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ROOT, INC. – 10-K – 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 included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from such forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those identified below and those discussed in the sections titled "Risk Factors" and "Special Note Regarding Forward-Looking Statements" included elsewhere in this Annual Report. Additionally, our historical results are not necessarily indicative of the results that may be expected for any period in the future. This Management's Discussion and Analysis does not discuss 2019 performance or a comparison of 2020 versus 2019 performance for select areas where we have determined the omitted information is not necessary to understand our current period financial condition, changes in our financial condition, or our results. The omitted information may be found in our Annual Report on Form 10-K for the year endedDecember 31, 2020 filed with theSecurities and Exchange Commission , or theSEC , onMarch 4, 2021 . Overview Root is a technology company revolutionizing personal insurance with a pricing model based upon fairness and a modern customer experience. We operate primarily a direct-to-consumer model in which we currently acquire the majority of our customers through mobile applications. We believe the Root advantage is derived from our unique ability to efficiently and effectively bind auto insurance policies quickly, aided by segmenting individual risk based on complex behavioral data and proprietary telematics, a customer experience built for ease of use and a product offering made possible with our full-stack insurance structure. These are all uniquely integrated into a single cloud-based technology platform that captures the entire insurance value chain-from customer acquisition to underwriting to claims and administration to ongoing customer engagement.
Our model benefits from portfolio maturity. As we scale the business, our
results are disproportionately weighted towards new customers compared to
traditional insurance carriers. As we build an underlying base of recurring
customers, we expect the following financial impacts:
•Improved loss ratio. Renewal premiums, referring to premiums from a customer's second term and beyond, have lower loss ratios as compared to new premiums in the customer's first term. As we grow our business, we anticipate, consistent with industry norms, that a greater proportion of our premiums will be from customer renewals and drive down the loss ratio across our portfolio. •Reduced marketing as a percentage of premium. Recurring customer premiums have no associated customer acquisition costs and minimal underwriting costs, driving profitability. As we grow our business, we anticipate, consistent with industry norms, that a greater proportion of our premiums will be from customer renewals without associated marketing costs. •Improved retention. As a young insurance carrier weighted towards new customers, we naturally have a higher percentage of more frequent shoppers. As our business tenures and our flywheel spins, allowing us to increase our pricing advantage, we will have the opportunity to acquire more long-standing customers and retain those that might naturally shop frequently. In addition to our pricing advantage, we anticipate our expanding relationships with customers through product bundling will demonstrate further improvement in retention.
•Increased revenue per customer. Our product expansion provides an opportunity
to generate additional premium and fee income per customer without material
incremental marketing cost.
We use technology to drive efficiency across all functions, including
distribution, underwriting, policy administration and claims in particular. We
believe this allows us to operate with a cost to acquire and cost to serve
advantage. We continue to develop machine learning loss models, which allows us
to respond more quickly to changes in the market, improve pricing segmentation
through enhancements to our UBI model and take appropriate rate actions. We
efficiently acquire customers directly through multiple channels, including
embedded, digital
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(performance), channel media, referrals and agency. Our marketing costs have
historically been well below industry averages, although in any given period,
these costs can vary by channel mix, by state, or due to seasonality or due to
the competitive environment. Today, we acquire the vast majority of our
customers through our mobile app and mobile website. We believe that through
prudent investment in and diversification of our marketing channels, including a
focus on embedded insurance through our exclusive partnership with Carvana, and
leveraging proprietary data science and technology to build out independent
agent products and relationships, will position us for more sustainable,
long-term and profitable growth. Additionally, we are realizing operating
efficiencies as we scale against our fixed expense base. Our claims management
expenses, as represented by our loss adjustment expenses, or LAE, are in line
with peers within only three years of bringing claims management in-house and we
expect to improve as we further embed machine learning into our processes.
We also use our proprietary technology to measure long-term benefits to our
business. When a state reaches certain maturation thresholds, we refer to it as
a seasoned state. A seasoned state is defined as a state where (1) the regulator
has approved our data science-driven telematics and pricing models and (2) we
have been writing policies in the state for a minimum of one year with a minimum
of two pricing filings.
As a full-stack insurance company, we currently employ a "capital-light" model,
which utilizes a variety of reinsurance structures at elevated levels of
reinsurance. These reinsurance structures deliver three core objectives (1)
top-line growth without a commensurate increase in regulatory capital
requirements, (2) support of customer acquisition costs and (3) protection from
outsized losses or tail events. We expect to maintain an elevated level of
third-party quota share reinsurance while rapidly growing our business in order
to operate a capital-light business model. As our business scales, we expect to
have the flexibility to reduce our quota share levels to maximize the return to
shareholders.
In August 2021 , we commenced a fronting arrangement with an unaffiliated Texas
county mutual insurance company, or the fronting carrier. Pursuant to this
arrangement, we route all of our new auto policies and, over time, expect to
route certain renewal auto policies, in Texas through the fronting carrier. In
exchange for a commission paid to the fronting carrier, we assume 100% of the
related premium and losses on those policies. Through this fronting arrangement,
we have greater rating and underwriting flexibility that we believe will allow
us to more accurately segment risk in Texas to improve profitability.
Given the significant impact of reinsurance on our results of operations, we use
certain gross basis key performance indicators to manage and measure our
business operations and enhance investor understanding of our business model
prior to reinsurance. We believe our long-term success will be apparent through
the progression of our gross metrics. Results of operations on a gross basis
alone are not achievable under our regulatory landscape given our top-line
growth and resulting capital requirements, which are relieved, in part, by
obtaining reinsurance. The gross metrics include gross written premium, gross
earned premium, direct contribution, ratio of direct contribution to gross
earned premium, gross loss ratio, gross LAE ratio and gross accident period loss
ratio. For additional information, including definitions of these key metrics,
see "- Key Performance Indicators" and for a reconciliation of direct
contribution to the most directly comparable generally accepted accounting
principles in the United States , or GAAP, metric, see "- Non-GAAP Financial
Measures."
Key Factors and Trends Affecting our Operating Performance
Our financial condition and results of operations have been, and will continue
to be, affected by a number of factors, including the following:
Our Ability to Manage Risk
We leverage technology to help manage risk. For instance, we leverage machine
learning to "clean" behavioral data obtained through a customer's mobile device,
and we use advanced statistical methods to model that data into usable behavior
scores. We leverage intelligent chat functions and various forms of machine
learning and advanced automation to help power our claims function. Technology
is a key differentiator in managing risk across our key functions. Our success
depends on our ability to adequately and competitively price risk.
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Our Ability to Attract New Customers
Our long-term growth will depend, in large part, on our continued ability to attract new customers to our platform. We intend to continue to drive new customer growth by leveraging our differentiated consumer experience, machine learning loss models and our telematics-based pricing. Additionally, our proprietary dataset will continue to scale as we grow, enabling us to enhance our predictive models to further improve pricing and attract potential new customers. We will also continue to target attractive potential customer segments through our embedded experience and digital marketing channels. Our ability to attract new customers will depend on a number of factors, including the pricing of our products, offerings of our competitors, our ability to expand into new markets, and the effectiveness of our marketing efforts. Our ability to attract and retain customers depends on maintaining and strengthening our brand by providing superior customer experiences and competitive pricing. In particular, we are challenged by traditional insurerswho have more diverse product offerings and longer established operating histories. These competitors can mimic certain aspects of our digital platform and offerings, and as they have more types of insurance products, can offer customers the ability to "bundle" multiple coverage types together, which may be attractive to many customers.
Our Ability to Retain Customers
Our ability to derive significant lifetime value from our customer relationships depends, in part, on our ability to retain our customers over time. Strong retention allows us to build a recurring revenue base, generating additional premiums term over term without material incremental marketing costs. As we broadly retain customers and our book of business evolves to be more weighted towards renewals versus new business, as is the case with our mature competitors, we will benefit from the inherently lower loss ratios that characterize renewed premiums. Our ability to retain customers will depend on a number of factors, including our customers' satisfaction with our products, offerings of our competitors and pricing of products.
Our Ability to be Licensed in all States in
Our long-term growth opportunity will benefit from our ability to provide insurance across more states inthe United States . Today, we are currently licensed in 50 states (48 states for personal auto) and theDistrict of Columbia and operate in 32 of those states. Our continuous state expansion has unlocked a large total addressable market for sustained growth, made our direct targeted marketing more efficient and created an opportunity to build a national brand, supporting our marketing holistically.
To expand our geographic footprint, in
authorized, issued and outstanding shares of
subsequently renamed
Property & Casualty.
Our Ability to Expand Premiums and Fee Income Per Policy Through Cross-Sell
We are in the early stages of cross-selling non-auto products across our customer base. In 2019, we began offering renters insurance and, inMay 2020 , we launched our homeowners insurance product in partnership withHomesite Insurance , or Homesite. Cross-sales allow us to generate additional premiums (renters) and fee income (homeowners) without material incremental marketing spend, and ultimately higher revenue per customer. We have also observed that bundling products with auto insurance improves retention as the relationship with our customer expands. Our success in expanding revenues through cross-sales depends on our marketing efforts with new products, continuous state expansion of these offerings and the pricing of our bundled products. The success of our renters insurance offering is also subject to our ability to develop underwriting capabilities to adequately price renters risk.
Recent Developments Affecting Comparability
COVID-19 Impact
In
pandemic. The pandemic and related measures taken to contain the spread of
COVID-19, such as government-mandated business closures,
64 -------------------------------------------------------------------------------- "shelter in place" orders, or SIPs, and travel and transportation restrictions, have negatively affected theU.S. and global economies, disrupted global supply chains and led to unemployment. We, and other businesses within the insurance industry, have been impacted by certain individual state bulletins that were issued in 2020 and outlined COVID-19 premium relief efforts, including restrictions on the ability to cancel policies for non-payment, requirements to defer insurance premium payments for up to 60 days and restrictions on increasing policy premiums. The COVID-19 pandemic and governmental responses thereto have impacted and may further impact the broader economic environment, including creating or exacerbating supply chain disruptions and inflation and negatively impacting unemployment levels, economic growth, the proper functioning of financial and capital markets and interest rates. As a result of the SIPs that started to occur toward the end ofMarch 2020 , our customers drove less and we had a resulting decline in loss costs during the first quarter of 2020. Most parts of the country eased COVID-19-related restrictions and began to return to customary levels of business activity during the second quarter of 2021. We are now seeing miles driven exceed pre-COVID-19 levels. As a result of the increase in average miles driven, claims frequency has rebounded proportionally. In addition, the economic instability caused by the COVID-19 pandemic has led to acute inflationary pressures and supply chain disruptions, which have increased the value of used vehicles and replacement parts in 2021. These cost increases have resulted in greater claims severity while being partially offset by higher salvage and subrogation recoveries on damaged vehicles. As a result of certain factors related to the COVID-19 global pandemic, we continue to file in multiple states to establish rates that more closely follow the evolving loss cost trends. The American Rescue Plan Act became law inMarch 2021 and provided a third round of stimulus payments from the federal government to many American consumers. The easing of COVID-19 SIPs and these stimulus payments led to an unexpected surge in interest in vehicle and auto insurance purchases. This elevated interest resulted in a significant increase in customer acquisition and advertising campaigns in digital channels on the part of our competitors, increasing our customer acquisition costs during 2021. With the recent surge of the Delta and Omicron variants of COVID-19 acrossthe United States and increasing rates of COVID-19 cases and hospitalizations, it is unclear what the impact of the pandemic will be on future operations. As the COVID-19 pandemic continues, there is ongoing uncertainty around the severity and duration of the pandemic and the pandemic's potential impact on our business and our financial performance. See the section titled "Risk Factors" for more details.
Comprehensive Reinsurance
We expect to continue to utilize reinsurance in the future, and our diversified
approach to reinsurance allows us to be flexible in response to changes in
market conditions or our own business changes, which allows us to strategically
fuel growth and technology investment by optimizing the amount of capital
required.
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Key Performance Indicators
We regularly review a number of metrics, including the following key performance
indicators, 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 the section titled "- Non-GAAP Financial Measures" for additional
information regarding our use of adjusted gross profit/(loss) and direct
contribution and their reconciliations to the most directly comparable GAAP
measures.
Years Ended December 31,
2021 2020 2019
(dollars in millions, except Premiums per policy)
Policies in force
Auto 354,371 322,759 281,310
Renters 8,802 7,739 1,747
Premiums per policy
Auto $ 1,006 $ 939 $ 904
Renters $ 140 $ 140 $ 127
Premiums in force
Auto $ 713.0 $ 606.1 $ 508.6
Renters $ 1.2 $ 1.1 $ 0.2
Gross written premium(1) $ 742.6 $ 616.8 $ 451.1
Gross earned premium(1) $ 719.6 $ 605.2 $ 352.9
Gross profit/(loss) $ (51.9) $ (14.2) $ (83.5)
Gross margin (15.0) % (4.1) % (28.8) %
Adjusted gross profit/(loss) $ (3.3) $ 21.0 $ (54.2)
Direct contribution $ 8.1 $ 18.9 $ (57.4)
Ratio of adjusted gross profit/(loss) to total
revenue (1.0) % 6.1 % (18.7) %
Ratio of adjusted gross profit/(loss) to gross
earned premium (0.5) % 3.5 % (15.4) %
Ratio of direct contribution to total revenue 2.3 % 5.4 % (19.8) %
Ratio of direct contribution to gross earned
premium 1.1 % 3.1 % (16.3) %
Gross loss ratio 86.0 % 82.0 % 99.9 %
Gross LAE ratio 10.5 % 10.1 % 12.0 %
Gross accident period loss ratio 87.9 % 76.2 % 103.0 %
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(1) Includes premiums assumed from the fronting carrier that commenced in August
2021 . Assumed written premium and assumed earned premium for the year ended
December 31, 2021 were $16.7 million and $7.3 million , respectively. Prior to
the fronting carrier commencement, we did not assume any premiums.
Policies in Force
We define policies in force as the number of current and active policyholders underwritten by us as of the period end date. We view policies in force as an important metric to assess our financial performance because policy growth drives our revenue growth, expands brand awareness, deepens our market penetration, and generates additional data to continue to improve the functioning of our platform.
Premiums per Policy
We define premiums per policy as the ratio of gross written premium on policies
in force divided by policies in force. We view premiums per policy as an
important metric since the higher the premiums per policy the greater the amount
of earned premium we expect from each policy. As discussed below in gross
written premium, this key
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performance indicator has been updated to include assumed written premiums
beginning during the third quarter of 2021. There is no impact to any prior
periods for this change.
Premiums in Force
We define premiums in force for our auto policies as premiums per policy multiplied by policies in force multiplied by two. We view premiums in force as an estimate of annualized run rate of gross written premium as of a given period. Since our auto policies are six-month policies, we multiply this figure by two in order to determine an annualized amount of premiums in force. We define premiums in force for our renters policies as premiums per policy multiplied by policies in force. We view this as an important metric because it is an indicator of the size of our portfolio of policies as well as an indicator of expected earned premium over the coming 12 months. Premiums in force is not a forecast of future revenue nor is it a reliable indicator of revenue expected to be earned in any given period. We believe that our calculation of premiums in force is useful to investors and analysts because it captures the impact of growth in customers and premiums per policy at the end of each reported period, without adjusting for known or projected policy updates, cancellations and non-renewals.
Gross Written Premium
We define gross written premium, as the total amount of gross premium on policies that were bound during the period less the prorated impact of policy cancellations. Gross written premiums includes direct premiums and assumed premiums. We began assuming premium during the third quarter of 2021 in connection with our entry into an arrangement with a fronting carrier inTexas ; therefore, there is no impact to this key performance indicator for any prior periods. We view gross written premium as an important metric because it is the metric that most closely correlates with our growth in gross earned premium. We use gross written premium, which excludes the impact of premiums ceded to reinsurers, to manage our business because we believe that it reflects the business volume and direct economic benefit generated by our customer acquisition activities, which along with our underlying underwriting and claims operations (gross loss ratio and gross LAE) are the key drivers of our future profit opportunities. Additionally, premiums ceded to reinsurers can change significantly based on the type and mix of reinsurance structures we use, and, as such, we have the optionality to fully retain the premiums from customers acquired in the future. Gross Earned Premium We define gross earned premium as the amount of gross premium that was earned during the period. Premiums are earned over the period in which insurance protection is provided, which is typically six months. Gross earned premium includes direct premiums and assumed premiums. We began assuming premium during the third quarter of 2021 in connection with our entry into an arrangement with a fronting carrier inTexas ; therefore, there is no impact to this key performance indicator for any prior periods. We view gross earned premium as an important metric as it allows us to evaluate our growth prior to the impacts of reinsurance. It is the primary driver of our consolidated GAAP revenues. As with gross written premium, we use gross earned premium, which excludes the impact of premiums ceded to reinsurers to manage our business, because we believe that it reflects the business volume and direct economic benefit generated by our customer acquisition activities, which along with our underlying underwriting and claims operations (gross loss ratio and gross LAE) are the key drivers of our future profit opportunities.
Gross Profit/(Loss)
We define gross profit/(loss) as total revenue minus net loss, and LAE expense and other insurance expense (benefit) inclusive of depreciation and amortization. We view gross profit/(loss) as an important metric because we believe it is informative of the financial performance of our core insurance business.
Gross profit/(loss) margin is equal to gross profit/(loss) divided by revenue.
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Adjusted Gross Profit/(Loss)
We define adjusted gross profit/(loss), a non-GAAP financial measure, as gross profit/(loss) excluding net investment income, net realized gains (losses) on investments, report costs, Personnel Costs, allocated Overhead, licenses, professional fees and other expenses, which are included in other insurance (benefit) expense. After these adjustments, the resulting calculation is inclusive of only those variable costs of revenue incurred on the successful acquisition of business. We view adjusted gross profit/(loss) as an important metric because we believe it measures our progress towards profitability for our core insurance business.
The ratio of adjusted gross profit/(loss) to total revenue is equal to adjusted
gross profit/(loss) divided by total revenue.
See the section titled "- Non-GAAP Financial Measures" for a reconciliation of
total revenue to adjusted gross profit/(loss).
Direct Contribution
We define direct contribution, a non-GAAP financial measure, as adjusted gross profit/(loss) excluding ceded earned premium, ceded loss and LAE, and net ceding commission and other. Net ceding commission and other is comprised of ceding commission received in connection with reinsurance ceded, partially offset by related sliding scale commission adjustments and amortization of excess ceding commission, and other impacts of reinsurance ceded which are included in other insurance (benefit) expense. After these adjustments, the resulting calculation is inclusive of only those gross variable costs of revenue incurred on the successful acquisition of business, but exclusive of net ceding commission, ceded loss and LAE and other impacts of reinsurance ceded. We view direct contribution as an important metric because we believe it measures progress towards the profitability of our total policy portfolio prior to the impact of reinsurance.
The ratio of direct contribution to total revenue is equal to direct
contribution divided by total revenue.
See the section titled "- Non-GAAP Financial Measures" for a reconciliation of
total revenue to direct contribution.
Ratio of Adjusted Gross Profit/(Loss) to Gross Earned Premium
The ratio of adjusted gross profit/(loss) 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/(loss) ratio as calculated in accordance with GAAP, because it
provides management with insight into our underlying profitability trends with
respect to our customer base. We use gross earned premium as the denominator in
calculating this ratio because it reflects business volume free of elective
capital-light choices related to our reinsurance programs. As discussed above in
gross written premium, this key performance indicator has been updated to
include assumed earned premiums in the calculation of ratio of adjusted gross
profit/(loss) to gross earned premium during the third quarter of 2021. There is
no impact to any prior periods for this change.
Years Ended December 31,
2021 2020 2019
(dollars in millions)
Numerator: adjusted gross profit/(loss) $ (3.3) $ 21.0 $ (54.2)
Denominator: total gross earned premium $ 719.6 $ 605.2 $ 352.9
Ratio of adjusted gross profit/(loss) to gross
earned premium (0.5) % 3.5 % (15.4) %
Ratio of Direct Contribution to Gross Earned Premium
The ratio of direct contribution 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, without contemplating the impacts of
reinsurance. We rely on this measure, which supplements our gross margin as
calculated in accordance with GAAP, because it provides
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management with insight into our underlying profitability trends with respect to
our total policy portfolio. We use gross earned premium as the denominator in
calculating this ratio because it reflects business volume free of elective
capital-light cession or commission structures choices from our reinsurance
ceded programs. As discussed above in gross written premium, this key
performance indicator has been updated to include assumed earned premiums in the
calculation of ratio of direct contribution to gross earned premium during the
third quarter of 2021. There is no impact to any prior periods for this change.
Years Ended December 31,
2021 2020 2019
(dollars in millions)
Numerator: direct contribution $ 8.1 $ 18.9 $ (57.4)
Denominator: total gross earned premium $ 719.6 $
605.2
Ratio of direct contribution to gross earned premium 1.1 % 3.1 % (16.3) %
Gross Loss Ratio We define gross loss ratio expressed as a percentage, as the ratio of gross losses to gross earned premium. Gross loss ratio excludes LAE. We view gross loss ratio as an important metric because it allows us to evaluate incurred losses and LAE separately prior to the impact of reinsurance. As discussed above in gross written premium, this key performance indicator has been changed to include assumed losses and assumed earned premiums in the calculation of gross loss ratio beginning during the third quarter of 2021. There is no impact to any prior periods for this change.
Gross LAE Ratio
We define gross LAE ratio expressed as a percentage, as the ratio of gross LAE to gross earned premium. We view gross LAE ratio as an important metric because it allows us to evaluate incurred losses and LAE separately. Currently, we do not cede any of our LAE to our third-party quota share reinsurance treaties; therefore, we actively monitor LAE ratio as it has a direct impact on our results regardless of our reinsurance strategy. As discussed above in gross written premium, this key performance indicator has been changed to include assumed LAE and assumed earned premium in the calculation of gross LAE ratio beginning during the third quarter of 2021. There is no impact to any prior periods from this change.
Gross Accident Period Loss Ratio
Gross accident period loss ratio, expressed as a percentage, represents all losses and claims expected to arise from insured events that occurred during the applicable period regardless of when they are reported and finally settled divided by gross earned premiums for the same period. Changes to our loss reserves are the primary driver of the difference between our gross accident period loss ratio and gross loss ratio. We believe that gross accident period loss ratio is useful in evaluating expected losses prior to the impact of reinsurance. As discussed above in gross written premium, this key performance indicator has been changed to include assumed accident period losses and assumed earned premium in the calculation of gross accident period loss ratio beginning during the third quarter of 2021. There is no impact to any prior periods from this change.
Components of Our Results of Operations
Revenue
We generate revenue primarily from the sale of auto insurance policies withinthe United States and, to a lesser extent, from the sale of renters insurance policies. We have agency operations that generate commission revenue by selling homeowners insurance policies on behalf of a third-party insurance company. We distribute website and app policy inquiry leads in geographies where we do not have a presence to third parties in exchange for fee revenue. We also generate revenue through fee income from our customers paying on installment and from net investment income earned on our investment portfolio. 69 --------------------------------------------------------------------------------
Net Premiums Earned
Premiums written are deferred and earned pro rata over the policy period. Net premiums earned represents the earned portion of our gross written premium, less the earned portion that is ceded to third-party reinsurers under our reinsurance agreements. Net Investment Income Net investment income represents interest earned from our fixed maturity and short-term investments and cash and cash equivalents less investment expenses, unrealized gains from our private equity investments, and impairment of our Low Income Housing Tax Credits, or LIHTC, project investments. Net investment income is directly correlated with the overall size of our investment portfolio, market level of interest rates, changes in fair value of our private equity investments and utilization of premium tax credits generated by our LIHTC investment. Net investment income will vary with both the size of our investment portfolio, market returns and the investment strategy.
Net Realized Gains on Investments
Net realized gains on investments represents the net positive difference between
the amount received by us on the sale of an investment as compared to the
investment's cost basis.
Fee Income
For those policyholderswho pay premiums on an installment basis, we charge a flat fee for each installment related to the additional administrative costs associated with processing more frequent billing. We recognize this fee income in the period in which we process each installment.
Other Income
Other income primarily comprises revenue earned from distributing website and app policy inquiry leads in geographies where we do not have a presence, recognized when we generate the lead; commissions earned for homeowners policies placed with a third-party insurance company where we have no exposure to the insured risk, recognized on the effective date of the associated policy; and sale of enterprise technology products to provide telematics-based data collection and trip tracking, recognized ratably as the service is performed.
Operating Expenses
Our operating expenses consist of loss and LAEs, sales and marketing, other
insurance expense (benefit), technology and development, and general and
administrative expenses.
Loss and Loss Adjustment Expenses
Loss and LAE include an amount determined using adjuster determined case-base estimates for reported claims and actuarial determined unpaid claim estimates using past experience and historical emergence patterns for unreported losses and LAE. These reserves are a liability established to cover the estimated ultimate cost to settle insured losses. The unpaid loss estimates consider loss trends, mix of business, and other risk factors impacting claims settlement. The method used to estimate unpaid LAE liability is based on claims transaction data, including the relative cost of adjusting and settling a range of claim types from express material damage claims to more complex injury cases. Loss and LAE is 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 may be paid out over a period of years.
Various other expenses incurred during claims processing are considered LAE.
These amounts include claims salaries, health benefits, bonuses, employee
retirement plan related expenses and employee share-based
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compensation expense, or Personnel Costs; software expense; internally developed
software amortization; and overhead allocated based on headcount, or Overhead.
Sales and Marketing
Sales and marketing expense includes spend related to performance and embedded channels, channel media, advertising, branding, public relations, consumer insights and referral fees. These expenses also include related Personnel Costs, Overhead and warrant compensation expense related to our embedded channel. We incur sales and marketing expenses for all product offerings. Sales and marketing are expensed as incurred. We plan to continue investing in and diversifying our marketing channels to attract and acquire new customers, increase our brand awareness, and expand our product offerings. We expect that in the long-term, our sales and marketing will decrease as a percentage of revenue as the proportion of renewals to our total business increases.
Other Insurance Expense (Benefit)
Other insurance expense (benefit) includes underwriting expenses, credit card and policy processing expenses, premium write-offs, insurance license expenses, and Personnel Costs and Overhead related to actuarial and certain data science activities. Other insurance expense (benefit) also includes amortization of deferred acquisition costs like premium taxes and report costs related to the successful acquisition of a policy. Other insurance expense (benefit) is expensed as incurred, except for costs related to deferred acquisition costs that are capitalized and subsequently amortized over the same period in which the related premiums are earned. These expenses are also recognized net of ceding commissions earned.
Technology and Development
Technology and development expense consists of software development costs related to our mobile app and homegrown information technology systems; third-party services related to infrastructure support; Personnel Costs and Overhead for engineering, product, technology, and certain data science activities; and amortization of internally developed software. Technology and development is expensed as incurred, except for development and testing costs related to internally developed software that are capitalized and subsequently amortized over the expected useful life. We expect technology and development to increase in absolute dollars and as a percentage of total revenue as we continue to devote significant resources to enhance our customer experience and continually improve our integrated technology platform. Over time, we expect technology and development to decrease as a percentage of revenue. General and Administrative General and administrative expenses primarily relate to external professional service expenses; Personnel Costs and Overhead for corporate functions; and depreciation expense for computers, furniture and other fixed assets. General and administrative expenses are expensed as incurred. We expect general and administrative expenses to continue to increase in the near term, both in absolute dollars and as a percentage of total revenue, and then decrease as a percentage of revenue over time.
Interest Expense
Interest expense is not an operating expense; therefore, we include these
expenses below operating expenses. Interest expense primarily relates to
interest incurred on our long-term debt, certain fees that are expensed as
incurred and the amortization of debt issuance costs. In addition, changes in
the fair value of warrant liabilities that were associated with our long-term
debt are recorded as interest expense.
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Loss on Early Extinguishment of Debt
Loss on early extinguishment of debt is not an operating expense; therefore, we include these expenses below operating expenses. Loss on early extinguishment of debt primarily relates to the difference between the reacquisition price of the debt and the net carrying amount of the extinguished debt. Upon extinguishment of debt, the remaining unamortized discount and debt and warrants issuance costs are recognized as expense. Results of Operations
Comparison of the Years Ended
The following table presents our results of operations for the periods
indicated:
Years Ended December 31,
% of Total % of Total
2021 Revenue 2020 Revenue $ Change % Change
(dollars in millions)
Revenue: Net premiums earned$ 310.3 89.8 %$ 322.5 93.0 %$ (12.2) (3.8) % Net investment income 5.0 1.4 % 5.4 1.6 % (0.4) (7.4) % Net realized gains on investments 2.4 0.7 % 0.3 0.1 % 2.1 700.0 % Fee Income 20.9 6.1 % 17.4 5.0 % 3.5 20.1 % Other income 6.8 2.0 % 1.2 0.3 % 5.6 466.7 % Total revenues 345.4 100.0 % 346.8 100.0 % (1.4) (0.4) % Operating expenses: Loss and loss adjustment expenses 392.3 113.6 % 362.8 104.6 % 29.5 8.1 % Sales and marketing 270.2 78.2 % 139.7 40.3 % 130.5 93.4 % Other insurance expense (benefit) 5.0 1.4 % (1.8) (0.5) % 6.8 377.8 % Technology and development 65.5 19.0 % 52.9 15.3 % 12.6 23.8 % General and administrative 97.6 28.3 % 78.5 22.6 % 19.1 24.3 % Total operating expenses 830.6 240.5 % 632.1 182.3 % 198.5 31.4 % Operating loss (485.2) (140.5) % (285.3) (82.3) % (199.9) N.M. Interest expense (20.0) (5.8) % (77.7) (22.4) % 57.7 (74.3) % Loss on early extinguishment of debt (15.9) (4.6) % - - % (15.9) 100.0 % Loss before income tax expense (521.1) (150.9) % (363.0) (104.7) % (158.1) N.M. Income tax expense - - % - - % - - % Net loss (521.1) (150.9) % (363.0) (104.7) % (158.1) N.M. Other comprehensive (loss) income: Changes in net unrealized (losses) gains on investments (5.2) (1.5) % 5.0 1.5 % (10.2) (204.0) % Comprehensive loss$ (526.3) (152.4) %$ (358.0) (103.2) %$ (168.3) N.M. ______________
N.M. - Percentage change not meaningful
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Revenue
Net Premiums Earned
Net premiums earned decreased$12.2 million , or 3.8%, to$310.3 million for the year endedDecember 31, 2021 compared to 2020. The decrease was primarily due to greater cessions of gross earned premium as a result of a change in reinsurance structure partially offset by growth in gross earned premium between the periods. During the years endedDecember 31, 2021 and 2020, we ceded approximately 56.9% and 46.7% of our gross earned premiums to third-party reinsurers, respectively. The change in ceding percentage between the periods was driven by our evolving approach to our reinsurance structure, in an effort to produce a capital-light model with reinsurance terms available to us in the market.
The following table presents gross written premium, ceded written premium, net
written premium, gross earned premium, ceded earned premium and net earned
premium for the years ended
Years Ended December 31,
2021 2020 $ Change % Change
(dollars in millions)
Gross written premium $ 742.6 $ 616.8 $ 125.8 20.4 %
Ceded written premium (397.3) (378.0) (19.3) 5.1 %
Net written premium 345.3 238.8 106.5 44.6 %
Gross earned premium 719.6 605.2 114.4 18.9 %
Ceded earned premium (409.3) (282.7) (126.6) 44.8 %
Net earned premium $ 310.3 $ 322.5 $ (12.2) (3.8) %
Gross earned premium growth was primarily due to a 20.4% increase in gross
written premium from deeper market penetration across our
We also saw a 7.1% increase in premiums per policy for automobile insurance
primarily resulting from pricing increases in several states between the
periods.
Net Realized Gains on Investments
Net realized gains on investments increased$2.1 million , or 700.0%, to$2.4 million for the year endedDecember 31, 2021 compared to 2020. The increase was due to proceeds received from sales of investments in excess of investments' cost bases. Fee Income Fee income increased$3.5 million , or 20.1%, to$20.9 million for the year endedDecember 31, 2021 compared to 2020. The increase was primarily due to increased customer volumes and an increase in customers paying in installments.
Other Income
Other income increased
ended
increased fee revenue from distributing web and app policy inquiry leads in
geographies where we do not have a presence to third parties.
Operating Expenses
Loss and Loss Adjustment Expenses
Loss and LAE increased
ended
higher claims volume, increased claim severity and greater
73 --------------------------------------------------------------------------------
reserves related to the growth in policies in force, partially offset by higher
cessions of incurred losses, net of higher loss corridor reserves due to an
increase in our loss ratio, as a result of a change in our reinsurance
structure.
Gross accident period loss ratios increased to 87.9% from 76.2% for the years endedDecember 31, 2021 and 2020, respectively. The change in the loss ratios was driven by higher loss costs due to elevated claims frequency as miles driven during the period exceeded pre-COVID-19 levels and average severity per claim for material damage increased as replacement parts and higher used car prices outpaced expected inflation. The increases in loss costs were partially offset by growth in average premium per policy. In addition, loss and LAE for the year endedDecember 31, 2021 includes a decrease in incurred losses and LAE attributable to accident periods prior to 2021 of$13.6 million . This decrease is primarily attributed to lower-than-expected reported losses on bodily injury claims from accident year 2020. In addition, recoveries from subrogation and salvage from 2020 material damage claims were higher than estimated.
Sales and Marketing
Sales and marketing increased$130.5 million , or 93.4%, to$270.2 million for the year endedDecember 31, 2021 compared to 2020. The increase was primarily due to increased investment in performance marketing of$73.9 million and branding and advertising of$35.6 million as we responded to changes in consumer behavior and increased customer acquisition and advertising campaigns in digital channels on the part of our competitors. Performance marketing spend declined during the second half of 2021 as we navigated the exposure to significant cost increases we experienced earlier in the year and responded to the elevated loss cost environment. We have focused on diversifying our marketing investments to reach more customers and drive profitable growth in the states in which we operate. Additionally, marketing spend was lower through much of the year endedDecember 31, 2020 due to uncertainty surrounding the ongoing COVID-19 pandemic. We also recognized$8.8 million of warrant compensation expense related to Carvana's progress toward an integrated automobile insurance solution for Carvana's car buying platform, or Integrated Platform. See Note 11, "Shared-Based Compensation," in the Notes to Consolidated Financial Statements for further details on these warrants.
Other Insurance Expense (Benefit)
Other insurance expense (benefit) increased$6.8 million , or 377.8%, to an expense of$5.0 million for the year endedDecember 31, 2021 compared to 2020. The increase was primarily driven by$6.7 million in greater underwriting costs, premium taxes and payment processing fee expense due to growth in the core insurance business and greater premiums collected on an installment basis and$5.5 million in higher Personnel Costs and Overhead due to headcount growth. This was partially offset by a$2.7 million decrease in bad debt expense primarily related to delayed cancellation of policies for non-payment stemming from compulsory state issued notices in reaction to the COVID-19 pandemic during 2020 and a$2.4 million increase in ceding commission contra-expense net of sliding scale commission expense due to reinsurance structure changes.
Technology and Development
Technology and development increased$12.6 million , or 23.8%, to$65.5 million for the year endedDecember 31, 2021 compared to 2020. The increase was primarily driven by incremental investments of$11.5 million in Personnel and Overhead costs as a result of headcount growth of engineering and product teams.
General and Administrative
General and administrative increased$19.1 million , or 24.3%, to$97.6 million for the year endedDecember 31, 2021 compared to 2020. The increase was primarily driven by a$14.6 million increase in Personnel and Overhead costs across finance, legal and administrative teams as a result of an increase in headcount. In addition, we incurred a$11.1 million increase in professional service expenses to support corporate functions and$1.5 million in higher depreciation and amortization as result of write-offs and more fixed assets in use. This was partially offset by a decrease in share-based compensation expense of$9.7 million for the year endedDecember 31, 2021 compared to 2020, primarily related to the completion of a secondary tender offer for common stock in 2020 by an investor. 74 --------------------------------------------------------------------------------
Non-Operating Expenses
Interest Expense
Interest expense decreased$57.7 million , or 74.3%, to$20.0 million for the year endedDecember 31, 2021 compared to 2020. The decrease was primarily due to the warrant fair value adjustment of$54.7 million that we recognized during 2020. In addition, there was a$2.9 million decrease in amortization of discount and debt and warrants issuance costs primarily attributable to debt modifications and lower average debt balance.
Loss on Early Extinguishment of Debt
Loss on early extinguishment of debt increased$15.9 million , or 100.0%, to$15.9 million for the year endedDecember 31, 2021 compared to 2020. The increase was driven by$15.9 million of accelerated amortization of unamortized discount and debt and warrant issuance costs from the extinguishment of our Term Loan B.
Other Comprehensive (Loss) Income
Changes in Net Unrealized (Losses) Gains on Investments
Changes in net unrealized (losses) gains on investments decreased$10.2 million , or 204.0%, to a loss of$5.2 million for the year endedDecember 31, 2021 compared to 2020. The decrease was primary driven by changes of$8.1 million in net unrealized losses on investments and$2.1 million in net realized gains reclassified to net loss. 75 --------------------------------------------------------------------------------
Comparison of the Years Ended
The following table presents our results of operations for the periods
indicated:
Years Ended December 31,
% of Total % of Total
2020 Revenue 2019 Revenue $ Change % Change
(dollars in millions)
Revenue: Net premiums earned$ 322.5 93.0 %$ 275.3 94.9 %$ 47.2 17.1 % Net investment income 5.4 1.6 % 5.2 1.8 %$ 0.2 3.8 % Net realized gains on investments 0.3 0.1 % - - %$ 0.3 100.0 % Fee and other income 18.6 5.3 % 9.7 3.3 %$ 8.9 91.8 % Total revenue 346.8 100.0 % 290.2 100.0 % 56.6 19.5 % Operating expenses: Loss and loss adjustment expenses 362.8 104.6 % 321.4 110.8 % 41.4 12.9 % Sales and marketing 139.7 40.3 % 109.6 37.8 % 30.1 27.5 % Other insurance (benefit) expense (1.8) (0.5) % 52.3 18.0 % (54.1) (103.4) % Technology and development 52.9 15.3 % 24.0 8.3 % 28.9 120.4 % General and administrative 78.5 22.6 % 43.0 14.7 % 35.5 82.6 % Total operating expenses 632.1 182.3 % 550.3 189.6 % 81.8 14.9 % Operating loss (285.3) (82.3) % (260.1) (89.6) % (25.2) N.M. Interest expense (77.7) (22.4) % (22.3) (7.7) % (55.4) 248.4 % Loss before income tax expense (363.0) (104.7) % (282.4) (97.3) % (80.6) N.M. Income tax expense - - % - - % - - % Net loss (363.0) (104.7) % (282.4) (97.3) % (80.6) N.M. Other comprehensive income: Changes in net unrealized gains on investments 5.0 1.5 % 0.6 0.2 % 4.4 N.M. Comprehensive loss$ (358.0) (103.2) %$ (281.8) (97.1) %$ (76.2) N.M. ______________
N.M. - Percentage change not meaningful
TheDecember 31, 2020 and 2019 results of operations discussion can be found in Part II, Item 7, "Results of Operations" of our Annual Report on Form 10-K for the year endedDecember 31, 2020 .
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/(loss) and direct contribution
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: (1) monitor and evaluate the performance of our business
operations and financial performance; (2) facilitate internal comparisons of the
historical operating
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performance of our business operations; (3) 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; (4)
review and assess the operating performance of our management team; (5) analyze
and evaluate financial and strategic planning decisions regarding future
operating investments; and (6) plan for and prepare future annual operating
budgets and determine appropriate levels of operating investments.
Adjusted Gross Profit/(Loss)
For the definition of adjusted gross profit/(loss) and why management believes this measure provides useful information to investors, see "- Key Performance Indicators." Direct Contribution
For the definition of direct contribution and why management believes this
measure provides useful information to investors, see "- Key Performance
Indicators."
The following table provides a reconciliation of total revenue to adjusted gross profit/(loss) and direct contribution for the years endedDecember 31, 2021 , 2020 and 2019: Years Ended December 31, 2021 2020 2019 (dollars in millions) Total revenue$ 345.4 $ 346.8 $ 290.2 Loss and loss adjustment expenses (392.3) (362.8) (321.4) Other insurance (expense) benefit (5.0) 1.8 (52.3) Gross profit/(loss)$ (51.9) $ (14.2) $ (83.5) Gross margin (15.0) % (4.1) % (28.8) % Less: Net investment income$ (5.0) $ (5.4) $ (5.2) Net realized gains on investments (2.4) (0.3) - Adjustments from other insurance (expense) benefit(1) 56.0 40.9 34.5 Adjusted gross profit/(loss) (3.3) 21.0 (54.2) Ceded earned premium 409.3 282.7 77.6 Ceded loss and loss adjustment expenses (302.5) (194.8) (73.6) Net ceding commission and other(2) (95.4) (90.0) (7.2) Direct contribution 8.1 18.9 (57.4) Gross earned premium$ 719.6 $ 605.2 $ 352.9 Ratio of adjusted gross profit/(loss) to total revenue (1.0) % 6.1 % (18.7) % Ratio of adjusted gross profit/(loss) to gross earned premium (0.5) % 3.5 % (15.4) % Ratio of direct contribution to total revenue 2.3 % 5.4 % (19.8) % Ratio of direct contribution to gross earned premium 1.1 % 3.1 % (16.3) % ______________
(1) Adjustments from other insurance expense includes report costs, personnel
costs, allocated overhead, licenses, professional fees and other.
(2) Net ceding commission and other is comprised of ceding commissions received
in connection with reinsurance ceded, partially offset by sliding scale
commission adjustments and amortization of excess ceding commission, and other
impacts of reinsurance ceded.
77
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Liquidity and Capital Resources
General
Since inception, we have financed operations primarily through sales of insurance policies and the net proceeds we have received from our issuance of stock and debt and from sales of investments. Cash generated from operations is highly dependent on being able to efficiently acquire and maintain customers while pricing our insurance products appropriately. We are continuously evaluating alternatives for efficiently funding our ongoing operations. We expect, from time to time, to engage in a variety of financing transactions for such purposes, including the issuance of securities.
Regulatory Considerations
We are organized as a holding company, but our primary operations are conducted by two of our wholly owned insurance subsidiaries,Root Insurance Company , anOhio -domiciled insurance company, andRoot Property & Casualty Insurance Company , aDelaware -domiciled insurance company. The payment of dividends by our insurance subsidiaries is subject to restrictions set forth in the insurance laws and regulations of the States ofOhio andDelaware , respectively, or the insurance laws. To date, our insurance subsidiaries have not paid any dividends and as ofDecember 31, 2021 , they were not permitted to pay any dividends without approval of the applicable superintendent, commissioner and/or director. As our insurance subsidiaries continue to grow, the amount of capital we are required to maintain to satisfy our risk-based capital requirements may increase significantly. To comply with these regulations, we may be required to maintain capital in the insurance subsidiaries that we would otherwise invest in our growth and operations. AtDecember 31, 2021 , our insurance subsidiaries maintained a risk-based capital level that is in excess of an amount that would require any corrective actions on our part. Our wholly owned,Cayman Islands -based reinsurance subsidiary,Root Reinsurance Company, Ltd. , or Root Re, maintains a Class B(iii) insurer license underCayman Islands Monetary Authority , or CIMA. AtDecember 31, 2021 , Root Re was subject to compliance with certain capital levels and a net earned premium to capital ratio of 15:1, which was maintained as ofDecember 31, 2021 . The capital ratio can fluctuate at Root Re's election, subject to regulatory approval. Root Re's primary sources of funds are capital contributions from the holding company, assumed insurance premiums and net investment income. These funds are primarily used to pay claims and operating expenses and to purchase investments. Root Re must receive approval from CIMA before it can pay any dividend to the holding company. Financing Arrangements OnJanuary 26, 2022 , we closed on a$300.0 million five-year term loan withBlackRock Financial Management, Inc. , or BlackRock. The maturity of this term loan isJanuary 27, 2027 . Interest is payable quarterly and is determined on a floating interest rate calculated on the Secured Overnight Financing Rate, or SOFR, plus 9%. Concurrently with the term loan, we also issued to the lender warrants to purchase 5,664,193 shares of Class A common stock. Under certain contingent scenarios, BlackRock may also receive additional warrants to purchase shares of Class A common stock equal to 1.0% of the aggregate number of issued and outstanding shares of our common stock on a fully-diluted basis as of the triggering date. InNovember 2021 , we repaid the outstanding Term Loan B principal balance of$100.0 million and accrued interest, including paid-in-kind, or PIK interest, and fees of$20.9 million . As a result, we recognized a$15.9 million loss on early extinguishment. InOctober 2021 , we consummated the transactions contemplated by the investment agreement with Carvana, or the Investment Agreement, that we entered into onAugust 11, 2021 . We received$126.5 million of gross proceeds from the issuance of 14.1 million shares of redeemable convertible preferred stock designated as the Series A Convertible Preferred Stock. We also issued Carvana eight tranches of warrants to purchase shares of our Class A common stock. In connection with the Investment Agreement, we incurred issuance costs of$19.6 million ,$9.0 78 --------------------------------------------------------------------------------
million of which are contingent upon the success of the Investment Agreement as
measured by achievement of certain warrant vesting milestones.
In
revolving loan, we repaid the outstanding Term Loan A principal balance of
InOctober 2020 , we completed our initial public offering, or IPO, which resulted in the issuance and sale of 24.2 million shares of Class A common stock at the IPO price of$27.00 . Concurrently, we issued and sold 18.5 million shares of our Class A common stock in private placements. We received total net proceeds of$1.1 billion after deducting underwriting discounts and other offering costs.
Liquidity
As ofDecember 31, 2021 , we had$706.0 million in cash and cash equivalents, of which$452.2 million was held outside of regulated insurance entities. We also had$129.9 million in available-for-sale fixed maturity securities. Our cash and cash equivalents primarily consist of bank deposits and money market funds. Our available-for-sale fixed maturity securities consist ofU.S. Treasury securities and agencies, municipal securities, corporate debt securities, residential and commercial mortgage-backed securities, and other debt obligations. We believe that our existing cash and cash equivalents, available-for-sale fixed maturity securities, cash flow from operations, along with the net proceeds from our issuance of redeemable convertible preferred stock and IPO, will be sufficient to support short-term working capital and capital expenditure requirements for at least the next 12 months. Our long-term capital requirements depend on many factors, including our insurance premium growth rate, renewal activity, including the timing and the amount of cash received from customers, the performance of our embedded product, the timing and extent of spending to support development efforts, the introduction of new and enhanced products, the continuing market adoption of offerings on our platform, and the ongoing uncertainty in the global markets resulting from the global COVID-19 pandemic. In the first quarter 2022, in response to inflation and loss cost trends and to further drive efficiency and increased focus on our strategic priorities we instituted an organizational realignment, including an involuntary workforce reduction affecting approximately 330 employees, which represented approximately 20% of our workforce. In the first quarter of 2022, we have recognized charges of$6.8 million for severance, benefits and related costs as a result of these actions, of which$4.3 million of these charges are expected to result in cash expenditures. Additionally, we expect to incur real estate exit costs comprising accelerated amortization of certain right of use assets and related leasehold improvements and furniture and fixtures of approximately$2.4 million . We continue to review the potential impact of the realignment, including additional facility lease exits and employee-related costs, and are unable to estimate any additional restructuring costs or charges at this time. We expect the annual expense savings related to the organizational realignment to be approximately$30 million annually. Through prudent deployment of capital we believe we have sufficient resources, and access to additional debt and equity capital, to adequately meet our obligations as they come due. Currently, our debt covenants require cash and cash equivalents held in entities other than our insurance subsidiaries to be at least$200 million at all times. This threshold may be reduced to$150 million under two sets of circumstances: issuing 62,500 insurance policies through our Carvana embedded product and achieving a ratio of direct contribution to gross earned premium of 12%; or ceasing any customer acquisition spend outside of the Carvana agreement and reducing our monthly cash burn to no greater than$12 million . 79 --------------------------------------------------------------------------------
Cash Flows
The following table summarizes our cash flow data for the periods presented:
Years Ended December 31,
2021 2020 2019
(in millions)
Net cash used in operating activities $ (403.4) $ (287.2) $ (127.2)
Net cash provided by (used in) investing activities 76.9 (114.1) (114.0)
Net cash (used in) provided by financing activities (80.3) 1,098.5 535.5
Comparison of Years Ended
Net cash used in operating activities for the year endedDecember 31, 2021 was$403.4 million compared to$287.2 million of net cash used in operating activities for the year endedDecember 31, 2020 . The increase in cash used in operating activities was primarily due to a greater net loss incurred during the year endedDecember 31, 2021 compared to the prior year. Additionally, our evolving reinsurance strategy and timing of related payments and cash receipts, timing of cash payments and accruals related to accounts payable and other expenses and PIK interest paid. Net cash provided by investing activities for the year endedDecember 31, 2021 was$76.9 million , primarily due to proceeds from sales, maturities, calls and pay downs of investments, partially offset by purchases of investments and other debt obligations. Net cash used in investing activities for the year endedDecember 31, 2020 was$114.1 million , primarily due to purchases of corporate debt securities, commercial mortgage-backed securities, residential mortgage-backed securities and other debt obligations, partially offset by sales, maturities, calls and pay downs of investments. Net cash used in financing activities for the year endedDecember 31, 2021 was$80.3 million , primarily due to the pay down of debt and payment of preferred stock and related warrants issuance costs, partially offset by proceeds from the issuance of preferred stock and related warrants in connection with our partnership with Carvana. Net cash provided by financing activities for the year endedDecember 31, 2020 was$1,098.5 million , primarily due to proceeds from the issuance of common stock in connection with our IPO and concurrent private placements.
Comparison of Years Ended
The
7, "Liquidity and Capital Resources" of our Annual Report on Form 10-K.
Material Cash Requirements from Contractual and Other Obligations
As ofDecember 31, 2021 , our material cash requirements from known contractual and other obligations consisted of purchase commitments, as discussed in Note 12, "Commitments and Contingencies" and operating leases, as discussed in Note 8, "Leases," in the Notes to Consolidated Financial Statements. We believe we have sufficient resources, and access to additional debt and equity capital, to adequately meet our obligations as they come due. d
Critical Accounting Policies and Estimates
Our financial statements are prepared in accordance with GAAP. The preparation
of the consolidated financial statements in conformity with GAAP 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 reserves for loss and LAE, premium write-offs, and
valuation allowance on our deferred tax assets. We base our estimates on
historical experience and on various other assumptions that we believe to be
reasonable under the circumstances, the
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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.
We believe that the accounting policies described below involve a significant
degree of judgment and complexity. Accordingly, we believe these are the most
critical to aid in fully understanding and evaluating our consolidated financial
condition and results of operations. For further information, see Note 2,
"Summary of Significant Accounting Policies," in the Notes to Consolidated
Financial Statements.
Loss and LAE Reserves
Loss and LAE reserves represent management's best estimate of the ultimate liability for all reported and unreported claims that occurred prior to the end of each accounting period but have not yet been paid. These reserves are established to cover the estimated ultimate cost to settle insured losses. Loss and LAE reserves include an amount determined using adjuster determined case-base estimates for reported claims and on actuarial unpaid claim estimates using past experience and historical emergence patterns for unreported loss and LAE. Case reserve amounts are determined by claims adjusters following our case reserving practices, which consider the circumstances presented with each claimant, applicable policy provisions, and state law. The unpaid claim estimates consider loss cost trends, mix of business, and other risk factors impacting claims settlement. The methods used to estimate ultimate loss reserves by accident month include reported loss development, paid loss development, expected loss ratio, or ELR, frequency-severity, premium based Bornhuetter/Ferguson, or B/F, and exposure based B/F using frequency-severity. The method used to estimate unpaid LAE reserves is determined by a transaction-based allocation method where historical claim department activities are measured by their relative effort or cost for handling different claim types. Our estimation for unpaid LAE reserves includes the ultimate cost of settling a range of claim types from express material damage claims to more complex bodily injury cases. The evaluation and estimation of ultimate losses and LAE requires considerable judgment in understanding how claims mature, how claims differ between lines of business, and how changes in the business impact claims settlement over time. Loss reserves represent a liability estimate at a given point in time based on many input variables including historical and statistical information, inflation, contract interpretation, weather catastrophe impacts, regulatory environment, and economic conditions. While we consider many inputs into the loss reserve valuation process, as well as several actuarial methodologies, there is no single method for determining the exact ultimate claims liability. In many cases, we use multiple estimation methods based on the particular facts and circumstances of the claims and liabilities being evaluated, resulting in a range of reasonable estimates for reserves for losses and LAE. We do not discount reserves. Our actuarial reserving team performs monthly reviews of the claims experience and loss emergence to support our estimation of ultimate losses and LAE. A few considerations and assumptions in estimating ultimate claim liabilities includes relative case reserve adequacy over time, claims cycle time, claims settlement practices, exposure growth, actuarial projections, current economic conditions, driving patterns observed from telematics, weather catastrophes, and claim litigation. Our loss reserves can be grouped by claim type, where amounts related to material damage of vehicles and property tend to settle within six to 12 months, while claims that involve injuries or personal liability have a much longer time period between the occurrence of a loss and the settlement of the claim. In general, the longer the time span between the incidence of a loss and the settlement of the claim, the more the ultimate settlement amount can vary. Because actual experience can differ from key assumptions used in establishing reserves, there is potential for significant variation in the development of loss reserves. There is considerable uncertainty associated with the actuarial estimates, and therefore the actual losses and LAE paid in the future may differ materially from the reserves we have recorded. Our loss estimates are continually reviewed by management and adjusted as necessary; with adjustments included in the period determined.
The key assumptions that materially affect the estimate of the reserves for loss
and LAE are as follows:
•Many of the actuarial estimation methods assume that the speed of claim
payments and claim closures, also known as cycle time, remains relatively
consistent over time. While fluctuations and improvements in cycle time
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are expected as we grow, these timing changes can be difficult to discern from
normal process risk variability in the data.
•For actuarial methods that rely on case reserve data, there is an implicit assumption that the adequacy of case reserve estimates stays relatively constant over time. For example, if the held case reserves represent the 50th percentile outcome for each claim, then any changes to this case reserve level, either higher or lower, would impact the ultimate loss estimates. •Actuarial methods that rely on exposure bases, such as premiums or car years, perform better when the mix of business is relatively stable over time. Rapid business growth can change the mix of business across several dimensions: new business versus renewal, geography profile, and underwriting profile. As such, prior estimates of claim frequency, claim severity, or loss ratio may not be as predictive of future results when the mix of business changes.
•Broader macro level economics can have a material impact on loss reserve
estimates, such as a rapid change in miles driven as was observed with the
COVID-19 pandemic; unanticipated inflation, regulatory restrictions, and legal
developments as they relate to contract and coverage interpretation and
enforceability.
Due to the inherent uncertainty in determining our ultimate cost of settling
claims, we evaluate what the potential impact on consolidated results of
operations, financial position, and liquidity would be based on a hypothetical
5% and 10% increase or decrease in key assumptions described above. The loss
reserve range noted below represents a range of reasonably likely reserves, not
a range of all possible reserves. Therefore, the ultimate losses could reach
levels corresponding to reserve amounts outside of the range provided. Given our
growth from inception in 2015, we believe evaluating sensitivity based on a
hypothetical increase or decrease of 5% and 10% is reflective of management's
best estimate and provides an illustrative range of variability in key
assumptions. The below tables present this sensitivity analysis:
Scenarios for Changes in Bodily
Injury Claim Severity for all Accident Years
(10)% (5)% -% 5% 10% Bodily injury liability$ 119.3 $ 125.9 $ 132.5 $ 139.1 $ 145.7 Uninsured and underinsured bodily injury 28.0 29.6 31.2 32.7 34.3 All other coverages 42.0 42.0 42.0 42.0 42.0
Total losses-net of reinsurance
Our loss and LAE expense reserves are recorded net of external reinsurance and net of amounts expected to be received from salvage (the amount recovered from the damaged property after the we pay for a total loss) and subrogation (the right to recover payments from third parties).
Premium Revenue, Fee Income and Related Expenses
Premiums written are deferred and earned pro rata over the policy period. Unearned premium is established to cover the unexpired portion of premiums written. A premium deficiency, as measured on a gross basis, is recorded when the sum of expected losses, LAE, unamortized acquisition costs and maintenance costs exceed the recorded unearned premium reserve and anticipated investment income. A premium deficiency reserve is recognized as a reduction of deferred acquisition costs and, if necessary, by accruing an additional liability for the deficiency, with a corresponding charge to operations. We did not record a premium deficiency reserve in 2021 or 2020. InAugust 2021 , we commenced a fronting arrangement with an unaffiliated Texas county mutual insurance company, or the fronting carrier. We route all of our new auto policies and, over time, expect to route certain renewal auto policies, inTexas through the fronting carrier whereby we assume 100% of the related premium and losses on those policies. The fronting arrangement allows us to have greater rating and underwriting flexibility. Premiums assumed are deferred and earned pro rata over the policy period. Unearned premium is established to cover the unexpired portion of premiums assumed. Through this fronting arrangement, we have greater rating and underwriting flexibility that we believe will allow us to more accurately segment risk inTexas to improve profitability. 82 -------------------------------------------------------------------------------- Premiums receivable represents premiums written but not yet collected. Generally, premiums are collected prior to providing risk coverage, minimizing our exposure to credit risk. Due to a variety of factors, including certain state regulations related to COVID-19 relief efforts, certain premiums billed may not be collected, for which we establish an allowance for doubtful accounts based primarily on an analysis of historical collection experience, adjusted for current economic conditions. Allowance for credit losses was$5.4 million and$3.5 million as ofDecember 31, 2021 and 2020, respectively, on the consolidated balance sheets. A policy is generally considered past due on the first day after its due date and policies greater than 90 days past due are written-off. We recognized premium write-offs, or bad debt expense, of$20.9 million ,$23.6 million and$9.0 million for the periods endedDecember 31, 2021 , 2020 and 2019 respectively. For those policyholderswho pay premiums on an installment basis, we charge a flat fee for each installment related to the additional administrative costs associated with processing more frequent billings. We recognize this fee income in the period which we process each installment. Policy acquisition costs, consisting of premium taxes, certain marketing costs and underwriting expenses, and fronting carrier commissions, net of ceding commissions, related to the successful acquisition of new or renewal business. They are deferred and amortized over the same period in which the related premiums are earned. Ceding commissions relating to reinsurance agreements are recorded as a reimbursement for both deferrable and non-deferrable acquisition costs. The portion of the ceding commission that is equal to the pro rata share of acquisition costs based on quota share percentage is recorded as an offset to the gross deferred acquisition costs. Any portion of the ceding commission that exceeds the acquisition costs of the business ceded is recorded as excess ceding commission, a deferred liability, and amortized over the same period in which the related premiums are earned.
Reinsurance
In the ordinary course of business, we cede and retrocede a portion of our business written and assumed, respectively, to reinsurers to limit the maximum net loss potential arising from large risks and catastrophes. These arrangements, known as treaties, provide for reinsurance coverage on quota-share and excess-of-loss basis. All reinsurance contracts provide for indemnification against loss or liability relating to insurance risk and have been accounted for as reinsurance. Although the ceding of reinsurance does not discharge us from our primary liability to the policyholder, the insurance company that assumes the coverage assumes the related liability. Amounts recoverable from and payable to reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business. Reinsurance premiums, commissions and expense reimbursements related to reinsured business are accounted for on a basis consistent with the basis used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums ceded to other companies have been reported as a reduction of premiums earned and are recognized over the remaining policy period based on the reinsurance protection provided. Amounts applicable to reinsurance ceded for unearned premium reserves are reported as a prepaid reinsurance premiums asset in the accompanying consolidated balance sheets and as reduction of unearned premiums in Note 6, "Reinsurance," in the Notes to Consolidated Financial Statements. Ceding commissions received in connection with reinsurance ceded have been accounted for as a reduction of other insurance (benefit) expense in the consolidated statements of operations and comprehensive loss. Some of our reinsurance agreements provide for adjustment of commissions or amount of coverage based on loss experience referred to as sliding scale commissions, loss corridors and loss ratio caps, respectively. We recognize the asset or liability arising from these adjustable features in the period the adjustment occurs, which is calculated based on experience to-date under the agreement. In the event that all or any of the reinsuring companies might be unable to meet their obligations under existing reinsurance agreements, we would be liable for such defaulted amounts. We evaluate and monitor the financial condition associated with our reinsurers in order to minimize our exposure to significant losses from reinsurer insolvencies. We obtain reinsurance from a diverse group of global reinsurers and monitor concentration as well as financial strength ratings of the reinsurers to minimize counterparty credit risk. For our reinsurance partnerswho are not rated, we require adequate levels of collateral or letters of credit to be available to us in the event of downside scenarios. To recognize this risk of credit loss, we have established an allowance for credit losses based on the probability of default and the expected loss given default as influenced by factors such as the reinsurer's credit rating 83 --------------------------------------------------------------------------------
and average life of our reinsurance recoverables. Allowance for credit losses
was
New Accounting Pronouncements
See Note 2, "Basis of Presentation and Summary of Significant Accounting
Policies," in the Notes to Consolidated Financial Statements.
Election Under the Jumpstart Our Business Startups Act of 2012
Prior toDecember 31, 2021 , we qualified as an "emerging growth company," or EGC, under the Jumpstart Our Business Startups Act, or JOBS Act. We previously elected to adopt new or revised accounting guidance within the same time period as private companies as permitted by our status as an EGC. We became a large accelerated filer onDecember 31, 2021 and lost our status as an EGC. Accordingly, we will follow the adoption criteria of public companies for new accounting pronouncements beginning with this Annual Report on Form 10-K. Prior to this Annual Report, our financial statements did not reflect adoption of certain amended guidance that public companies generally may have been required to adopt, but we were not required to adopt based on our EGC status. This includes Accounting Standard Update, or ASU, 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. We adopted this guidance using a modified retrospective approach which resulted in a cumulative-effect adjustment to opening accumulated loss as ofJanuary 1, 2021 since ASU 2016-13 may only be adopted as of the beginning of a fiscal year. This adoption did not have a material impact on our previously filed quarterly information. For additional information on the impact of this guidance, see Note 2, "Basis of Presentation and Summary of Significant Accounting Policies" in the Notes to Consolidated Financial Statements.
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