Root, Inc. — Q3 2023 Form 10-Q
Business context and reporting period. Root is a technology-enabled personal insurer, primarily offering auto insurance through direct and embedded channels, with renters insurance also available. This unaudited filing covers the quarter and nine months ended September 30, 2023; comparisons are to the same 2022 periods unless noted. Amounts are in millions except per-share data and operating metrics.
Financial performance and position
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Total revenue | $115.3 | $73.7 | $260.2 | $239.5 |
| Operating loss | $(34.0) | $(57.1) | $(89.0) | $(215.4) |
| Net loss | $(45.8) | $(66.4) | $(123.4) | $(239.4) |
| Adjusted EBITDA (non-GAAP) | $(19.4) | $(46.4) | $(42.6) | $(161.4) |
| Net combined ratio | 143.1% | 185.1% | 150.1% | 199.3% |
| Gross combined ratio | 118.7% | 130.4% | 119.9% | 139.5% |
Q3 net premiums earned were $100.0, up 45.8%; net investment income was $9.0, up from $0.9. For the first nine months, net premiums earned rose 1.0% to $223.9 and net investment income rose to $22.5 from $2.2. The effective income tax rate was zero, primarily because of a full valuation allowance on U.S. deferred tax assets. Basic and diluted loss per share was $3.16 for Q3 and $8.57 for the nine months.
Key operating indicators: Q3 gross premiums written increased 48.8% to $224.2; policies in force were 259,522 versus 255,279, premiums per policy were $1,398 versus $1,150, and premiums in force were $725.6 versus $587.1. Direct contribution, a non-GAAP measure, was $37.0 in Q3 and $84.9 for the nine months.
For the nine months, operating cash use was $79.7, versus $163.9; investing cash use was $46.2, versus $5.7; financing cash use was $0.9, compared with $283.3 of financing inflows in 2022, largely from the term loan. Cash, cash equivalents and restricted cash declined $126.8 during the period.
At September 30, cash and cash equivalents were $635.3, including $502.2 outside regulated insurance entities; marketable securities were $167.1. Long-term debt had a carrying value of $298.3, including a $300.0 term loan due January 2027. Its floating rate is based on SOFR, with a 1% floor, plus 9%. Stockholders’ equity was $177.1; redeemable convertible preferred stock was $112.0.
Material changes and drivers
- Results improved year over year, with narrower operating and net losses and lower combined ratios. The nine-month decline in loss and LAE to $208.6 from $273.3 reflected better loss experience; expense reductions also reflected prior workforce cuts and cost initiatives.
- Root reduced external quota-share reinsurance and ceded a smaller portion of earned premiums: 37.4% in Q3 2023 versus 55.8% in Q3 2022, and 46.9% for the nine months versus 55.8%. This helped lift net premiums earned, but means Root retains more premiums and losses and may face higher capital requirements.
- Rate actions increased auto premium per policy by 21.6% year over year, contributing to lower gross accident-period loss ratios. Offsetting pressure included higher claim severity—up 10% in Q3 and 8% for the nine months—attributed to vehicle repair and medical costs. Q3 claim frequency was flat; nine-month frequency decreased 5%.
- Net investment income increased substantially, mainly because more funds were invested in higher-yielding investments. Interest expense rose 43.3% for the nine months to $34.4, primarily reflecting higher average interest rates.
- Other insurance expense was $18.3 in Q3, compared with $1.1 a year earlier, partly due to lower ceding commissions, higher report costs, Carvana warrant expense and deferred acquisition cost amortization. Nine-month expense was $22.2, versus a $5.7 benefit in 2022.
Outlook, risks and unusual items
- Outlook: The filing provides no specific numerical earnings or revenue guidance. Management said existing cash, marketable securities and operating cash flow should support working-capital and capital expenditure needs for at least 12 months and the foreseeable future, while noting that longer-term capital needs depend on growth, pricing, renewals, claims trends, partnerships and spending.
- Liquidity and covenants: The term-loan covenant requires at least $200.0 of cash and cash equivalents outside insurance subsidiaries, subject to potential reduction to $150.0 if specified Carvana-policy/direct-contribution or customer-acquisition/cash-burn conditions are met. Regulated subsidiaries’ dividends are restricted, and the filing says they could not pay dividends without regulatory approval as of the reporting date.
- Reinsurance commutations: Q3 commutations contributed $4.4 of net premiums earned, $4.2 of loss and LAE, and $5.8 of other insurance expense (benefit). A $2.8 allowance for credit losses was established in connection with a reinsurer commutation. The filing notes Root remains liable to policyholders if reinsurers fail to meet their obligations.
- Controls and prior-period revision: Management concluded disclosure controls were not effective as of September 30 because a previously reported material weakness involving vendor oversight, approvals and control circumvention had not operated long enough to demonstrate effective remediation. Root also revised the presentation of certain 2022 expenses connected to purported misappropriation by a former senior marketing employee; it concluded the errors were not material to the interim statements.
- Claims and market risks: Inflation and higher repair and medical costs may increase claims severity; higher interest rates raise borrowing costs and may constrain access to capital. Root also cites competition, underwriting and pricing, customer retention, reinsurance availability, regulatory capital and the execution of embedded partnerships among its risks.
- Legal and other contingencies: A Texas insurance class action was dismissed with prejudice in August 2023 and appealed. A shareholder class action dismissal and a shareholder derivative action remain subject to appeal or stay, respectively; Root says it cannot estimate potential loss. The company also has contingent exposure to assessments related to insolvencies or impairments of unaffiliated insurers.
- Restructuring disclosure: The notes estimate about $1.7 of employee compensation expense remaining, with cash expected in January 2024; MD&A separately states expected cash expenditure of approximately $8.3 in Q1 2024. The filing does not clearly reconcile these different amounts.
Most important facts for investors to verify
- Whether the improved loss ratios and lower losses persist as claim severity, inflation and rate adequacy evolve.
- The effect of reduced reinsurance cessions on future earnings volatility, regulatory capital needs and liquidity.
- Compliance with the $200.0 minimum-cash covenant and the terms for any potential reduction to $150.0.
- Progress and testing results for remediation of the material weakness in internal controls.
- The outcome of pending or appealed litigation and any related financial exposure.
- The basis for the different $1.7 and $8.3 restructuring-related cash estimates.
- Carvana partnership performance, warrant expense and the relationship between reported non-GAAP measures and GAAP losses.