Root, Inc. (ROOT) Earnings Call Transcript & Summary

Hello, everyone. I'm Tracy Dolin-Benguigui, insurance analyst at Barclays. And I'm pleased to host the session in person with Root. To my right, I have Alex Timm, CEO. And further to my right, I have Rob Bateman, CFO. We have a lot to talk about. So maybe we could just jump right in. Alex, I'm not sure if you have any opening remarks before kicking in.

Sure. First, thanks for having us. It's good to be here. We are Root insurance, and we started the company in 2016. And really, we started the company with the promise of building a better auto insurance carrier based on modern technology and so engineering and data science. And we launched the company in 2016. We really acquire customers across 2 different product experiences and platforms. The first is our website and our mobile app, where we use all of the rich sensor data off of phones to more accurately price insurance. So consumer download their app to take a test drive with the app. And then if they're a good driver, and only if they're a good driver, we'll give them an insurance quote. If they're not a good driver. We'll tell them we believe another insurance carrier is actually better for them. And then the second is our embedded platform, which is growing nicely. We are the exclusive insurance provider for all of Carvana vehicle sales. which is, I believe, the largest online used car seller in the United States and the fastest growing. And so we're really excited about that. We meet consumers where they are in their time of need. It's about a 3-click experience, and that's been really where we're focused quite a bit as well. We launched our company or we IPO-ed our company in late 2020 -- in Q2 of 2021. So about a year ago now is when we really saw, I think, what most auto insurance carriers are dealing with today, which is probably the largest ever increase in loss costs in a relatively short period of time. So I think in 60 days, we saw used car prices on average go about 25%. Since then, we have been laser-focused on underwriting profitability. We reacted faster than our competitors. And we believe that, over the last year, we've driven down our loss ratios substantially for the first time ever, actually. First 6 months of this year, our loss ratios surpassed, are now superior than multiple of the top 10 carriers in the United States. And so it was certainly -- we've been very, very focused on driving to underwriting profitability through leveraging our technology stack that allows us to actually get new rates in markets quickly and then also through continuing to grow our embedded platform. That's where we are today, and we're excited to talk a bit about the company.

Excellent. We're going to touch on a lot of things that you just mentioned. It just feels like Root is reinventing itself made the tough backdrop that you just spoke about. Can you discuss on the strategy side, how Root looks different today than the past you might have envisioned at the IPO, if there's any silver lining on it?

Absolutely. I think at the time of IPO, really, since we started Root as a company, and we launched in 2016, we've consistently gotten about 3 to 4 points out of our loss ratio every quarter. We get more data. We'd reprice our policies. We tightened underwriting. We learned, and what that learning would do is it allows us to improve pricing and then improved loss ratios. And that was pretty consistent. We were growing. When we IPO-ed in Q1, I think we had our best -- in Q1 of '21, we had our best loss ratio quarter ever. We -- first time we did over $200 million in premium as well. And so we were continuing on that trajectory. And then really, when the inflation, just the almost shock level of inflation to the system, that's really when we started to, as you said, sort of transform and reinvent the business. And we recognized it very early in Q2, and we said this is a different world. Losses and loss costs and cost of goods sold has fundamentally changed. And we now need to completely sprint towards getting to that point of underwriting adequacy. Since then, we responded faster than anyone in the industry. And now again, I think that those results have shown. Over the first 6 months of this year, we had a loss ratio better than GEICO, and ours is continuing to trend down. And we still are seeing a lot of the incumbents struggle to actually take rate in the market. We've seen Progressive respond well. We've seen a few others respond well, but a lot are just now waking up to the reality of a different level of claims cost in the system. And so that's been a real focus of ours. It's not just been rates, as we've gone through and filed over 35 different rate changes in the system. We've also actually improved our segmentation model. So our current sort of pricing plans when we look at policies on those pricing plans, we're actually writing business at more than a 10-point difference in loss ratio, 10-point improvement to our prior versions of loss ratio. So we're also improving segmentation. And then we also have really invested in underwriting. So we, over the last year, have really shifted our book of business mix even more towards good drivers as we've declined a larger portion of bad drivers. We've shifted our mix to state that are more profitable because some of these states, because of regulatory restrictions, are much harder to drive towards profitability. And so we've done that. We've done that very -- and yes, we're seeing those results now really come through, and we're continuing to see those loss ratios drop. I think the silver lining there is all of that strengthens our foundation for when it is time to return to growth and when we are rate adequate and these large carriers are just beginning to take rate, which will turn out a big portion of their books, and we've seen this every time trend has turned. I think that will allow us then to actually be there rate adequate and able to grow. And then the other thing I think we did is we invested -- we started to build a moat around the distribution of our business. We have differentiated access to customers through our embedded platform. Carvana is just the beginning, and we think that there's going to be many more like it. We're actually in the, in the middle of a commercial agreement right now to hopefully announce a new embedded partner shortly. And so we also believe that, that's something that we built through real product differentiation where you can get insurance in just 3 clicks even amidst that sort of macro backdrop. And so I think all of that's going to mean coming out of this will have differentiated distribution and a much stronger foundation of underwriting and pricing discipline to grow off of.

Great. Root is also very much focused on less cash burn and fiscal responsibility these days. And it feels like you're operating more like the insurer in the insurtech. What pieces are you spending the most time on to improve your adjusted EBITDA on a sustained basis? Maybe Rob, you could take that, would it repricing, reselection, market spend, reinsurance.

So just a little history going back to last year in the second quarter when we saw the severity trends change, we shut down our marketing just so we would be taking on new business at very unfavorable loss ratios. Right after that, we started to take rate. We took rate through the latter half of last year all the way through the second quarter of this year. This year, we followed up cumulatively. We've had rate increases of 25% over about 34 rate filings. In addition, we've revised our underwriting forms in 23 states. So very focused on the loss -- what's happened last year. Coming into this year to just add to it, that's sort of the growth and loss ratio piece. We had an expense reduction. We took about 20% of our workforce out. Right now, for our cash -- all of those actions reduced our operating loss by about 50% in the first half of this year. So we took it down 50% from the first half of last year. We still have work to do. And right now primarily focused on the loss ratio. As Alex said, we spend much of our time looking at rates, underwriting forms, claims and the things that could help us. But in addition, the other big lever is expenses. We still have more work to do on expenses. We've tightened out our hiring. We've tightened down -- where we're right now and where we are on non-headcount expenses. We'll look at those over the latter half of the year decide what type of things we have to do going into 2023. So those are really the things we're focused on right now. That's sort of the corollaries to that. The next level down, we're spending time in our reinsurance strategy. As you can imagine, as the loss ratio gets better, we can back up in some of our reinsurance, for example. We have a captive in the Cayman Islands. We had a stop loss on that captive. It attached a loss ratio of 90. Our loss ratios are going in the other direction. So we don't need that captive anymore. So we'll back up on our reinsurance costs there. As well as we'll look at going forward other ways we can access paper from other carriers, whether it's through agency agreements or as reinsurance markets improve MGA capacity, those types of things. So we're really focused at this time on the loss ratio and expenses. But then we'll look at more of the sort of capital capacity coming out of the cycle. We do have enough cash for -- to make it through the cycle we're in now and consider some of those options.

I'm just curious, what are your sources of cash that are at your disposal? And if I could also even touch on Alex, something you said about the embedded partnership. Would it look something like that partner would also put a stake into Root?

So the biggest source of cash right now for us is our balance sheet. I mean the capital market is not great. So we have -- we had $700 million of unencumbered cash at the end of the second quarter. And then just all the operating improvements that I talked about.

Yes. I agree with Rob. When we look at where our business is today and the trajectory, particularly of the loss ratio, I think our biggest source of capital is going to be profitable underwriting, which we also think is the best source of capital. And again, as that loss ratio improves, we expect things like our net loss ratios to convert with our direct loss ratios as we get out of loss ratio corridors. So we think that, that will be much stronger. In terms of new partnerships, we are constantly -- both through the embedded platform and even our SaaS platform, we are constantly in conversations with folks who may or may not want to put more money into the business. And at that time, that's a strategic decision. Carvana did put over $100 million into our business. And so that is something we've seen folks want to do before. But we'll -- each of those negotiations, as you can imagine, our process, and we sort of work through each one-on-one.

Earlier this year, we also had a $300 million facility for BlackRock as well.

Okay. So we touched on evolution and also you mentioned MGA. So I'm just wondering your thoughts on how you view fee income versus premium.

We like them both. No. I think it really -- it's a balance between the two. When the loss ratios are adequate, we want to be able to grow the premium. But that's a balance with the fee income because if fee income is too high, you can tamper some of that growth. So it really depends on where you are on the cycle. I think there's a balance between the 2 of them, both on the growth side and on fee income. That said, we have an active -- we have a lot of opportunities to grow our fee income. If you look at us compared to the industry, we -- in the types of business we write, there's definitely opportunities there for increase or increase the amount of fees that we're charging our customers at this point.

And Alex, in your opening remarks, you're mentioning all the rate filings and your success there. You seem to do that really quickly. If you could just walk us through how are you able to accomplish that. And I'm also curious, because it feels like real IP, if you're able to commercialize that at all to other carriers.

Absolutely. It's something that's kind of near and dear to my heart. I'm actually an actuary by training and worked at a large insurance carrier before starting Root. And as an actuary at a big insurance carrier, a lot of it's in spreadsheets. You're sort of taking data out. You're loading it into a spreadsheet. You're trying to make a chart that a regulator asked for. It might take you a week to get it right. Sometimes the data is wrong, and it's all of this back and forth. So it's this really onerous process. Oftentimes, there's like multiple back-end systems at the data then that you're trying to marry. It's a bit of a mess. And that's why you've got companies like Guidewire and these other companies, the multibillion-dollar market caps just trying to solve that one problem. At Root, when we started, we actually started with an engineering platform where we call it the pricing tooling team, and really the actuary was the customer. And so at this point, we have about 85% of our actuarial workflow is 100% automated. So if I want to do a rate change in Texas, well, if you think about it, it's -- insurance is just a quantitative problem. I've got new data. I need to always have, generally speaking, the same support exhibits, again hit a button, and that filing is created. Once that filing is created, I can pass it over to the regulator. If they have any additional questions, well, we generate pretty much all of those exhibits in an automated fashion as well. And so that's really why we've been able to position ourselves through this period of what I'd call hyper trends or hyperinflation just much faster. That's why we've been able to get these states in line and to rate adequacy much faster than what we've really seen our competitors be able to do. And we think that positions us well. In terms of potentially leveraging that, it has taken -- other large carriers have noticed that. And we've -- in diligence, we've confirmed two things. One is that our technology is modular, so you can actually take our rating, our tooling platform, what I was just discussing and sort of only use that; and two is that it's scalable, and so we looked and we know that it will scale over a customer base of tens of millions of policyholders. And so it's definitely an interesting play. And I think as we move more towards balance sheet like models, that's also something interesting where we could potentially have other carriers writing on our pricing platforms.

Great. Maybe you could shift gears to loss cost trends. Maybe you'll start off on the frequency side, higher gas prices, how is that impacting your view of frequency.

Yes. So when we saw frequency -- when we saw gas prices increase by -- I think it was roughly 50%, we saw mileage-driven decrease roughly 4%. Now if you look at the Department of Energy's studies and some other places, you might have expected it to decrease more like 5%. So it didn't increase quite to the same level that we had expected. And so -- but we did see that 4% decrease. In general, we are still seeing about a 4% decrease in miles driven, and that equates to about a half a trip a day. So consumers are taking, particularly pre pandemic, about half a trip less a day on average. But that trip has changed pretty substantially. They also are driving almost the equivalent level of miles because they're driving further. So we're seeing consumers now drive to destinations that are farther away. And so they're taking fewer and longer trips. We are seeing the -- what we call the entropy or the randomness of the of where they're going decrease. So now consumers maybe you used to frequently visit 10 different places pre pandemic. Now you might only visit 3. And so we're starting to see sort of the consolidation of, okay, you're not traveling. You're not traveling as many different places as well. So there's been a lot of changes in consumer mobility that we've been watching. And we have seen frequency sort of come down. Lately, we aren't seeing them really spike right now, and it seems like we're at a bit of a new normal.

I guess just also a debate out there with hybrid working environment, if we'll ever return fully to prepandemic miles driven. What's your view on that?

Yes, I don't think we will. And I think that on -- the flip side of this is the severity side, too, where we are still seeing the number of miles driven above 80 miles per hour is up roughly 30% still from prepandemic. And so we're seeing sort of those really high speeds still be much more prevalent. And so I think that a lot of that behavior we aren't seeing come back. Commute time, early-morning commute miles are still down about 14%, which is pretty substantial because you take 14% of the cars off the road. Actually, everything gets quite a bit safer in terms of frequency. So we aren't really seeing everything go back sort of to prepandemic levels. I think we're in a different world now.

That's a good segue because to think about bad driving behaviors that were learned during the pandemic, like you've mentioned the excess seating. So if you could maybe touch upon bodily injury trends.

Yes. Yes. bodily injury, we did see severity increase both because of speeding. We also saw an increase in distracted driving. So you're seeing basically -- well, for severity, that's the worst case because when we monitor distracted driving, the interesting thing about those is that they don't even hit the brakes before they run in, before the accident. They actually just sort of don't see it coming and running full speed. So you're seeing both much higher speeds driven, and then you're also seeing more distraction in the system. And so that has contributed to more severe accidents, which then obviously contributes more to bodily injury severity. We haven't seen that normalize, but we also haven't seen it get worse. And so it sort of looks like we're in this new world. Really when we saw a lot of those severity behaviors, actually, that started in 2020. And so we're sort of now past -- it's been a couple of years we've been living in this world.

Got it. And an industry dynamic that we're seeing right now is on the claims notification side, so something you might have been notified last year by the time it settles this year. They might have had adverse experience. Is that something you're experiencing?

Yes, it's interesting. That's absolutely true. So through the inflation, we did see any most carriers saw some modest level of reserve increases. So any claim that was -- occurred last year and settled this year or where there was a substantial claim lag, we did see loss costs pick up there somewhat. We actually saw some reserve decreases in Q -- from some of our competitors in Q2 of '21 when the inflation hit. We sort of had some minor development. But right now, it feels like most of that is behind us, and it was a very small amount of development.

Okay. And larger incumbents would say that scale is an advantage on solving the car part scarcity issue. What are you doing to reduce the claims cycle and ensure that your policyholders have access to car parts?

That's interesting because we haven't seen our claims cycle. We did for a bit. And last year, we saw claims cycle get a little bit longer. And so, for instance, rental, when you're paying for somebody in a rental car, we saw that increase somewhat. We have seen that come back down. We have a partnership with [ Weeze, PCC ] we use that has partnerships with lots of dealers and lots of parts, and they're actually the largest sort of network in the country that many of our largest insurance -- many of our competitors use too -- and that really helps us sort of act bigger than we are, I suppose, in terms of bargaining power for parts. So we haven't seen that be a big issue.

Great. We've heard you in the past talk a lot about the telematics side pricing. I would love to hear how are you using telematics on the claims side.

Yes. It's -- telematics, when we started, it was interesting. When we started in 2016, people didn't think you would do telematics on a mobile phone. They thought it would kill the battery. There's too much noise. You need -- it's much more difficult to do mobile telematics than it is to do like a plug-in device telematics. Plug-in device basically says there's a very consistent reading with almost no noise, how fast the wheels are moving. The mobile phone, all sorts of things can be happening. You can be in the front seat, you could be in the back seat. You could be a passenger driver. Maybe you dropped your phone and it wasn't actually a hard break or maybe it was a real hard break. So you have to actually do a lot more machine learning because there's a lot more noise. And so we're paying all of those sensors in the phone, the GPS, the accelerometer and the gyroscope multiple times a second. And then we use an ensemble method of machine learning algorithms to try to figure out what those physical events were that were going on in the car. And as part of the IPO, we actually had -- it validated, we compared against all of the leading telematics service providers, and ours was much more predictive. And the reason for that is because we've also married the telematics data with all the traditional underwriting data. And so instead of outsourcing telematics, like you see most insurance companies do, we actually marry it with things like age and gender, which we know, by the way, correlate to how you drive. Not sure if you've driven with a 16-year-old lately, but it explains a bit in terms of driving behavior. And so that's been really, really important. And that's created what we believe to be the most predictive algorithm using mobile telematics data in the country. Along with that, we have explored more on both crash detection and claims and then also fraud detection. Oh, you said you were driving here, but you weren't really driving here. You said this is when the accident happened. It looked like, yes, an accident happened there but maybe not at that same time of day, maybe before you purchased the policy. And we have seen some benefits there. We're also really focused on getting telematics from connected vehicles. And so Carvana is a really interesting opportunity there. All these vehicles are in their possession and their reconditioning centers is that -- an opportunity for us to actually embed directly into those vehicles. And that's really where our telematics product road map is focused right now.

Really interesting. Could you also recap more recent changes in your reinsurance program, how that may change? I know you mentioned, maybe this is a good question for Rob, eliminating loss corridors.

So at this point, I've been on -- I've been here for about 5 months now. So we're just looking at our reinsurance programs. We have renewals at each of the quarter. So what would come up so far is the stop-loss that we mentioned that we got rid of. Right now, we're actively looking at all our quota shares and how to restructure those as a company that becomes more profitable. Alex says we expect the directed net loss ratios to converge over time, right? We're heavily reinsured at this point. And we have some loss corridors in our existing contracts that, as our results get better, that will help our reinsurance costs. But also, we just need to take a fresh look at all of that and see what makes sense for the long term.

Great. Just going to pause for a second and see if anyone from the audience -- we have a question.

Just a quick question then on the inflation and the severity, the impact to the loss cost. It sounds like the way you're running the business going forward that that's kind of structurally higher. Is that correct to say that you're not thinking of it as a temporary spike?

That's correct. Yes. We do not think it's just transitory inflation. And -- the good news is if it is, and we see loss cost come way down, rate decreases are much easier to process through regulators. You can imagine then rate increases. But we are operating as if we are in a new normal and that we do believe that these loss costs are high. Now as demand dries up, that could be quite different.

I'll give you a sense of that. So in the second quarter, our severity was 8 points. But if you look at it from a material damage perspective is it's sort of the low to mid-double digits to low to mid-teens. Our frequency has been relatively flat. We haven't since -- it's just about a point or 2 in the second quarter. But if you were to take a look at what we're using for rate indications for pricing and for our reserving, we're using about a 9% trend point, a 9% annual trend. So we're -- that's all forward-looking. So that gives you a sense of where we are.

A question.

Given your very successful rate increases, what are your renewal rates running?

Do you want to answer that?

Yes. So we've been fairly successful in our retention. We have not seen our retention -- well, there's a couple of aspects to that. On the rate piece, we've -- we took 25 points of rate in the first half of the year. We earned in about 6 points. Our efficiency has been over 80%. So we're getting the rate that we put through. Our retention rates have stayed about stable. We've not seen our retention rates move down much with the rate increases. And we -- there's so much activity in the marketplace at this point. I think the switching and the shopping has been kind of tempered because everyone's taking sense significant rate increases at this point.

Maybe just a follow-up for me on that. So could some of that be geographic mix, like you're purposely not in states like California? You could just talk to where you gained the most success pushback.

Yes, I think that's a great -- awful. So if you look at our book, we're mostly in file and use and files. So we do not have -- our California book is 6,000 policies. So we're not in California. So we're not in these -- we're not up in California or Florida or New York where getting the rate has been difficult. So for us, we've been able to -- with minimal regulatory friction to be able to most of our -- not only our rate increases but our form changes through pretty seamlessly. And they've been very significant. To give you an example, in Nevada, we took just about 55 points of rate in our last rate increase there. In Louisiana, it was in the mid-30s, I think, on the last rate increase we had. And I'll also say we look at the renewal book and the renewal indication separately from our new business indication as well. So we will, in some states where we have low renewal loss ratios in the 50s, there, we will actually rate cap more aggressively. In some states like, well, Rob has mentioned, in Nevada, where even renewal book is running very hot, that is -- the full indication will come through. But we have seen renewal elasticity. It would be less elastic at renewal than even what our models had suggested we would experience.

And I guess it's not just the absolute number of the rate that you're filing or that the frequency of rate filing. Is there any pushback from any state going several times?

I would say nothing substantial at this point. I mean, nothing that's prevented us from getting timely rate increases.

Yes. I mean, there are some states where as soon as the one rating plan is approved, the next one comes in the same day. And we aren't hearing -- we have not heard at this point a lot of consternation.

I guess if there's no other questions from the audience, the last question for me is if we just fast forward the next 5 years, do you think there's enough reinsurance capacity to support growth by insurtech?

I think it's going to be really hard for insurtech in the early days of starting this company and the early days of insurtech, I think before there was a sizable enough book to sort of show what underwriting profitability was, you had a lot of the reinsurers, quite frankly, take it back. And that didn't work out for a lot of them or most of them. I think now -- and I think that, that is going to make sort of it much more difficult for that second wave of insurtechs to continue to get capacity without a materially sized book of business, say, this is what our loss ratio is. For us, given the loss ratio trend, given the fact that now we have a superior loss ratio than multiple in the top 10 take a more aggressive action and most of the improvement is still in front of us, and we're still seeing a decline I think with an auto book, if you can run loss ratios like we believe we can run in the 60s, then I just -- I think that there will always be business for that. I think it's both in reinsurance capacity and MGA capacity, and I think that's going to allow us to be much more capital light, and I think we'll be okay. But I do think it will be more -- it'll be harder for sort of start-ups to gather that kind of capacity that we did in the past.

Yes, I mean I would agree. I think there's a cycle to this. And 5 years out, I always look at auto books. If you have a good profitable auto book is a natural balance to heavy property cap book. So we can run consistent adequate loss ratio. I believe there will be capacity to be able to do that.

Great. Thank you so much. Enjoyed the chat.

Thank you.

Thank you.