wide margin in sales. In 2021, Tesla sold 936,172 vehicles, while GM had sales of 2.2 million cars during the same period.

Initial comments about Tesla’s insurance product should also be cause for concern. While investors have given the product a thumbs up in boosting the company’s share price, customers are a harder sell. Immediately after launch, Tesla’s insurance registration site crashed, prompting complaints from those trying to register. Commenters on a Reddit forum said that their estimated rates from Tesla were higher than what they were already paying to established insurance companies.

Tesla insurance underwriters also have a mixed record with customers, receiving above-average customer complaints compared to other insurers. There’s also the fact that the company’s driver monitoring systems, used in its Full Self-Driving (FSD) and Autopilot, are a work in progress. A Consumer Reports test last year found that GM’s Cruise systems did a better job of monitoring drivers than Tesla’s.

But Tesla’s vertically integrated supply chain may give it a long-term insurance advantage. The high insurance costs of their cars are a function of their production costs. Those costs are falling rapidly, as reflected in the company’s growing operating profit. Tesla’s insurance product also streamlines the claims process by providing a direct connection to the manufacturer and making it easy for vehicle owners to schedule maintenance and repairs. This could generate a lock-in effect. As car sales increase in the coming years, Tesla owners are likely to prefer insurance offered by the company.

But that is in the future. Usage-based insurance is relatively unknown territory. According to the National Association of Insurance Commissioners, there is much uncertainty regarding the selection and interpretation of driving data using UBI and the premium price rates based on that data.

Regardless, analysts are bullish on Tesla’s insurance. According to Morningstar’s Seth Goldstein, the insurance business will generate the majority of sales and all profits from services and other segments going forward.