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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, 2022 filed with theSecurities and Exchange Commission , orSEC , onFebruary 22, 2023 , or the 2022 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 2022 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 tech-enabled insurance 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 are also focused on expanding
our embedded insurance platform, where we acquire customers through strategic
partnerships.
We believe the Root advantage is derived from our unique ability to efficiently
and effectively bind auto insurance policies quickly, through direct and
embedded channels, aided by segmenting individual risk based on complex
behavioral data and proprietary telematics. Our customer experience is 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 and develop
our embedded products, 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. We also
continue to revise contracts to tighten underwriting and implement rate
increases to control the impact of increased loss costs.
•Reduced marketing as a percentage of premium. Certain 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.
•Increased revenue per customer. Over time we expect to refine our fee schedules
to be more consistent with industry norms. This, paired with strengthened
underwriting, will facilitate the opportunity to generate additional fee revenue
per customer.
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
and take appropriate and timely rate actions. We efficiently acquire customers
directly through multiple channels, including embedded, digital (performance),
channel media, referrals and agency. Our evolving acquisition strategy includes
utilizing our embedded platform through current and future embedded partners.
Traditionally, our marketing costs have historically been well below industry
averages, although in any given period, these costs can vary by acquisition
strategy, channel mix, by state, or due to
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seasonality or due to the competitive environment. Today, we acquire the vast
majority of our customers through mobile applications and our embedded platform.
We believe that through prudent investment in and diversification of our
marketing channels, including a focus on embedded insurance through our current
and future strategic partners, and leveraging proprietary data science and
technology will position us for more sustainable, long-term and profitable
growth.
As a full-stack insurance company, we currently employ a "capital-efficient"
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 scaling our business in order to
operate a capital-efficient 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 historical
top-line growth and resulting capital requirements, which are relieved, in part,
by obtaining reinsurance.
In addition to our gross basis metrics, management uses adjusted earnings before
interest, tax, depreciation, amortization, or adjusted EBITDA, as an integral
part of managing our business. We believe adjusted EBITDA provides investors
with useful insight into our business because such measure eliminates the
effects of certain charges that are not directly attributable to our underlying
operating performance. For additional information, including definitions of
these key metrics, see "- Key Performance Indicators" and for reconciliations of
Direct Contribution and adjusted EBITDA to the most directly comparable
generally accepted accounting principles in the United States , or GAAP, metric,
see "- Non-GAAP Financial Measures."
Recent Developments Affecting Comparability
General Macroeconomic Factors
Economic instability has led to acute inflationary pressures, supply chain disruptions, rising interest rates, a downturn in equity markets and recent bank failures. There is a risk of inflation remaining elevated for an extended period, which could cause claims and claim expenses to increase, impact the performance of our investment portfolio or have other adverse effects. We have seen an increase in the value of used vehicles and replacement parts. These cost increases have resulted in greater claims severity while being partially offset by higher subrogation recoveries on damaged vehicles.We continue to file in multiple states to establish rates that more closely follow the evolving loss cost trends. Rising interest rates and reduced equity values have increased the cost of capital and may limit our ability to raise additional capital.
COVID-19 Impact
InMarch 2020 , theWorld Health Organization declared COVID-19 a global pandemic. 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 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 2022 10-K for more details. 22 --------------------------------------------------------------------------------
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.
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 direct contribution and adjusted EBITDA and
their reconciliations to the most directly comparable GAAP measures.
Three Months Ended March
31,
2023 2022
(dollars in millions, except premiums
per policy) Policies in force 199,685 335,273 Premiums per policy$ 1,292 $ 1,040 Premiums in force$ 516.0 $ 697.4 Gross premiums written$ 134.7 $ 187.2 Gross premiums earned$ 130.1 $ 174.7 Gross profit/(loss) $ 5.5$ (12.3) Net loss$ (40.9) $ (77.5) Direct contribution$ 18.6 $ 6.4 Adjusted EBITDA$ (11.3) $ (51.8) Net loss and LAE ratio 105.5 % 123.5 % Net expense ratio 55.7 % 71.3 % Net combined ratio 161.2 % 194.8 % Gross loss ratio 71.5 % 84.1 % Gross LAE ratio 11.2 % 9.1 % Gross expense ratio 40.3 % 42.4 % Gross combined ratio 123.0 % 135.6 % Gross accident period loss ratio 69.3 % 81.5 % Policies in Force We define policies in force as the number of current and active auto insurance 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 premiums written on auto
insurance policies in force at the end of the period 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.
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Premiums in Force
We define premiums in force 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 premiums written 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 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 fluctuations 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 Premiums Written
We define gross premiums written, as the total amount of gross premium on policies that were bound during the period less the prorated impact of policy cancellations. Gross premiums written includes direct premiums and assumed premiums. We view gross premiums written as an important metric because it is the metric that most closely correlates with changes in gross premiums earned. We use gross premiums written, 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 Premiums Earned We define gross premiums earned 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 premiums earned includes direct premiums and assumed premiums. We view gross premiums earned as an important metric as it allows us to evaluate our premium levels prior to the impacts of reinsurance. It is the primary driver of our consolidated GAAP revenues. As with gross premiums written, we use gross premiums earned, 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. We view gross profit/(loss) as an important metric because we
believe it is informative of the financial performance of our core insurance
business.
Direct Contribution
We define direct contribution, a non-GAAP financial measure, as gross
profit/(loss) excluding net investment income, net realized gains on
investments, report costs, salaries, health benefits, bonuses, employee
retirement plan related expenses and employee share-based compensation expense,
allocated overhead, licenses, net commissions, professional fees and other
expenses, ceded premiums earned, 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 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. 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.
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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, restructuring charges, write-off of prepaid marketing expenses, legal fees and other items that do not reflect our ongoing operating performance. 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 a 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.
Net Loss and LAE Ratio We define net loss and LAE ratio expressed as a percentage, as the ratio of net loss and LAE to net premiums earned. We view net loss and LAE ratio as important metric because it allows us to evaluate loss trends as a percentage of net premiums and believe it is useful for investors to evaluate those separately from other operating expenses.
Net Expense Ratio
We define net expense ratio expressed as a percentage, as the ratio of all
operating expenses less loss and LAE and less fee income to net premiums earned.
We view net expense ratio as important because it allows us to analyze our
expense and acquisition trends, net of fee income, and allows investors to
evaluate these expenses exclusive of our loss and LAE expenses.
Net Combined Ratio
We define net combined ratio expressed as a percentage, as the sum of net loss and LAE ratio and net expense ratio. We view net combined ratio as important because it allows us to analyze our underwriting result trends and is a key indicator of overall profitability and health of the overall business. We believe it is useful to investors to evaluate these components separately and in the aggregate when reviewing our underwriting performance. A net combined ratio under 100% indicates an underwriting profit, while a net combined ratio greater than 100% indicates an underwriting loss.
Gross Loss Ratio
We define gross loss ratio expressed as a percentage, as the ratio of gross
losses to gross premiums earned. 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.
Gross LAE Ratio
We define gross LAE ratio expressed as a percentage, as the ratio of gross LAE
to gross premiums earned. 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.
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Gross Expense Ratio
We define gross expense ratio expressed as a percentage as the ratio of gross operating expenses less loss and LAE and less fee income to gross premiums earned. We view gross expense ratio as important because it allows us to analyze the underlying expense base of the business and establish expense targets, prior to the impact of reinsurance. We believe gross expense ratio is useful for investors to further evaluate business health and performance, prior to the impact of reinsurance.
Gross Combined Ratio
We define gross combined ratio expressed as a percentage as the sum of the gross loss ratio, gross LAE ratio and gross expense ratio. We view gross combined ratio as important because it allows us to evaluate financial performance and establish targets that we believe more closely reflects the underlying performance and profitability of the business prior to reinsurance. Further, we believe it is useful for investors to evaluate these components separately and in the aggregate when reviewing our gross underwriting performance. A gross combined ratio under 100% indicates an underwriting profit while a gross combined ratio greater than 100% indicates an underwriting loss, prior to the impact of reinsurance.
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 premiums earned 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.
Components of Our Results of Operations
Revenue
We generate revenue from net premiums earned, net investment income, net
realized gains on investments, fee income and other income.
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 premiums written, less the earned portion that is ceded to third-party reinsurers under our reinsurance agreements. We expect net premiums earned to decrease in the short-term as our policies in force decrease continues to outpace premiums written from new business. In the near-term, we expect to grow new writings with our embedded products and greater premiums per policy to generate growth in net premiums earned. Net Investment Income Net investment income represents interest earned from our fixed maturity and short-term investments and cash and cash equivalents and unrealized gains and losses from our private equity investments less investment expenses. 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 and composition of our investment portfolio, market returns and the investment strategy.
Net Realized Gains on Investments
Net realized gains on investments represents the difference between the amount
received by us on the sale of an investment as compared to the investment's
amortized cost basis.
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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 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.
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 the costs incurred for claims, payments made and estimated future payments to be made to or on behalf of our policyholders, including expenses needed to adjust or settle claims, net of amounts ceded to reinsurers. 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 are 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 to write more business. 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 related salaries, health benefits, bonuses, employee retirement plan related expenses and employee share-based compensation expense, or Personnel Costs, for claims related employees; software expense; internally developed software amortization; and overhead allocated based on headcount, or Overhead.
Sales and Marketing
Sales and marketing expense includes spending related to performance and
embedded channels, channel media, advertising, branding, public relations,
sponsorship, consumer insights and referral fees. These expenses also include
related Personnel Costs, Overhead and certain 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. Certain warrant
compensation expense is recognized on a pro-rata basis considering progress
toward completing the Integrated Platform under the Carvana commercial
agreement.
We plan to continue investing in and diversifying our marketing channels,
including costs incurred related to our embedded channel, to attract and acquire
new customers, increase our brand awareness, and expand our product offerings
within certain markets. 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, certain warrant compensation expense related to our embedded channel, and Personnel Costs and Overhead related to actuarial and certain data science activities. Other insurance expense also includes amortization of deferred acquisition costs like certain commissions, 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. Certain warrant compensation expense is recognized on a pro-rata basis for policies originated from the Integrated Platform towards milestones as defined under the Carvana commercial agreement.
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. 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; write-offs; and restructuring costs which include employee costs, real estate exit costs and other costs. General and administrative expenses are expensed as incurred. We expect general and administrative expenses to decrease as a percentage of total revenue over time.
Non-Operating Expenses
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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Results of Operations
Comparison of the Three Months Ended
Three Months Ended March 31,
2023 2022 $ Change % Change
(dollars in millions)
Revenues:
Net premiums earned $ 60.0 $ 78.3 $ (18.3) (23.4) %
Net investment income 6.7 0.6 6.1 1,016.7 %
Net realized gains on investments - 1.2 (1.2) (100.0) %
Fee income 3.2 4.9 (1.7) (34.7) %
Other income 0.2 0.4 (0.2) (50.0) %
Total revenues 70.1 85.4 (15.3) (17.9) %
Operating expenses:
Loss and loss adjustment expenses 63.3 96.7 (33.4) (34.5) %
Sales and marketing 3.6 15.3 (11.7) (76.5) %
Other insurance expense 1.3 1.0 0.3 30.0 %
Technology and development 10.2 13.9 (3.7) (26.6) %
General and administrative 21.5 30.5 (9.0) (29.5) %
Total operating expenses 99.9 157.4 (57.5) (36.5) %
Operating loss (29.8) (72.0) 42.2 (58.6) %
Interest expense (11.1) (5.5) (5.6) 101.8 %
Loss before income tax expense (40.9) (77.5) 36.6 (47.2) %
Income tax expense - - - - %
Net loss (40.9) (77.5) 36.6 (47.2) %
Other comprehensive income (loss):
Changes in net unrealized gains (losses) on
investments 1.1 (3.7) 4.8 129.7 %
Comprehensive loss $ (39.8) $ (81.2) $ 41.4 (51.0) %
Revenue
Net Premiums Earned
Net premiums earned decreased $18.3 million , or 23.4%, to $60.0 million , for the
three months ended March 31, 2023 , compared to the same period in 2022. The
decrease was primarily due to lower policies in force, partially offset by an
increase in premium per policy resulting from rate actions.
During the three months ended
53.9% and 55.2% of our gross premiums earned to third-party reinsurers,
respectively. The change in ceding percentage between periods was primarily
driven by retaining a slightly larger share of our book of business.
29 -------------------------------------------------------------------------------- The following table presents gross premiums written, ceded premiums written, net premiums written, gross premiums earned, ceded premiums earned and net premiums earned for the three months endedMarch 31, 2023 and 2022: Three Months Ended March 31, 2023 2022 $ Change % Change (dollars in millions) Gross premiums written$ 134.7 $ 187.2 $ (52.5) (28.0) % Ceded premiums written (69.9) (102.4) 32.5 (31.7) % Net premiums written 64.8 84.8 (20.0) (23.6) % Gross premiums earned 130.1 174.7 (44.6) (25.5) % Ceded premiums earned (70.1) (96.4) 26.3 (27.3) % Net premiums earned$ 60.0 $ 78.3 $ (18.3) (23.4) %
The decrease in gross premiums earned was primarily due to lower policies in
force. This decrease was partially offset by 24.2% increase in premium per
policy for automobile insurance primarily attributable to rate actions.
Net Investment Income
Net investment income increased$6.1 million , or 1,016.7%, to$6.7 million for the three months endedMarch 31, 2023 compared to the same period in 2022. The increase was primarily driven by$5.7 million in higher interest and dividends received as a result of investing more in higher yielding investments.
Operating Expenses
Loss and Loss Adjustment Expenses
Loss and LAE decreased$33.4 million , or 34.5%, to$63.3 million for the three months endedMarch 31, 2023 compared to the same period in 2022. The decrease was primarily due to lower policies in force and better loss experience for the three months endedMarch 31, 2023 compared to the same period in 2022. Gross accident period loss ratios decreased to 69.3% from 81.5% for the three months endedMarch 31, 2023 and 2022, respectively. The change in the ratios was driven by growth in average premium per policy primarily attributable to rate actions and improved tenure mix as our book of business matures. This was partially offset by higher loss costs as a result of increased severity per claim due to higher vehicle repair and medical costs. We experienced a 12% increase in severity per claim and a 7% decrease in claim frequency for the three months endedMarch 31, 2023 compared to the same period in 2022. The claim severity and frequency estimates are tenure mix adjusted based on bodily injury, collision, and property damage coverages.
Sales and Marketing
Sales and marketing expense decreased$11.7 million , or 76.5%, to$3.6 million for the three months endedMarch 31, 2023 compared to the same period in 2022. The decrease was due to a$5.3 million decline in warrant compensation expense related to the completion of the Integrated Platform pursuant to the Carvana commercial agreement in the prior year and a$2.6 million decrease in content development and partnership costs due to a shift in direct marketing strategy. We also experienced a$1.7 million decrease in Personnel Costs as a result of a decrease in headcount, primarily attributable to the involuntary workforce reductions in 2022.
Other Insurance Expense
Other insurance expense increased$0.3 million , or 30.0%, to$1.3 million for the three months endedMarch 31, 2023 compared to the same period in 2022. The increase was primarily driven by a$4.4 million increase in Carvana 30 -------------------------------------------------------------------------------- warrant expense as a result of policies originating from the Integrated Platform and a$2.1 million increase in amortization of deferred acquisition costs related to the successful acquisition of policies. This was partially offset by decreases in premium write-offs of$1.9 million , premium taxes of$1.3 million , payment processing fees of$0.9 million and net ceding commission contra-expense of$0.7 million primarily attributable to a decline in gross premiums written. We also experienced a$1.3 million decrease in Personnel Costs as a result of a decrease in headcount, due to the involuntary workforce reductions in 2022.
Technology and Development
Technology and development decreased$3.7 million , or 26.6%, to$10.2 million for the three months endedMarch 31, 2023 compared to the same period in 2022. The decrease was primarily driven by a$2.7 million decrease in Personnel Costs as a result of a decrease in headcount, primarily attributable to the involuntary workforce reductions in 2022.
General and Administrative
General and administrative decreased$9.0 million , or 29.5%, to$21.5 million for the three months endedMarch 31, 2023 compared to the same period in 2022. The decrease was primarily driven by a$9.2 million decrease in Personnel Costs as a result of a decrease in headcount, primarily attributable to the involuntary workforce reductions in 2022.
Non-Operating Expenses
Interest Expense
Interest expense increased$5.6 million , or 101.8%, to$11.1 million for the three months endedMarch 31, 2023 compared to the same period in 2022. The increase was primarily due to a$5.4 million increase in debt interest expense as a result of a greater average interest rate and a higher average outstanding debt as ofMarch 31, 2023 compared to the same period in 2022.
Other Comprehensive Income (Loss)
Changes in Net Unrealized Gains (Losses) on Investments
Changes in net unrealized gains (losses) on investments increased$4.8 million , or 129.7%, to net unrealized gains of$1.1 million for the three months endedMarch 31, 2023 compared to the same period in 2022. The increase is primarily attributable to investments being reinvested at maturity in securities that reflect the current interest rate environment.
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, 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
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strategic planning decisions regarding future operating investments; and (6)
plan for and prepare future annual operating budgets and determine appropriate
levels of operating investments.
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 direct
contribution for the three months ended
Three Months Ended
March 31,
2023 2022
(dollars in millions)
Total revenue $ 70.1 $ 85.4
Loss and loss adjustment expenses (63.3) (96.7)
Other insurance expense (1.3) (1.0)
Gross profit/(loss) 5.5 (12.3)
Net investment income (6.7) (0.6)
Net realized gains on investments - (1.2)
Adjustments from other insurance expense(1) 13.0 8.6
Ceded premiums earned 70.1 96.4
Ceded loss and loss adjustment expenses (44.2) (66.2)
Net ceding commission and other(2) (19.1) (18.3)
Direct contribution $ 18.6 $ 6.4
______________
(1) Adjustments from other insurance expense includes report costs, personnel
costs, allocated overhead, licenses, net commissions, professional fees and
other.
(2) Net ceding commission and other is comprised of ceding commissions received
in connection with reinsurance ceded, partially offset by amortization of excess
ceding commission and other impacts of reinsurance ceded.
32
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Adjusted EBITDA
For the definition of adjusted EBITDA and why management believes this measure
provides useful information to investors, see "- Key Performance Indicators."
The following table provides a reconciliation of net loss to adjusted EBITDA for
the three months ended
Three Months Ended March 31,
2023 2022
(dollars in millions)
Net loss $ (40.9) $ (77.5)
Adjustments:
Interest expense 10.4 5.0
Income tax expense - -
Depreciation and amortization 2.6 2.6
Share-based compensation 2.1 4.5
Warrant compensation expense 4.4 5.3
Restructuring costs(1) 5.6 7.8
Write-offs and other(2) 4.5 0.5
Adjusted EBITDA $ (11.3) $ (51.8)
______________
(1) Restructuring costs consist of employee costs, real estate exit costs, and
other. This includes $0.4 million and $2.1 million of share-based compensation
for the three months ended March 31, 2023 and 2022, respectively. This also
includes $0.1 million and $1.0 million in depreciation and amortization for the
three months ended March 31, 2023 and 2022, respectively. For further
information on restructuring costs, see Note 9, "Restructuring Costs," in the
Notes to Condensed Consolidated Financial Statements.
(2) Write-offs and other primarily reflects legal costs, write-off of prepaid
marketing expense and other items that do not reflect our ongoing operating
performance.
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. Certain events may impact our liquidity such as the economic instability resulting in acute inflationary pressures, supply chain disruptions, rising interest rates, a downturn in equity markets and recent bank failures. There is a risk of inflation remaining elevated for an extended period, which could cause claims and claim expenses to increase, impact the performance of our investment portfolio or have other adverse effects. Rising interest rates and reduced equity values have increased the cost of capital and may limit our ability to raise additional capital. 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 33 -------------------------------------------------------------------------------- andDelaware . To date, our insurance subsidiaries have not paid any dividends and, as ofMarch 31, 2023 , they were not permitted to pay any dividends without approval of the applicable superintendent, commissioner and/or director. If our insurance subsidiaries' businesses grow or the regulatory requirements change, 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, 2023 , 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. AtMarch 31, 2023 , Root Re was subject to compliance with certain capital levels and a net premiums earned to capital ratio of 15:1, which we maintained as ofMarch 31, 2023 . 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. The maturity of the Term Loan isJanuary 27, 2027 . Interest is payable quarterly and is determined on a floating interest rate calculated on the Secured Overnight Financing Rate, with a 1.0% floor, plus 9%, plus 0.26161% per annum. Liquidity As ofMarch 31, 2023 , we had$679.3 million in cash and cash equivalents, of which$523.6 million was held outside of regulated insurance entities. We also had$126.5 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, rate adequacy, renewal activity, the timing and the amount of cash received from customers, the performance of our products, including the success of our embedded partnerships, loss cost trends, 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, operating costs, and the ongoing uncertainty in the global markets resulting from the global COVID-19 pandemic. Currently, our debt covenants require cash and cash equivalents held in entities other than our insurance subsidiaries to be at least$200.0 million at all times. This threshold may be reduced to$150.0 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 premiums earned of 12%; or ceasing any customer acquisition spend outside of the Carvana commercial agreement and reducing our monthly cash burn to no greater than$12.0 million .
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.
34 --------------------------------------------------------------------------------
Cash Flows
The following table summarizes our cash flow data for the periods presented:
Three Months Ended March 31,
2023 2022
(in millions)
Net cash used in operating activities $ (83.7) $ (51.2)
Net cash provided by (used in) investing activities 0.9 (6.3)
Net cash provided by financing activities - 286.2
Net cash used in operating activities for the three months ended March 31, 2023
was $83.7 million compared to $51.2 million of net cash used in operating
activities for the three months ended March 31, 2022 . The increase in cash used
in operating activities was primarily due to timing of reinsurance payments and
receipts, claim payments and payments of accounts payable and accrued expenses
during the three months ended March 31, 2023 compared to the same period in
2022. This was partially offset by a decline in net loss incurred.
Net cash provided by investing activities for the three months ended March 31,
2023 was $0.9 million , primarily due to proceeds from maturities, calls and pay
downs, which was partially offset by purchases of investments and capitalization
of internally developed software. 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 financing activities for the three months ended March 31,
2023 was zero. 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.
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 2022 10-K. We believe we have sufficient resources, and access to additional debt and equity capital, to adequately meet our obligations as they come due.
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 Estimates
Our financial statements are prepared in accordance with GAAP. The preparation
of the condensed 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 condensed 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.
35
--------------------------------------------------------------------------------
Our critical accounting estimates are described under the heading "Management's
Discussion and Analysis of Financial Condition and Results of
Operations-Critical Accounting Estimates," in our 2022 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, 2023 ,
there were no material changes to our critical accounting estimates from those
discussed in our 2022 10-K.
36
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GLOBE LIFE INC. REPORTS First Quarter 2023 Results
JAMES RIVER GROUP HOLDINGS, LTD. – 10-Q – Management's Discussion and Analysis of Financial Condition and Results of Operations
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