There is a lively debate in the investor community over what kind of company Trupanion (NASDAQ:TRUP) really is.

The company describes itself as a subscription-based business focused on ensuring cat and dog owners can afford medical treatment for their pets. Going with this categorization, the company has compared itself to other subscription-oriented businesses such as Costco and Opentable (owned by Booking).

However, the company's critics point out that Trupanion is an insurance company and should be thought of by investors in this light.

young woman walking four dogs through park

Image source: Getty Images.

Technically an insurance company

To be sure, Trupanion is definitely an insurance company. The company's product provides comprehensive medical coverage for when pets get sick or have an accident. Furthermore, Trupanion has an insurance underwriting subsidiary and must maintain its insurance license to stay in business.

Looks like a duck, walks like a duck, quacks like a duck, therefore it's a duck, right? Maybe.

The nuance is that pet insurance doesn't have long open-ended liabilities to insure. Dogs and cats generally live between 10 and 15 years, and their health issues tend to be more predictable than human health issues or natural disasters. This translates into pet insurance policies being shorter in duration and easier to price due to more predictable claims.

The business model of a traditional insurance company (think life insurance or property and casualty) is to collect premiums that can be invested in financial assets. In many cases, insurance companies will underwrite policies at a loss because they know they can make money through their investments.

Trupanion has a unique pricing model. It uses its data on historical claims to figure out what it would cost to pay the medical bills of the average pet over the course of its life and adds a 30% margin to this cost. This "cost-plus" pricing model makes Trupanion's business model more akin to a subscription business in many ways, even if it's technically an insurance company.

Managed like a subscription business

Regardless of how investors think about Trupanion, its founder and CEO, Darryl Rawlings, is managing the company like a subscription business. What this tangibly means is that the company's goal is to profitably grow its subscriber base.

In the company's financial reports, it clearly lays out the metrics it believes to be important for its business. The table below lays out these key metrics.

Metric Description 2018 Value
Total pets enrolled Total pets with an insurance policy 521,326
Monthly average revenue per pet Average monthly payment per pet $54.34
Lifetime value of a pet Average lifetime gross profit per pet $710
Average pet acquisition cost Marketing costs to add each new pet customer  $164
Average monthly retention The monthly average percentage of pets for which a policy is not canceled over the last 12 months 98.6%

Source: Trupanion financial reports.

Anyone who has studied subscription business models will recognize the metrics Trupanion has laid out. The basic mechanics behind these metrics is that Trupanion wants to increase its subscriber count over time. Growing its subscriber count creates value for shareholders as long as the lifetime value of a pet is greater than the cost to acquire a new pet customer. The lifetime value of a pet is sensitive to the average revenue per customer and the average length of a subscription (driven by the retention rate).

The bottom line is that management runs Trupanion like a subscription business and clearly projects this to the investor community.

Why the company's business model categorization matters

So what's the big deal about whether investors should think of Trupanion as an insurance company or a subscription business? It's a matter of valuation.

Insurance companies typically trade based on a multiple of book value, and "normal" book value multiple will be in the range of one to four. Trupanion currently trades at seven times book value, which makes the stock appear quite expensive.

Subscription businesses, on the other hand, may trade based on a multiple of revenue or projected profitability. Trupanion trades for three times its 2018 revenue, which doesn't appear as rich as its book value-based valuation. Trupanion is currently unprofitable and there are no other publicly traded pet insurance companies to compare Trupanion to, making it difficult to determine what the "right" valuation multiple is.

Trupanion is technically an insurance company, but it is managed like a subscription company. The company's management team has done a good job communicating their approach to investors and the market mostly agrees with this assessment. While some market participants may disagree with this framing, it makes sense after getting a better understanding of the financial metrics and business levers involved. This makes the stock's valuation appear much more reasonable in context and worth considering for long-term investors.