Root, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the section titled “Selected Historical Consolidated Financial Data” and our consolidated financial statements and related notes included elsewhere in this annual report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from such forward-looking statements. Factors that could cause or contribute to those differences include, but are not limited to, those identified below and those discussed in the sections titled “Risk Factors” and “Special Note Regarding Forward-Looking Statements” included elsewhere in this annual report. Additionally, our historical results are not necessarily indicative of the results that may be expected for any period in the future. This Management’s Discussion and Analysis does not discuss 2018 performance or a comparison of 2019 versus 2018 performance for select areas where we have determined the omitted information is not necessary to understand our current period financial condition, changes in our financial condition, or our results. The omitted information may be found in our Final Prospectus for our initial public offering, or our IPO, dated as of October 27, 2020 and filed with the Securities and Exchange Commission, or the SEC, pursuant to Rule 424(b)(4) on October 29, 2020. Overview Root is a technology company revolutionizing personal insurance with a pricing model based upon fairness and a modern customer experience. We operate a direct-to-consumer model in which we acquire majority of our customers through mobile applications. We are currently writing auto insurance in 30 states in the US. Since launch in 2015, our model has delivered rapid growth and continuously improving operating results. Our DWP grew to $ 616.8 million in 2020 from $ 451.1 million in 2019 and $106.4 million in 2018. Similarly our DEP grew to $ 605.2 million in 2020 from $352.9 million in 2019 and $61.4 million in 2018. We experienced declines in our direct loss ratios to 82.0% in 2020, compared to 99.9% in 2019 and 93.6% in 2018 with corresponding declines in our direct accident period loss ratios to 78.0% in 2020 down from 103.7% in 2019 and 112.1% in 2018. See the section titled “ — Components of Our Results of Operations.” The Root advantage is derived from our unique ability to segment individual risk based on complex behavioral data and proprietary telematics, a customer experience built for ease of use and a product offering made possible with our full-stack insurance structure all uniquely integrated into a single cloud-based technology platform that captures the entire insurance value chain—from customer acquisition to claims and administration to ongoing customer engagement. Our model benefits from portfolio maturity. As we scale the business rapidly our results are disproportionately weighted towards new customers compared to traditional insurance carriers. As we build an underlying base of recurring customers, we expect the following financial impact: • Improve loss ratio. Renewal premiums, referring to premiums from a customer’s second term and beyond, have lower loss ratios as compared to new premiums in the customer’s first term. As we grow our business, we anticipate, consistent with industry norms, that a greater proportion of our premiums will be from customer renewals driving down the loss ratio across our portfolio. • Increase revenue per customer. Our product expansion provides an opportunity to generate additional premium and fee income per customer without material incremental marketing cost. • Reduce marketing as a percentage of premium . Recurring customer premiums have no associated customer acquisition costs and minimal underwriting costs, driving profitability. As we grow our business, we anticipate, consistent with industry norms, that a greater proportion of our premiums will be from customer renewals without associated marketing costs. • Improve retention. As a young insurance carrier weighted towards new customers, we naturally have a higher percentage of more frequent shoppers. As our business tenures and our flywheel spins allowing us to increase our pricing advantage, we will have the opportunity to acquire more long-standing customers and retain those that 59 might naturally shop frequently. In addition to our pricing advantage, our expanding relationships with customers through bundling has also demonstrated improvement in retention. We use technology to drive efficiency across all functions, including distribution, underwriting, policy administration and claims in particular. This allows us to operate with a cost to acquire and cost to serve advantage. We efficiently acquire customers directly through multiple channels, including digital (performance), strategic partnerships, channel media and referrals, and as a result our marketing costs are well below industry averages. Today, we acquire more than 75% of our customers through our mobile app and mobile website. Additionally, we are realizing operating efficiencies as we scale against our fixed expense base. Our claims management expenses, as represented by our loss adjustment expense, or LAE, are in line with peers within only two years of bringing claims management in-house and will improve as we further embed machine learning into our processes. We also use our proprietary technology to measure long-term benefits to our business. When a state reaches certain maturation thresholds, we refer to it as a seasoned state. A seasoned state is defined as a state where (1) the regulator has approved our data science-driven telematics and pricing models and (2) we have been writing policies in the state for a minimum of one year with a minimum of two pricing filings. As a rapidly growing full-stack insurance company, we currently employ a “capital light” model, which utilizes a variety of reinsurance structures at elevated levels of reinsurance. These reinsurance structures deliver three core objectives (1) Top-Line Growth Without a Commensurate Increase in Regulatory Capital Requirements. (2) Support of Customer Acquisition Costs and (3) Protection from Outsized Losses or Tail Events . While reinsurance has been core to our strategy since inception, beginning on July 1, 2020, we increased our use of third-party quota share reinsurance with the implementation of our staggered multi-treaty approach to our program. We expect to maintain an elevated level of third-party quota share reinsurance while rapidly growing our business in order to operate a capital light business model. As our business scales, we expect to have the flexibility to reduce our quota share levels to maximize the return to shareholders. Given the significant impact of reinsurance on our results of operations, we added new direct basis key performance indicators to enhance investor understanding of the results of our business model prior to reinsurance. We believe our long-term success will be determined by the progression of our direct metrics used to manage and measure operations. Although we believe these direct metrics help investors understand the results of our business model, these results are not achievable under our regulatory landscape given our top-line growth and resulting capital requirements, which are relieved, in part, by obtaining reinsurance. The newly disclosed direct basis metrics include direct contribution, ratio of direct contribution to total revenue, ratio of direct contribution to direct earned premium and direct accident period loss ratio. For additional information, including definitions of these metrics, see “— Key Performance Indicators” and for reconciliation of direct contribution to the nearest GAAP metric, see “— Non-GAAP Financial Measures.” Key Factors and Trends Affecting our Operating Performance Our financial condition and results of operations have been, and will continue to be, affected by a number of factors, including the following: Our Ability to Attract New Customers Our long-term growth will depend, in large part, on our continued ability to attract new customers to our platform. We intend to continue to drive new customer growth by leveraging our differentiated consumer experience and our telematics-based pricing. Additionally, our proprietary dataset will continue to scale as we grow, enabling us to enhance our predictive models that will further improve pricing and attract potential new customers. We will also continue to target attractive potential customer segments through our digital marketing channels and strategic partnerships. Similarly, we intend to increase our presence in digital and traditional channel media and expand on our recently launched a national advertising campaign to build our brand awareness. Our ability to attract new customers will depend on a number of factors, including the pricing of our products, offerings of our competitors, our ability to expand into new markets, and the effectiveness of our marketing efforts. Our ability to attract and retain customers depends on maintaining and strengthening our brand by providing superior customer experiences and competitive pricing. In particular, we are challenged by traditional insurers who have more diverse product 60 offerings and longer established operating histories. These competitors can mimic certain aspects of our digital platform and offerings and as they have more types of insurance products, can offer customers the ability to “bundle” multiple coverage types together, which may be attractive to many customers. Our Ability to Retain Customers Our ability to derive significant lifetime value from our customer relationships depends, in part, on our ability to retain our customers over time. Strong retention allows us to build a recurring revenue base, generating additional premiums term over term without material incremental marketing costs. As we broadly retain customers and our book of business evolves to be more weighted towards renewals versus new business, as is the case with our mature competitors, we will benefit from the inherently lower loss ratios that characterize renewed premiums. Our ability to retain customers will depend on a number of factors, including our customers’ satisfaction with our products, offerings of our competitors and pricing of products. Our Ability to be Licensed in all States in the United States Our long-term growth opportunity will benefit from our ability to provide insurance across more states in the United States. Today, we are currently licensed in 50 states (48 states for personal auto) and the District of Columbia and operate in 30 of those states. Our continuous state expansion has unlocked a large total addressable market for sustained growth, made our direct targeted marketing more efficient and creates an opportunity to build a national brand, supporting our marketing holistically. To expand our geographic footprint, in November 2020, we acquired all of the authorized, issued and outstanding shares of Catlin Indemnity Company, subsequently renamed Root Property & Casualty Insurance Company, or Root Property & Casualty, for $ 22.8 million, which included cash, cash equivalents, and accrued investment income of $ 14.4 million and insurance license indefinite-lived intangible assets of $ 8.4 million. The transaction costs associated with this acquisition were $ 0.5 million and were allocated to the insurance license indefinite-lived intangible assets acquired. For further information, see Note 2, “Significant Accounting Policies,” in the Notes to Consolidated Financial Statements. Our Ability to Expand Premiums and Fee Income Per Policy Through Cross-Sell We are in the early stages of cross-selling non-auto products across our customer base. In 2019, we began offering renters insurance and, in May 2020, we launched our homeowners insurance policy in partnership with Homesite Insurance, or Homesite. Cross-sales allow us to generate additional premiums (renters) and fee income (homeowners) without material incremental marketing spend, and ultimately higher revenue per customer. We have also observed that bundling products with auto insurance improves retention as the relationship with our customer expands. Our success in expanding revenues through cross-sales depends on our marketing efforts with new products, continuous state expansion of these offerings and the pricing of our bundled products. The success of our renters insurance offering is also subject to our ability to develop underwriting capabilities to adequately price renters risk. Our Ability to Manage Risk We leverage technology to help manage risk. For instance, we leverage machine learning to “clean” behavioral data obtained through a customer’s mobile device and we use advanced statistical methods to model that data into usable behavior scores. We leverage intelligent chat functions, and various forms of machine learning and advanced automation help power our claims function. Technology is a key differentiator in managing risk across our key functions. Our success depends on our ability to adequately and competitively price risk. Recent Developments Affecting Comparability COVID-19 Impact In December 2019, COVID-19 was first reported in Wuhan, China and in March 2020, the World Health Organization declared a global pandemic. The ongoing global pandemic has severely impacted businesses worldwide, including within the insurance industry. We have been impacted by certain individual state bulletins that 61 outline COVID-19 premium relief efforts, including restrictions on the ability to cancel policies for non-payment, requiring deferral of insurance premium payments for up to 60 days and restrictions on increasing policy premiums. Our business has also been impacted by COVID-19 by a slowdown in growth, lower loss ratios due to decreased claim frequency and improved retention. Throughout 2020, COVID-19 has impacted and may further impact the broader economic environment, including negatively impacting unemployment levels, economic growth, the proper functioning of financial and capital markets and interest rates. As the COVID-19 pandemic continues, there is uncertainty around the severity and duration of the pandemic and the pandemic’s potential change on our business and our financial performance. See the section titled “Risk Factors” for more details. Comprehensive Reinsurance We expect to continue to utilize reinsurance in the future, and our diversified approach to reinsurance allows us to be flexible in response to changes in market conditions or our own business changes, which allows us to strategically fuel growth and technology investment by optimizing the amount of capital required in a “capital-light” model. Key Performance Indicators We regularly review a number of metrics, including the following key performance indicators, to evaluate our business, measure our performance, identify trends in our business, prepare financial projections and make strategic decisions. We believe these non-GAAP and operational measures are useful in evaluating our performance, in addition to our financial results prepared in accordance with GAAP. See the section titled “— Non-GAAP Financial Measures” for additional information regarding our use of adjusted gross profit/(loss) and direct contribution and their reconciliation to the most comparable GAAP measures. Years Ended December 31, 2020 2019 2018 (dollars in millions, except Premiums per Policy) Policies in Force Auto 322,759 281,310 111,736 Renters 7,739 1,747 — Premiums per Policy Auto $ 939 $ 904 $ 729 Renters $ 140 $ 127 $ — Premiums in Force Auto $ 606.1 $ 508.6 $ 162.9 Renters $ 1.1 $ 0.2 $ — Direct Written Premium $ 616.8 $ 451.1 $ 106.4 Direct Earned Premium $ 605.2 $ 352.9 $ 61.4 Gross Profit/(Loss) $ (14.2) $ (83.5) $ (10.4) Gross Margin (4.1) % (28.8) % (24.0) % Adjusted Gross Profit/(Loss) $ 21.0 $ (54.2) $ (0.2) Direct Contribution $ 18.9 $ (57.4) $ (7.6) Ratio of Adjusted Gross Profit/(Loss) to Total Revenue 6.1 % (18.7) % (0.5) % Ratio of Adjusted Gross Profit/(Loss) to Direct Earned Premium 3.5 % (15.4) % (0.3) % Ratio of Direct Contribution to Total Revenue 5.4 % (19.8) % (17.6) % Ratio of Direct Contribution to Direct Earned Premium 3.1 % (16.3) % (12.4) % Direct Loss Ratio 82.0 % 99.9 % 93.6 % Direct LAE Ratio 10.1 % 12.0 % 16.9 % Direct Accident Period Loss Ratio 78.0 % 103.7 % 112.1 % 62 Policies in Force We define policies in force as the number of current and active policyholders underwritten by us as of the period end date. We view policies in force as an important metric to assess our financial performance because policy growth drives our revenue growth, expands brand awareness, deepens our market penetration, and generates additional data to continue to improve the functioning of our platform. Premiums per Policy We define premiums per policy as the ratio of direct written premium on policies in force divided by policies in force. We view premiums per policy as an important metric since the higher the premiums per policy the greater the amount of earned premium we expect from each policy. Premiums in Force We define premiums in force for our auto policies as premiums per policy multiplied by policies in force multiplied by two. We view premiums in force as an estimate of annualized run rate of direct written premium as of a given period. Since our auto policies are six month policies, we multiply this figure by two in order to determine an annualized amount of premiums in force. We define premiums in force for our renters policies as premiums per policy multiplied by policies in force. We view this as an important metric because it is an indicator of the size of our portfolio of policies as well as an indicator of expected earned premium over the coming 12 months. Premiums in force is not a forecast of future revenue nor is it a reliable indicator of revenue expected to be earned in any given period. We believe that our calculation of premiums in force is useful to investors and analysts because it captures the impact of growth in customers and premiums per policy at the end of each reported period, without adjusting for known or projected policy updates, cancellations and non-renewals. Direct Written Premium We define direct written premium, as the total amount of direct premium on policies that were bound during the period. We view direct written premium as an important metric because it is the metric that most closely correlates with our growth in direct earned premium. We use direct written premium, which excludes the impact of premiums ceded to reinsurers, to manage our business because we believe that it reflects the business volume and direct economic benefit generated by our customer acquisition activities, which along with our underlying underwriting and claims operations (direct loss ratio and direct LAE) are the key drivers of our future profit opportunities. Additionally, premiums ceded to reinsurers can change significantly based on the type and mix of reinsurance structures we use, and as such we have the optionality to fully retain the premiums from customers acquired in the future. Direct Earned Premium We define direct earned premium as the amount of direct premium that was earned during the period. Premiums are earned over the period in which insurance protection is provided, which is typically 6 months. We view direct earned premium as an important metric as it allows us to evaluate our growth prior to the impacts of reinsurance. It is the primary driver of our consolidated GAAP revenues. As with direct written premium, we use direct earned premium, which excludes the impact of premiums ceded to reinsurers to manage our business, because we believe that it reflects the business volume and direct economic benefit generated by our customer acquisition activities, which along with our underlying underwriting and claims operations (direct loss ratio and direct LAE) are the key drivers of our future profit opportunities. Gross Profit/(Loss) We define gross profit/(loss) as total revenue minus net loss, LAE and other insurance (benefit) expense inclusive of depreciation and amortization. We view gross profit/(loss) as an important metric because we believe it is informative of the financial performance of our core insurance business. Gross margin is equal to gross profit/(loss) divided by total revenue. 63 Adjusted Gross Profit/(Loss) We define adjusted gross profit/(loss), a non-GAAP financial measure, as gross profit/(loss) excluding net investment income, net realized gains (losses) on investments, report costs, Personnel Costs, allocated Overhead, licenses, professional fees and other expenses, which are included in other insurance (benefit) expense. After these adjustments, the resulting calculation is inclusive of only those variable costs of revenue incurred on the successful acquisition of business. We view adjusted gross profit/(loss) as an important metric because we believe it measures our progress towards profitability for our core insurance business. The ratio of adjusted gross profit/(loss) to total revenue is equal to adjusted gross profit/(loss) divided by total revenue. See the section titled “— Non-GAAP Financial Measures” for a reconciliation of total revenue to adjusted gross profit/(loss). Direct Contribution We define direct contribution, a non-GAAP financial measure, as adjusted gross profit/(loss) excluding ceded earned premium, ceded loss and LAE, and net ceding commission and other. Net ceding commission and other is comprised of ceding commission received in connection with reinsurance ceded, partially offset by sliding scale commission adjustments and amortization of excess ceding commission, and other impacts of reinsurance which are included in other insurance (benefit) expense. After these adjustments, the resulting calculation is inclusive of only those direct variable costs of revenue incurred on the successful acquisition of business, but exclusive of net ceding commission, ceded loss and LAE and other impacts of reinsurance. We view direct contribution as an important metric because we believe it measures progress towards the profitability of our total policy portfolio prior to the impact of reinsurance. The ratio of direct contribution to total revenue is equal to direct contribution divided by total revenue. See the section titled “— Non-GAAP Financial Measures” for a reconciliation of total revenue to direct contribution. Ratio of Adjusted Gross Profit/(Loss) to Direct Earned Premium The ratio of adjusted gross profit/(loss) to direct earned premium measures the relationship between the underlying business volume and gross economic benefit generated by our underwriting operations, on the one hand, and our underlying profitability trends, on the other. We rely on this measure, which supplements our gross margin as calculated in accordance with GAAP, because it provides management with insight into our underlying profitability trends with respect to our customer base. We use direct earned premium as the denominator in calculating this ratio because it reflects business volume free of elective capital efficiency choices related to our reinsurance programs. Years Ended December 31, 2020 2019 2018 (dollars in millions) Numerator: Adjusted Gross Profit/(Loss) $ 21.0 $ (54.2) $ (0.2) Denominator: Total Direct Earned Premium $ 605.2 $ 352.9 $ 61.4 Ratio of Adjusted Gross Profit/(Loss) to Direct Earned Premium 3.5 % (15.4) % (0.3) % Ratio of Direct Contribution to Direct Earned Premium The ratio of direct contribution to direct earned premium measures the relationship between the underlying business volume and gross economic benefit generated by our underwriting operations, on the one hand, and our underlying profitability trends, on the other, without contemplating the impacts of reinsurance. We rely on this measure, which supplements our gross margin as calculated in accordance with GAAP, because it provides management with insight into our underlying profitability trends with respect to our total policy portfolio. We use 64 direct earned premium as the denominator in calculating this ratio because it reflects business volume free of elective capital efficiency cession or commission structures choices from our reinsurance programs. Years Ended December 31, 2020 2019 2018 (dollars in millions) Numerator: Direct Contribution $ 18.9 $ (57.4) $ (7.6) Denominator: Total Direct Earned Premium $ 605.2 $ 352.9 $ 61.4 Ratio of Direct Contribution to Direct Earned Premium 3.1 % (16.3) % (12.4) % Direct Loss Ratio We define direct loss ratio expressed as a percentage, as the ratio of direct losses to direct earned premium. Direct loss ratio excludes LAE. We view direct loss ratio as an important metric because it allows us to evaluate incurred losses and LAE separately prior to the impact of reinsurance. Direct LAE Ratio We define direct LAE ratio expressed as a percentage, as the ratio of direct LAE to direct earned premium. We view direct LAE ratio as an important metric because it allows us to evaluate incurred losses and LAE separately. We actively monitor LAE ratio as it has a direct impact on our results regardless of our reinsurance strategy. Direct Accident Period Loss Ratio Direct accident period loss ratio, expressed as a percentage, represents all losses and claims expected to arise from insured events that occurred during the applicable period regardless of when they are reported and finally settled divided by direct earned premiums for the same period. Changes to our loss reserves are the primary driver of the difference between our direct accident period loss ratio and direct loss ratio. We believe that direct accident period loss ratio is useful in evaluating expected losses prior to the impact of reinsurance. Components of Our Results of Operations Revenue We generate revenue primarily from the sale of auto insurance policies within the United States and to a lesser extent from the sale of renters insurance policies. We have agency operations that generate commission revenue by selling homeowners insurance policies on behalf of a third-party insurance company. We also generate revenue through fee income from our customers paying on installment and from net investment income earned on our investment portfolio. Net Premiums Earned Premiums written are deferred and earned pro rata over the policy period. Net premiums earned represents the earned portion of our gross written premium, less the earned portion that is ceded to third-party reinsurers under our reinsurance agreements. Net Investment Income Net investment income represents interest earned from our fixed maturity and short-term investments and cash and cash equivalents less investment expenses. Net investment income is directly correlated with the overall size of our investment portfolio and with the market level of interest rates. Net investment income will vary with both the size of our investment portfolio, market returns and the investment strategy. 65 Fee and Other Income For those policyholders who pay premiums on an installment basis, we charge a flat fee for each installment related to the additional administrative costs associated with processing more frequent billing. Other income primarily comprises commissions earned for homeowners policies placed with third-party insurance companies where we have no exposure to the insured risk, recognized on the effective date of the associated policy, and sale of enterprise technology products to provide telematics-based data collection and trip tracking, recognized ratably as the service is performed. Operating Expenses Our operating expenses consist of loss and loss adjustment expenses, sales and marketing, other insurance (benefit) expense, technology and development, and general and administrative expenses. Loss and Loss Adjustment Expenses Loss and LAE include an amount determined using adjuster determined case-base estimates for reported claims and actuarial determined unpaid claim estimates using past experience and historical emergence patterns for unreported losses and loss adjustment expenses. These reserves are established to cover the estimated ultimate cost to settle insured losses. The unpaid claim estimates consider loss trends, mix of business, and other risk factors impacting claims settlement. The method used to estimate unpaid LAE reserves is based on claims transaction data, including the relative cost of settling the range of claim types from express material damage claims to more complex injury cases. Loss and LAE is net of amounts ceded to reinsurers. We enter into reinsurance contracts to limit our exposure to potential losses as well as to provide additional capacity for growth. These expenses are a function of the size and term of the insurance policies we write and the loss experience associated with the underlying risks. Loss and LAE may be paid out over a period of years. Various other expenses incurred during claims processing are allocated to LAE. These amounts include claims salaries, health benefits, bonuses, employee retirement plan related expenses and share-based compensation expense, or Personnel Costs; software expense; internally developed software amortization; and overhead allocated based on headcount, or Overhead. Sales and Marketing Sales and marketing includes spend related to performance and partnership channels, channel media, advertising, branding, public relations, consumer insights and referral fees. These expenses also include related Personnel Costs and Overhead. We incur sales and marketing activities for all product offerings. Sales and marketing are expensed as incurred. We plan to continue investing in marketing to attract and acquire new customers, increase our brand awareness, and expand our Enterprise product offering. We expect that sales and marketing will increase in absolute dollars in future periods and vary from period-to-period as a percentage of revenue in the near-term. We expect that, in the long-term, our sales and marketing will decrease as a percentage of revenue as the proportion of renewals to our total business increases. Other Insurance (Benefit) Expense Other insurance (benefit) expense includes underwriting expenses, credit card and policy processing expenses, premium write-offs, insurance license expenses, and Personnel Costs and Overhead related to actuarial and certain data science activities. Other insurance expense also includes amortization of deferred acquisition costs like premium taxes and report costs related to the successful acquisition of a policy. Other insurance expense is expensed as incurred, except for costs related to deferred acquisition costs that are capitalized and subsequently amortized over the same period in which the related premiums are earned. These expenses are also recognized net of ceding commissions earned. 66 Technology and Development Technology and development consists of software development costs related to our mobile app and homegrown information technology systems; third-party services related to infrastructure support; Personnel Costs and Overhead for engineering, product, technology, and certain data science activities; and amortization of internally developed software. Technology and development is expensed as incurred, except for development and testing costs related to internally developed software that are capitalized and subsequently amortized over the expected useful life. We expect technology and development to increase in absolute dollars and as a percentage of total revenue as we continue to devote significant resources to enhance our customer experience and continually improve our integrated technology platform. Over time, we expect technology and development to decrease as a percentage of revenue. General and Administrative General and administrative expenses primarily relate to external professional service expenses; Personnel Costs and Overhead for corporate functions; and depreciation expense for computers, furniture and other fixed assets. General and administrative expenses are expensed as incurred. We expect general and administrative expenses to continue to increase in the near term, both in absolute dollars and as a percentage of total revenue, and then decrease as a percentage of revenue over time. Interest Expense Interest expense is not an operating expense; therefore, we include these expenses below operating expenses. Interest expense primarily relates to interest incurred on our long term debt; certain fees that are expensed as incurred; and the amortization of debt issuance costs, and the issuance of warrants. In addition, changes in the fair value of warrant liabilities that are associated with our long term debt and changes in the fair value of our former Simple Agreement for Future Equity, or SAFE, are recorded as interest expense. 67 Results of Operations Comparison of the Years Ended December 31, 2020 and 2019 The following table presents our results of operations for the periods indicated: Years Ended December 31, 2020 % of Total Revenue 2019 % of Total Revenue $ Change % Change (dollars in millions) Revenue: Net premiums earned $ 322.5 93.0 % $ 275.3 94.9 % $ 47.2 17.1 % Net investment income 5.4 1.6 % 5.2 1.8 % $ 0.2 3.8 % Net realized gains on investments 0.3 0.1 % — — % $ 0.3 100.0 % Fee and other income 18.6 5.4 % 9.7 3.3 % $ 8.9 91.8 % Total revenue 346.8 100.0 % 290.2 100.0 % 56.6 19.5 % Operating expenses: Loss and loss adjustment expenses 362.8 104.6 % 321.4 110.8 % 41.4 12.9 % Sales and marketing 139.7 40.3 % 109.6 37.8 % 30.1 27.5 % Other insurance (benefit) expense ( 1.8 ) (0.5) % 52.3 18.0 % (54.1) (103.4) % Technology and development 52.9 15.3 % 24.0 8.3 % 28.9 120.4 % General and administrative 78.5 22.6 % 43.0 14.8 % 35.5 82.6 % Total operating expenses 632.1 182.3 % 550.3 189.6 % 81.8 14.9 % Interest expense 77.7 22.4 % 22.3 7.7 % 55.4 248.4 % Loss before income tax expense (363.0) (104.7) % (282.4) (97.3) % (80.6) 28.5 % Income tax expense — — % — — % — — % Net loss (363.0) (104.7) % (282.4) (97.3) % (80.6) 28.5 % Other comprehensive income: Changes in net unrealized gains on investments 5.0 1.4 % 0.6 0.2 % 4.4 N.M. Comprehensive loss $ (358.0) (103.2) % $ (281.8) (97.1) % $ (76.2) N.M. ______________ N.M. - Percentage change not meaningful Revenue Net Premiums Earned Net premiums earned increased $47.2 million, or 17.1%, to $ 322.5 million for the year ended December 31, 2020 compared to 2019. The increase was primarily due to growth in direct earned premium driven by deeper penetration in the markets in which we operate and a greater proportion of seasoned states, partially offset by higher cessions of earned premium as a result of a change in third-party reinsurance structure. During the years ended December 31, 2020 and 2019, we ceded approximately 46.7% and 22.0% of our direct earned premiums to third-party reinsurers, respectively. The change in ceding percentage was driven by a new reinsurance treaty that became effective on July 1, 2020 whereby we increased our use of third-party quota share reinsurance with the implementation of a staggered multi-treaty approach. Under this new quota share reinsurance program, we began ceding approximately 70% of direct earned premiums with a sequence of inception and maturity dates, and with the majority of the ceded premiums covered on a cohort basis for a four year duration. 68 The following table presents direct written premium, ceded written premium, net written premium, direct earned premium, ceded earned premium and net earned premium for the years ended December 31, 2020 and 2019: Years Ended December 31, 2020 2019 $ Change % Change (dollars in millions) Direct written premium $ 616.8 $ 451.1 $ 165.7 36.7 % Ceded written premium ( 378.0 ) ( 82.3 ) (295.7) 359.3 % Net written premium 238.8 368.8 (130.0) (35.2) % Direct earned premium 605.2 352.9 252.3 71.5 % Ceded earned premium ( 282.7 ) ( 77.6 ) (205.1) 264.3 % Net earned premium $ 322.5 $ 275.3 $ 47.2 17.1 % Direct earned premium growth was primarily due to a 36.7% increase in direct written premium from greater market share in served U.S. states and expansion of our U.S. state footprint. Since December 31, 2019, we began writing auto insurance policies in one additional U.S. state. We also saw a 3.9% increase in Premium per Policy for automobile insurance primarily resulting from pricing increases in several U.S. states. Fee and Other Income Fee and other income increased $8.9 million, or 91.8%, to $ 18.6 million for the year ended December 31, 2020 compared to 2019. The increase was primarily due to increased customer volumes and an increase in customers paying in installments. Operating Expenses Loss and Loss Adjustment Expenses Loss and LAE increased $41.4 million, or 12.9%, to $ 362.8 million for the year ended December 31, 2020 compared to 2019. The increase was primarily due to higher claims volume and reserves related to the growth in policies in force, net of higher cessions of incurred losses as a result of a change in third-party reinsurance structure. We experienced declines in our direct loss ratios to 82.0% in 2020, compared to 99.9% in 2019 with corresponding declines in our direct accident period loss ratios to 78.0% in 2020 down from 103.7% in 2019. The decrease in direct loss ratios and direct accident period loss ratios year over year was driven by deployment of improved and additional underwriting and rating criteria in 2020, an increase in the number of seasoned states from three at the end of 2019 to 20 at the end of 2020, as well as a decrease in claims frequency beginning in March 2020 as a result of a reduction in driving attributable to the COVID-19 pandemic. Our net loss ratios experienced similar declines between the periods primarily driven by the same factors outlined above, partially offset by an increase in loss corridor provisions. In addition, loss and LAE for the year ended December 31, 2020 includes an increase to held reserves for prior accident periods of $ 20.9 million primarily related to higher than estimated reported losses resulting from frequency and severity in excess of expectations for bodily injury claims as well as higher emergence of collision claims from accident years 2019 and prior, partially due to timing of reported claims. The year ended December 31, 2020 also included development of incurred losses related to accident years 2019 and prior as a result of a change in estimate. The adjustments recorded in the year ended December 31, 2020 were necessary in order to effectuate management’s best estimate for determining the estimated ultimate cost of settling claims using our knowledge and experience about past and current events and developments. 69 Sales and Marketing Sales and marketing increased $30.1 million, or 27.5%, to $ 139.7 million for the year ended December 31, 2020 compared to 2019. The increase was primarily due to increased investment in digital advertising and partnership marketing channels to support growth and market expansion. Other Insurance (Benefit) Expense Other insurance (benefit) expense decreased $54.1 million, or (103.4)%, to $( 1.8 ) million for the year ended December 31, 2020 compared to 2019. The decrease was primarily due to increased ceding commission contra-expense of $91.6 million related to our increased use of third-party quota share reinsurance compared to $7.2 million of ceding commission contra-expense net of sliding scale commission expense for the year ended December 31, 2019. Under the external quota share reinsurance agreement effective July 1, 2020, which is on a loss occurring basis, we recognized ceding commissions under the agreement in proportion to the recognition of the direct written premiums during the period, including the remaining unearned premiums on ceded policies at the inception of the agreement. The ceding commission provides for reimbursement of both direct and other periodic acquisition costs, including certain underwriting and marketing costs, and is presented as a reduction of other insurance expense. This was partially offset by a $14.6 million increase in bad debt expense primarily related to delayed cancellation of policies for non-payment stemming from compulsory state issued notices in reaction to the COVID-19 pandemic and driven by growth in direct written premiums, $8.8 million increase in premium taxes driven by growth in direct written premiums and a $3.1 million increase in payment processing fee expense driven by the increase in collected premiums between periods, $1.9 million increase in personnel and overhead costs due to headcount growth. Technology and Development Technology and development increased $28.9 million, or 120.4%, to $ 52.9 million for the year ended December 31, 2020 compared to 2019. The increase was primarily driven by a $16.7 million increase in personnel and overhead costs due to headcount growth of engineering and product teams and a $5.8 million increase in share-based compensation expense related to the secondary tender offer completed in the first quarter of 2020. In addition, we incurred a $6.4 million increase in external software and amortization of internally developed software expense for the year ended December 31, 2020 compared to 2019, as we continued to invest in developing and improving our technology platforms and infrastructure. General and Administrative General and administrative increased $35.5 million, or 82.6%, to $ 78.5 million for the year ended December 31, 2020 compared to 2019. The increase was primarily driven by a $14.2 million increase in legal and other professional costs to support our overall growth and emerging compliance initiatives, including the IPO. In addition, a $10.3 million increase in share-based compensation expense mainly due to the secondary tender offer completed in the first quarter of 2020 and a $10.3 million increase in personnel costs across finance, legal, and administrative teams as a result of an increase in headcount. Interest Expense Interest expense increased $55.4 million, or 248.4%, to $ 77.7 million for the year ended December 31, 2020 compared to 2019. The increase was primarily due to a $54.7 million fair value adjustment of warrants that were exercised to purchase common stock. In addition, there was a $8.6 million increase in payment-in-kind, or PIK, interest expense and interest paid, and a $3.3 million increase in amortization of debt discount and debt and warrants issuance costs as a result of a higher average debt balance during 2020 compared to 2019. This was partially offset by a $11.2 million SAFE instrument fair value adjustment recognized during 2019. 70 Comparison of the Years Ended December 31, 2019 and 2018 The following table presents our results of operations for the periods indicated: Years Ended December 31, 2019 % of Total Revenue 2018 % of Total Revenue $ Change % Change (dollars in millions) Revenue: Net premiums earned $ 275.3 94.9 % $ 40.2 92.8 % $ 235.1 584.8 % Net investment income 5.2 1.8 % 1.2 2.8 % $ 4.0 333.3 % Fee and other income 9.7 3.3 % 1.9 4.4 % $ 7.8 410.5 % Total revenue 290.2 100.0 % 43.3 100.0 % 246.9 570.2 % Operating expenses: Loss and loss adjustment expenses 321.4 110.8 % 43.5 100.5 % 277.9 638.9 % Sales and marketing 109.6 37.8 % 40.3 93.1 % 69.3 172.0 % Other insurance expense 52.3 18.0 % 10.2 23.6 % 42.1 412.7 % Technology and development 24.0 8.3 % 8.2 18.9 % 15.8 192.7 % General and administrative 43.0 14.8 % 9.3 21.5 % 33.7 362.4 % Total operating expenses 550.3 189.6 % 111.5 257.5 % 438.8 393.5 % Interest expense 22.3 7.7 % 0.9 2.1 % 21.4 2377.8 % Loss before income tax expense (282.4) (97.3) % (69.1) (159.6) % (213.3) N.M. Income tax expense — — % — — % — % Net loss (282.4) (97.3) % (69.1) (159.6) % (213.3) N.M. Other comprehensive income: Changes in net unrealized gains on investments 0.6 0.2 % — — % 0.6 N.M. Comprehensive loss $ (281.8) (97.1) % $ (69.1) (159.6) % $ (212.7) N.M. ______________ N.M. - Percentage change not meaningful The December 31, 2019 and 2018 results of operations discussion can be found in our Final Prospectus for our IPO, dated as of October 27, 2020 and filed with the Securities and Exchange Commission, or the SEC, pursuant to Rule 424(b)(4) on October 29, 2020 . Non-GAAP Financial Measures The non-GAAP financial measures below have not been calculated in accordance with generally accepted accounting principles in the United States, or GAAP, and should be considered in addition to results prepared in accordance with GAAP and should not be considered as a substitute for, or superior to, GAAP results. In addition, adjusted gross profit/(loss) and direct contribution should not be construed as indicators of our operating performance, liquidity or cash flows generated by operating, investing and financing activities, as there may be significant factors or trends that they fail to address. We caution investors that non-GAAP financial information, by its nature, departs from traditional accounting conventions. Therefore, its use can make it difficult to compare our current results with our results from other reporting periods and with the results of other companies. Our management uses these non-GAAP financial measures, in conjunction with GAAP financial measures, as an integral part of managing our business and to, among other things: (1) monitor and evaluate the performance of our business operations and financial performance; (2) facilitate internal comparisons of the historical operating performance of our business operations; (3) facilitate external comparisons of the results of our overall business to 71 the historical operating performance of other companies that may have different capital structures and debt levels; (4) review and assess the operating performance of our management team; (5) analyze and evaluate financial and strategic planning decisions regarding future operating investments; and (6) plan for and prepare future annual operating budgets and determine appropriate levels of operating investments. Adjusted Gross Profit/(Loss) For the definition of adjusted gross profit/(loss) and why management believes this measure provides useful information to investors, see “— Key Performance Indicators.” Direct Contribution For the definition of direct contribution and why management believes this measure provides useful information to investors, see “— Key Performance Indicators.” The following table provides a reconciliation of total revenue to adjusted gross profit/(loss) and direct contribution for the years ended December 31, 2020, 2019 and 2018: Years Ended December 31, 2020 2019 2018 (dollars in millions) Total revenue $ 346.8 $ 290.2 $ 43.3 Loss and loss adjustment expenses (362.8) (321.4) (43.5) Other insurance benefit (expense) 1.8 (52.3) (10.2) Gross profit/(loss) (14.2) (83.5) (10.4) Gross margin (4.1) % (28.8) % (24.0) % Less: Net investment income (5.4) (5.2) (1.2) Net realized gains on investments (0.3) — — Adjustments from other insurance benefit (expense) (1) 40.9 34.5 11.4 Adjusted gross profit/(loss) $ 21.0 $ (54.2) $ (0.2) Ceded earned premium 282.7 77.6 21.2 Ceded loss and LAE (194.8) (73.6) (24.4) Net ceding commission and other (2) (90.0) (7.2) (4.2) Direct contribution $ 18.9 $ (57.4) $ (7.6) Direct earned premium $ 605.2 $ 352.9 $ 61.4 Ratio of adjusted gross profit/(loss) to total revenue 6.1 % (18.7) % (0.5) % Ratio of adjusted gross profit/(loss) to direct earned premium 3.5 % (15.4) % (0.3) % Ratio of direct contribution to total revenue 5.4 % (19.8) % (17.6) % Ratio of direct contribution to direct earned premium 3.1 % (16.3) % (12.4) % ______________ (1) Adjustments from other insurance benefit (expense) includes report costs, personnel costs, allocated overhead, licenses, professional fees and other . (2) Net ceding commission and other is comprised of ceding commissions received in connection with reinsurance ceded, partially offset by sliding scale commission adjustments and amortization of excess ceding commission, and other impacts of reinsurance . Liquidity and Capital Resources We are organized as a holding company, but our primary operations are conducted by our wholly-owned insurance subsidiary, Root Insurance Company, an Ohio-domiciled insurance company. Additionally, in November 72 2020, we acquired Root Property & Casualty, which expands our ability to sell personal auto insurance in 48 states and the District of Columbia. The payment of dividends by Root Insurance Company and Root Property & Casualty are subject to restrictions set forth in the insurance laws and regulations of the States of Ohio and Delaware, respectively, or the insurance laws. The insurance laws require domestic insurance companies to notify the supervisory superintendent, commissioner and/or director to seek prior regulatory approval to pay a dividend or distribute cash or other property if the fair market value thereof, together with that of other dividends paid or distributions made within the preceding 12 months, exceeds the greater of 10% of the insurance company’s statutory basis policyholders’ surplus as of the preceding December 31 or the statutory basis net income of the insurance company for the 12-month period ended as of the preceding December 31. To date, our insurance subsidiaries have not paid any dividends and as of December 31, 2020, it was not permitted to pay any dividends to us without approval of the applicable superintendent, commissioner and/or director. In addition, the Risk-Based Capital Model Act adopted by the NAIC provides formulas to determine the amount of capital that an insurance company must maintain to ensure that it has an acceptable expectation of not becoming financially impaired. As Root Insurance Company and Root Property & Casualty continue to grow, the amount of capital we are required to maintain to satisfy our risk-based capital requirements may increase significantly. To comply with these regulations, we may be required to maintain capital in our insurance subsidiaries that we would otherwise invest in our growth and operations. At December 31, 2020, Root Insurance Company and Root Property & Casualty maintained risk-based capital levels that are in excess of an amount that would require any corrective actions on our part. Our insurance subsidiaries’ primary sources of funds are capital contributions from the holding company, premiums earned, fee income revenues, and net investment income. Funds are primarily used to pay claims and operating expenses and to purchase investments. Our wholly-owned, Cayman Islands-based reinsurance subsidiary, Root Re, maintains a Class B(iii) insurer license under CIMA. At December 31, 2020, Root Re was subject to compliance with certain capital levels and a net earned premium to capital ratio of 8:1, which was maintained as of December 31, 2020. The capital ratio can fluctuate at Root Re’s election, subject to regulatory approval. Root Re’s primary sources of funds are capital contributions from the holding company, ceded insurance premiums and net investment income. These funds are primarily used to pay claims and operating expenses and to purchase investments. Root Re must receive approval from CIMA before it can pay any dividend to the holding company. Since inception, we have financed operations primarily through sales of insurance policies and the net proceeds we have received from our issuance of common stock, debt, and sales of investments. As of December 31, 2020, we had $ 1,112.8 million in cash and cash equivalents, of which $1,082.1 million was held at Root, Inc. and outside of regulated insurance entities, and $ 224.5 million was held in marketable securities. Our cash and cash equivalents primarily consist of bank deposits and money market funds. Our marketable securities consist of U.S. treasury securities, municipal securities, corporate debt securities, residential and commercial mortgage-backed securities, and other debt obligations. In October 2020, we completed our IPO, which resulted in the issuance and sale of 24.2 million shares of common stock at the IPO price of $27.00. Concurrently, we issued and sold 18.5 million shares of our Class A common stock in private placements. We received net proceeds of $1.1 billion after deducting underwriting discounts and other offering costs. We believe that our existing cash and cash equivalents, marketable securities, cash flow from operations, along with the net proceeds from our IPO, will be sufficient to support working capital and capital expenditure requirements for at least the next 12 months. Our future capital requirements will depend on many factors, including our insurance premium growth rate, renewal activity, including the timing and the amount of cash received from customers, the expansion of marketing activities, the timing and extent of spending to support development efforts, the introduction of new and enhanced products, the continuing market adoption of offerings on our platform, and the current uncertainty in the global markets resulting from the worldwide COVID-19 pandemic. 73 The following table summarizes our cash flow data for the periods presented: Years Ended December 31, 2020 2019 2018 (in millions) Net cash used in operating activities $ ( 287.2 ) $ ( 127.2 ) $ ( 26.1 ) Net cash used in investing activities ( 114.1 ) ( 114.0 ) ( 20.6 ) Net cash provided by financing activities 1,098.5 535.5 150.9 Comparison of Years Ended December 31, 2020 and 2019 Net cash used in operating activities for the year ended December 31, 2020 was $ 287.2 million compared to $ 127.2 million of net cash used in operating activities for the year ended December 31, 2019. The increase was primarily due to the volume and timing of premium receipts, claims payments and reinsurance activity as well as the non-cash impact of the tender offer, warrant fair value adjustment and bad debt expense. Net cash used in investing activities for the year ended December 31, 2020 was $ 114.1 million compared to $ 114.0 million of net cash used in investing activities for the year ended December 31, 2019. Although net cash used in investing activities was flat year-over-year, it resulted from our acquisition of Root Property & Casualty, largely offset by the sale, maturities, calls and pay downs of investments for the year ended December 31, 2020 compared to the year ended December 31, 2019. Net cash provided by financing activities for the year ended December 31, 2020 was $ 1,098.5 million, primarily due to proceeds from the issuance of common stock in connection with our IPO and concurrent private placements. Net cash provided by financing activities for the year ended December 31, 2019 was $ 535.5 million primarily due to the proceeds from issuing preferred stock, our Term Loan A, Term Loan B and SAFE agreements, which was partially offset by the repayment of long-term debt, and debt and warrants issuance costs. Comparison of Years Ended December 31, 2019 and 2018 The December 31, 2019 and 2018 net cash discussion can be found in our Final Prospectus for our IPO, dated as of October 27, 2020 and filed with the Securities and Exchange Commission, or the SEC, pursuant to Rule 424(b)(4) on October 29, 2020 . Contractual Obligations The following is a summary of material contractual obligations and commitments as of December 31, 2020: Payments Due by Period Total Less than 1 year 1-3 Years 3-5 Years After 5 Years (in millions) Long-term debt $ 199.5 $ 99.5 $ — $ 100.0 $ — Interest on long-term debt (1) 68.6 4.9 29.3 34.4 — Operating leases 21.6 3.9 8.8 5.8 3.1 Purchase commitments 25.6 10.0 15.0 0.6 — Total $ 315.3 $ 118.3 $ 53.1 $ 140.8 $ 3.1 _______________ (1) We have the option to pay interest in-kind, or PIK, on Term Loan B until October 15, 2021. Through the year-ended December 31, 2020, we have elected to PIK interest on Term Loan B and we plan to PIK interest for the full PIK Period. See Note 8, “Long-Term Debt,” in the Notes to the Consolidated Financial Statements. Financing Arrangements In February 2020, we amended Term Loan A to add a new financial institution (Goldman Sachs Lending Partners LLC) to the syndicate in the amount of $12.5 million. Accordingly, $12.4 million of the $24.9 million 74 escrowed funds was remitted to us and the other $12.5 million was remitted to the two aforementioned existing holders to pay down the pro rata portion of the reallocated Term Loan A. In September 2020, we amended Term Loan A to add financial institutions (Barclays, Deutsche Bank, Morgan Stanley, Wells Fargo and Citibank) to the syndication, upsize the outstanding facility by $13.5 million, and extend its maturity to October 15, 2021. We also added a $100 million revolving line of credit with members of the Term Loan A syndication as a part of the amendment. In order to amend Term Loan A, we also amended Term Loan B as the terms are pari passu. For further information, see Note 8, “Long-Term Debt,” in the Notes to Consolidated Financial Statements. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on our financial condition, results of operations, liquidity or cash flows. Critical Accounting Policies and Estimates Our financial statements are prepared in accordance with GAAP. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires our management to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the period. We evaluate our significant estimates on an ongoing basis, including, but not limited to, estimates related to reserves for loss and loss adjustment expense, premium write-offs, share-based compensation, and valuation allowance on our deferred tax asset. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. We believe that the accounting policies described below involve a significant degree of judgment and complexity. Accordingly, we believe these are the most critical to aid in fully understanding and evaluating our consolidated financial condition and results of operations. For further information, see Note 2, “Summary of Significant Accounting Policies,” in the Notes to Consolidated Financial Statements. Loss and LAE Reserves Loss and LAE reserves represent management’s best estimate of the ultimate liability for all reported and unreported claims that occurred prior to the end of each accounting period but have not yet been paid. These reserves are established to cover the estimated ultimate cost to settle insured losses. Loss and LAE reserves include an amount determined using adjuster determined case-base estimates for reported claims and on actuarial unpaid claim estimates using past experience and historical emergence patterns for unreported loss and LAE. Case reserve amounts are determined by claims adjusters following our case reserving practices, which consider the circumstances presented with each claimant, applicable policy provisions, and state law. The unpaid claim estimates consider loss cost trends, mix of business, and other risk factors impacting claims settlement. The methods used to estimate ultimate loss reserves by accident month include reported loss development, paid loss development, expected loss ratio, or ELR, frequency-severity, premium based Bornhuetter/Ferguson, or B/F, and exposure based B/F using frequency-severity. The method used to estimate unpaid LAE reserves is determined by a transaction-based allocation method where historical claim department activities are measured by their relative effort or cost for handling different claim types. Our estimation for unpaid LAE reserves includes the ultimate cost of settling a range of claim types from express material damage claims to more complex bodily injury cases. The evaluation and estimation of ultimate losses and LAE requires considerable judgment in understanding how claims mature, how claims differ between lines of business, and how changes in the business impact claims settlement over time. Loss reserves represent a liability estimate at a given point in time based on many input variables including historical and statistical information, inflation, contract interpretation, weather catastrophe impacts, regulatory environment, and economic conditions. While we consider many inputs into the loss reserve valuation process, as well as several actuarial methodologies, there is no single method for determining the exact 75 ultimate claims liability. In many cases, we use multiple estimation methods based on the particular facts and circumstances of the claims and liabilities being evaluated, resulting in a range of reasonable estimates for reserves for losses and LAE. We do not discount reserves. Our actuarial reserving team performs monthly reviews of the claims experience and loss emergence to support our estimation of ultimate losses and LAE. A few considerations and assumptions in estimating ultimate claim liabilities includes relative case reserve adequacy over time, claims cycle time, claims settlement practices, exposure growth, actuarial projections, current economic conditions, driving patterns observed from telematics, weather catastrophes, and claim litigation. Our loss reserves can be grouped by claim type, where amounts related to material damage of vehicles and property tend to settle within 6 to 12 months, while claims that involve injuries or personal liability have a much longer time period between the occurrence of a loss and the settlement of the claim. In general, the longer the time span between the incidence of a loss and the settlement of the claim, the more the ultimate settlement amount can vary. Because actual experience can differ from key assumptions used in establishing reserves, there is potential for significant variation in the development of loss reserves. There is considerable uncertainty associated with the actuarial estimates, and therefore the actual losses and LAE paid in the future may differ materially from the reserves we have recorded. Our loss estimates are continually reviewed by management and adjusted as necessary; with adjustments included in the period determined. The key assumptions that materially affect the estimate of the reserves for loss and LAE are as follows: • Many of the actuarial estimation methods assume that the speed of claim payments and claim closures, also known as cycle time, remains relatively consistent over time. While fluctuations and improvements in cycle time are expected as we grow, these timing changes can be difficult to discern from normal process risk variability in the data. • For actuarial methods that rely on case reserve data, there is an implicit assumption that the adequacy of case reserve estimates stays relatively constant over time. For example, if the held case reserves represent the 50th percentile outcome for each claim, then any changes to this case reserve level, either higher or lower, would impact the ultimate loss estimates. • Actuarial methods that rely on exposure bases, such as premiums or car years, perform better when the mix of business is relatively stable over time. Rapid business growth can change the mix of business across several dimensions: new business versus renewal, geography profile, and underwriting profile. As such, prior estimates of claim frequency, claim severity, or loss ratio may not be as predictive of future results when the mix of business changes. • Broader macro level economics can have a material impact on loss reserve estimates, such as a rapid change in miles driven as was observed with COVID-19; unanticipated inflation, regulatory restrictions, and legal developments as they relate to contract and coverage interpretation and enforceability. 76 Due to the inherent uncertainty in determining our ultimate cost of settling claims, we evaluate what the potential impact on consolidated results of operations, financial position, and liquidity would be based on a hypothetical 5% and 10% increase or decrease in key assumptions described above. The loss reserve range noted below represents a range of reasonably likely reserves, not a range of all possible reserves. Therefore, the ultimate losses could reach levels corresponding to reserve amounts outside of the range provided. Given our growth from inception in 2015, we believe evaluating sensitivity based on a hypothetical increase or decrease of 5% and 10% is reflective of management’s best estimate and provides an illustrative range of variability in key assumptions. The below tables present this sensitivity analysis: Scenarios for Changes in Bodily Injury Claim Severity for all Accident Years (10)% (5)% —% 5% 10% Bodily injury liability $ 77.7 $ 82.0 $ 86.3 $ 90.6 $ 95.0 Uninsured and underinsured bodily injury 17.7 18.7 19.7 20.7 21.7 All other coverages 27.0 27.0 27.0 27.0 27.0 Total losses—net of reinsurance $ 122.4 $ 127.7 $ 133.0 $ 138.3 $ 143.7 Our loss and LAE expense reserves are recorded net of external reinsurance and net of amounts expected to be received from salvage (the amount recovered from the damaged property after the we pay for a total loss) and subrogation (the right to recover payments from third parties). Premium Revenue, Fee Income and Related Expenses Premiums written are deferred and earned pro rata over the policy period. Unearned premium is established to cover the unexpired portion of premiums written. A premium deficiency, as measured on a direct basis, is recorded when the sum of expected losses, loss adjustment expenses, unamortized acquisition costs and maintenance costs exceed the recorded unearned premium reserve and anticipated investment income. A premium deficiency reserve is recognized as a reduction of deferred acquisition costs and, if necessary, by accruing an additional liability for the deficiency, with a corresponding charge to operations. We did not record a premium deficiency reserve in 2020 and 2019, respectively. Premiums receivable represents premiums written but not yet collected. Generally, premiums are collected prior to providing risk coverage, minimizing our exposure to credit risk. Due to a variety of factors, including certain state regulations related to COVID-19 relief efforts, certain premiums billed may not be collected, for which we establish an allowance for doubtful accounts based on an analysis of historical collection experience. Allowance for doubtful accounts was $ 3.5 million and $ 2.0 million as of December 31, 2020 and 2019 on the consolidated balance sheets. A policy is generally considered past due on the first day after its due date and policies greater than 90 days past due are written-off. We recognized premium write-offs, or bad debt expense, of $ 23.6 million and $ 9.0 million for the periods ended December 31, 2020 and 2019, respectively. For those policyholders who pay premiums on an installment basis, we charge a flat fee for each installment related to the additional administrative costs associated with processing more frequent billings. We recognize this fee income in the period which we process each installment. Policy acquisition costs, consisting of premium taxes and certain marketing costs and underwriting expenses, net of ceding commissions, related to the successful acquisition or renewal business, are deferred and amortized over the same period in which the related premiums are earned. Ceding commissions relating to reinsurance agreements are recorded as a reimbursement for both deferrable and non-deferrable acquisition costs. The portion of the ceding commission that is equal to the pro rata share of acquisition costs based on quota share percentage is recorded as an offset to the direct deferred acquisition costs. Any portion of the ceding commission that exceeds the acquisition costs of the business ceded is recorded as excess ceding commission, a deferred liability, and amortized over the same period in which the related premiums are earned. 77 Reinsurance In the ordinary course of business, we cede a portion of our business written to affiliated and unaffiliated reinsurers to limit the maximum net loss potential arising from large risks and catastrophes. These arrangements, known as treaties, provide for reinsurance coverage on quota-share and excess-of-loss basis. Although the ceding of reinsurance does not discharge us from our primary liability to the policyholder, the insurance company that assumes the coverage assumes the related liability. Amounts recoverable from and payable to reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business. Reinsurance premiums, commissions and expense reimbursements related to reinsured business are accounted for on a basis consistent with the basis used in accounting for the original policies issued and the terms of the reinsurance contracts. Premiums ceded to other companies have been reported as a reduction of premiums earned and are recognized over the remaining policy period based on the reinsurance protection provided. Amounts applicable to reinsurance ceded for unearned premium reserves are reported as a prepaid reinsurance premiums asset in the accompanying consolidated balance sheets and as reduction of unearned premiums in Note 6, “Reinsurance,” in the Notes to Consolidated Financial Statements. Ceding commissions received in connection with reinsurance ceded have been accounted for as a reduction of other insurance (benefit)/expense in the consolidated statements of operations and comprehensive loss. Some of our reinsurance agreements provide for adjustment of commissions or amount of coverage based on loss experience referred to as sliding scale commissions and loss corridors, respectively. We recognize the asset or liability arising from these adjustable features in the period the adjustment, calculated based on experience to-date under the agreement, occurs. In the event that all or any of the reinsuring companies might be unable to meet their obligations under existing reinsurance agreements, we would be liable for such defaulted amounts. We evaluate and monitor the financial condition associated with our reinsurers in order to minimize our exposure to significant losses from reinsurer insolvencies. We obtain reinsurance from a diverse group of global reinsurers and monitor concentration as well as financial strength ratings of the reinsurers to minimize counterparty credit risk. For our reinsurance partners who are not rated, we require adequate levels of collateral or letters of credit to be available to us in the event of downside scenarios. All reinsurance contracts provide for indemnification against loss or liability relating to insurance risk and have been accounted for as reinsurance. Share-Based Compensation We award share-based compensation, including stock options with only a service condition, stock options with service and performance conditions, restricted stock units, or RSUs, and restricted stock, to our officers, directors, employees, and certain advisors through approval from the Compensation Committee of the Board of Directors. Share-based compensation expense is recognized based on the grant date fair value of the awards. The fair value of stock options is determined on the grant date using the Black-Scholes Merton, or BSM, option-pricing model. The BSM option pricing model requires inputs based on certain subjective assumptions, including the expected stock price volatility, the expected term of the options, the risk-free interest rate for a period that approximates the expected term of the option and our expected dividend yield. The fair value of restricted stock and RSUs granted before our IPO had historically been determined by our board of directors, with input from management, and considering third-party valuations of our common stock. Because there had been no public market for our common stock, our board of directors had determined its fair value at the time of grant of the pre-IPO option by considering a number of objective and subjective factors, including financing investment rounds, operating and financial performance, the lack of liquidity of share capital and general and industry specific economic outlook, among other factors. Our board of directors determined the fair value of common stock based on valuations performed using the Option Pricing Method and the Probability Weighted Expected Return Method subject to relevant facts and circumstances. After our IPO, our common stock is now listed on the Nasdaq and we use these market prices for the fair value of our common shares. Stock options are exercisable for a period up to ten years from the grant date. We recognize forfeitures as they occur. 78 Stock options with only a service condition generally vest over four years — 25% cliff vests after one year and approximately 2% vests each month over three years thereafter. Stock options with service and performance conditions generally vest ratably over a four-year period assuming achievement of the performance conditions. The compensation expense associated with non-vested stock options that have performance conditions is dependent on our periodic assessment of the probability of the performance conditions being achieved. If deemed probable, we recognize compensation expense on a straight-line basis over the requisite service period. If a performance condition is no longer probable of achievement, any previously recognized compensation expense is reversed and no subsequent compensation expense is recognized until achievement is once again probable, at which point a cumulative catch-up is recognized. RSUs generally vest over four years - 25% cliff vests after one year and approximately 2% vests each month over three years thereafter. Certain other RSUs vest over four years - 25% cliff vests after one year and in equal increments quarterly over three years thereafter; vest over four years in equal quarterly increments; and fully cliff vest after one year. We generally recognize share-based compensation expense ratably over the respective vesting period. Before our IPO, the fair value of common stock underlying the options had historically been determined by our board of directors, with input from management, and considering third-party valuations of our common stock. Because there had been no public market for our common stock, our board of directors had determined its fair value at the time of grant of the pre-IPO option by considering a number of objective and subjective factors, including financing investment rounds, operating and financial performance, the lack of liquidity of share capital and general and industry specific economic outlook, among other factors. Our board of directors determined the fair value of common stock based on valuations performed using the Option Pricing Method and the Probability Weighted Expected Return Method subject to relevant facts and circumstances. After our IPO, our common stock is now listed on the Nasdaq and we use these market prices for the fair value of our common shares. For additional information refer to Note 11, “Share-Based Compensation,” in the Notes to Consolidated Financial Statements. New Accounting Pronouncements See Note 2, “Basis of Presentation and Summary of Significant Accounting Policies,” in the Notes to Consolidated Financial Statements. Election Under the Jumpstart Our Business Startups Act of 2012 We currently qualify as an “emerging growth company” under the JOBS Act. Accordingly, we are provided the option to adopt new or revised accounting guidance either (1) within the same periods as those otherwise applicable to non-emerging growth companies or (2) within the same time periods as private companies. We have elected to adopt new or revised accounting guidance within the same time period as private companies, unless management determines it is preferable to take advantage of early adoption provisions offered within the applicable guidance. Our utilization of these transition periods may make it difficult to compare our financial statements to those of non-emerging growth companies and other emerging growth companies that have opted out of the transition periods afforded under the JOBS Act.