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LEMONADE, INC. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes and other information included elsewhere in this Quarterly Report, Annual Report on Form 10-K, and in our other filings with theSecurities and Exchange Commission ("SEC"). The discussion and analysis below includes forward-looking statements that are subject to risks, uncertainties and other factors described in the "Risk Factors" section of this Quarterly Report and our Annual Report on Form 10-K that could cause actual results to differ materially from such forward-looking statements. Additionally, our historical results are not necessarily indicative of the results that may be expected for any period in the future. Our Business Lemonade is rebuilding insurance from the ground up on a digital substrate and an innovative business model. By leveraging technology, data, artificial intelligence, contemporary design, and social impact, we believe we are making insurance more delightful, more affordable, and more precise. To that end, we have built a vertically-integrated company with wholly-owned insurance carriers inthe United States ,Europe , including theUnited Kingdom , and the full technology stack to power them. A brief chat with our bot, AI Maya, is all it takes to get covered with renters, homeowners, pet, car or life insurance, and we expect to offer a similar experience for other insurance products over time. Claims are filed by chatting with another bot, AI Jim, who pays claims in as little as three seconds. This breezy experience belies the extraordinary technology that enables it: a state-of-the-art platform that spans marketing to underwriting, customer care to claims processing, finance to regulation. Our architecture melds artificial intelligence with the human kind, and learns from the prodigious data it generates to become ever better at delighting customers and evaluating risk. In addition to digitizing insurance end-to-end, we also reimagined the underlying business model to minimize volatility while maximizing trust and social impact. To lessen the volatility inherent in an industry directly impacted by the weather, we utilize several forms of reinsurance, with the goal of dampening the impact on our gross margin. The result is that excess claims are generally offloaded to reinsurers, while excess premiums can be donated to nonprofits selected by our customers as part of our annual "Giveback". These two ballasts, reinsurance and Giveback, reduce volatility, while creating an aligned, trustful, and values-rich relationship with our customers.
Acquisition of
OnJuly 28, 2022 (the "Acquisition Date"), the Company completed the acquisition ofMetromile, Inc. ("Metromile"), a leading digital insurance platform inthe United States that offers real-time, personalized car insurance policies by the mile. The Company acquired 100% ofMetromile's equity through an all-stock transaction based upon the exchange ratio of 0.05263 shares of Lemonade for each outstanding share ofMetromile (the "Metromile Acquisition"). As a result of the Metromile Acquisition,Metromile stockholders received 6,901,934 shares of Lemonade's common stock, with minimal cash paid in lieu of fractional shares. In addition, the Company assumed all outstanding and unexercised options, and outstanding restricted stock units as of the Acquisition Date, which were converted into corresponding awards with substantially identical terms and conditions prior to the Acquisition Date, at the same exchange ratio of 0.05263. Our results of operations include those ofMetromile from the Acquisition Date throughMarch 31, 2023 . 25
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Key Factors and Trends Affecting our Operating Results
Our financial condition and results of operations have been, and will continue
to be, affected by a number of factors, including the following:
Seasonality
Seasonal patterns can impact both our rate of customer acquisition and the
incurrence of claims and losses.
Based on historical experience, existing and potential customers move more frequently in the third quarter, compared to the rest of the calendar year. As a result, we may see greater demand for new or expanded insurance coverage, and increased online engagement resulting in proportionately more growth during the third quarter. We expect that as we grow our customers, expand geographically, and launch new products, the impact of seasonal variability on our rate of growth may decrease. Additionally, seasonal weather patterns impact the level and amount of claims we receive. These patterns include hurricanes, wildfires, and coastal storms in the fall, cold weather patterns, and changing home heating needs in the winter, and tornados and hailstorms in the spring and summer. The mix of geographic exposure and products within our customer base impacts our exposure to these weather patterns.
Current Macroeconomic Environment
The global pandemic resulting from the coronavirus, including variants
("COVID-19") has severely impacted the global economy and caused a significant
slowdown in economic activity. While the global economy began to reopen in 2021,
there remains to be an uncertainty about the duration and macroeconomic impact
of COVID-19. Although the Company did not see a material impact on its results
of operations, management continues to monitor and cannot definitively determine
the ultimate financial impact of COVID-19, and the related economic conditions.
Our investment portfolio consists of high-quality securities, and we do not
expect a material adverse impact in the value of our investment portfolio, or
long-term negative impact on our financial condition, results of operations or
cash flows as it relates to COVID-19.
General economic inflation has increased and there is a risk of inflation
remaining elevated for an extended period. We anticipate the effects of
inflation impacting our investment portfolio, pricing of our products and in
estimating reserves for unpaid claims and claim expenses. The actual effects of
the current and potential future increase in inflation on our results remains to
be unknown and cannot be estimated with precision.
See "Risk Factors - Risks Relating to our Industry - Severe weather events and
other catastrophes, including the effects of climate change and global
pandemics, are inherently unpredictable and may have a material adverse effect
on our financial results and financial condition." in our Annual Report on Form
10-K.
Reinsurance
We obtain reinsurance to help manage our exposure to property and casualty
insurance risks. Although our reinsurance counterparties are liable to us
according to the terms of the reinsurance policies, we remain primarily liable
to our policyholders as the direct insurers on all risks reinsured, see "Risk
Factors - Risks Relating to Our Business" and "Risks relating to our Industry"
in our Annual Report on Form 10-K. As a result, reinsurance does not eliminate
the obligation of our insurance subsidiaries to pay all claims, and we are
subject to the risk that one or more of our reinsurers will be unable or
unwilling to honor its obligations, that the reinsurers will not pay in a timely
fashion, or that our losses are so large that they exceed the limits inherent in
our reinsurance contracts, each of which could have a material effect on our
results of operations and financial condition. Furthermore, reinsurance may be
unavailable at current levels and prices, which may limit our ability to write
new business.
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The Company maintained proportional reinsurance contracts which cover all of the
Company's products and geographies, and transferred, or "ceded," a specified
percentage of the premium to reinsurers ("Proportional Reinsurance Contracts").
In exchange, these reinsurers paid a ceding commission for every dollar ceded,
in addition to funding all of the corresponding claims at the same specified
percentage as applied to premium. The Company opted to manage the remaining
percentage of the business with alternative forms of reinsurance through
non-proportional reinsurance contracts ("Non-Proportional Reinsurance
Contracts").
The Company decreased the overall share of proportional reinsurance from 75% of
the premium to 70% effective July 1, 2021 , and to 55% effective July 1, 2022 . In
addition, we purchased a reinsurance program to protect us against natural
catastrophe risk in the U.S. that exceeds $80 million in losses effective July
1, 2022 . Other non-proportional reinsurance contracts were renewed with terms
similar to the expiring contracts.
Metromile entered into a Quota Share reinsurance agreement effective January 1,
2022 through June 30, 2023 . Under the terms of the agreement, the Company cedes
30% of premiums and losses to reinsurers.
Components of our Results of Operations
Revenue
Gross Written Premium
Gross written premium is the amount received, or to be received, for insurance policies written by us during a specific period of time without reduction for premiums ceded to reinsurance. Gross written premium includes direct and assumed premium. InDecember 2022 , we began assuming premium related to car insurance policies written inTexas , in connection with our fronting arrangement with a third party carrier inTexas . Following the Metromile Acquisition, we also include gross written premium from the sale of pay-per-mile auto insurance policies withinthe United States . The volume of our gross written premium in any given period is generally influenced by new business submissions, binding of new business submissions into policies, renewals of existing policies, and average size and premium rate of bound policies.
Ceded Written Premium
Ceded written premium is the amount of gross written premium ceded to reinsurers. We enter into reinsurance contracts to limit our exposure to potential losses as well as to provide additional capacity for growth. Ceded written premium is earned over the reinsurance contract period in proportion to the period of risk covered. The volume of our ceded written premium is impacted by the level of our gross written premium and any decision we make to increase or decrease reinsurance limits, retention levels, and co-participation. Our ceded written premium can also be impacted significantly in certain periods due to changes in reinsurance agreements. In periods where we start or stop ceding a large volume of our premium, ceded written premium may increase or decrease significantly compared to prior periods and these fluctuations may not be indicative of future trends.
Gross Earned Premium
Gross earned premium represents the earned portion of our gross written premium. Gross earned premium includes direct and assumed premium. Our insurance policies generally have a term of one year and premium is earned pro rata over the term of the policy. In addition, following the Metromile Acquisition, we also include earned premiums from the pay-per-mile auto insurance policies which is written for six-month terms. Premium for the policy provides a base rate per month for the entire policy term upon binding of the policy plus a per-mile rate multiplied by the miles driven each day (based on data from the telematics device, subject to a daily maximum).
Ceded Earned Premium
Ceded earned premium is the amount of gross earned premium ceded to reinsurers.
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Net Earned Premium
Net earned premium represents the earned portion of our gross written premium, less the earned portion that is ceded to third-party reinsurers under our reinsurance agreements. Premium is earned pro rata over the term of the policy, which is generally one year. Net earned premiums from the pay-per-mile auto insurance policies is earned over the term of the policy which is written for six-month terms. Ceding Commission Income Ceding commission income is commission we receive based on the premium ceded to third-party reinsurers to reimburse us for acquisition and underwriting expenses. We earn commissions on reinsurance premium ceded in a manner consistent with the recognition of the earned premium on the underlying insurance policies, on a pro-rata basis over the terms of the policies reinsured. The portion of ceding commission income which represents reimbursement of successful acquisition costs related to the underlying policies is recorded as an offset to other insurance expense.
Net Investment Income
Net investment income represents interest earned from fixed maturity securities, short term and other investments, and the gains or losses from the sale of investments, net of investment fees paid to the Company's investment manager. Our cash and invested assets are primarily comprised of fixed maturity securities, and may also include cash and cash equivalents, equity securities, and short-term investments. The principal factors that influence net investment income are the size of our investment portfolio and the yield on that portfolio. As measured by amortized cost (which excludes changes in fair value, such as changes in interest rates), the size of our investment portfolio is mainly a function of our invested equity capital along with premium we receive from our customers less payments on customer claims. Over time, we expect that net investment income will represent a more meaningful component of our results of operations. Commission and Other Income Commission income consists of commissions earned for policies placed with third-party insurance companies where we have no exposure to the insured risk. Such commission is recognized on the effective date of the associated policy which is when the performance obligation is completed. Other income primarily consists of fees collected from policyholders relating to installment premiums. These fees are recognized at the time each policy installment is billed.
Expense
Loss and Loss Adjustment Expense, Net
Loss and loss adjustment expense ("LAE"), net represent the costs incurred for
losses net of amounts ceded to reinsurers. We enter into reinsurance contracts
to limit our exposure to potential losses as well as to provide additional
capacity for growth. These expenses are a function of the size and term of the
insurance policies we write and the loss experience associated with the
underlying risks. Loss and LAE are based on an actuarial analysis of the
estimated losses, including losses incurred during the period and changes in
estimates from prior periods. Loss and LAE may be paid out over a period of
years. Certain policies we write are subject to catastrophe losses. Catastrophe
losses are losses resulting from events involving claims and policyholders,
including earthquakes, hurricanes, floods, storms, terrorist acts or other
aggregating events that are designated by internationally recognized
organizations, such as Property Claims Services, that track and report on
insured losses resulting from catastrophic events.
Other Insurance Expense
Other insurance expense consists primarily of amortization of commissions costs
and premium taxes incurred on the successful acquisition of business written on
a direct basis, and credit card processing fees not charged to our customers.
Other insurance expense also includes employee compensation, including
stock-based compensation and benefits, of our underwriting teams as well as
allocated occupancy costs and related overhead based on headcount. Other
insurance expense is offset by the portion of ceding commission income which
represents reimbursement of successful acquisition costs related to the
underlying policies.
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Sales and Marketing
Sales and marketing includes third-party marketing, advertising, branding,
public relations and sales expenses. Sales and marketing also includes
associated employee compensation, including stock-based compensation and
benefits, as well as allocated occupancy costs and related overhead based on
headcount. Sales and marketing costs are expensed as incurred.
We plan to continue to invest in sales and marketing to attract and acquire new customers and increase our brand awareness. We expect that, in the long-term, our sales and marketing costs will decrease as a percentage of revenue as we continue to drive customer acquisition efficiencies and as the proportion of renewals to our total business increases.
Technology development consists of employee compensation, including stock-based compensation and benefits, and expenses related to vendors engaged in product management, design, development and testing of our websites and products. Technology development also includes allocated occupancy costs and related overhead based on headcount. We expense technology development costs as incurred, except for costs that are capitalized related to internal-use software development projects and subsequently depreciated over the expected useful life of the developed software. We expect product technology development costs, a portion of which will be capitalized, to continue to grow in the foreseeable future as we identify opportunities to invest in the development of new products and internal tools and enhancement of our existing products and technologies that we believe will drive the long-term profitability of the business.
General and Administrative
General and administrative includes employee compensation, including stock-based compensation and benefits for executive, finance, accounting, legal, business operations, and other administrative personnel. In addition, general and administrative includes outside professional services, non-income based taxes, insurance, charitable donations, bad debt expense and allocated occupancy costs and related overhead based on headcount. Depreciation and amortization expense is also recorded as a component of general and administrative. We expect to incur incremental general and administrative costs to support our global operational growth and enhancements to support our reporting and planning functions. We have incurred and expect to continue to incur significant additional general and administrative expense as a result of operating as a public company, including expenses related to compliance with the rules and regulations of theSEC and the listing standards of theNew York Stock Exchange , additional corporate, director and officer insurance expenses, greater investor relations expenses and increased legal, audit and consulting fees.
Income Tax Expense
Our provision for income taxes consists primarily of foreign income taxes related to income generated by our subsidiaries organized under the laws ofthe Netherlands andIsrael . As we expand the scale of our international business activities, any changes in theU.S. and foreign taxation of such activities may increase our overall provision for income taxes in the future. We have a valuation allowance for ourU.S. deferred tax assets, including federal and state net operating losses. We expect to maintain this valuation allowance until it becomes more likely than not, that the benefit of our federal and state deferred tax assets will be realized through expected future taxable income inthe United States . 29 --------------------------------------------------------------------------------
Key Operating and Financial Metrics
We regularly review a number of metrics, including the following key operating and financial metrics, to evaluate our business, measure our performance, identify trends in our business, prepare financial projections and make strategic decisions. We believe these non-GAAP and operational measures are useful in evaluating our performance, in addition to our financial results prepared in accordance with GAAP. See "-Non-GAAP Financial Measures" for additional information on non-GAAP financial measures and a reconciliation to the most directly comparable financial measures prepared in accordance withU.S. generally accepted accounting principles ("GAAP"). The following table sets forth these metrics as of and for the periods presented: Three Months Ended March 31, 2023 2022 ($ in millions, except Premium per customer) Customers (end of period) 1,856,012 1,504,197 In force premium (end of period)$ 653.3 $ 419.0 Premium per customer (end of period) $ 352$ 279 Annual dollar retention (end of period) 87 % 82 % Total revenue$ 95.2 $ 44.3 Gross earned premium$ 154.2 $ 96.0 Gross profit$ 16.5 $ 10.2 Adjusted gross profit$ 20.6 $ 16.3 Net loss$ (65.8) $ (74.8) Adjusted EBITDA$ (50.8) $ (57.4) Gross profit margin 17 % 23 % Adjusted gross profit margin 22 % 37 % Ratio of Adjusted Gross Profit to Gross Earned Premium 13 % 17 % Gross loss ratio 87 % 90 % Net loss ratio 93 % 89 % Customers We define customers as the number of current policyholders underwritten by us or placed by us with third-party insurance partners (who pay us recurring commissions) as of the period end date. A customer that has more than one policy counts as a single customer for the purposes of this metric. We view customers as an important metric to assess our financial performance because customer growth drives our revenue, expands brand awareness, deepens our market penetration, creates additional upsell and cross-sell opportunities, and generates additional data to continue to improve the functioning of our platform.
In Force Premium
We define in force premium ("IFP"), as the aggregate annualized premium for
customers as of the period end date. At each period end date, we calculate IFP
as the sum of:
i)In force written premium - the annualized premium of in force policies
underwritten by us; and
ii)In force placed premium - the annualized premium of in force policies placed
with third party insurance companies for which we earn a recurring commission
payment. In force placed premium currently reflects approximately 1% of IFP.
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The annualized value of premiums is a legal and contractual determination made
by assessing the contractual terms with our customers. The annualized value of
contracts is not determined by reference to historical revenues, deferred
revenues or any other GAAP financial measure over any period. IFP is not a
forecast of future revenues nor is it a reliable indicator of revenue expected
to be earned in any given period. We believe that our calculation of IFP is
useful to analysts and investors because it captures the impact of growth in
customers and premium per customer at the end of each reported period, without
adjusting for known or projected policy updates, cancellations, rescissions, and
non-renewals. We use IFP because we believe it gives our management useful
insight into the total reach of our platform by showing all in force policies
underwritten and placed by us. Other companies, including companies in our
industry, may calculate IFP differently or not at all, which reduces the
usefulness of IFP as a tool for comparison.
Premium per customer
We define premium per customer as the average annualized premium customers pay for products underwritten by us or placed by us with third-party insurance partners. We calculate premium per customer by dividing IFP by customers. We view premium per customer as an important metric to assess our financial performance because premium per customer reflects the average amount of money our customers spend on our products, which helps drive strategic initiatives.
Annual Dollar Retention
We define Annual Dollar Retention ("ADR"), as the percentage of IFP retained
over a twelve month period, inclusive of changes in policy value, changes in
number of policies, changes in policy type, and churn. To calculate ADR we first
aggregate the IFP from all active customers at the beginning of the period and
then aggregate the IFP from those same customers at the end of the period. ADR
is then equal to the ratio of ending IFP to beginning IFP. We believe that our
calculation of ADR is useful to analysts and investors because it captures our
ability to retain customers and sell additional products and coverage to them
over time. We view ADR as an important metric to measure our ability to provide
a delightful end-to-end customer experience, satisfy our customers' evolving
insurance needs and maintain our customers' trust in our products. Our customers
become more valuable to us every year they continue to subscribe to our
products. Other companies, including companies in our industry, may calculate
ADR differently or not at all, which reduces the usefulness of ADR as a tool for
comparison.
Gross Earned Premium
Gross earned premium is the earned portion of our gross written premium. Gross
earned premium includes direct and assumed premium. In December 2022 , we began
assuming premium related to car insurance policies written in Texas , in
connection with our fronting arrangement with a third party carrier in Texas ,
and this did not impact the key performance indicators prior to fourth quarter
of 2022.
We use this operating metric as we believe it gives our management and other
users of our financial information useful insight into the gross economic
benefit generated by our business operations and allows us to evaluate our
underwriting performance without regard to changes in our underlying reinsurance
structure. See "- Components of Our Results of Operations - Revenue - Gross
Earned Premium."
Unlike net earned premium, gross earned premium excludes the impact of premiums
ceded to reinsurers, and therefore should not be used as a substitute for net
earned premium, total revenue, or any other measure presented in accordance with
GAAP.
Gross Profit
Gross profit is calculated in accordance with GAAP as total revenue less loss
and loss adjustment expense, net, other insurance expense, and depreciation and
amortization (allocated to cost of revenue).
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Adjusted Gross Profit
We define adjusted gross profit, a non-GAAP financial measure, as:
•Gross profit, excluding net investment income and interest income and expense,
plus
•Employee-related costs, plus
•Professional fees and other, plus
•Depreciation and amortization (allocated to cost of revenue).
•See "- Non-GAAP Financial Measures" for a reconciliation of total revenue to
adjusted gross profit.
Adjusted EBITDA We define adjusted EBITDA, a non-GAAP financial measure, as net loss excluding the impact of income tax expense, depreciation, amortization, stock-based compensation, interest income and expense, net investment income, change in fair value of warrants liability, fair value adjustment on reserves for loss and loss adjustment expenses relating to the Metromile Acquisition, and other non-cash adjustments and other transactions that we consider to be unique in nature. See "- Non-GAAP Financial Measures" for a reconciliation of net loss to adjusted EBITDA in accordance with GAAP.
Gross Profit Margin
We define gross profit margin, expressed as a percentage, as the ratio of gross
profit to total revenue.
Adjusted Gross Profit Margin We define adjusted gross profit margin, a non-GAAP financial measure, expressed as a percentage, as the ratio of adjusted gross profit to total revenue. See "- Non-GAAP Financial Measures."
Ratio of Adjusted Gross Profit to Gross Earned Premium
We define Ratio of Adjusted Gross Profit to Gross Earned Premium, a non-GAAP financial measure, expressed as a percentage, as the ratio of adjusted gross profit to gross earned premium. Our Ratio of Adjusted Gross Profit to Gross Earned Premium provides management with useful insight into our operating performance. See "- Non-GAAP Financial Measures."
Gross Loss Ratio
We define gross loss ratio, expressed as a percentage, as the ratio of losses
and loss adjustment expense to gross earned premium.
Net Loss Ratio
We define net loss ratio, expressed as a percentage, as the ratio of losses and
loss adjustment expense, less amounts ceded to reinsurers, to net earned
premium.
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Results of Operations
Comparison of the Three Months Ended
Three Months Ended March 31,
2023 2022 Change % Change
($ in millions)
Revenue
Net earned premium $ 68.2 $ 27.4 $ 40.8 149 %
Ceding commission income 17.2 14.0 3.2 23 %
Net investment income 5.0 0.9 4.1 456 %
Commission and other income 4.8 2.0 2.8 140 %
Total revenue 95.2 44.3 50.9 115 %
Expense
Loss and loss adjustment expense, net 63.6 24.4 39.2 161 %
Other insurance expense 13.6 9.1 4.5 49 %
Sales and marketing 28.2 38.3 (10.1) (26 %)
Technology development 21.8 16.9 4.9 29 %
General and administrative 32.7 28.2 4.5 16 %
Total expense 159.9 116.9 43.0 37 %
Loss before income taxes (64.7) (72.6) 7.9 (11 %)
Income tax expense 1.1 2.2 (1.1) (50 %)
Net loss $ (65.8) $ (74.8) $ 9.0 (12 %)
Net Earned Premium
Net earned premium increased $40.8 million , or 149%, to $68.2 million for the
three months ended March 31, 2023 compared to the three months ended March 31,
2022 , primarily due to the earning of increased gross written premium and
increased retention of ceded written premium under our Proportional Reinsurance
Contracts as discussed above under "Reinsurance".
Three Months Ended March 31,
2023 2022 Change % Change
($ in millions)
Gross written premium $ 164.0 $ 110.6 $ 53.4 48 %
Ceded written premium (81.3) (75.6) (5.7) 8 %
Net written premium $ 82.7 $ 35.0 $ 47.7 136 %
Gross written premium increased $53.4 million , or 48%, to $164.0 million for the
three months ended March 31, 2023 compared to the three months ended March 31,
2022 . The increase was primarily due to a 23% increase in net added customers
year over year driven by the success of our digital advertising campaigns. We
also continued to expand our geographic footprint and product offerings. In
addition, we also saw a 26% increase in premium per customer year over year due
to an increasing prevalence of multiple policies per customer, growth in the
overall average policy value, and continued shift in the mix of underlying
products toward higher value policies. Assumed premium related to car insurance
policies written in Texas from our fronting arrangement with a third party
carrier in Texas which began in December 2022 also contributed to the increase
in gross written premium during the period.
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Ceded written premium increased $5.7 million , or 8%, to $81.3 million for the
three months ended March 31, 2023 compared to the three months ended March 31,
2022 , primarily due to growth in business across all products offset by a
reduction in the participation under our Proportional Reinsurance Contracts .
The Company decreased the overall share of proportional reinsurance from 75% of
premium to 70% effective July 1, 2021 , and to 55% effective July 1, 2022 . The
Company also purchased a reinsurance program to protect against natural
catastrophe risk in the U.S that exceed $80 million in losses effective July 1,
2022 . Other non-proportional reinsurance contracts were renewed with terms
similar to the expired contracts.
Net written premium increased $47.7 million , or 136%, to $82.7 million for the
three months ended March 31, 2023 compared to the three months ended March 31,
2022 . The increase was primarily due to the $53.4 million , or 48%, increase in
gross written premium offset by the increase in ceded written premium of $5.7
million , or 8%, for the three months ended March 31, 2023 , as compared to the
three months ended March 31, 2022 .
The table below shows the amount of premium we earned on a gross and net basis.
Ceded earned premium as a percentage of gross earned premium decreased to
approximately 56% for the three months ended March 31, 2023 , as compared to
approximately 71% for the three months ended March 31, 2022 primarily due to the
change in proportional reinsurance contracts.
Three Months Ended March 31,
2023 2022 Change % Change
($ in millions)
Gross earned premium $ 154.2 $ 96.0 $ 58.2 61 %
Ceded earned premium (86.0) (68.6) (17.4) 25 %
Net earned premium $ 68.2 $ 27.4 $ 40.8 149 %
Ceding Commission Income
Ceding commission income increased $3.2 million , or 23%, to $17.2 million for
the three months ended March 31, 2023 compared to the three months ended March
31, 2022 , consistent with the increase in ceded earned premium related to the
proportional reinsurance contracts with third-party reinsurers during the
period.
Net Investment Income
Net investment income amounted to$5.0 million for the three months endedMarch 31, 2023 and$0.9 million for the three months endedMarch 31, 2022 . The increase was primarily driven by the diversification of the Company's investment portfolio with higher returns, offset by investment expenses of$0.1 million . We mainly invest in cash, money market funds,U.S. Treasury bills, corporate debt securities, asset-backed securities, notes and other obligations issued or guaranteed by theU.S. Government .
Commission and Other Income
Commission and other income increased$2.8 million , or 140%, to$4.8 million for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 , due to growth in premiums placed with third-party insurance companies during the period and an increase in installment fees billed.
Loss and Loss Adjustment Expense, Net
Loss and LAE, net increased$39.2 million , or 161%, to$63.6 million for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 . The increase was primarily in line with growth in premium, increase in net retained losses due to the change in participation in proportional reinsurance contract, and increased claims costs due to impact of inflation. During first quarter of 2023, net incurred losses included$0.3 million due to Hurricane Ian,$9.6 million due to winter storm Elliott and$0.9 million from the tornados that impacted customers from the Southeast. 34 --------------------------------------------------------------------------------
Other Insurance Expense
Other insurance expense increased$4.5 million , or 49%, to$13.6 million for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 consistent with growth in earned premium. Professional fees and other services increased$2.1 million , or 84%, primarily in support of growth and expansion initiatives. Amortization of deferred acquisition costs, net of ceding commissions increased$1.6 million , or 200%. Credit card processing fees increased$0.9 million , or 45%, as a result of the increase in customers and associated premium. Employee-related expense, including stock-based compensation decreased by$0.1 million , or 3%, as compared to the three months endedMarch 31, 2022 . Sales and Marketing Sales and marketing expense decreased$10.1 million , or 26%, to$28.2 million for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 . Expense related to advertising and other customer acquisition channels decreased$9.6 million , or 37%, as compared to the three months endedMarch 31, 2022 . Software expenses decreased by$0.4 million , or 100%, as compared to the three months endedMarch 31, 2022 . Partner payments increased by$0.4 million , or 133% as compared to the three months endedMarch 31, 2022 due to increased customers and premiums during the period.
Technology development expense increased$4.9 million , or 29%, to$21.8 million for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 . Employee-related expense, including stock-based compensation, and net of capitalized costs for the development of internal-use software, increased$2.4 million , or 17%, as compared to the three months endedMarch 31, 2022 , driven by an increase in payroll expense for product, engineering, design and quality assurance personnel to support our continued growth and product development initiatives, including automation, improvement in machine learning and geographic expansion. Hosting and development costs also increased by$1.5 million , or 107%, as compared to three months endedMarch 31, 2022 consistent with growth of business. General and Administrative General and administrative expense increased$4.5 million , or 16%, to$32.7 million for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 . Depreciation expense increased$3.7 million , or 247%. Employee-related expense, including stock-based compensation, increased$1.9 million , or 15%, as we increased finance, legal, business operations and administrative personnel. Software costs increased$0.8 million , or 67%, as compared to three months endedMarch 31, 2022 . Bad debt expense increased$0.3 million , or 15% as compared to three months endedMarch 31, 2022 . Legal, accounting and other professional fees decreased$2.6 million , or 43%, compared to three months endedMarch 31, 2022 . Insurance expense decreased$0.7 million , or 28%. Income Tax Expense Income tax expense decreased$1.1 million , or 50%, to$1.1 million for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 due to increased tax liability primarily related to change in profit before tax of our subsidiary inIsrael and uncertain tax positions.
Net Loss
Net loss decreased$9.0 million , or 12%, to$65.8 million for the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 due to the factors described above. 35 --------------------------------------------------------------------------------
Non-GAAP Financial Measures
The non-GAAP financial measures below have not been calculated in accordance with GAAP and should be considered in addition to results prepared in accordance with GAAP and should not be considered as a substitute for, or superior to, GAAP results. In addition, adjusted gross profit and adjusted gross profit margin, ratio of adjusted gross profit to gross earned premium, and adjusted EBITDA should not be construed as indicators of our operating performance, liquidity or cash flows generated by operating, investing and financing activities, as there may be significant factors or trends that they fail to address. We caution investors that non-GAAP financial information, by its nature, departs from traditional accounting conventions. Therefore, its use can make it difficult to compare our current results with our results from other reporting periods and with the results of other companies. Our management uses these non-GAAP financial measures, in conjunction with GAAP financial measures, as an integral part of managing our business and to, among other things: (i) monitor and evaluate the performance of our business operations and financial performance; (ii) facilitate internal comparisons of the historical operating performance of our business operations; (iii) facilitate external comparisons of the results of our overall business to the historical operating performance of other companies that may have different capital structures and debt levels; (iv) review and assess the operating performance of our management team; (v) analyze and evaluate financial and strategic planning decisions regarding future operating investments; and (vi) plan for and prepare future annual operating budgets and determine appropriate levels of operating investments.
Adjusted Gross Profit and Adjusted Gross Profit Margin
We define adjusted gross profit, a non-GAAP financial measure, as gross profit excluding net investment income, interest income, plus fixed costs and overhead associated with our underwriting operations including employee-related expense and professional fees and other, and depreciation and amortization allocated to cost of revenue. After these adjustments, the resulting calculation is inclusive of only those variable costs of revenue incurred on the successful acquisition of business and without the volatility of investment income. We use adjusted gross profit as a key measure of our progress towards profitability and to consistently evaluate the variable contribution to our business from underwriting operations from period to period.
We define adjusted gross profit margin, a non-GAAP financial measure, expressed
as a percentage, as the ratio of adjusted gross profit to total revenue.
The following table provides a reconciliation of total revenue and gross profit
margin to adjusted gross profit and the related adjusted gross profit margin,
respectively for the periods presented:
Three Months Ended March 31,
2023 2022
($ in millions)
Total revenue $ 95.2 $ 44.3
Adjustments:
Loss and loss adjustment expense, net $ (63.6) $ (24.4)
Other insurance expense (13.6) (9.1)
Depreciation and amortization (1.5) (0.6)
Gross profit $ 16.5 $ 10.2
Gross profit margin (% of total revenue) 17 % 23 %
Adjustments:
Net investment income $ (5.0) $ (0.9)
Interest income (0.7) -
Employee-related expense 3.8 3.9
Professional fees and other 4.5 2.5
Depreciation and amortization 1.5 0.6
Adjusted gross profit $ 20.6 $ 16.3
Adjusted gross profit margin (% of total revenue) 22 % 37 %
36
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Ratio of Adjusted Gross Profit to Gross Earned Premium
The Ratio of Adjusted Gross Profit to Gross Earned Premium measures the relationship between the underlying business volume and gross economic benefit generated by our underwriting operations, on the one hand, and our underlying profitability trends, on the other. We rely on this measure, which supplements our gross profit ratio as calculated in accordance with GAAP, because it provides management with insight into our underlying profitability trends over time. We use gross earned premium as the denominator in calculating this ratio, which excludes the impact of premiums ceded to reinsurers, because we believe that it reflects the business volume and the gross economic benefit generated by our underlying underwriting operations, which in turn are the key drivers of our future profit opportunities. We exclude the impact of ceded premiums from the denominator because ceded premiums can change rapidly and significantly based on the type and mix of reinsurance structures we use and, therefore, add volatility that is not indicative of our underlying profitability. For example, a shift to a proportional reinsurance arrangement would result in an increase in ceded premium, with offsetting benefits to gross profit from ceded losses and ceding commissions earned, resulting in a nominal overall economic impact. This shift would result in a steep decline in total revenue with a corresponding spike in gross margin, whereas we expect that the Ratio of Adjusted Gross Profit to Gross Earned Premium would remain relatively unchanged. We expect our reinsurance structure to evolve along with our costs and capital requirements, and we believe that our reinsurance structure at a given time does not reflect the performance of our underlying underwriting operations, which we expect to be the key driver of our costs of reinsurance over time. On the other hand, the numerator, which is adjusted gross profit, includes the net impact of all reinsurance, including ceded premiums and the benefits of ceded losses and ceding commissions earned. Because our reinsurance structure is a key component of our risk management and a key driver of our profitability or loss in a given period, we believe this is meaningful. Therefore, by providing this Ratio of Adjusted Gross Profit to Gross Earned Premium for a given period, we are able to assess the relationship between business volume and profitability, while eliminating the volatility from the cost of our then-current reinsurance structure, which is driven primarily by the performance of our insurance underwriting platform rather than our business volume.
The following table sets forth our calculation of the Ratio of Adjusted Gross
Profit to Gross Earned Premium for the periods presented:
Three Months Ended March 31,
2023 2022
($ in millions)
Numerator: Adjusted gross profit $ 20.6 $ 16.3
Denominator: Gross earned premium $ 154.2 $ 96.0
Ratio of Adjusted Gross Profit to Gross Earned Premium 13 % 17 %
Adjusted EBITDA
We define adjusted EBITDA, a non-GAAP financial measure, as net loss excluding
interest income and expense, income tax expense, depreciation, amortization,
stock-based compensation, net investment income, change in fair value of
warrants liability, amortization of fair value adjustment on insurance contract
intangible liability relating to the Metromile Acquisition, and other non-cash
adjustments and other transactions that we would consider to be unique in
nature. We exclude these items from adjusted EBITDA because we do not consider
them to be directly attributable to our underlying operating performance. We use
adjusted EBITDA as an internal performance measure in the management of our
operations because we believe it gives our management and other customers of our
financial information useful insight into our results of operations and our
underlying business performance. Adjusted EBITDA should not be viewed as a
substitute for net loss calculated in accordance with GAAP, and other companies
may define adjusted EBITDA differently.
37
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The following table provides a reconciliation of adjusted EBITDA to net loss for
the periods presented:
Three Months Ended March 31,
2023 2022
($ in millions)
Net loss $ (65.8) $ (74.8)
Adjustments:
Income tax expense $ 1.1 $ 2.2
Depreciation and amortization 5.2 1.5
Stock-based compensation 15.4 14.1
Transaction and integration costs from Metromile acquisition - 0.5
Interest (income) expense, net (0.7) -
Net investment income (5.0) (0.9)
Change in fair value of warrants liability (0.3) -
Amortization of fair value adjustment on insurance contract
intangible liability relating to the
(0.7) - Adjusted EBITDA$ (50.8) $ (57.4) 38
--------------------------------------------------------------------------------
Liquidity and Capital Resources
As ofMarch 31, 2023 , we had$250.1 million in cash and cash equivalents, and$737.9 million in investments. From the date we commenced operations, we have generated negative cash flows from operations, and we have financed our operations primarily through private and public sales of equity securities. Our principal sources of funds are insurance premiums, investment income, reinsurance recoveries and proceeds from the maturity and sale of invested assets. These funds are primarily used to pay claims, operating expenses and taxes. We believe our existing cash and cash equivalents as ofMarch 31, 2023 will be sufficient to meet our working capital, liquidity and capital expenditures needs over at least the next 12 months. However, this is subject, to a certain extent, on general economic, financial, competitive, regulatory and other factors that are beyond our control.
Our cash flows used in operations may differ substantially from our net loss due
to non-cash charges or due to changes in balance sheet accounts.
The timing of our cash flows from operating activities can also vary among periods due to the timing of payments made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be significant. Therefore, their timing can influence cash flows from operating activities in any given period. The potential for a large claim under an insurance or reinsurance contract means that our insurance subsidiaries may need to make substantial payments within relatively short periods of time, which would have a negative impact on our operating cash flows. We are a holding company that transacts a majority of our business through operating subsidiaries. Consequently, our ability to pay dividends to stockholders, meet debt payment obligations and pay taxes and operating expenses is largely dependent on dividends or other distributions from our subsidiaries and affiliates, whose ability to pay us is highly regulated. OurU.S. and Dutch insurance company subsidiaries, and our Dutch insurance holding company, are restricted by statute as to the amount of dividends that they may pay without the prior approval of their respective competent regulatory authorities. As ofMarch 31, 2023 , cash and investments held by these companies was$357.8 million , of which$148 million is held as regulatory surplus. Insurance companies inthe United States are also required by state law to maintain a minimum level of policyholder's surplus. Insurance regulators in the states in which we operate have a risk-based capital standard designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of the insurer's assets and liabilities and its mix of net written premium. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. As ofMarch 31, 2023 , the total adjusted capital of ourU.S. insurance subsidiaries was in excess of its respective prescribed risk-based capital requirements. The following table summarizes our cash flow data for the periods presented: Three Months Ended March 31, 2023 2022 ($ in millions) Net cash used in operating activities$ (46.4) $ (39.5) Net cash provided by investing activities $ 15.3$ 4.1 Net cash provided by financing activities $ 0.1$ 0.6 Operating Activities Cash used in operating activities was$46.4 million for the three months endedMarch 31, 2023 , an increase of$6.9 million from$39.5 million for the three months endedMarch 31, 2022 . This reflected the$9.0 million decrease in our net loss, primarily offset by changes in our operating assets and liabilities. The increase in cash used in operating activities from the three months endedMarch 31, 2023 compared to the three months endedMarch 31, 2022 was primarily due to claim payments, settlements with our reinsurance partners, and increased spend related to growth and expansion, offset by collection of premiums and recoveries from reinsurance partners. 39 -------------------------------------------------------------------------------- Cash used in operating activities was$39.5 million for the three months endedMarch 31, 2022 . This reflected our net loss of$74.8 million , partially offset by non-cash charges and net cash provided by changes in our operating assets and liabilities. Non-cash charges primarily consisted of non-cash stock-based compensation. Net cash provided by changes in operating assets and liabilities primarily consisted of increases in unearned premiums, unpaid loss and loss adjustment expense, funds held and accrued and other liabilities partially offset by increases in prepaid reinsurance, premiums receivables and amounts expected to be recovered from our reinsurance partners, and increased spend related to growth and expansion.
Investing Activities
Cash provided by investing activities was$15.3 million for the three months endedMarch 31, 2023 primarily due to proceeds from sales and maturities ofU.S. government obligations, corporate debt securities, asset-backed securities, short term investments offset by purchases ofU.S. government obligations, corporate debt securities, asset-backed securities, short term investments. We also purchased property and equipment during the period. Cash used in investing activities was$4.1 million for the three months endedMarch 31, 2022 primarily due to proceeds from sales and maturities of fixed maturities and short term investments offset by purchases of fixed maturities and short term investments. We also purchased property and equipment during the period. Financing Activities
Cash provided by financing activities was
ended
Cash provided by financing activities was
ended
We do not have any current plans for material capital expenditures other than current operating requirements. There have been no material changes as ofMarch 31, 2023 to our contractual obligations from those described in our Annual Report on Form 10-K. To the extent our future operating cash flows are insufficient to cover our net losses from catastrophic events, we had$992.7 million in cash and cash equivalents, and investments available atMarch 31, 2023 . We may also seek to raise additional capital through third-party borrowings, sales of our equity, issuance of debt securities or entrance into new reinsurance arrangements. There can be no assurance that we will be able to raise additional capital on favorable terms or at all. 40 --------------------------------------------------------------------------------
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with GAAP inthe United States . The preparation of the consolidated financial statements in conformity with accounting principles generally accepted inthe United States requires our management to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the period. We evaluate our significant estimates on an ongoing basis, including, but not limited to, estimates related to unpaid loss and loss adjustment expense, reinsurance assets, intangible assets, stock-based compensation prior to the Company's IPO, income tax assets and liabilities, including recoverability of our net deferred tax asset, income tax provisions and certain non-income tax accruals. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. Our critical accounting policies are described under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" in our Annual Report on Form 10-K and the notes to the unaudited interim condensed consolidated financial statements appearing elsewhere in this Quarterly Report. During the three months endedMarch 31, 2023 , there were no material changes to our critical accounting policies from those discussed in our Annual Report on Form 10-K.
Recently Issued and Adopted Accounting Pronouncements
See "Note 4 - Summary of Significant Accounting Policies" in the notes to the
unaudited condensed consolidated financial statements included elsewhere in this
Quarterly Report for a discussion of new accounting pronouncements.
41
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REINSURANCE GROUP OF AMERICA INC – 10-Q – MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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