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ROOT, 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 unaudited condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our audited consolidated financial statements and the related notes and the discussion under the heading "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year endedDecember 31, 2021 filed with theSecurities and Exchange Commission , orSEC , onFebruary 23, 2022 , or the 2021 10-K. This discussion, particularly information with respect to our future results of operations or financial condition, business strategy and plans and objectives of management for future operations, includes forward-looking statements that involve risks and uncertainties as described under the heading "Special Note Regarding Forward-Looking Statements" in this Quarterly Report on Form 10-Q. You should review the disclosure under the heading "Risk Factors" in this Quarterly Report on Form 10-Q and in the 2021 10-K for a discussion of important factors that could cause our actual results to differ materially from those anticipated in these forward-looking statements.
Our Business
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$273 billion U.S. auto insurance market is ripe for disruption. Auto insurance is required for the vast majority of drivers inthe United States and we believe it is typically the first insurance policy purchased by consumers. As a result, our auto-first strategy establishes the foundation for an expansive lifetime relationship with the opportunity to add other personal insurance lines as customer needs evolve. As part of our strategy, we have also established the technological foundation for an enterprise software offering, diversifying our revenue streams over time. 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.
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•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 (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 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 are expected 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. 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 basis metrics include gross written premium, gross earned premium, direct contribution, ratio of direct contribution to total revenue, ratio of direct contribution to gross earned premium, gross loss ratio, gross LAE ratio and gross accident period loss ratio. We have added a new key performance indicator to strengthen investor understanding of our business results that exclude certain non-cash, unusual or infrequent transactions. We believe that adjusted earnings before interest, tax, depreciation, amortization, or adjusted EBITDA, will provide investors with useful insight into the underlying performance of our business. For additional information, including definitions of these metrics, see "- Key Performance Indicators", and for a reconciliation of our non-GAAP measures to the most directly comparable generally accepted accounting principles inthe United States , or GAAP, measures, see "- Non-GAAP Financial Measures." 20 --------------------------------------------------------------------------------
Recent Developments Affecting Comparability
COVID-19 Impact
InMarch 2020 , theWorld Health Organization declared COVID-19 a global pandemic. The pandemic and related measures taken to contain the spread of COVID-19, such as government-mandated business closures, "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. 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. 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. 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" in the 2021 10-K 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.
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 third-party insurance companies. 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.
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,
and unrealized gains from our private equity investments. Net investment income
is directly correlated with the overall size of our investment portfolio, market
level of interest rates and changes in fair value of our private equity
investments. Net investment income will vary with the size of our investment
portfolio, market returns and the investment strategy.
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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 and Other 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 is primarily comprised of 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 third-party insurance companies 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 LAE, sales and marketing, other
insurance expense, 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 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. Warrant compensation expense is recognized
on a pro-rata basis considering progress toward completing the Integrated
Platform.
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.
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Other Insurance Expense
Other insurance expense 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 also includes amortization of deferred acquisition costs like premium taxes and report costs related to the successful acquisition of a policy. Other insurance expense 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; depreciation expense for computers, furniture and other fixed assets; and restructuring costs associated with the organizational realignment. 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 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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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), direct
contribution and adjusted EBITDA and their reconciliations to the most directly
comparable GAAP measures.
Three Months Ended March
31,
2022 2021
(dollars in millions, except premiums
per policy)
Policies in force
Auto 335,273 360,290
Renters 8,351 8,835
Premiums per policy
Auto $ 1,040 $ 958
Renters $ 140 $ 140
Premiums in force
Auto $ 697.4 $ 690.3
Renters $ 1.2 $ 1.2
Gross written premium(1) $ 187.2 $ 202.5
Gross earned premium(1) $ 174.7 $ 160.2
Gross profit/(loss) $ (12.3) $ 6.3
Gross margin (14.4) % 9.2 %
Adjusted gross profit/(loss) $ (5.5) $ 17.0
Direct contribution $ 6.4 $ 26.6
Net loss $ (76.4) $ (99.6)
Adjusted EBITDA $ (51.2) $ (90.2)
Ratio of adjusted gross profit/(loss) to total revenue (6.4) % 24.8 %
Ratio of adjusted gross profit/(loss) to gross earned premium (3.1) % 10.6 %
Ratio of direct contribution to total revenue 7.5 % 38.8 %
Ratio of direct contribution to gross earned premium 3.7 % 16.6 %
Gross loss ratio 84.1 % 70.9 %
Gross LAE ratio 9.1 % 9.8 %
Gross accident period loss ratio 81.4 % 76.2 %
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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 three months
ended March 31, 2022 was $13.7 million and $9.2 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.
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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 performance indicator has been updated to include assumed written premiums beginning during the third quarter of 2021.
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 include 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 . 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 . 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 and other insurance expense 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 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 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.
Adjusted EBITDA
We define adjusted EBITDA, a non-GAAP financial measure, as net loss excluding interest expense, income tax expense, depreciation and amortization, share-based compensation, warrant compensation expense and restructuring charges. After these adjustments, the resulting calculation represents expenses directly attributable to our operating performance. We use adjusted EBITDA as an internal performance measure in the management of our operations because we believe it provides management and other users of our financial information useful insight into our results of operations and underlying business performance. Adjusted EBITDA should not be viewed as substitute for net loss calculated in accordance with GAAP, and other companies may define adjusted EBITDA differently.
See the section titled "- Non-GAAP Financial Measures" for a reconciliation of
net loss to adjusted EBITDA.
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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.
Three Months Ended
March 31,
2022 2021
(dollars in millions)
Numerator: Adjusted gross profit/(loss) $ (5.5) $ 17.0
Denominator: total gross earned premium $ 174.7 $ 160.2
Ratio of adjusted gross profit/(loss) to gross earned premium (3.1) % 10.6 %
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 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 structure 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.
Three Months Ended
March 31,
2022 2021
(dollars in millions)
Numerator: direct contribution $ 6.4 $ 26.6
Denominator: total gross earned premium $ 174.7 $ 160.2
Ratio of direct contribution to gross earned premium 3.7 % 16.6 %
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.
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.
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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 ultimate loss estimates from prior periods 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.
Results of Operations
Comparison of the Three Months Ended
The following table presents our results of operations for the periods
indicated:
Three Months Ended March 31,
2022 2021 $ Change % Change
(dollars in millions)
Revenues:
Net premiums earned $ 78.3 $ 59.1 $ 19.2 32.5 %
Net investment income 0.6 0.9 (0.3) (33.3) %
Net realized gains on investments 1.2 2.4 (1.2) (50.0) %
Fee and other income 5.3 6.2 (0.9) (14.5) %
Total revenues 85.4 68.6 16.8 24.5 %
Operating expenses:
Loss and loss adjustment expenses 96.7 59.9 36.8 61.4 %
Sales and marketing 14.7 68.4 (53.7) (78.5) %
Other insurance expense 1.0 2.4 (1.4) (58.3) %
Technology and development 13.9 13.8 0.1 0.7 %
General and administrative 30.0 18.4 11.6 63.0 %
Total operating expenses 156.3 162.9 (6.6) (4.1) %
Operating loss (70.9) (94.3) 23.4 N.M.
Interest expense (5.5) (5.3) (0.2) 3.8 %
Loss before income tax expense (76.4) (99.6) 23.2 N.M.
Income tax expense - - - - %
Net loss (76.4) (99.6) 23.2 N.M.
Other comprehensive loss:
Changes in net unrealized losses on investments (3.7) (3.5) (0.2) 5.7 %
Comprehensive loss $ (80.1) $ (103.1) $ 23.0 N.M.
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N.M. - Percentage change not meaningful
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Revenue
Net Premiums Earned
Net premiums earned increased$19.2 million , or 32.5%, to$78.3 million for the three months endedMarch 31, 2022 compared to the same period in 2021. The increase was primarily due to growth in gross earned premium and lower cession rates on gross earned premiums. During the three months endedMarch 31, 2022 and 2021, we ceded approximately 55.2% and 63.1% of our gross earned premiums to third-party reinsurers, respectively. The change in ceding percentage between the periods was primarily driven by retaining a larger share of our renewal book of business.
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 three months ended
Three Months Ended March 31,
2022 2021 $ Change % Change
(dollars in millions)
Gross written premium $ 187.2 $ 202.5 $ (15.3) (7.6) %
Ceded written premium (102.4) (89.6) (12.8) 14.3 %
Net written premium 84.8 112.9 (28.1) (24.9) %
Gross earned premium 174.7 160.2 14.5 9.1 %
Ceded earned premium (96.4) (101.1) 4.7 (4.6) %
Net earned premium $ 78.3 $ 59.1 $ 19.2 32.5 %
Gross earned premium growth was primarily due to an 8.6% increase in premium per
policy for automobile insurance primarily resulting from pricing increases in
several states and improved customer retention between the periods. This
increase was partially offset by lower gross written premium as a result of
reducing marketing expenditures.
Operating Expenses
Loss and Loss Adjustment Expenses
Loss and LAE increased$36.8 million , or 61.4%, to$96.7 million for the three months endedMarch 31, 2022 compared to the same period in 2021. The increase was primarily due to retaining a larger share of business, as the reinsurance ceding percentage was lower for the three months endedMarch 31, 2022 compared to the same period in 2021. In addition, we experienced higher claim severity due to inflation, greater claims volume and a reduction in favorable prior accident years development for the three months endedMarch 31, 2022 compared to the prior period. For further information on prior accident years development, see Note 5, "Loss and Loss Adjustment Expense Reserves," in the Notes to Condensed Consolidated Financial Statements. Gross accident period loss ratios increased to 81.4% from 76.2% for the three months endedMarch 31, 2022 and 2021, respectively. The change in the ratios was driven by higher loss costs from increased severity per claim due to inflation, as the industry experienced higher replacement parts cost and growth in used car values. The increase in loss costs was partially offset by growth in average premium per policy and improved tenure mix of our book of business. We also experienced a 12 percent increase in severity per claim and a slight increase in claim frequency of two percent for the three months endedMarch 31, 2022 compared to the same period in 2021. The severity and frequency estimates are based on bodily injury, collision and property damage coverages. 29 --------------------------------------------------------------------------------
Sales and Marketing
Sales and marketing expense decreased$53.7 million , or 78.5%, to$14.7 million for the three months endedMarch 31, 2022 compared to the same period in 2021. The decrease was primarily due to a decline in performance marketing of$45.9 million and branding and advertising of$12.0 million as a result of lower marketing expenditures. This was partially offset by$5.3 million of warrant compensation expense related to Carvana's progress toward the Integrated Platform.
General and Administrative
General and administrative increased$11.6 million , or 63.0%, to$30.0 million for the three months endedMarch 31, 2022 compared to the same period in 2021. The increase was driven by$7.8 million in restructuring costs related to an organizational realignment in the first quarter of 2022. In addition, we incurred a$2.9 million increase in employee-related costs as a result of an increase in headcount compared to the same period in 2021.
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), direct contribution 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: (1) monitor and evaluate the performance of our business
operations and financial performance; (2) facilitate internal comparisons of the
historical operating 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.
30
-------------------------------------------------------------------------------- The following table provides a reconciliation of total revenue to adjusted gross profit/(loss) and direct contribution for the three months endedMarch 31, 2022 and 2021: Three Months Ended March 31, 2022 2021 (dollars in millions) Total revenue$ 85.4 $ 68.6 Loss and loss adjustment expenses (96.7) (59.9) Other insurance expense (1.0) (2.4) Gross profit/(loss)$ (12.3) $ 6.3 Gross margin (14.4) % 9.2 % Less: Net investment income$ (0.6) $ (0.9) Net realized gains on investments (1.2) (2.4) Adjustments from other insurance expense(1) 8.6 14.0 Adjusted gross profit/(loss) (5.5) 17.0 Ceded earned premium 96.4 101.1 Ceded loss and LAE (66.2) (69.3) Net ceding commission and other(2) (18.3) (22.2) Direct contribution 6.4 26.6 Gross earned premium$ 174.7 $ 160.2 Ratio of adjusted gross profit/(loss) to total revenue (6.4) % 24.8 % Ratio of adjusted gross profit/(loss) to gross earned premium (3.1) % 10.6 % Ratio of direct contribution to total revenue 7.5 % 38.8 % Ratio of direct contribution to gross earned premium 3.7 % 16.6 %
______________
(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.
31
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Adjusted EBITDA
The following table provides a reconciliation of net loss to adjusted EBITDA for
the three months ended
Three Months Ended March 31,
2022 2021
(dollars in millions)
Net loss $ (76.4) $ (99.6)
Adjustments:
Interest expense 5.0 3.6
Income tax expense - -
Depreciation and amortization 2.6 3.5
Share-based compensation 4.5 2.3
Warrant compensation expense 5.3 -
Restructuring charges(1) 7.8 -
Adjusted EBITDA $ (51.2) $ (90.2)
______________
(1) Restructuring costs consist of severance, benefits, related costs and real
estate exit costs comprising of accelerated amortization of certain right of use
assets, leasehold improvements, furniture and fixtures. This includes $2.1M of
share-based compensation and $1.0M in depreciation and amortization. For further
information on restructuring costs, see Note 9, "Restructuring Cost," in the
Notes to Condensed Consolidated Financial Statements.
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 . To date, our insurance subsidiaries have not paid any dividends and, as ofMarch 31, 2022 , they were not permitted to pay any dividends without approval of the applicable superintendent, commissioner and/or director. As our insurance subsidiaries' businesses 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. As ofMarch 31, 2022 , 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. 32 -------------------------------------------------------------------------------- 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. AtMarch 31, 2022 , Root Re was subject to compliance with certain capital levels and a net earned premium to capital ratio of 15:1, which we maintained as ofMarch 31, 2022 . 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, or Term Loan C. The maturity of the term loan isJanuary 27, 2027 . Interest is payable quarterly and is determined on a floating interest rate calculated on the SOFR, with a 1.0% floor, plus 9%, plus 0.26161% per annum. Concurrently with the term loan, we also issued to the lender warrants to purchase 5.7 million shares of Class A common stock. Under certain contingent scenarios, the lender 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 Class A common stock on a fully-diluted basis as of the triggering date.
Liquidity
As ofMarch 31, 2022 , we had$934.7 million in cash and cash equivalents, of which$735.9 million was held outside of regulated insurance entities. We also had$129.6 million in marketable securities.
Our cash and cash equivalents primarily consist of bank deposits and money
market funds. Our marketable securities primarily consist of
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, marketable securities and cash flow from operations will be sufficient to support short-term working capital and capital expenditure requirements for at least the next 12 months and for the foreseeable future thereafter. 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 recognized charges of$5.6 million for severance, benefits and related costs as a result of these actions, of which$3.3 million resulted in cash expenditures. Additionally, we incurred real estate exit costs related to accelerated amortization of certain right of use assets and related leasehold improvements and furniture and fixtures of$1.5 million . We also recognized$0.7 million related to accelerated expense for software that no had no economic value. For certain other space that we ceased using, we currently have the intent or ability to sublease that space and have not recognized any related charges related to accelerated amortization of the right-of-use asset. If that changes in a future period, we may incur additional restructuring charges. 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 . 33 --------------------------------------------------------------------------------
Cash Flows
The following table summarizes our cash flow data for the periods presented:
Three Months Ended March 31,
2022 2021
(in millions)
Net cash used in operating activities $ (51.2) $ (90.9)
Net cash (used in) provided by investing activities (6.3) 81.3
Net cash provided by financing activities 286.2 3.1
Net cash used in operating activities for the three months ended March 31, 2022
was $51.2 million compared to $90.9 million of net cash used in operating
activities for the three months ended March 31, 2021 . The decrease in cash used
in operating activities was primarily due to timing of payments and cash
receipts related to reinsurance activity, a decline in net loss incurred
primarily a result of a decrease in marketing expense and timing of premium
receipts and claim payments during the three months ended March 31, 2022
compared to the same period in 2021.
Net cash used in investing activities for the three months ended March 31, 2022
was $6.3 million , primarily due to purchases of investments and indefinite-lived
intangible assets and capitalization of internally developed software, which was
partially offset by sales, maturities, calls and pay downs of investments. Net
cash provided by investing activities for the three months ended March 31, 2021
was $81.3 million , primarily due to proceeds from the sale, maturities, calls
and pay downs of investments.
Net cash provided by financing activities for the three months ended March 31,
2022 was $286.2 million , primarily due to proceeds from our Term Loan C. Net
cash provided by financing activities for the three months ended March 31, 2021
was $3.1 million primarily due to proceeds from employees exercising stock
options, net of tax proceeds (withholding), which was offset by a partial
repayment of long term debt.
Material Cash Requirements from Contractual and Other Obligations
There have been no material changes to our contractual and other obligations from those described in our 2021 10-K other than entering into a$300.0 million five-year Term Loan C. The maturity of this term loan isJanuary 27, 2027 . For additional information regarding the term loan refer to Note 7 "Long-Term Debt," in the Notes to Condensed Consolidated Financial Statements.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, results of operations, liquidity or cash flows.
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 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.
34
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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 2021 10-K and the
Notes to Condensed Consolidated Financial Statements appearing elsewhere in this
Quarterly Report on Form 10-Q. During the three months ended March 31, 2022 ,
there were no material changes to our critical accounting policies from those
discussed in our 2021 10-K, other than the potential accounting effects
resulting from net operating loss, or NOL, limitations discussed below.
We calculate the tax effects of temporary differences that give rise to deferred
tax assets and deferred tax liabilities in accordance with ASC 740, Income
Taxes. The application of ASC 740 requires a company to evaluate the
recoverability of deferred tax assets and to establish a valuation allowance if
necessary to reduce the carrying value of the deferred tax asset to an amount
that is more likely than not to be realized. Considerable judgment is required
in determining whether a valuation allowance is necessary and, if so, the amount
of such valuation allowance. In evaluating the need for a valuation allowance we
consider many factors, including: (1) the nature of the deferred tax assets and
liabilities; (2) whether they are ordinary or capital; (3) the timing of
expected reversal; (4) taxable income in prior carry back years as well as
projected taxable earnings exclusive of reversing temporary differences and
carry forwards; (5) the length of time that carryovers can be used; (6) unique
tax rules that would impact the utilization of the deferred tax assets; and (7)
any tax planning strategies that we would employ to avoid a tax benefit expiring
unused.
As of March 31, 2022 , we had federal income tax NOLs of approximately $1,087.6
million available to offset our future taxable income, if any, prior to
consideration of annual limitations that may be imposed under Section 382 of the
Internal Revenue Code, or the Code, or otherwise. We have recognized a deferred
tax asset of $228.4 million related to these NOLs, which is fully offset by a
valuation allowance.
We may be unable to fully use our NOLs, if at all. Under Section 382 of the
Code, if a corporation undergoes an "ownership change" (very generally defined
as a greater than 50% change, by value, in the corporation's equity ownership by
certain shareholders or groups of shareholders over a rolling three-year
period), the corporation's ability to use its pre-ownership change NOLs to
offset its post-ownership change income may be limited.
We performed an estimated ownership change analysis as of March 31, 2022 and
concluded there was no ownership change. However, our estimated ownership
percentage by certain shareholders over the most recent rolling three-year
period changed significantly, although such change did not exceed the 50%
threshold. We may experience ownership changes in the future as a result of
subsequent shifts in our stock ownership, some of which may be outside of our
control, or a change in our methodology for determining such ownership. If we
undergo an ownership change, we may be prevented from fully utilizing our NOLs
existing at the time of the ownership change prior to their expiration. To the
extent there is a limitation, there could be a substantial reduction in the
deferred tax asset with an offsetting reduction in the valuation allowance.
35
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