Root, Inc. (NASDAQ:ROOT) Q3 2023 Earnings Call Transcript

Root, Inc. (NASDAQ:ROOT) Q3 2023 Earnings Call Transcript November 2, 2023

Operator: Good morning. My name is Chris, and I will be your conference operator today. At this time, I’d like to welcome everyone to the Root Inc. Q3 2023 Earnings Conference Call. [Operator Instructions] Thank you. Matt LaMalva, head of Investor Relations, you may begin.

Matt LaMalva: Good morning, and thank you for joining us today. Root is hosting this call to discuss its third quarter 2023 earnings results. Participating on today’s call are Alex Timm, Co-Founder and Chief Executive Officer, and Megan Binkley, Chief Financial Officer. Last evening, Root issued a shareholder letter announcing its financial results. While this call will reflect items discussed within that document, for more complete information about our financial performance, we also encourage you to read our Q3 2023 Form 10-Q, which was filed with the Securities and Exchange Commission last evening. Before we begin, I want to remind you that the matters discussed on today’s call will include forward-looking statements related to our operating performance, financial goals and business outlook, which are based on management’s current beliefs and assumptions.

Please note that these forward-looking statements reflect our opinions as of the date of this call, and we undertake no obligation to revise this information as a result of new developments that may occur. Forward-looking statements are subject to various risks, uncertainties and other factors that could cause our actual results to differ materially from those expected and described today. In addition, we are subject to a number of risks that may significantly impact our business and financial results. For a more detailed description of our risk factors, please review our Form 10-K for the year ended December 31, 2022, as well as our shareholder letter and third quarter Form 10-Q. A replay of this conference call will be available on our website under the Investor Relations section.

I would also like to remind you that during the call, we will discuss some non-GAAP measures while talking about Root’s performance. You can find reconciliations of those historical measures to the nearest comparable GAAP measures in our shareholder letter and our Form 10-Q filed with the SEC, which are posted on our website at ir.joinRoot.com. I will now turn the call over to Alex Timm, Root’s Co-Founder and CEO.

Alex Timm: Thank you, Matt. Q3 marks an excellent quarter for Root. We broke company records for both gross written premiums and direct contribution this quarter. For the third consecutive quarter, we saw material growth in new writings and our direct channel. We grew total new writings 141% over the last quarter, and 376% over the third quarter of 2022, all while posting a gross loss ratio of 66%. Management’s top priority remains driving Root to profitability. We developed a three-part plan to get us there. One, drive to healthy margins on our business by hitting our target loss ratios. Two, reduce fixed expenses to materially lower our burn rate, and three, efficiently grow to scale to profitability. We have successfully executed on one and two, as has been demonstrated in previous quarters.

Our performance in Q3 shows our ability to execute on all three. We believe this, combined with advancements in our reinsurance strategy, which Megan will detail, has put us on a clear path to growth and profitability. The strong growth this quarter was primarily driven by our direct channel. This can be attributed to our rapid response to inflation, our advancements in segmentation and underwriting, and our ability to leverage favorable marketing conditions with our automated marketing approach. Today, we are in a strong position as we continue to exceed profitability targets on our new business. If we see changes in the environment or degradation in our loss ratios, our systems are designed to automatically pull back on growth. Our objective remains to optimize for profit.

Root’s embedded channel is a core part of our distribution strategy, and we continue to believe it is a meaningful part of our foundation for long-term growth. Our embedded product is now active in 33 States, with new writings and premiums up quarter-over-quarter. Additionally, we launched several partnerships this quarter, and we believe we have a strong funnel for future launches. All of this is made possible by Root’s technology and data science. This strategic advantage allows for quick responses to an ever-changing environment, more accurately priced business, and seamless quote to buying experiences. With continued investment in our data and technology, we are building an enduring company and driving Root to profitability with the capital we have.

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We are grateful to our customers, employees, and investors. Lastly, I would like to announce that Frank Palmer will be leaving Root at the end of the year. We are grateful for his contributions, and thanks to his leadership, have established strong pricing and underwriting teams to have fully assumed his previous duties. I’ll now turn the call over to Megan to discuss our operating results in more in detail.

Megan Binkley: Thanks, Alex. Overall, we are very pleased to report the progress in our financial results this quarter. Our growth trajectory continued, with total new writings and policies in-force higher on both a quarter-over-quarter and year-over-year basis. Gross written premium was $224 million, a 55% increase quarter-over-quarter, and a 49% increase year-over-year. Gross earned premium was $160 million, a 22% increase quarter-over-quarter, and a 3% increase year-over-year. We achieved this growth while also posting a gross loss ratio of 66%, which is flat quarter-over-quarter, and a 12-point improvement year-over-year. This is a testament to the power of our technology and data science. During the third quarter, our net loss was $46 million, a 31% improvement year-over-year.

Adjusted EBITDA improved 58% over the prior year to a loss of $19 million. Compared to the second quarter, our net loss and adjusted EBITDA loss increased $9 million and $8 million, respectively. This increase was primarily the result of higher acquisition expenses and one-time reinsurance costs of $6 million associated with commutations executed during the quarter. Our higher acquisition expenses were largely concentrated in the direct marketing channel. It’s important to note that we do not defer the majority of customer acquisition costs over the life of our customer, which leads to accelerated expense recognition relative to earned premiums. Overall, results for the third quarter reflect the sustained momentum towards management’s top priority of reaching profitability with our existing capital.

And to that end, we are vigilantly managing our capital position. Unencumbered cash was $502 million as of the end of Q3, compared with $520 million as of the end of Q2. Our unencumbered cash consumption rate continues to improve on a year-over-year basis following a reset of our fixed expense base, and was partially offset by an increase in customer acquisition costs, as we continue to position the business for profitable growth. As Alex outlined, we have improved the loss ratio, reduced fixed expenses, and are now scaling the business. This execution allows us the opportunity to optimize our quota share reinsurance strategy. We have been reducing our sessions to third party reinsurers on new treaties and commuting existing treaties. These actions reduce the overall session percentage and result in further retention of underwriting results on a net basis.

We believe the resulting reduction in reinsurance costs going forward is a pivotal component in driving the company to profitability, and in the near term, we expect to narrow the gap between the growth and net loss and LAE ratios to single digits. We expect to continue managing volatility in our loss ratio through catastrophe and excess of loss reinsurance programs. When considering our improved underwriting results, careful expense management, and strong capital position, we believe there is a bright future ahead. We appreciate your time and look forward to your questions.

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Q&A Session

Operator: [Operator Instructions] Our first question is from Josh Siegler with Cantor Fitzgerald. Your line is open.

Josh Siegler: Yes. Hi, team. Good morning. Thanks for taking my call. As you pivot back towards expanding direct marketing channels and turning back on growth, I was wondering if you could give us any insight into payback period for some of the new policies brought in, especially at these lower loss ratios. Thank you.

Alex Timm: Thanks, Josh. We’re seeing, particularly driven by these lower loss ratios, is really a very large improvement in our payback periods. And so, we are seeing very tight payback periods. We are monitoring that, and that’s really driven by the large improvement in our loss ratios, as well as very favorable customer acquisition costs. So, the improvement has really been encouraging for us.

Josh Siegler: Great. Glad to hear that. And then I was curious, what have you seen that’s persisted through the beginning of 4Q that gives you confidence in maintaining these lower loss ratios? Are there any notable trends in accident or frequency or severity?

Alex Timm: I think we’re still seeing – we’re seeing in the macro environment, some of the indicators there, Manheim and others, really begin to level off. We still are assuming a fairly significant trend and don’t believe that we’re back into normal trend environment. And so, we’re pricing to that. We’re still pricing to a high single-digit to low double-digit net trend. And so, we’re certainly not banking on inflation really abating at this moment in time. We have seen and continue to see our unit economics. And so, that’s loss ratios, retention, all come in more favorably than what we had anticipated. And that’s one of the reasons why you continue to see us accelerate our growth as we continue to see these cohorts come through and perform more favorably than what our initial expectations were. And that’s been very consistent really over the last nine months, and we’re seeing that continue.

Josh Siegler: Understood. Thanks for taking my questions today.

Operator: The next question is from Tommy McJoynt with KBW. Your line is open.

Tommy McJoynt: Hey, good morning, guys. Thanks for taking the questions. Can you start off by just walking through the components of the other insurance expense? And perhaps it’d be helpful just to bridge the change either on a quarter-over-quarter basis or year-over-year basis, whichever you think is more helpful.

Megan Binkley: Yes, thanks, Tommy. I appreciate the question. I think what you’re getting at is, and what you’re seeing in terms of other insurance expense during the quarter, a lot of the change quarter-over-quarter is really driven by changes in reinsurance. So, over the past 18 months, we’ve been constantly evaluating our reinsurance structures just to make sure that we’ve got the right terms for the business. This is certainly not new. We’ve been decreasing our external quota share percentage as the underlying business has improved. Historically, we’ve been seeing a lot of our business through quota share reinsurance, and we’ve been reducing those sessions over time. So, we took several actions during the quarter, which we believe are very positive.

After strict underwriting and pricing discipline, we are sitting here today with a fundamentally and improved book. So, those improvements have really opened the door for us to further our reinsurance strategy to Root’s benefit. So, what you’re seeing come through this quarter is really a result of us reducing our quota share sessions over time. On a net basis, we did – well, we commuted several agreements during the quarter, and really what that involves is us settling for an amount today, and what we’re getting in return is future underwriting profits as we take that business back onto our books. So, you’re going to see less ceding commission going forward, and what you see come through this quarter is really a one-time hit to our P&L, primarily related to one commutation.