Insurance’s $1 Trillion Opportunity

I don’t envy the job of an insurance executive in 2017. The traditional insurers are being challenged like never before. Web-focused insurtech startups threaten the conventional brokerage model the industry has utilized for decades. New MGAs are unlocking fresh sources of data that compel incumbent underwriters to innovate or risk obsolescence. Even the established geopolitical order is being upended by systemic shocks on both sides of the Atlantic, exacerbating risk. Not least of all, an insurance executive in 2017 enjoys no easy choices in deciding where to direct excess capital. On one hand, historically low interest rates prevent insurers from earning their required rates of return through investment of their cash balances. Even if central banks continue to pursue policies that preemptively rein in inflation, it is unlikely that incremental rate increases will enable insurers to reach their target yields. On the other hand, an increasingly competitive underwriting environment is squeezing profits as insurers vie for the same customers. There is a riff on a trendy insurance theme that suits this challenge: “when the market gives you lemons, make lemonade.” In the absence of yield and premium growth, traditional insurance firms need to be open to capturing new market opportunities as they arise. See also: 5 Cs of Transformation in Insurance   One vast and largely untapped opportunity for premium growth is the global solar energy market - specifically insuring the energy production risk of solar power assets. The solar market has grown exponentially over the last decade. Propelled by a virtuous cycle that resembles Moore’s Law – in which cost reductions drive demand and new demand growth further reduces cost – solar power equipment has never been cheaper. This dynamic, coupled with innovative business models that have opened the doors to new customers, transformed solar from a niche industry to a half trillion-dollar market in a little over ten years. In 2020, there will be over a trillion dollars of solar assets in operation. Insuring the energy production of these assets represents a similarly gargantuan market opportunity for new premiums estimated at $50 billion. Why has such a large market opportunity for insurance not been pursued previously? The solar market is not completely new to the insurance industry. Solar power asset owners have had a range of risk transfer options. A solar asset owner might have a policy insuring sunny weather or construction quality, in addition to standard manufacturer warranties on the solar equipment. The problem with these narrowly-tailored options has been two-fold. First, relying on manufacturer warranties for equipment has been a dubious risk transfer strategy for solar asset owners. The global solar manufacturing business is highly competitive with thin margins spread across hundreds of equipment brands. It makes sense – this intense competition has driven the cost declines that have helped facilitate the market’s growth. But it also means that many manufacturers are forced to exit the market altogether, leaving the validity of their warranties in question. Second, and most importantly, holding so many different policies creates burdensome claim processing, decreasing the value of insurance for asset owners. If a solar power asset does not produce as expected, the various insurers holding risk have been prone to attribute these impediments to factors not covered by their policies. Weather insurers will blame construction practices, the construction claims adjuster attributes problems to equipment failure, and so on. This “passing of the buck” on liability diminishes the value of these policies, consequently suppressing the market opportunity for insurers. A complete production insurance offering, wrapping all of these risk factors into a single policy, would solve this challenge. In solar project finance, loans are supported by revenue from electricity sales contracts. Lenders, therefore, chiefly care about one question: will an asset produce the power it is expected to generate in order to yield cash for loan installments? As cautious institutions facing a novel risk, lenders typically issue loans that are up to 50 percent smaller than the size that solar asset owners want. This is far from ideal. Every dollar of project capital not financed by loans requires a dollar in equity, which invariably has a higher cost of capital. By transferring the lender’s energy production risk to an insurance balance sheet, asset owners are able to swap debt in place of equity in project capital stacks. But, of course, how should an insurer get comfortable with this new risk? How can insurers be confident they can underwrite this risk? As clear as this new opportunity is, insurers still face hurdles when determining the best approach to entering the solar market. The barrier for insurers is how to have a clear understanding of the new risk pool they would be assuming. See also: Shaping the Future of Insurance The missing bridge between the solar market and insurers has been the availability of historical asset performance data. Would-be MGAs assessing the solar market quickly discover that they lack the actuarial data necessary to offer competitive policies that fit the solar market need. Instead, MGAs seeking to enter this market would be forced to rely on proxies for data, such as theoretical models. The subjective nature of these proxies ultimately undercuts the value created for solar asset owners and reduces the opportunity for new premiums. Big Data analytics can fill this gap by aggregating the performance of tens of thousands of solar energy assets across dozens of variables, including equipment brand, climate, weather, construction company, and more. Such aggregation and statistical modeling would resolve the knowledge gap currently preventing insurers from reaching this market. In my conversations with the various stakeholders in this market opportunity– insurers, potential policyholders, and lenders – I’ve discovered that there is strong appetite for this kind of policy offering in solar project financings. Solar energy production insurance adds value for all of these parties. By allowing more debt in the project capital stack facilitated by data-informed insurance underwriting, asset owners can access a lower cost of capital. Lenders can be confident that their exposure to power production risk is limited. And insurers, faced with challenging macro conditions, will have found a natural growth market to boost premium revenue, profitably. Lemonade indeed.