Business context and reporting period
Root, Inc. filed this unaudited Form 10-Q for the quarter ended June 30, 2023. Root is a technology-enabled personal auto and renters insurer, selling primarily through mobile channels and an embedded insurance platform. Comparisons below are with the same 2022 period; the filing notes certain 2022 expense presentations were revised following the discovery of a former senior marketing employee’s misappropriation of funds.
Financial performance and position
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Total revenue | $74.8 million | $80.4 million | $144.9 million | $165.8 million |
| Net premiums earned | $63.9 million | $74.7 million | $123.9 million | $153.0 million |
| Net loss | $(36.7) million | $(95.5) million | $(77.6) million | $(173.0) million |
| Adjusted EBITDA | $(11.9) million | $(63.2) million | $(23.2) million | $(115.0) million |
| Direct contribution | $29.3 million | $(0.2) million | $47.9 million | $6.2 million |
| Operating cash flow | Not presented separately | Not presented separately | $(94.3) million | $(104.9) million |
Q2 gross profit, a company-defined measure, was $12.7 million versus a gross loss of $7.5 million. The Q2 net loss and LAE ratio was 93.1% (128.1%); net expense ratio was 57.4% (89.2%); and net combined ratio was 150.5% (217.3%). Gross combined ratio was 118.2% (151.7%). A combined ratio above 100% indicates an underwriting loss. For the first half, net combined ratio was 155.7% versus 205.8%, and gross combined ratio was 120.5% versus 143.6%.
At June 30, 2023, Root reported cash and cash equivalents of $628.0 million, marketable securities of $162.7 million, total assets of $1.195 billion, and total liabilities of $868.5 million. Cash and cash equivalents declined from $762.1 million at year-end 2022; cash, cash equivalents and restricted cash fell $134.1 million in the first half. Debt carrying value was $297.4 million, including a $300 million term loan due January 2027. The loan bears a floating rate of SOFR, subject to a 1% floor, plus 9% (plus 0.26161% through June 30, 2023). Cash held outside regulated insurance entities was $520.3 million.
Material changes versus the prior comparable period
- Q2 revenue declined 7.0%; net premiums earned fell 14.5%, primarily because policies in force decreased. Gross premiums written rose 3.5% in Q2, but were down 14.5% for the first half.
- Policies in force were 203,840 versus 297,716 a year earlier. Premiums per policy increased to $1,353 from $1,077, and premiums in force declined to $551.6 million from $641.3 million.
- Q2 net loss improved by $58.8 million, reflecting lower loss and LAE and lower operating costs. Loss and LAE expense decreased 37.8%; sales and marketing fell 71.5%, technology and development 38.0%, and general and administrative 47.6%. Cost reductions included effects of 2022 workforce reductions and lower marketing spend.
- Net investment income increased to $6.8 million in Q2 from $0.7 million, mainly due to higher interest and dividends. Interest expense increased to $11.5 million from $9.2 million.
- Gross accident-period loss ratio improved to 68.2% from 84.8%, supported by rate actions and higher average premiums per policy. Root reported claim severity up 8% and claim frequency down 6% year over year.
Outlook, risks, contingencies and unusual items
Management expects net premiums earned to decrease in the short term as policies in force continue to decline, while anticipating that embedded products and higher premiums per policy can support new writings and future growth. Root stated that cash, marketable securities and operating cash flow should support short-term working capital and capital expenditure needs for at least the next 12 months and the foreseeable future; this is management’s assessment, not a quantified earnings forecast.
Management plans to continue using elevated third-party quota-share reinsurance. Changes to, or non-renewal of, reinsurance could increase retained risk and capital requirements. Inflation and higher vehicle repair and medical costs are increasing claim severity; interest rates raise financing costs and may constrain access to capital. Insurance-subsidiary dividends are restricted, and debt covenants require at least $200 million of cash and equivalents outside insurance subsidiaries, with reductions to $150 million available only if specified conditions are met.
The filing reports a material weakness in internal control over financial reporting related to monitoring and the control environment, including controls circumvented in the former employee fraud. Remediation steps are underway, but management concluded disclosure controls were not effective as of June 30, 2023; the weakness is not considered remediated until controls operate effectively for a sufficient period and testing supports that conclusion.
Legal matters include a Texas purported insured class action, which Root intends to defend and for which it cannot estimate potential loss; a shareholder derivative action that is stayed; and an appeal of the dismissal of a separate shareholder class action. A Louisiana insured class action was settled for an immaterial amount and dismissed with prejudice in July 2023. Root also disclosed approximately $3.6 million of remaining employee compensation expense from restructuring, expected to be recognized through Q4 2023, with cash payment expected in January 2024. No material changes to risk factors were reported.
Important facts for investors to verify
- Whether policy count stabilizes and premium increases translate into sustainable earned-premium growth and retention.
- Whether improved loss ratios persist as severity, repair costs and medical costs evolve, and how rate actions affect customers and renewals.
- Cash burn, liquidity accessible outside regulated insurers, and ongoing compliance with the term-loan cash covenant and regulatory capital requirements.
- Reinsurance terms, counterparty performance, and the capital impact if Root retains more of its business.
- Progress in remediating the material weakness and developments in the Texas litigation and shareholder appeals.
- The composition and sustainability of non-GAAP measures such as adjusted EBITDA and direct contribution, which are not substitutes for GAAP results or cash flows.