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Will Tesla's Insurance Cost Offset The Gas Savings?

|About:Tesla Motors (TSLA)

Lately everybody talks about Tesla's (NASDAQ:TSLA) fire incidents. There were three separate incidents two of which happened in the US (one in Washington and one in Tennessee) as a result of hitting metal objects which apparently cut through the batteries of these cars. Luckily, no one died or seriously injured in these events, which is great for Tesla; however, if more of these fires start happening, insurance companies might start increasing their premium rates for Tesla owners, which can pretty much most if not all their gas-savings.

First, let me tell you this, when we currently look at all the available data in our hands, it is pretty much impossible to tell whether Tesla cars are more or less likely to catch fire than ICE cars. A lot of people look at the 19,000 Model S vehicles in traffic and the 3 fire incidents we know of and say that the chances of a Tesla catching fire is about 3 out of 19,000. Then, they compare these numbers to ICE figures which say that hundreds of gasoline cars catch fire every day. There are two problems with comparing the probability of a Tesla fire event to the probability of an ICE car fire event. First problem stems from the fact that not all ICE cars are created equal. The average ICE car in the US is 11 years old and a lot of these cars are cheaper models that are not well-maintained. Furthermore, a lot of ICE cars might be driven in small towns and rural areas where road conditions are less than perfect. On the other hand, average age of a Model S vehicle is less than 1 year old, and these cars are owned by wealthier people, which means that they are more likely to maintain their cars well and drive them in nicer roads.

The second problem with comparing the probability of a Tesla fire incident to probability of an ICE car fire incident is that we don't really know how many Teslas actually caught fire. I know that we saw 3 separate incidents that were photographed and made it to the media, but does that really mean those are the only incidents? There is really no way of us knowing unless the incident gets photographed, released on the internet and makes it to the media. Lately a lot of Tesla longs say that it is suspicious how we haven't seen any Tesla fire incidents for months but now we are seeing 3 incidents within a 6 week period. This doesn't mean that no fires happened before. This might simply mean that older fire incidents did not make it in the media. Lately, Tesla has been on the media more than usual and people have been paying more attention to Tesla fires in the recent weeks than they ever did.

Two months ago, no one might have thought of photographing a burning Tesla and posting it on Twitter, but now, people are more likely to photograph this incident and share it on the internet in order to make it on the evening news. In human psychology, when something becomes salient, people pay more attention to it and they start behaving on it more often. This is why we are more likely to see Tesla fire incidents being reported on the media in the future, but this doesn't mean that there were no incidents outside of the 3 we saw on the internet so far. Think about the incident in Mexico. We saw the photos of the incident 2 weeks after it has already happened and Tesla has been quiet about the incident until the photos made it in the media. If the photos never appeared, Tesla would have never made the incident known.

Since we can't really calculate the risk of a Tesla burning compared to an ICE car's risk of burning, all we can do is to speculate. On the other hand, insurance companies have more data than we do and they can conduct all kinds of risk analyses to determine how risky a car is for them. If we see more fire incidents, insurance companies will start seeing Tesla cars as a "high-risk" category.

So, what makes Tesla cars so expensive for insurance companies? Well, if a Ford driver has a bad accident and totals his car, the insurance company will take the car, give the owner a check. After this, the insurance company will try to get its money back in one of the two ways: 1) if the damage is not really, really bad, it will try to get the car fixed and sell it in the used-market, 2) if the car is badly damaged, it will try to salvage the good parts of the car and sell these parts separately in the parts-market. Usually, insurance companies will minimize their losses by selling whatever is left of a car after it gets totaled. In Tesla's case, we are looking at a different story. If a Tesla collides with a metal object and its battery starts burning, the insurance company doesn't have much to do in this case. It will have to write the car off as a total loss. Can the insurance company fix the burned up Tesla and sell it in the used-car market? It can't because the battery is the most expensive part of a Tesla and replacing it would cost the insurance company too much to make any money on it. Besides, this is not even practical since the contracted mechanics wouldn't have access to extra Model S batteries, neither would they know how to install it. The insurance company couldn't just sell parts of burned up Model S vehicles either because, 1) there isn't much of a market for Tesla parts since the volume of these cars is so small, and 2) most of a Model S car's parts are not that valuable once you take out the battery. Since Model S doesn't have many moving parts, it can't really have much of a parts-market.

So, if we see more fire incidents, the insurance companies will have no choice but to increase their premiums for Tesla owners. Of course in the worst case scenario, the insurance companies might even consider Model S cars as "uninsurable" and refuse to insure these cars altogether. In a more likely scenario, they will charge these cars so much in insurance premium that it will eat away all the gas-savings that came with these cars.

I know that most Tesla owners don't really care about gas savings since they tend to be pretty wealthy to begin with, but if Tesla wants to eventually sell 500,000 cars and go mainstream (possibly with its Gen III models), it will have to make its cars affordable. If a Tesla car will save me $200 in monthly gas savings but cost me $200 in extra insurance premiums, it makes little sense for me to buy this car unless I am a big-time environmentalist, which most people are not. This is something to think about.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long both call and put options of TSLA.

Stocks: TSLA