ElectroFinance PART III...
Electric Restructuring and Electrofinance: An Opportunity for Insurers

In 1994, the California Public Utilities Commission issued a Bluebook outlining that state's initial plan to restructure its electric industry by introducing competition among retail power providers for customers. Since then, a number of other states have passed legislation or have administratively enabled electricity providers to engage in some degree of competition. The process reflects both the judgment on the part of some interests that competition can provide better service at lower cost—at least to some customers—and an ideological dissatisfaction with government regulation on the part of some policymakers.

In response to these regulatory changes, and helping to drive them, increasing numbers of firms have entered or are considering entering the power marketing business. These include unregulated affiliates of established utilities, small start-ups, and large nonenergy companies attracted to new opportunities. Other entities have entered the fray as well, including municipalities, cooperatives, and for-profit go-betweens anxious to act on behalf of customers to secure favorable terms from power suppliers. Many of these "aggregators" seek to market electricity in new and interesting ways, often "bundled" with other consumer services. (See Box 2.)

In contrast to permutations based on consumer products, we suggest electrofinance. In a deregulated electric market, insurers, other financial institutions, or those who offer such services could be the foremost aggregators of electrical customers. They would do so in a way that would bundle property-casualty insurance, a retirement annuity, and electricity all into one bill. Any savings from reduced electricity bills from aggregation and conservation would flow seamlessly into the annuity portion of the bill. Another appealing option would be for those same savings to help procure a photovoltaic (PV) system with a low-interest, long-term loan.

The basic idea of electrofinance has at least one precedent: United Services Automobile Association (USAA), the sixth largest auto and home insurer in the nation, began offering long-distance telephone services to its members in 1990. While USAA is a special case, in that it is a member-owned firm, it provides a model of one-stop shopping.

The Basic Plan

The electrofinance package could take several forms. At its most basic, it will provide property-casualty insurance, a retirement annuity, and electricity. Clients will choose varieties of each portion of the package most suited to their specific needs. Normal underwriting criteria would guide the coverage provided by the property-casualty portion, specifying the amount insured as well as the amount of the deductible. The annuity could be a standard low-interest, low-risk annuity, or one with higher returns and higher risk, according to client preference. The client would also specify a base amount that would be invested on a monthly basis. For purposes of simplicity, we will refer to this in a generic way as the "annuity."

The electricity portion presents slightly different choices. For an existing home, analysis of prior bills could supply a base figure on which to estimate future usage. For a new home, a simple analysis could determine approximate usage. In either case, it would make sense to levelize monthly usage to an average annual figure, so as to smooth out seasonal and monthly variations.26 Provision of such a flat fee is offered by some heating fuel dealers, with benefits both for their own annual cash flows and those of their customers.

For the sake of illustration, suppose that a homeowner purchases a package of home insurance at $50 per month, a retirement annuity at $50 per month, and levelized electricity service at $50 per month, for a total bill of $150 per month. With access to a competitive electric market, the insurer would purchase power on behalf of the homeowner at a far lower cost than otherwise available. The first savings come immediately from the insurer's ability to aggregate demand and provide buying power. According to some analysts observing states that have already introduced competition to the retail electric sector, this might be 5% below the current norm.27 The savings might be greater, given more participants or aggregation by the insurer of clients' usage with the insurance company's own usage as well as that of their extensive offices, property, and management holdings, said to be in excess of $50 billion.28

Figure 2 The second and most lucrative way to achieve savings—and the key to the environmental benefits of the electrofinance concept—is through the encouragement of aggressive energy efficiency and load management (EE&LM).29 These measures might include limited fuel switching. States that make EE&LM programs available through system benefits charges would be particularly attractive markets for electrofinance, and insurers could act as information sources, motivators, and facilitators for such programs, which include low-cost acquisition of compact fluorescent lighting, efficient appliances, and even special time-of-day rates for voluntary load reduction or shifting. Depending on numerous variables, aggressive EE&LM might lower electric bills by an additional 15­40% from the base amount. The key for electrofinance purposes would be the subsequent addition of this sum to the base annuity; in the example cited, this represents an additional $20 added to the $50 base annuity amount, for a total of $70 per month. (See Figure 2.)

Insurers are also concerned about reduction of hazards around the home that might lead to property losses for which they would have to pay the replacement costs. Through the work of Lawrence Berkeley National Labs and others, insurers could identify for their clients appliances that are not only efficient but also safer than the market norm. For instance, the electrofinance plan provider might have a list of preferred appliances that included a clothes dryer—an appliance responsible for 24,000 residential fires annually—that was both energy-efficient and engineered with insurance industry inputs to collect fire-prone lint more effectively.30

If actuarial evidence suggests that hazard reduction does result, insurers might consider a premium reduction in the base insurance amount for plan participants who choose safe appliances. The savings from the property-casualty premium would also be transferred into the annuity portion. Some precedent does exist for such incentives; insurers reduce premiums for customers who install certain types of burglar alarms or sprinklers systems to fight fires. And in the early 1980s, Hanover Insurance Co. of Worcester, Massachusetts, instituted a 10% premium reduction for active and passive solar heating as well as for underground homes that were energy-efficient. The company reasoned that since backup energy sources would fire less frequently, the probability of a fire would be reduced.31

Any such reductions would have to be based on sound business judgments, but some of the internal arguments against them might be lessened with the knowledge that the funds would flow into the annuity division of the same company and remain there for 20­30 years.

How much of a difference might these changes make in a client's annuity? This would depend on a number of factors such as the base amount invested, the amount derived from energy and property-casualty insurance savings, the interest rate of the investment, other enhancements, and the time for which it was invested. Figure 3 illustrates the savings that could be expected to accrue over 20 years at a modest 5% rate for the base of $50 per month and then with energy savings added and energy safe home premium reduction. For this example, at the end of 20 years the value of the annuity is increased by one-half—from $20,000 to $30,000.

But the profit possibilities do not end here. There are innumerable ways that entrepreneurial insurers could further maximize profits for their clients and themselves. (See Appendix A.)

Figure 3

The Photovoltaic Option

The greatest challenge in selling consumer products is branding: how can a firm convince consumers that its product offers key advantages compared with those of its competitors, and then retain those consumers over the long term? In the case of electric power, this problem proves acute. Americans are simply unused to shopping for electricity or comparing one "variety" to another. In fact, electricity suppliers in states that have allowed retail competition have differentiated their products on two grounds: price and environmental impact. In the case of electrofinance, incorporation of home-based renewable energy systems—chiefly PV panels or small wind systems—can provide branding and competitive advantage to the insurer as well as power reliability and satisfaction regarding environmental concerns to the customer.

Specifically, the electrofinance package could offer plan holders the opportunity to procure a home PV or wind system through a low-interest, long-term loan. A portion of that loan could be paid for via the savings from energy efficiency and load management. The potential market for such a product might be large. One recent survey notes that 25% of U.S. homeowners are actively considering purchase of backup generating systems, and suggests that affluent consumers, concerned about their computer systems, security, and hobby and home entertainment equipment, would be willing to pay a premium of 10% to their energy supplier to provide backup for their home generators. Proprietors of home businesses show particular interest in a power system that would ensure power quality and protect them during emergencies.32

Another group of homeowners potentially interested in PV electrofinance are those facing high hook-up costs for conventional electrical service due to their remote location. Traditionally, much of this has been paid for by all ratepayers, and it might cost some $600, but under restructuring this installation has the potential to cost $6,900—as it did for one couple in the PG&E service territory.33 At this cost, PV looks far more competitive even as a stand-alone system.

PVs on the roof may also hold additional appeal to insurers for loss mitigation, since they could be designed to act as a Uninterruptible Power System. As such, they might allow certain essential appliances to remain up and running during a hurricane or blizzard. During the massive ice storm in the northeast in January 1998, Prudential Property and Casualty Insurance Company allowed its policyholders to spend up to $600 for emergency generators, for which they would be reimbursed.34 During that same ice storm, it was ascertained that solar availability was high enough to allow most normal operations.35

In certain locales, some PV roof shingle products might provide the additional benefit of being impervious to hail storms, which cost insurers $1.5 billion annually. This has been so costly that some insurers are offering 16­35% discounts on their premiums for installation of hail-resistant roofing.36 While not translating into large amounts of dollars, in tandem with other values accorded on-site generation, insurance incentives may provide the margin for more homeowners to install PV systems.

Figure 4 In the example used here, with an up-front cost of $7,000 and with a 20-year, 5% loan, a 1-kilowatt PV system would add $46.20 a month to an electrofinance customer's payment plan, for a total monthly payment of $196.20 for all services. If the output of the PV system is 1,400 kilowatt-hours (kWh) per year at equivalent value of 8¢/kWh, this would translate into an additional monthly savings on electricity of $9.33 that could be put into the annuity portion of the plan. (See Figure 4.)

Although the PV option does increase the overall cost of the package and might reduce the annuity portion if savings went instead into buying down the PV system, it also introduces another factor that further reduces the cost of the electric portion of the billing. One of the greatest values is that rather than maintaining a continuing expense to purchase electricity, it transfers money to add equity through the purchase of the system. In doing so, along with the energy efficiency savings, it also provides more assurance against loan default for the home and system. Not only would it provide greater choice to the consumer as well as interest payments to the aggregator, it would simultaneously "brand" the company in a positive way.

Relation to Insurers' Core Business

Why would insurers enter the electricity market, which apparently lies well outside their core business? At first glance, most insurers presumably define their core business as offering property-casualty insurance and retirement services to members of the public, to the economic advantage of both parties. Yet a broader answer might include offering total financial security to their clients. This latter definition could justify any number of additional activities in addition to insurance and retirement funds—why not electricity too?

Electrofinance can indeed add value to insurers' core business, by lowering insurers' internal electric costs, drawing new customers into the core insurance business, increasing investment activities of existing customers, and mitigating property-casualty losses in the following ways:

Viewed more broadly, there have been several biting critiques of the notion, increasingly popular in the 1990s, that firms should pare away all functions outside their core competence—the activity that they do better than anyone. Michael Porter, for instance, has warned repeatedly against mistaking such simple management mantras for strategic thinking. Porter defines "operational effectiveness" as "performing similar activities better than rivals perform them," and he contrasts this to "strategic positioning [which] means performing different activities from rivals." The former, he argues, seldom succeeds in sustaining a company over a long period, and proves mutually destructive to firms as they slide inevitably toward an undifferentiated commodity market. The latter, by contrast, allows firms to deliver a unique mix of value that exploits the "fit" among a firm's activities.41

Electrofinance indeed can prove a good "fit" with the tools already possessed by insurers. Most important, insurers possess the gold mine sought most feverishly by potential electricity providers: an established customer base contained in extensive electronic databases, and a "brand" familiar to those customers as reliable and stable. Almost as important, insurers have long experience in selling their services to wary individuals in a competitive market; these skills are unmatched—and envied—both by newly established electricity retailers and the affiliates of stodgy electric utilities accustomed to the slower pace of government-granted monopoly markets. Finally, the national scope of many insurers gives them an advantage both in marketing and in negotiating on the wholesale market on behalf of their aggregated customers.

Providing some evidence for the reasonableness of this outlook, several corporations have begun to reassess the concept of core competence. In documented cases, selling these services has provided them with additional profit centers. Perhaps most relevant is American Reinsurance's technology transfer arm for environmental risk management.42

Beyond Regulatory Barriers

Insurance is a regulated industry. Not only must it meet federal requirements, it also is subject to vastly different regulations in each state. Thus most insurers have stuck to insurance products not only by inclination but to avoid regulatory infractions. USAA, mentioned earlier, is an exception due to its unique organizational structure.

Our preliminary investigations of this concept uncovered split opinion on the ability of insurers to undertake such activities directly. Attorney Peter Gilles, a former Connecticut Commissioner of Insurance, saw no reason why it would not be possible for an insurer to sell electricity.43

Attorney Robert Googins of the Insurance Law Center of the University of Connecticut Law School (and a former Commissioner of Insurance) suspects that no one had conceived of insurers selling electricity when the insurance regulations were written, and it might be a "square peg in a round hole" sort of issue. Thus there might not exist any prohibition against electricity being sold, but because a security is also sold, the transaction may also be subject to federal security laws. Googins felt that insurers might not be able to produce the power themselves, since they are "restricted in what is on their balance sheets," but could probably procure and resell it. In addition, he noted that this would differ in each state, and figuring out what could and could not be undertaken could prove quite complex.44

California's Chief Property Casualty Actuary, Richard Roth, believed that it would either be already possible for insurers to sell electricity or that "it could be worked out"—although he thought they might not want to deviate too far from their core business.45

But the Florida Department of Insurance has noted the following:

"At present, the business of insurance, defined as "a contract whereby one undertakes to indemnify another or pay or allow a specified amount or determinable benefit upon determinable contingencies," is a highly regulated industry with specific requirements for the conduct of business. Among those requirements are company licensure, capitalization, asset and investment limitations as well as product specific regulations.

"In reviewing the concept of insurers selling electricity, it appears that this business activity does not fall within the allowable insurance lines of business. Additionally, electricity and power issues are regulated by the Public Service Commission."46

With the continued breakdown of barriers between financial sectors as well as the ability of the financial community to expand beyond traditional business transactions, the preliminary evidence indicates that it may just be a matter of time until insurers are allowed to sell electricity as a normal course of business in any jurisdiction. Even in the interim, however, there are alternate structures that would allow the joint sale of insurance products and electricity through a third-party aggregator. In fact, with respect to insurance and annuities, the American Association of Retired Persons (AARP) solicits its members to buy numerous forms of insurance as well as retirement savings plans under its umbrella.

Any number of groups might provide this umbrella, including holding companies, cooperatives, chambers of commerce, or any other group that has already aggregated people to increase their buying or political power. Such a structure that is not under the direct auspices of the insurer might have greater appeal for at least two reasons:

What is partially lost under this system is the pure profit motivation on the part of an insurer that also offered the annuity to maximize the amount going into the annuity portion through offering energy conservation inducements.

Whether consumers will support such one-stop shopping models is also debatable. Again, using USAA insurance as a model, General Robert F. McDermott, its Chairman Emeritus, attributes that company's growth over the last several decades "to the implementation of the one-stop shopping model, and to the superior service USAA offers its customers....the one-stop financial services concept hinges upon customer loyalty."47 The mega-merger between Travelers Insurance and Citicorp has been touted as a marriage that would also allow a one-stop financial services model "to reach larger customer bases and attain geographical diversification."48

Other reactions, however, may indicate underlying distrust of one financial services industry segment's ability to serve. "Serious people want serious agents. Buying insurance from a bank is kind of like going to a carpenter to get some plumbing done," reflected one long-time insurance agent.49 Still, the popularity of bundled USAA financial services is high not only with customers but with rating agencies, which have cited them for excellence in several categories such as investment management and universal and whole life.50 This appears to prove that a diversified financial services company providing a one-stop shopping model can attain excellence in several fields.

Even without the example of USAA, involvement of insurers and utility suppliers is not altogether new, nor is it a one-way street, since some electricity providers have made limited excursions into supplying insurance. One such program, ApplianceGard, offered by Salt River Project and Arizona Public Service, provides appliance repair and replacement insurance from $9.99 to $19.49 per month, depending upon which appliances are covered and their age. The 24-hour-per-day service pays for most parts and labor up to the value of the appliance and has no deductible or service fee associated with it. While appliance insurance or extended warranty plans are commonly provided by manufacturers or third parties, the utility, which may often receive the blame for damaging power surges, has an incentive to provide this as a high-value product.

Australians might soon be able to buy insurance through an electricity provider, and the opposite may also be true, since at least one Australian insurer is actively exploring the sales of electricity. FAI General Insurances of Sydney envisions "the convenience of combining three services—insurance, annuity and electricity into one bill. This is close to the project I am currently working on for an insurance company and a utility company in Australia. We are in the process of pursuing the concept of single billing system: this will comprise of electricity bill and insurance premium in one statement."51

Branding for the New Millennium: Driving the Electrofinance Revolution

A key premise of the appeal of the entire electrofinance concept is that the nature of "branding" is undergoing fundamental change. As we enter the new millennium, corporations will increasingly be rewarded by consumers for brand positioning that fosters social and environmental good in a meaningful way. A Co-op America survey reports that almost 25% of the adult population integrates social and environmental concerns into their purchasing and investment decisions.52 Consumers are increasingly discriminating in favor of corporations that give something back to society. Companies like Working Assets Long Distance and Ben and Jerry's Ice Cream both hold loyal followings not just because they produce quality products but also because they meet the psychological needs of their audience. Others like Patagonia, the outdoor clothing company, and Toyota Motor Sales have both made strong commitments to use renewable resources even though it will cost as much as $1 million more annually. They justify this for numerous reasons, among which is that it is a strong marketing tool.53 To consumers, the brand represents "possibility" and helps them become something they long to be—concerned citizens.54

Some analysts expect that insurance companies will increasingly have to brand themselves as consumers become more savvy, as media outreach and direct marketing become more sophisticated, and as bundled consumer products—such as electrofinance—become more common.55 Some insurers have already begun to reinvent themselves. Sun Life, for example, is reportedly undertaking undergoing a major post-merger rebranding exercise focusing on the parent company's name (AXA).56 Similarly, Guardian Life Insurance Co. of America is expected to launch its first-ever corporate branding campaign next year, spending as much as four times its annual advertising budget of $2.5 million. Other firms looking to branding include Liberty Mutual Group, AXA/Equitable, and Aetna Life and Casualty.57 Meanwhile, the electric sector is if anything far more concerned with branding. The specter of competition in a field in which customers think of the product as a commodity has retailers scrambling to establish an appealing brand identity.

All too often, however, the resulting brand is shallow, based on nothing more meaningful than a catchy name.58 Electrofinance, especially a package incorporating renewable energy and energy efficiency, offers an alternative: a product with real benefits to the seller, the buyer, and the world at large. While the energy efficiency portion of the electrofinance plan is immediately profitable and practical, the PV component provides a vivid image with enormous public appeal—appeal that energy conservation has unfortunately never achieved. That image could be cast as the embodiment of an environmental imperative that recognizes the need to generate electricity without producing emissions that cause global warming or reduce air quality. In this respect, the consumer's PV purchase makes them part of a "club"—an emerging culture—that sees value and good in a pooled, international, solar-based approach to individual and collective financial, energy, and environmental security. To this end, a small margin or finders' fee to the PV companies could be assessed for a fund to provide PV systems in developing countries,59 or a checkoff on the monthly bill could use $1 of the electric savings in the same way.

Most important, the brand identity thus established would stand not only on a catchy name or a warm-and-fuzzy ad campaign, but also on a unique product that provided value to buyer and seller alike.

The Prize: Insurer Investment in PV Technology

Insurers' involvement in the use and promotion of PV technology could lead to deeper involvement in the development of the technology through investment. This might make sense for insurers for several reasons:

Indeed, some insurers have already begun to explore not just insurance-related aspects of PV technology but also investments to aid in the deployment of the technology as well. GAIA Kapital, which is funded by the Gerling Insurance Group and Swiss Re, has invested in the projects of SunLight Power International, which provides PV systems to people in developing nations by making long-term, low-interest loans available.62

In the United Kingdom, Guardian Royal Exchange's chief executive John Robbins has affirmed the importance of investing in renewable energy, and announced his firm's intention to install PV technology at its headquarters.63 Tim Mills, Director of Guardian Properties, said, "It's expensive at the moment but as an act of faith we are going to install photovoltaics on at least one of our properties. As a company we have decided to lead by example."64 Likewise, banking giant National Westminster has pledged to install PVs on one of its buildings.65

As of yet there has been no corresponding action by any U.S.-based insurers to investigate and install the technology. Representatives of some companies have begun to attend forums that highlight PVs as a disaster mitigation and recovery tool. From this meager beginning, perhaps it will be possible to elicit their interest to the point of offering an electrofinance program with a PV component and eventual investment in the technology.

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