Root (ROOT 9.10%) was founded on the belief that data and technology could disrupt a $260 billion auto insurance industry and eliminate the usage of credit scores, which it says are inherently biased. The auto insurer is known for its heavy use of telematics -- or driving data it collects from users' cellphones -- and its machine learning models for underwriting policies and dealing with claims.
Since going public in October 2020, Root has seen its stock drop by more than half. Investors have been down on the insurtech company, which has yet to turn a profit. Root is making progress, but there are still boxes I want to see it check off before considering it a buy. Here's what you should know.
A few bright spots in a down quarter
Last year, Root posted a net loss of $363 million. In the first quarter of this year, the bottom line wasn't much better, with another net loss of nearly $100 million.
On a positive note, direct written premiums of $203 million were the highest in the company's young history, representing a 23% increase from last year's first quarter and a 39% increase from the fourth quarter of 2020. Management was also happy about its direct loss ratio of 71%, its best quarter with the exception of the second quarter of last year, which saw drastically fewer claims due to less driving amid the early stages of the coronavirus pandemic.
Root had a $27 million direct contribution, an improvement from its $11 million loss last year. CFO Dan Rosenthal described direct contribution as a key profitability metric for the company. Direct contribution is a non-GAAP measure, and it is the adjusted gross profit (or loss), excluding ceded premium, losses, and loss adjustment expenses. Management views the metric as important because it measures progress toward the profitability of its total portfolio of policies before considering the impact of reinsurance.
However, net premium earned, which is direct earned premium less ceded earned premium, declined during the period by 50%. This was due to a big increase to ceded earned premium, or premium that was ceded to third-party reinsurers under reinsurance agreements, of $101 million, up from $26 million last year. As investors, we must consider the amount ceded to reinsurers because this ultimately flows down to the bottom line, impacting net income and earnings per share.
How Root is looking to grow in 2021
The company prides itself on its claims turnaround times, which management says is one of the fastest in the industry. It does this by leveraging its mobile platform, making claims easy and fast for customers and getting cash into their hands in half the time that competitors do. Root credits its mobile app for fast claims time, which gives it a rich dataset on claims. This in turn speeds up future claims times as a result, creating increasing efficiencies.
Root currently has a big footprint in Texas, Georgia, Pennsylvania, Louisiana, Colorado, Utah, and Nevada, which account for half of its direct written premiums in the first quarter. It has secured its license for insurance in 48 states and is currently in the process of working with regulators across several states to get its telematics pricing models approved. Once that happens, it expects to see accelerated growth in premiums written, with Rosenthal saying 2020 will be "a year of significant growth" and that there will be some pressure on the loss ratio in the short term as the company adds customers.
Root has made progress on some of its key metrics, including direct contribution and its direct loss ratio. However, for this to be a company I would consider buying, I'd want to see improvements where it matters most -- on the bottom line.
Root is expanding into more states and could see a lot of success as it applies its telematics insurance model to the industry. In the coming quarters, I'm looking for progress with that expansion, as well as continued growth in written premiums and an improvement to its net income (loss) on a year-over-year basis. Until then, it's best for investors to stay on the sidelines.