- Root Insurance is a tech powered insurance company which aims to disrupt the trillion dollar insurance industry.
- The company has a strong product and used AI powered Telematics to track drivers' style in real time.
- Root has reported declining premiums for the second quarter of 2022 and the company is burning a lot of cash.
- The good news is they have a huge partnership with Carvana, the fastest growing online used car retailer in the US.
Root Insurance ( ROOT ) is an Insurtech company that plans to disrupt the incumbent Auto insurance industry through the power of technology. The company had its IPO in 2020 at $23/share and a whopping $6.7 billion valuation. Since then the stock price has been butchered by ~96% due to a combination of declining revenue and Gross written premiums. In addition, macroeconomic headwinds from the rising interest rate environment further compressed the valuation multiples of growth stocks. Things got so bad for Root that its share price dropped below $1 and management has had to announce an 18 to 1 reverse stock split, which has just become active at the time of writing. Now although things may look bad there is some good news. The global insurance market is worth over $5 trillion and the US Auto Insurance market alone is estimated to be worth $312 billion. In addition, Insurtech market is forecasted to grow at a rapid 51.7% CAGR. In this post, I'm going to dive into the company's Innovative Business Model, and deep dive into its Financials. Let's dive in.
Disruptive Business Model
Founded in 2015, Root Insurance was one of the first licensed insurance companies in the U.S.A to be powered entirely by Mobile.
The company believes the archaic insurance industry is broken, unfairly priced, complicated and inefficiently built. Root doesn't accept this status quo and therefore plans to change it. The heart of Root's platform is its easy to use mobile application which really does make insurance simple, as a user can sign up in 47 seconds, using a "login with gmail" function. Then they follow a quick and easy online process to get a quote. No more complicated forms with long clauses trying to catch you out or clunky sign up processes. Then when you wish to file a claim it doesn't require ringing some call center and being put on hold for hours. Instead you simply login to the app and file a claim in around 3 minutes. But this is not just about a great user interface and customer experience.
Root Car Insurance (Website Official)
Its platform uses telematics to track and personalize insurance to each individual driver. The company's technology has collected over 10 billion miles of driving data and dive deep into granular metrics, such as how fast you drive and even how smooth you hit the brakes. The beauty of Root's system is the more drivers that use it, the more driving data its model will collect and thus the more accurate the company can underwrite (assess the risk) of each driver.
The end goal is to create hyper personalized car insurance where "good drivers" pay less and "bad drivers" pay more. According to Root's website "good drivers" save up to $900/year.
This method is in stark contrast to traditional Auto insurance companies which give you an insurance quote based on age, location, where you park at night etc. Now although these factors are important, they make sweeping generalizations. Most insurance providers even look a person's credit score, which I personally believe is irrelevant and this is a factor Root wishes to change.
Root's model is reportedly 10x more predictive of driving behaviour than the industry standard. In addition, it shows that the "riskiest" 10% of drivers are 5.8 times more risky than the safest 10% of drivers.
Root Driving Score (Official Website)
The company even offers an Enterprise white label app which allows other insurance companies to leverage the technology to increase the accuracy of their own insurance underwriting. Now although this seems like a risky strategy, as they are effectively destroying their own competitive advantage it does offer the potential to become the software backbone of other insurance companies.
As a bonus Root's consumer app offers 24/7 Roadside Assistance as part of every policy and a cash based referral scheme for friends, which many archaic insurance companies are still behind on.
The company currently sells car insurance in 34 states (recently entered Alabama and Florida) and have goals to cover all 50. In addition, the company has recently branched out to renters and homeowners insurance which is now available across 9 and 13 states respectively.
Root has a strong brand, investor story and mission driven purpose. I particular liked their product marketing campaign called "driving differently" which used the perfect combination of emotion and logic to talk about how we tended appreciate driving for special reasons like seeing family during the pandemic. The company has also done some influencer marketing through sponsorship of NASCAR driver Bubba Wallace.
Carvana Partnership
Root scored a key partnership with Carvana in 2021. This is a huge deal as this $9 billion company is the fastest growing online used car deal in the U.S.A. They are also widely known for their iconic multi story car vending machines.
Recently Root has started to integrate Version 2 of its embedded product into Carvana's website. Which reportedly gives buyers car insurance coverage in as little as three clicks. This partnership has been very successful so far as New Premium volume from Carvana grew to 31% of new business in the second quarter of 2022. However, I do imagine the margins will be less for Root issued policies as they will be required to provide a referral fee to the company.
Acquisition Target?
Rival Insurtech company Lemonade ( LMND ) has recently acquired Metromile a smaller competitor Root which also offers in car telematics. Now despite Root being much larger and more established its declining market cap could make it open for an acquisition from a larger entity.
Volatile Financials
In theory Root has an amazing market opportunity and all tools needed for success, however execution is what the company has struggled with since going public.
Written Premiums is the total amount customers actually pay for insurance policies, this can be seen as the main revenue driver. In this case, the company reported a 21% decline in Q2 Gross Written Premiums to $140 million.
Gross Written premium (Q2 Earnings Report)
In addition, it should be noted that this is a "Gross" figure which likely doesn't include deductions for agent fee's (possibly Carvana kickbacks) and even legal fee's associated with case disputes. Thus as the great investor Peter Lynch used to say the real stuff of an earnings report is at the back. In this case, we see Net Written Premium is $59 million, down 12% year over year.
Net Premiums (Q2 Earnings Report)
As insurance policyholders pay premiums in advance, insurers do not count premiums paid initially as profit. Therefore, the company's only change the premium status to "earned" once the policy has been fulfilled for that time period. To assess that we can look at Gross Earned Premiums which were $170.8 million in Q2,22 down 5% year over year. With Net earned premium of $74.7 million, down 8% year over year. Overall Revenue (which includes interest on float) was $80 million in the second second quarter of 2022 , which was down 10% year over year. This declining trend is not great to see and is partially the reason why the stock has continued to decline.
Gross Earned Premium (Root Insurance)
The "Loss Ratio" is a common insurance metric which measures the ratio of losses to premiums earned. These losses tend to include paid insurance claims and adjustment expenses. For example, if a company pays out $100 in claims for every $200 in collected premiums, the loss ratio would be 50%, lower is better. In this case, Root's Gross Loss Ratio, did improve by 5% percentage points year over year to 85% in Q2,22. The company achieved this improvement through a combination of 35 rate increases and a higher percentage of renewal premiums. However, it is still higher than the 65% achieved in the second quarter of 2020.
Gross Loss Ratio (Q2 Earnings Report)
The company's Gross Profit was minus $7.5m in the second quarter which was an improvement over the same period last year (-$18.9m) but still much worse than two years ago.
Net Loss and Adjusted EBITDA have improved by 53% and 59%, respectively versus the same period last year. This improvement was driven by hard cost cutting measures such as slashing marketing expenses by 77% year over year to $25.4 million. In addition, to reducing headcount and run rate expenses.
The company has $696 million in "unencumbered capital" which basically means the unrestricted cash and cash equivalents held outside of its regulated insurance entities. Now although the company has reduced its cash burn by 54%. I still estimate the company only has three to four years of cash runway left before they need to raise capital again or become more profitable. Its $292 million in long-term debt also doesn't help the situation given the rising interest rate environment.
Simple Valuation
Root is trading at a Price to Sales Ratio (forward) = 0.811 which is cheaper than historic levels. In addition it is cheaper than competitors in the industry such as Lemonade which trades at a PS Ratio = 9.7 and Hippo ( HIPO ) which trades at a PS Ratio [FWD] = 4.7. However, due to the aforementioned issues with declining Premiums and high losses it could also be a "value trap".
Risks
Competition
The elephants in the room include, State Farm which is the largest auto insurer in the USA and Progressive ( PGR ). In addition, to GEICO which has over $30 billion in written premiums and is owned by Warren Buffett's Berkshire Hathaway. Buffett has previously called Ajit Jain who runs Berkshires insurance arm a "Genius", this is a testament to the challenging nature of the industry.
Recession
The high inflation and rising interest rate environment is increasing the input costs of the consumer and some analysts are forecasting a recession. If an individual has higher fuel costs, then they may also drive less or be less likely to purchase a car which could impact Root further.
Final Thoughts
Root's brand, product and investor story all make complete sense. They are disrupting an incumbent industry and have the technology to back it up. However, the company has failed to execute sufficiently and are now slashing costs to slow the cash burn down. The shining light is its Carvana partnership and vast Total Addressable market, but the stock is still a speculative investment currently especially given the uncertain economic environment.
For further details see:
Root Insurance: Spiral Of Death But There Is Hope