SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2021
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-39484
(Exact name of registrant as specified in its Charter)
|(State or other jurisdiction of |
incorporation or organization)
|(I.R.S. Employer |
425 Market Street #700
San Francisco, California
|(Address of principal executive offices)||(Zip Code)|
Registrant’s telephone number, including area code: (888) 242-5204
Securities registered pursuant to Section 12(b) of the Act:
|Title of each class||Trading symbol(s)||Name of each exchange on which registered|
|Common Stock, $0.0001 par value per share||MILE|
The Nasdaq Capital Market
|Warrants, each whole warrant exercisable for one share of common stock at an exercise price of $11.50 per share||MILEW|
The Nasdaq Capital Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐ No ☒
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company or an emerging growth company. (See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act).
|Large accelerated filer|
|Smaller reporting company|
|Emerging growth company|
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The aggregate market value of the registrant’s common stock held by non-affiliates of the registrant as of June 30, 2021, the last business day of the registrant’s most recently completed second fiscal quarter, was $809 million, based on the closing price of the registrant’s common stock on the Nasdaq Capital Market of $9.15 per share for such date.
As of February 23, 2022, there were 128,221,885 shares of the Company’s common stock, par value $0.0001 per share, issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
The registrant met the requirements for accelerated filers as of the end of the fiscal year ended December 31, 2021 pursuant to Rule 12b-2 of the Securities Exchange Act of 1934, as amended. However, pursuant to Rule 12b-2 and SEC Release No. 33-8876, the registrant (as a smaller reporting company transitioning to the larger reporting company system) is not required to satisfy the accelerated filer reporting company disclosure requirements until its quarterly report on Form 10-Q for the fiscal quarter ending March 31, 2022.
Unless the context otherwise indicates, references in this report to the terms “Metromile,” “the Company,” “we,” “our” and “us” refer to Metromile, Inc. and its wholly owned subsidiaries. Prior to February 9, 2021, we were known as INSU Acquisition Corp. II, or INSU. On February 9, 2021, INSU completed the acquisition of 100% of the outstanding shares of MetroMile, Inc., or Legacy Metromile, which we refer to as the “Business Combination.” References herein to “we,” “our” and “us” may refer, as context requires, to Legacy Metromile and its wholly owned subsidiaries prior to the Business Combination.
TABLE OF CONTENTS
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K and the documents incorporated by reference herein contain forward-looking statements. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act of 1933, as amended and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. All statements other than statements of historical fact contained in this Annual Report, including without limitation statements regarding our future results of operations and financial position, our ability to attract, retain and expand our customer base, our ability to operate under and maintain our business model, our ability to maintain and enhance our brand and reputation, our ability to effectively manage the growth of our business, the effects of seasonal trends on our results of operations, our ability to attain greater value from each customer, our ability to compete effectively in our industry, the future performance of the markets in which we operate, and our ability to maintain reinsurance contracts, and the plans and objectives of management for future operations and capital expenditures are forward-looking statements.
Forward-looking statements in this Annual Report on Form 10-K may include, for example, statements about:
•our ability to recognize the anticipated benefits of the pending transaction with Lemonade;
•our financial and business performance, including financial projections and business metrics and any underlying assumptions thereunder;
•changes in our strategy, future operations, financial position, estimated revenues and losses, projected costs, prospects and plans;
•potential disruptions to our ongoing business operations caused by the announcement, pendency or completion of the Proposed Transaction (as defined herein);
•our ability to consummate the Proposed Transaction and realize the anticipated benefits thereof;
•the implementation, market acceptance and success of our business model;
•our ability to scale in a cost-effective manner;
•developments and projections relating to our competitors and industry;
•the impact of health epidemics, including the COVID-19 pandemic, on our business and the actions we may take in response thereto;
•our expectations regarding our ability to obtain and maintain intellectual property protection and not infringe on the rights of others;
•expectations regarding the time during which we will be an emerging growth company;
•our future capital requirements and sources and uses of cash;
•our ability to obtain funding for our future operations;
•our business, expansion plans and opportunities; and
•the outcome of any known and unknown litigation and regulatory proceedings.
These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.
In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “could,” “intend,” “target,” “project,” “contemplate,” “believe,” “estimate,” “predict,” “potential”, or “continue” or the negative of these terms or other similar expressions. The forward-looking statements in this Annual Report are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. These forward-looking statements speak only as of the date of this Annual Report and are subject to a number of important factors that could cause actual results to differ materially from those in the forward-looking statements, including the factors described under the sections in this Annual Report titled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
You should read this Annual Report and the documents that we reference in this Annual Report completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events, changed circumstances or otherwise.
SUMMARY OF RISK FACTORS
Our business involves significant risks, including risks arising in connection with the pending acquisition of Metromile by Lemonade, Inc. pursuant to a merger agreement, which is contemplated to occur upon completion of the merger transactions completed by the merger agreement. Below is a summary of the material risks that our business faces, which makes an investment in our common stock speculative and risky. This summary does not address all these risks. These risks are more fully described below in “Item 1A. Risk Factors.” Before making investment decisions regarding our common stock, you should carefully consider these risks. The occurrence of any of the events or developments described below could have a material adverse effect on our business, results of operations, financial condition, prospects and stock price. In such event, the market price of our common stock could decline, and you could lose all or part of your investment. In addition, there are also additional risks not described below that are either not presently known to us or that we currently deem immaterial, and these additional risks could also materially impair our business, operations or market price of our common stock.
•The announcement and pendency of the mergers may result in disruptions to our business.
•The mergers may not be completed within the intended timeframe, or at all, and the failure to complete the mergers could adversely affect our business, results of operations, financial condition, and the market price of our common stock.
•We have a history of net losses and could continue to incur substantial net losses in the future.
•We may lose existing customers or fail to acquire new customers.
•We may require additional capital to support business growth or to satisfy our regulatory capital and surplus requirements, and this capital might not be available on acceptable terms, if at all.
•The COVID-19 pandemic has caused disruption to our operations and may negatively impact our business, key metrics, and results of operations in numerous ways that remain unpredictable.
•We rely on telematics, mobile technology and its digital platform to collect data points that we evaluate in pricing and underwriting insurance policies, managing claims and customer support, and improving business processes. To the extent regulators prohibit or restrict this collection or use of this data, our business could be harmed.
•Regulatory changes may limit our ability to develop or implement our telematics-based pricing model and/or may eliminate or restrict the confidentiality of our proprietary technology.
•We expect a number of factors to cause our results of operations to fluctuate on a quarterly and annual basis, which may make it difficult to predict future performance.
•Denial of claims or our failure to accurately and timely pay claims could materially and adversely affect our business, financial condition, results of operations, brand and prospects.
•Unexpected increases in the frequency or severity of claims may adversely affect our results of operations and financial condition.
•Failure to maintain our risk-based capital at the required levels could adversely affect our ability to maintain regulatory authority to conduct our business.
•We are subject to stringent and changing privacy and data security laws, regulations, and standards related to data privacy and security. Our actual or perceived failure to comply with such obligations could harm our reputation, subject us to significant fines and liability, or adversely affect our business.
•If we are unable to underwrite risks accurately or charge competitive yet profitable rates to our customers, our business, results of operations and financial condition will be adversely affected.
•Litigation and legal proceedings filed by or against us and our subsidiaries could have a material adverse effect on our business, results of operations and financial condition.
•The insurance business, including the market for automobile, renters’ and homeowners’ insurance, is historically cyclical in nature, and we may experience periods with excess underwriting capacity and unfavorable premium rates, which could adversely affect our business.
•We are subject to extensive regulation and potential further restrictive regulation may increase our operating costs and limit our growth.
•Our actual incurred losses may be greater than our loss and loss adjustment expense reserves, or LAE, which could have a material adverse effect on our financial condition and results of operations.
ITEM 1. BUSINESS
We started Metromile based on the simple observation that the physical world is being increasingly digitized, that this digital data can be used to better estimate the future, and that the best opportunity to create value for everyday customers in an increasingly predictable world is to reinvent insurance, one of the largest and most important global markets.
At its core, insurance financially protects the insured customer from the occurrence of specific future events. If these events can be more accurately estimated, using data and data science, then the insurance provided can be more accurately priced — lower likelihood events would cause the price of insurance to go down and higher likelihood events would cause the price of insurance to go up. The proliferation of sensor data, from cars, mobile phones, and elsewhere, means we have a greater ability to estimate the likelihood of future events and, thus, help many customers who are overpaying for insurance save money.
We founded Metromile in 2011 to realize this opportunity and tackle the broken auto insurance industry. With data science as our foundation, we offer our insurance customers real time, personalized auto insurance policies, priced and billed by the mile, with rates based on precisely how and how much they actually drive, instead of using the industry standard approximations and estimates that make prices unfair for most customers.
Through our digitally native offering, built around the needs of the modern driver, we believe our per-mile insurance policies save our customers, on average, 47% over what they were paying their previous auto insurer. We base this belief on data our customers self-reported in 2018 with respect to premiums paid to providers before switching to Metromile.
We believe the opportunity for our personalized per-mile insurance product is significant. Federal Highway Administration data indicates that approximately 35% of drivers drive more than half the total miles driven. We believe there is a correlation between the number of miles driven and the number of insurable losses. An October 2016 report by the Insurance Information Institute noted that the increase in claims frequency appears directly linked to the increase in the number of miles driven. Notwithstanding the relationship between miles driven and claims, auto insurance premiums have historically been priced based on a driver’s “class” — and drivers are charged the same basic premium rate as others in their class no matter the actual miles driven. In the traditional pricing model, a driver’s age, credit score, accident history, and geography influences the premium paid more than the actual miles driven. Thus, the 35% of drivers who account for more than half the miles driven are not paying premiums based on how often they are behind the wheel and increasing the potential for an insurable loss claim. We believe the traditional pricing model is inherently unfair to the majority of drivers — the 65% of drivers who drive less than half the miles driven — as they are effectively subsidizing the minority of drivers who are high-mileage drivers. By offering auto insurance using a per-mile rate and then billing each customer monthly based on their actual miles driven, we are able to provide significant savings to the vast majority of drivers, the 65% of drivers who drive less than half the miles driven. Customers can simply use their connected car or use a Metromile Pulse device ("The Pulse") to share their data with us — which includes miles driven, and in certain states where permitted by insurance regulators, driving habits, such as phone use, speeding, hard-braking, accelerating, cornering, and location. Our customers are able to choose when and how to drive and share this information with us to realize these data driven savings every day. See “— Our Technology Platform” for more information regarding The Pulse and data collection.
Our offering is also more appealing to the modern digital consumer beyond just the savings we offer. Customers sign up, access customer support, and file claims entirely through our mobile app. Claims are handled quickly and, in many cases, are fully automated. Our proprietary technology underpins these unique capabilities. We are built using data science at our core — we know how to acquire and unlock the predictive value of the data generated by the car, mobile phones, and elsewhere. This translates into a better experience, higher customer retention rates, lower cost of customer acquisition, less fraud, less servicing expense, and greater operating profits.
Our core technology capabilities have also unlocked a powerful new business for us — Metromile Enterprise, a cloud-based enterprise software solution for insurance carriers that provides them advanced claims automation and fraud detection tools, improving their operating margins, while earning us a share of their insurance premium as a service fee. With Metromile Enterprise already in market, we have started to realize returns on our earlier technology investments and expect to see this business help the large incumbents in the insurance industry transition into a more digital world, while helping us quickly grow our earnings.
Today, we consider ourselves a leading digital insurance platform, providing unique and advantaged products to auto insurance customers in the United States and auto insurance companies in the United States and globally.
The U.S. auto insurance market is massive, dominated by insurers stuck on legacy technology infrastructure who offer antiquated services. U.S. personal auto insurers write approximately $250.0 billion of premiums each year, with no carrier currently achieving more than 20% market share. We believe we are strategically positioned to succeed as industry incumbents struggle to meet the significant structural changes underway in an increasingly digital world. The advent of mobile phones has revolutionized modern mobility, while connected and autonomous technologies are drastically changing consumer relationships with vehicles. As we scale and accumulate more data, we believe that we can deliver increasingly better service, pricing and experiences for customers across all stages of the policy lifecycle.
Through our core competencies in technology and operating as a full-stack insurance carrier, we are already achieving durable margin advantages that we believe will allow us to maintain a competitive edge in pricing and generate incremental cash to invest in future growth for the years and decades ahead. We believe our focus on technology will allow us to gain efficiencies through automation and the ability to scale.
We believe our customers are loyal. We measure this, in part, by our average overall net promoter score, or NPS, of 50 as of end of year 2021. The NPS metric is a management tool used to measure customer satisfaction and loyalty and indicates the percentage of customers rating their likelihood to recommend a product or service to a friend or colleague. After 51 days of joining Metromile, we ask each new customer the likelihood that they will recommend Metromile to a friend or colleague on a scale of 0 to 10. Scores between 0-6 are considered detractors and scores between 9-10 are considered promoters. To arrive at Metromile’s NPS score in a given month, the percentage of detractors is subtracted from the percentage of promoters. Scores between 7-8 are considered passive and are counted toward the total number of respondents, thus decreasing the percentage of detractors and promoters and pushing the net score toward 0. By recommending our services to their friends and family, we believe our customers demonstrate their satisfaction and loyalty to our services. We believe our overall NPS of 50 demonstrate our customer satisfaction and loyalty to Metromile.
We have trained our predictive models to deliver what we believe is one of the most sophisticated pricing engines in the industry using the approximately three billion miles of customer driving data we have collected since our founding. Our data-driven approach is designed to improve the accuracy of risk-profiling customers while simultaneously reducing the likelihood of fraud and losses.
We built these models in the early days by carefully selecting our first markets, acquiring data and quickly iterating on our proprietary rating and underwriting models, building out our own customer service and claims functions, and reinventing as we gained new data and experience.
As our models have matured, we have also learned how to more efficiently and effectively acquire customers, as these models can also be applied to estimate the lifetime profitability of any potential new customer lead based on key indicators. We migrated from marketing in well-defined offline channels to using a variety of more cost-effective digital solutions for our customer funnel, where we can tailor ad targeting, content, and a quote funnel to each individual prospect.
We leverage a diverse mix of channel strategies to optimize our marketing efforts including search, display, and social marketing, as well as app acquisition, aggregators (like compare.com, The Zebra, and Everquote), our free app Ride Along (akin to a try before you buy experience) and key automotive original equipment manufacturer, or OEM, partnerships. Our experience and financial profile equip us to excel in our next phase of growth across the United States.
We believe we have put together one of the best leadership teams in our industry who have significant experience with top technology and insurance companies. They will help us execute our ambitious growth plans through our unique approach to insurance. We believe that we have a truly differentiated value proposition that puts customers in the driver’s seat. Through data science, we have built an impactful business that we believe will help transform the insurance industry.
Acquisition of Metromile, Inc. by Lemonade, Inc.
On November 8, 2021, we entered into an Agreement and Plan of Merger (the “Agreement”) with Lemonade, Inc., a Delaware corporation (“Lemonade”), Citrus Merger Sub A, Inc., a Delaware corporation and a wholly-owned subsidiary of Lemonade (“Acquisition Sub I”) and Citrus Merger Sub B, LLC, a Delaware limited liability company and wholly owned subsidiary of Lemonade (“Acquisition Sub II”). The Agreement provides that, pursuant to and on the terms and conditions set forth therein, (i) Acquisition Sub I will merge with and into the Company (the “First Merger” and the effective time of the First Merger, the “First Effective Time”)), with the Company continuing as the surviving entity (the “Initial Surviving Corporation”), and (ii) the Initial Surviving Corporation will merge with and into Acquisition Sub II (the “Second Merger”), with Acquisition Sub II continuing as the surviving entity as a wholly owned subsidiary of Lemonade (the First Merger, the Second Merger and the other transactions contemplated by the Agreement, collectively, the “Proposed Transaction”). The Proposed Transaction implies a fully diluted equity value of approximately $500 million, or an enterprise value of about $340 million net of unrestricted cash and cash equivalents as of September 30, 2021. Under the terms of the Agreement, stockholders of the Company will receive shares of Lemonade common stock at a ratio of 19:1. The transaction is conditioned on customary closing conditions, and is expected to close in the second quarter of 2022. The Boards of Directors of both the Company and Lemonade have each approved the Proposed Transaction as well as stockholders of the Company.
Our Technology Platform
Our proprietary technology platform is a key competitive advantage. Through the collection of high frequency telematics data, we have developed a platform capable of understanding moment-by-moment driving behavior. Using data science and machine learning, we build predictive models to accurately determine the risk profiles of our customers and offer fairer, more accurate pricing.
Our customer-friendly, intuitive interface paired with The Pulse creates a seamless user experience. The Pulse device easily plugs into the diagnostic port of our customer’s car and transmits data over wireless cellular networks. The Pulse device provides visibility into customer braking behavior at each intersection, miles driven, speed, acceleration, hard-braking, cornering, and location. In addition, through our OEM partnerships, we will be able to connect directly with vehicles and stream the same sensor data without a device. The more data we collect, the better our predictive models will become, allowing us to enhance our unit economics and value to consumers.
The moment of truth for all insurers is when a customer submits a claim. In a traditional experience, a customer is required to go through many hurdles simply to get their car repaired after an accident, causing customer frustration. The fundamental cause of this high friction experience is that up to 17% of claims are fraudulent and insurers are forced to implement onerous processes and look at every claim with suspicion, where trust is eroded with the customer. Alternatively, our platform is capable of algorithmically reconstructing the accident scene and letting the majority of drivers have the claim nearly instantly approved. We create loyal customers by helping them get back on the road quickly and seamlessly.
We have been able to identify and reduce fraudulent claims by three times the rate of our industry peers. The structural costs associated with high fraud rates in the auto insurance industry are ultimately passed on to consumers. Our fraud detection advantage ultimately improves our loss ratio, which allows us to keep our costs lower and pass on additional savings to our customers.
The net result of our technology advantage is a fundamentally lower cost structure. Because premiums charged to the consumer ultimately reflect the underlying costs of the insurance business and its losses, we have developed a competitive advantage beyond our pricing model. Built from the ground-up with technology and sensors first, we have developed a durable competitive advantage with a highly efficient and streamlined operation.
The Metromile app
From the outset, we believed the experience with an auto insurer should go beyond being a compulsory purchase, selected based solely on price. With our app, our customers benefit from rich functionality, tools, and features. Prospects are able to sign up within minutes or try Ride Along to estimate and earn more savings. Aligned with our first value of creating loyal customers, we aim to stay engaged with our customers every step of the way.
Our app increases engagement and improves our relationship with customers by providing helpful features such as street sweeping notifications to help avoid parking tickets, get walking directions to their car, and monitor their car health. Everything needed to manage a policy can be done in the app, such as viewing policy information and documents, auto insurance ID cards, monthly billing summaries, and detailed trip maps. With an always-connected vehicle, we have an 85% stolen car recovery rate.
Metromile Enterprise is a cloud-based enterprise software offering for third party insurance carriers that was built on top of our sophisticated automated claims technology. The service helps carriers automate the claims processes for both customers and claims agents while reducing the cost of fraudulent claims through advanced fraud detection features. The service works cooperatively with existing property and casualty, or P&C, insurance enterprise software platforms and is priced based on a percentage of the insurance premium the service is used to help manage.
Our automation and fraud detection capabilities have allowed Metromile’s auto insurance claims program to detect three times more fraud than the industry average, benefiting our loss ratio, while reducing our loss adjustment expense ratio by an estimated 20% due to advanced automation. We saw an opportunity in applying these capabilities to help the broader P&C insurance industry transform and better manage their claims processes and are excited by the progress we’ve made since launching Metromile Enterprise in 2019.
Metromile Enterprise is not just for telematics-based auto insurance programs — the software helps global P&C insurers improve customer experience and reduce claim costs across a variety of use cases in auto, home, renters, pet, workers compensation and other specialized P&C insurance programs. This unique business allows us to diversify our revenue base into recurring, high-margin enterprise SaaS revenue, while actively participating in the digital transformation underway in the broader insurance markets, with minimal incremental cost.
With respect to the platform’s specific feature set, our Metromile Enterprise offering consists of Report, Detect, Replay, and Streamline modules.
•Report: The secret to success with predictive models lies in gathering rich, reliably structured data at first notice of loss, or FNOL. The Report module is a smart digital FNOL solution for customer-facing data collection and call center representatives that creates opportunities for improved fraud detection, efficient downstream processing, and a “no-touch” claims experience.
•Detect: Our Detect module is an artificial intelligence, or AI, powered fraud detection tool trained to scan incoming claims in seconds and build a feedback loop with existing investigative experts. We help capture more fraud and cut costs by eliminating investigations on low probability claims.
•Portal: The Portal enables insurance carriers to offer their insureds a one-stop digital destination for filing claims, tracking updates on claims in progress and taking action on pending items. This solution helps improve claim handling efficiency and save claim adjuster time.
•Streamline: Streamline is a powered automation suite, enabled by sophisticated data science modeling, that reduces repetitive tasks done by claims handlers so that they can spend more time providing service for customers with more complex needs. The Streamline solution enables claims self-servicing to settle claims with efficiency.
Our platform architecture
We believe our platform provides us with a true competitive advantage. We built our technology from the ground-up with the secular shifts in insurance in mind. Our platform is built on a number of foundational architecture principles.
We are able to deliver a flexible and scalable platform where customer services can be added and evolved over time.
Through delivering micro-services, we ensure a constant evolution of the technology platform, both in terms of features supported as well as technology used. Micro-services also allow efficient scaling of the engineering organization, as it allows an ever-growing number of teams to work in parallel with the least dependency bottlenecks.
Our unified user interface is technology-agnostic and built on a back-end service that can enable a diverse range of clients.
This allows us to remain agnostic to mobile and web applications along with third-party integrations. We have the flexibility to isolate part of or all of our platform features for third-party integration both directly into a user experience and into the backend of a given platform. This provides us the opportunity to service different enterprises with different technology platforms.
Our offerings were created with the core ideas of resiliency and durability in mind to allow for uninterrupted scale.
All services are built to enable a distributed and horizontal scaling deployment. This not only supports our scalability but also provides resilience as distributed service instances can survive fault tolerances of individual instances or full zone fails.
We heavily leverage machine learning to underpin our business. From personalized pricing through to claims, our technology stack is critical to our success.
Industry and market opportunity
The U.S. auto insurance market is massive, fragmented, and ripe for disruption as pricing and risk identification remain key components to drive competitive demand. Additionally, shifting consumer preferences toward an online environment creates opportunity for new entrants with a focus on customer experience.
•Massive market: In 2020, the U.S. personal auto insurance market generated in excess of $250 billion in premiums.
•Highly fragmented: Market share in the United States is fragmented with no carrier holding more than 20% market share. Additionally, 108 carriers generated greater than $100.0 million in premiums in 2020.
•Ripe for disruption: The auto insurance placement and claims process suffers from poor overall consumer experience, which is attributable to opaque and tiered pricing, lengthy sign-up processes, and arduous claims processes that are often long and repetitive. Additionally, traditional insurance carriers do not consider technology-driven developments to the auto industry when pricing risk. With a developing driver model including autonomous features and new means of transportation, additional factors need to be considered.
•Limited use of technology: The insurance market has typically relied on a number of factors to provide pricing and risk assessment information. Statistics like age, credit score, accident history, and geography have often been deciding factors that categorize drivers into buckets and price them accordingly. Technological developments and data science provide new applications to better understand individual driver risk, such as actual miles driven and driving behaviors, and are able to adjust pricing models to consider these variable factors. While other auto insurance providers consider an individual’s prior accident history, we believe Metromile is distinguished by further adjusting to real-time driving behavior. This real-time capture, we believe, allows Metromile to better understand each driver’s risk in ways that backward-looking algorithms, such as “good-driver rewards,” are unable to.
•COVID-19 pandemic: Although the ultimate impacts of COVID-19 remain uncertain and consumer demand for auto insurance may be impacted in a recessionary or stationary environment, a recent survey published by Capgemini SE found that 87% of global consumers prefer to use a personal vehicle to ensure safe travel, up from 57% in 2020. Further, the dramatic decline in miles driven during the second quarter of 2020 and the fact that legacy carriers were forced to react through ad hoc refund and rebate programs and were sued in class action lawsuits proves that the existing fixed priced insurance model is outdated.
Metromile is well positioned to capitalize on these tailwinds by providing a product that solves fundamental issues with auto insurance and fairly prices policies to individual drivers. This is driven by Metromile’s view that auto insurance today is unfair to most consumers, as insureds are broadly categorized into the same buckets and charged similar rates while still holding varying driving habits and vehicular uses. The distinction between this broad classification and a more technology and data driven approach to assessing risk underpins Metromile’s vision to change how insureds are assessed and charged.
Several areas within the personal lines auto space are most significant to understanding this unique market opportunity. The first and most important is regarding the traditional insurance model where insurance products are built for a “class of driver” rather than individual insureds. This foundational concept of pricing risk gained traction in the 1990s when carriers discovered independent factors such as credit score were good indicators of an individual’s driving habits and risk classification. Using additional rating variables like credit expanded segmentation via proxy and moved the industry further away from evaluating individual risk. The widespread use of such factors became industry norm where the process of receiving an insurance quote is dictated by several key factors that place customers into classes associated with varying risk levels and premium payments. While still broadly used today, this results in a significant bifurcation of insureds within each class level where drivers that have the same gender, geographic location, vehicle make, accident
history, and credit score receive similar quotes. Other factors, however, still vary between two similar applications, the most significant and quantifiable being miles driven. This creates a pricing imbalance where a small portion of drivers within a class create significant liabilities because of their frequent driving habits. Drivers who infrequently use their vehicles therefore are subsidizing the higher risk of their peers by paying similar rates while having fundamentally different risk profiles. We believe this results in approximately 65% of drivers overpaying for personal auto insurance and 35% of drivers underpaying, as the Federal Highway Administration data indicates that approximately 35% of drivers drive more than half the total miles driven. We believe there is a correlation between the number of miles driven and the number of insurable losses. An October 2016 report by the Insurance Information Institute noted that the increase in claims frequency appears directly linked to the increase in the number of miles driven. Thus, the 35% of drivers who account for more than half the miles driven are not paying premiums based on how often they are behind the wheel and increasing the potential for an insurable loss claim. We believe the traditional pricing model is inherently unfair to the majority of drivers — the 65% of drivers who drive less than half the miles driven — as they are effectively subsidizing the minority of drivers who are high-mileage drivers.
To address this issue, Metromile has leveraged technology to create accurate methods of measuring car usage and charging drivers on a “per-mile” basis. Our product development has maintained a unique focus on understanding individual driver habits to provide more granular insight into the likelihood of requiring a claim. Metromile’s position as one of the only large carriers to offer this approach to pricing — and the only carrier solely focused on low mileage drivers — underpins its opportunity to capture market share and change the industry’s approach to risk assessment.
An additional factor supporting this market opportunity is the large market size and significant fragmentation found in personal lines auto insurance. With over $250.0 billion in annual premiums in the United States, personal auto insurance is one of the largest lines globally. An outsized number of companies operate in the space, pricing customers with varying risk demographics and underwriting a book that meets operational and loss standards. In a market with a relatively commoditized product, pricing, customer experience and added factors becomes significant to attracting new customers. Metromile has created a new competitive advantage that drives customer volume by differentiating their core product from large and traditional carriers. This large amount of fragmentation mixed with Metromile’s unique approach supports its ability to readily attract new customers by providing a different approach to pricing.
The tech enabled landscape within the automotive and broader industries has also been a key point of focus for Metromile. As the usage of smartphones and technology that collects individual consumer data becomes more widespread, so too do the opportunities for insurance companies to collect more data and conduct analytics on it. This pairs with innovation in the auto space changing the true risk of operating a vehicle. Autonomous driving, driving assistance features on vehicles, or the decrease in vehicular usage due to ride-share applications have all made the personal lines auto insurance landscape more complex with respect to individual risk that cannot be captured by a collection of data points like credit score and age. This creates a fundamental need to gain insight into individual usage and leverage this data to paint a better picture of what true risk and therefore price looks like.
•Structurally advantaged through data science. To date, we have collected approximately three billion miles of data through our core data engine. We built our engine from the ground up to realize a structural pricing and cost advantage in auto insurance. We collect our data through the next generation of connected vehicles, mobile and telematics devices to generate what we believe is the most granular and insightful data on driving behavior in the industry. We analyze data such as miles driven, speed, acceleration, hard-braking, cornering, and location to deliver market-leading intelligence. This enables us to provide highly personalized policies at scale and attractive unit economics. We currently deploy behavioral telematics, other than miles driven, in four of the eight states where we operate. We are building a durable competitive advantage through personalization, superior pricing, better fraud detection, approval automation and customer loyalty. The strength of our technological offering has even turned our infrastructure into a source of revenue. We offer our Metromile Enterprise services to a number of leading insurance carriers looking to digitize their platforms.
•Customer-oriented approach with member loyalty. We leverage our data advantage and technology to offer customers better experiences through our use of mobile technology. We were born as a digital-first entity and have invested meaningfully to develop a seamless mobile and online experience for customers long-underserved by the traditional auto insurance industry. Customers can quickly download and use our app and access our rich feature set, enabling a shorter time to receive a quote. They also receive real-time feedback on fuel consumption and driving behavior, while we are additionally automating claims through our AI enabled platform. We believe these features and customer experience have established member loyalty to our platform and cultivated a strong brand affiliation. As of December 31, 2021, Metromile’s one-year retention rate on new policies is 60%, which is the percentage of customers that remain with Metromile after two policy terms, and is inclusive of all cancellation reasons, whether initiated by the customer or by us. According to the California Department of Insurance, in 2020 in California, which is Metromile’s largest market, Metromile received 4 justified complaints, which was lower than the average number of justified complaints received by the 50 largest automobile carriers in terms of exposure counts (of which Metromile ranked 41st). Each exposure count represents an insured vehicle. In addition, in 2020 in California, Metromile ranked 41 out of 50 in terms of the ratio of justified complaints to exposure counts. In 2020, Metromile decreased its justified complaint count in California by over 50%.
•Full-Stack Insurance provider. In 2016, we became a full-stack carrier, enabling us to recapture economics from third-party providers. We have complete control over the entire process of writing a policy, from underwriting and investment discretion to the back-end processing that drives new customer acquisition and growth, leading to high capital-efficiency. Our premiums can grow with minimal increase in surplus, while mitigating large or tail losses. We partner with some of the leading reinsurers in the industry. Today, we are licensed in 49 states and the District of Columbia, with licenses active in 46 states and the District of Columbia, and writing business in eight
states. We aim to be a fully national provider of insurance across 49 states and the District of Columbia in the future.
•Strategic partnerships in new channels. We are developing strategic partnerships with automotive giants that will help us to win sustainable market share. Our OEM partners can help us identify low mileage drivers based on the data collected from a newly purchased vehicle and target new customer segments with our product. Access to customers that fit our target demographic who are at a decision point in insurance buying post vehicle purchase is highly valuable and allows us to showcase our unique value proposition to the right customers at the right time. And, by connecting directly to vehicles, these connected car owners can bypass needing our Pulse device.
•World-class talent. The Metromile team comprises a blend of experienced technology industry executives, the best data scientists and leading insurance industry veterans. Our diverse mix of talent has helped us look at the automotive insurance industry through an alternative lens. We pride ourselves on our unique DNA and fresh outlook. We focus on hiring the best talent from a wide array of backgrounds to provoke diversity of thought and ideas. Our leadership team exemplifies our foundation in data science. Dan Preston first trained as a data scientist and joined Metromile as Chief Technology Officer in 2013 before becoming Chief Executive Officer in 2014. Prior to joining Metromile, Dan was the co-founder and Chief Technology Officer of AisleBuyer, a mobile retail innovator that was acquired by Intuit in April 2012. Outside of key leadership, Dan has built a tremendous team of technologists, insurance experts and finance veterans culled from companies including Progressive, Salesforce, and PricewaterhouseCoopers to the most innovative startups.
Our Operating Model
Our playbook for developing and growing markets is an iterative, deliberate methodology designed to ensure that all types of consumers, regardless of their “driver class”, receive competitive rates that deliver substantial savings, while pricing to accurately reflect their expected losses. Thus, as a market matures and achieves positive unit economics, we believe our ability to scale and deploy additional capital in that market increases. Our most mature markets have the largest market penetration and strongest unit economics, which is the result of a focused effort to both improve unit profitability and efficiency in Customer Acquisition Cost, or CAC.
Our revenue and gross profit are significantly impacted by our reinsurance program, the terms of which vary from year-to-year. Our reinsurance program includes an upfront policy fee paid to us by the reinsurers for each new policy entering into the program, as a way for us to recover policy acquisition costs. We record this as other revenue in the consolidated statements of operations. We then cede most of the premium earned on that policy to the reinsurance syndicate and earn back a share of the realized profit from the policy, over time, which is also recognized as other revenue.
Because our reinsurance program has varied year-to-year and the onboarding allowance portion of the program results in the recognition of more revenue during periods in which we sell more policies, we have seen a significant variance in our quarterly and annual revenue. For example, our other revenue and gross profit declined year-over-year in 2020 and 2019, primarily due to the upfront policy fee we received from our reinsurers for new policies sold in 2019 relative to 2020. In the years ended December 31, 2021 and 2020, we had other revenue of $29.2. million and $22.1 million, respectively. Our gross profit/(loss) declined to $(15.2) million from $(14.1) million for the same period.
We use reinsurance to reduce the likelihood of paying a large obligation resulting from an insurance claim. Our reinsurance arrangements provide for the transfer of a portion of our risk portfolio to a third-party in exchange for a share of the insurance premium, e.g., we cede a portion of the premium paid per policy. As we cede risk and premium, we not only transfer risk of loss, but are able to underwrite additional policies and generate additional premiums.
Effective as of April 30, 2021, the Company commuted all of its outstanding reinsurance agreements. For additional information, please see Note 10, Reinsurance, to our consolidated financial statements included in Part II, Item 8, of this Annual Report on Form 10-K.
Because of the effect that our reinsurance program has on our revenue and gross profit, we believe contribution profit, a non-GAAP financial measure, is a more useful metric to evaluate the fundamentals underlying the profitability of our insurance operation. Contribution profit is calculated as direct earned premium, plus investment income earned at the insurance company, minus direct losses, direct loss adjustment expense, and variable costs associated with the servicing of policies. Contribution margin is contribution profit divided by direct earned premium plus investment income earned at the insurance company. See “Metromile’s Management’s Discussion and Analysis of Financial Condition and Results of Operations — Non-GAAP Financial Measures” for additional information regarding our use of contribution profit/(loss) and contribution margin and a reconciliation to the most comparable GAAP measures.
Our negative gross margin decreased to (14.5)% for the year ended December 31, 2021 from (40.3)% for the year ended December 31, 2020, primarily due to higher revenue in 2021, partially offset by reinsurance coverage on losses in 2020 combined with both increased frequency and severity of losses as well as claims related to Hurricane Ida in 2021. Our contribution margin has declined from 2020 to 2021, primarily due unfavorable prior period loss development.
As of December 31, 2021, one-year new customer retention was 60% for policies that completed their second term in the fourth quarter of 2021. We define retention as the percentage of new customers who remain with us after their first two policy terms, inclusive of all cancellation reasons.
Metromile’s Growth Strategy
Scale our position in existing markets.
We have an established presence in our existing markets — eight states in the United States that represent approximately 30% of the market for drivers. Our data engine is helping us to continuously learn more about our customers and their driving behaviors, which allows us to improve price competitiveness in new segments. As our data aggregates over time, we become more sophisticated in our pricing, analysis and predictions while our competitors remain broadly stagnant. Our financial profile improves as we scale and refine our local market knowledge. This improved financial profile frees up more capital to invest in furthering our technical advantages and growing our customer base.
Expand nationally across the United States.
We will apply our highly replicable model nationally, with a tailored approach to each state, driven by the regulatory environment and local market dynamics. This will allow us to expand rapidly and efficiently across different geographies while maintaining a high level of control over the specific strategy within each state. We aim to be in 49 states and the District of Columbia in the future. We do not yet have visibility on whether or not these 41 new markets will permit the use of behavioral telematics data to offer polices and premiums based on driving habits in addition to miles driven. As we expand into new markets, when appropriate, we plan to engage in discussion with state insurance regulators to expand our ability to use behavioral telematics, which we expect will evolve over time. Our data platform will continue to inform new and existing markets as we successfully scale.
Scale partnerships & key channels.
Our existing channels have been continually optimized for lower CAC and heightened throughput. We market through a variety of channels, including direct-to-consumer advertisements, display, search, and social media marketing, search engine optimization, and customer referrals. Our products are customer-centric with an overall NPS of 50, and we benefit greatly from word-of-mouth marketing.
Cross-sell with new products and services.
With active and loyal customers, we intend to build on that foundation to offer an expanded product offering. We believe that there is a compelling cross-sell opportunity for other insurance services including homeowners' insurance, and renters insurance, and car maintenance. Through a mix of strong partners and new internal product development, we expect to bring these products to market in an intuitive manner, consistent with the experience Metromile customers expect from us.
Our portfolio of investable assets is primarily held in cash, short-term investments, and available-for-sale fixed maturity securities, including U.S. Treasury securities, corporate debt securities, commercial paper, and asset backed securities. We manage the portfolio in accordance with investment policies and guidelines approved by our board of
directors, in consultation with legal counsel and as may be required to be approved by applicable regulatory authorities. We have designed our investment policy and guidelines to provide a balance between current yield, conservation of capital, and liquidity requirements of our operations setting guidelines that provide for a well-diversified investment portfolio that is compliant with insurance regulations applicable to the states in which we operate.
We operate in a highly competitive segment of the insurance industry. Many of our primary and direct competitors have well-established national brands, a longer operating history, and market similar products, including at prices comparable to ours. Our competitors include large national insurance companies such as Progressive, Allstate, and Nationwide, as well as up-and-coming companies and new market entrants in the InsurTech industry, some of whom also utilize telematics and offer forms of usage-based insurance. Several of these established national insurance companies are larger than us and have significant competitive advantages over us, including increased name recognition, greater resources, access to additional capital, and more types of insurance coverage to offer the consumer, such as renters, homeowners, health and life, than we currently do. In particular, many of these competitors offer consumers the ability to purchase multiple other types of insurance coverage and “bundle” them together into one policy and, in certain circumstances, include an umbrella liability policy for additional coverage at competitive prices. We do not offer such “bundles” and are specialized in one type of insurance — personal automotive insurance. Moreover, as we expand into new lines of business and offer additional products, we could face intense competition from traditional insurance companies that are already established in such markets.
Competition is based on many factors, including the reputation and experience of the insurer, coverages offered, pricing and other terms and conditions, customer service, size, and financial strength ratings, among other considerations. We believe we compete favorably across many of these factors, and have developed a platform and business model based on data science, artificial intelligence, machine learning and a stand out customer experience that we believe will be difficult for incumbent insurance providers to emulate and utilize like we have.
Telematics Device Production, Sourcing and Fulfillment
We utilize telematics technology to gather data that we use to underwrite insurance policies, bill customers, and manage claims and customer service. Our telematics hardware is designed and manufactured, and telematics data services are provided to us by a single third party. From a fulfillment perspective, we also use one third-party logistics company for our end-to-end physical inventory management process as well as the shipping and receiving of our telematics devices. We believe that we have good relationships with our vendors and that there are alternative sources in the event that one or more of these vendors is not available. We continually review our customer demands against the capacity of our manufacturer and supplier with a view to ensuring that we are able to meet our customer commitments, reduce costs and operate more efficiently. For additional information, see the section titled “Risk Factors — Technology and Security.”
Employees and Human Capital Resources
As of December 31, 2021, we had 384 full-time employees. None of our employees is represented by a labor union or covered by collective bargaining agreements. We have not experienced any work stoppages. We consider our relationship with our employees to be good.
Our human capital resources objectives include, as applicable, identifying, recruiting, retaining, incentivizing and integrating our existing and additional employees. The principal purposes of our equity incentive plans are to attract, retain and motivate selected employees, consultants and directors through the granting of stock-based compensation awards.
We believe that our intellectual property rights are valuable and important to our business. We rely on trademarks, patents, copyrights, trade secrets, license agreements, intellectual property assignment agreements, confidentiality procedures, non-disclosure agreements, and electronic and physical security measures to establish and protect our proprietary rights. Though we rely in part upon these legal, contractual, and other protections, we believe that factors such as the skill and ingenuity of our employees and the functionality and frequent enhancements to our platform are large contributors to our success in the marketplace. We intend to pursue additional intellectual property protection on such enhancements to the extent we believe it would be beneficial and cost-effective.
As of December 31, 2021, we have five issued patents and two pending patent applications in the United States. The issued patents generally relate to determining the route and parking location of a vehicle, recording trip data associated with a vehicle, and estimating the usage of a vehicle based on refueling events. The issued patents are expected to expire between September 1, 2035 and January 11, 2036. We continually review our development efforts to assess the existence and patentability of new intellectual property.
We have trademark rights in our name, our logo, and other brand indicia, and have trademark registrations for select marks in the United States. We also have registered domain names for websites that we use in our business.
Although we believe our intellectual property rights are valuable and strong, intellectual property rights are sometimes subject to invalidation or circumvention. For additional information, see the sections titled “Risk Factors —
Risks Related to Our Business — Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand.”
Metromile is subject to insurance regulation in the jurisdictions in which we transact insurance through licensed insurance carrier and producer subsidiaries. Insurance regulatory authorities have broad administrative powers to regulate all aspects of an insurance carrier or producer’s business, including the powers to restrict or revoke licenses to transact business, and to levy fines and monetary penalties against insurers and insurance producers found to be in violation of applicable laws and regulations. Regulations to which the licensed insurance carrier and producer subsidiaries are subject include, but are not limited to:
•prior approval of transactions resulting in a change of “control” (as such term is defined under the Insurance Holding Company System Registration Act of Delaware (the “Delaware Holding Company Act”));
•prior approval of transactions resulting in a change of “control” (as such term is defined under the Insurance Holding Company System Regulatory Act of California (the “California Holding Company Act”));
•state-mandated premium rebates, refunds, or reductions as a result of potentially lower risk exposure due to the Coronavirus pandemic and related emergency orders;
•approval of policy forms and premiums in each state in which the insurance carrier operates;
•approval of intercompany service agreements in Delaware and California;
•statutory and risk-based capital solvency requirements, including the minimum capital and surplus the insurance carrier must maintain pursuant to applicable laws and the CMA entered into as required by the Delaware Department of Insurance described above;
•establishing minimum reserves that the insurance carrier must hold to pay projected insurance claims;
•required participation by the insurance carrier in state guaranty funds;
•restrictions on the type and concentration of the insurance carrier’s investments;
•restrictions on the advertising and marketing of insurance;
•restrictions on the adjustment and settlement of insurance claims;
•restrictions on the use of rebates or other consideration to induce a policyholder to purchase insurance;
•restrictions on the sale, solicitation, and negotiation of insurance;
•restrictions on the sharing of insurance commissions and payment of referral fees with unlicensed persons;
•prohibitions on the underwriting of insurance on the basis of race, sex, religion, and other protected classes;
•restrictions on disparate treatment of similarly situated applicants and policyholders;
•restrictions on the ability to use telematics to underwrite and price insurance policies, particularly in California;
•restrictions on the use and weight of certain underwriting factors;
•restrictions on the ability of the insurance carrier to pay dividends to us or enter into certain related party transactions without prior regulatory approval;
•rules requiring the maintenance of statutory deposits for the benefit of policyholders;
•privacy regulation and data security;
•regulation of corporate governance and risk management;
•periodic examinations of operations, finances, market conduct, and claims practices; and
•required periodic financial reporting.
The business of insurance is principally regulated at the state level, and the laws and regulations to which the licensed insurance carrier and producer subsidiaries are subject vary depending on the state. Unless the context otherwise requires, references herein to “state” include any of the 50 states, the District of Columbia and the five U.S. territories. These rules are subject to change as state legislatures and regulatory agencies update their laws and regulations to address real and perceived issues and concerns. These laws and regulations are also subject to interpretation by courts. The NAIC and the National Council of Insurance Legislators (“NCOIL”) are the principal organizations tasked with establishing standards and best practices across the various states, the District of Columbia and five U.S. territories, and from time to time promulgate model rules and regulations that often are the basis for insurance rules and regulations adopted by such jurisdictions. We cannot predict precisely whether or when regulatory actions may be taken that could adversely affect us or the operations of the insurance carrier and producer subsidiaries. Interpretations of regulations by regulators may change and statutes, regulations, and interpretations may be applied with retroactive effect, particularly in areas such as accounting or reserve requirements.
The U.S. insurance carrier, Metromile Insurance Company, is domiciled and admitted in the state of Delaware to transact certain lines of property and casualty insurance. In addition to Delaware (the domiciliary state) and California (currently, a commercial domicile for the insurance carrier), Metromile Insurance Company maintains licenses to transact insurance in all states except Tennessee, and currently writes policies in Arizona, California, Illinois, Oregon, New Jersey, Pennsylvania, Virginia, and Washington. No additional license applications are currently pending.
The licensed insurance producer subsidiary, Metromile Insurance Services LLC, must maintain an insurance producer license in every state in which it sells, solicits, or negotiates insurance. Metromile Insurance Services LLC currently holds a resident insurance producer license in California and a non-resident license in Arizona, Illinois, New Jersey, Oregon, Pennsylvania, and Virginia. No additional license applications are currently pending.
Insurance regulators have broad authority to restrict or revoke licenses of insurance carriers and producers who are found to be in violation of any applicable laws and regulations.
Licensing of Our Employees
Unless directly employed by the insurance carrier, any of our employees who sell, solicit, or negotiate insurance must be licensed insurance producers and must fulfill pre-licensing and annual continuing education and license renewal requirements. In certain states in which we operate, insurance claims adjusters are also required to be licensed and fulfill annual continuing education requirements.
Insurance Holding Company Regulation
We are a member of an “insurance holding company system” under the Delaware Holding Company Act and the California Holding Company Act as the parent company of a wholly owned regulated insurance subsidiary. Under the insurance holding company system rules and regulations, Metromile Insurance Company is required to register with the insurance departments of Delaware and California and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management, or financial condition of Metromile Insurance Company. Although the insurance carrier is currently commercially domiciled in California and therefore subject to certain provisions of the California Holding Company Act, this is not necessarily a permanent designation. The insurance carrier will remain commercially domiciled in California only for so long as during its three preceding fiscal years taken together it wrote an average of more direct premiums in California than it wrote in Delaware during the same period, and the California direct premiums written constitute 33 percent or more of its total direct premiums written everywhere in the U.S. for that three-year period.
As the ultimate controlling person in our insurance holding company system, we are required to file an annual enterprise risk report pursuant to both the Delaware Holding Company Act and the California Holding Company Act. The report discloses, among other things, any material activities or developments that could adversely affect the insurance holding company system and/or the domestic insurance carrier specifically. In some states, any person divesting control of an insurer must provide thirty (30) days’ written notice to the regulator and the insurer. In addition, most states require insurance holding company systems to make annual corporate governance disclosures.
Under the Delaware Holding Company Act and the California Holding Company Act, all inter-affiliate transactions within a holding company system must meet the following conditions: (i) the terms must be fair and reasonable; (ii) charges or fees for services performed must be fair and reasonable; and (iii) expenses incurred and payments received must be allocated to the insurer in conformity with customary insurance accounting practices consistently applied. The regulators in California and Delaware, respectively, often interpret these requirements differently, which can lead to delays in approval of affiliate agreements and unexpected terms or conditions. The insurance carrier generally must disclose any transaction between the insurance carrier and any other affiliate(s) to the insurance departments of Delaware and California and the insurance carrier must obtain prior approval from each such regulator before entering into certain material inter-affiliate transactions, including, but not limited to, management agreements, tax allocation agreements, service contracts, cost-sharing arrangements, extraordinary dividends, certain reinsurance transactions, and certain loan agreements.
Pursuant to the ORSA Model Act, an insurance company with direct written and unaffiliated assumed premium of more than $500.0 million or that is part of an insurance group with direct written and unaffiliated assumed premium of more than $1.0 billion must maintain a risk management framework to assist the insurer with identifying, assessing, monitoring, managing, and reporting on its material and relevant risks. In addition, the insurer must regularly conduct an “own risk and solvency assessment” in accordance with NAIC’s ORSA Guidance Manual. Upon the request of the Commissioner of the Delaware Department of Insurance, and not more than once a year, any insurer subject to these requirements must submit an ORSA summary report, or any combination of reports that together contain the information described in the ORSA Guidance Manual, with respect to the insurer and the insurance group of which it is a member. Metromile Insurance Company was exempt from these requirements in 2021 and 2020 since it had direct written and unaffiliated assumed premium of less than $500.0 million for that year, but at some point Metromile Insurance Company could become subject to the ORSA requirements.
Restrictions on Paying Dividends
We are a holding company that transacts a majority of its business through operating subsidiaries. Consequently, our ability to pay dividends to stockholders and meet our debt payment obligations depends on the results of operations of our operating subsidiaries and on the ability of such subsidiaries to provide us with cash, whether in the form of dividends, distributions, loans, or otherwise. The payment of any extraordinary dividend by our regulated insurance subsidiary requires the prior approval (or no disapproval after thirty days’ notice) of the Commissioner of the Delaware Department of Insurance and the Commissioner of the California Department of Insurance.
“Extraordinary dividend” is defined under the Delaware Insurance Code as any dividend or distribution of cash or other property, whose fair market value together with that of other dividends or distributions made within the preceding twelve months, exceeds the greater of (a) ten percent of Metromile Insurance Company’s surplus as of December 31 of the preceding year, or (b) Metromile Insurance Company’s net income for the twelve-month period ending December 31 of the preceding year, but does not include pro rata distributions of any class of the insurance company’s own securities. In addition, Metromile Insurance Company may not declare or pay a dividend or other distribution from any source other than earned surplus without the Delaware Commissioner’s prior approval.
“Extraordinary dividend” is similarly defined under the California Insurance Code as any dividend or distribution that, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (a) ten percent of Metromile Insurance Company’s policyholder’s surplus as of December 31 of the preceding year, or (2) Metromile Insurance Company’s net income for the 12-month period ending the preceding December 31.
As of December 31, 2021, and December 31, 2020, Metromile Insurance Company was not permitted to pay any dividends to its holding company parent without approval of the Commissioner of the Delaware Department of Insurance. See the section titled “Risk Factors — Risks Related to Our Business — Failure to maintain our risk-based capital at the required levels could adversely affect our ability to maintain regulatory authority to conduct our business.”
In addition, insurance regulators have broad powers to prevent a reduction of statutory surplus to inadequate levels, and there is no assurance that dividends of the maximum amount calculated under any applicable formula would be permitted. Delaware and/or California may in the future adopt statutory provisions more restrictive than those currently in effect.
Metromile Insurance Company is required to hold admitted assets as reserves to cover projected losses under its policies, in accordance with actuarial principles. In accordance with the NAIC’s property and casualty statement instructions, Metromile Insurance Company must submit an annual Statement of Actuarial Opinion from a qualified actuary appointed by the company, certifying that its reserves are reasonable. The insurance departments of Delaware and California have the authority to dispute the reasonableness of the reserves certified by the actuary.
Metromile Insurance Company is required to maintain minimum levels of risk-based capital to support its overall business operations and minimize the risk of insolvency. State insurance regulators use risk-based capital to set capital requirements, based on the size and degree of risk taken by the insurer, taking into account various risk factors including asset risk, credit risk, underwriting risk, and interest rate risk. As the ratio of an insurer’s total adjusted capital and surplus decreases relative to its risk-based capital, the risk-based capital laws provide for increasing levels of regulatory scrutiny and intervention.
Delaware adopted the model legislation promulgated by the NAIC pertaining to risk-based capital, and requires annual reporting by Delaware-domiciled insurers to confirm that the insurer is meeting its risk-based capital requirements. Delaware-domiciled insurers falling below a risk-based capital threshold may be subject to varying degrees of regulatory action. An insurance company with total adjusted capital that is less than 200% of its authorized control level risk-based capital is at a company action level, which would require the insurance company to file a risk-based capital plan that, among other things, contains proposals of corrective actions the company intends to take that are reasonably expected to result in the elimination of the company action level event. Additional action level events occur when the insurer’s total adjusted capital falls below 150%, 100% and 70% of its authorized control level risk-based capital. When total adjusted capital falls below 70%, a mandatory control event is triggered which results in the Delaware Department of Insurance placing the insurance company in receivership and assuming control of the operations of the insurer. As of December 31, 2021, Metromile Insurance Company’s risk-based capital levels are above all of these regulatory action level thresholds. As part of its regulatory review and approval of this transaction, the Delaware Department of Insurance required us to enter into a Capital Maintenance Agreement (the “CMA”). The CMA requires us to ensure that the regulated insurance subsidiary, Metromile Insurance Company, has and will maintain total adjusted capital in an amount equal to at least 300% of the insurance company’s authorized control level risk based capital from the close of the transaction until a date to be determined by the regulator in mid-2025. Being required to maintain capital levels above the statutory requirement could put constraints on our ability to deploy capital to which our competitors are not subject.
Hazardous Financial Conditions
The Delaware Department of Insurance has the authority to deem Metromile Insurance Company to be in a hazardous financial condition such that the insurer’s continued operation may be hazardous to its policyholders, creditors, or the general public. A finding of a hazardous condition can be based upon a number of factors, including, but not limited to: (i) adverse findings in a financial, market conduct or other examination; (ii) failure to maintain adequate reserves in accordance with presently accepted actuarial standards of practice; (iii) net loss or negative net income in the last twelve month period or any shorter period of time; (iv) failure to meet financial and holding company filing requirements; (v) insolvencies with a company’s reinsurer(s) or within the insurer’s insurance holding company system; (vi) a finding of incompetent or unfit management of the insurer; (vii) a failure to furnish requested information or provide accurate information in relation to a response to an inquiry or filing of a financial statement; and (viii) any other finding determined by the commissioner to be hazardous to the insurer’s policyholders, creditors or the general public.
If the Delaware Department of Insurance finds Metromile Insurance Company to be in hazardous condition it has the authority, in lieu of placing the insurer into supervision, rehabilitation or liquidation, to enter into a memorandum of understanding with the insurer or issue an order to require the insurer to remedy the hazard. This would include, but is not limited to, ordering the insurer to: (i) increase its capital and surplus, (ii) suspend payment of dividends, (iii) limit or withdraw from certain investments, (iv) correct corporate governance deficiencies, and (v) take any other action necessary to cure the hazardous condition.
Metromile Insurance Company is subject to on-site and remote or virtual visits and examinations by the state insurance regulatory authorities. Metromile Insurance Company is subject to market conduct examinations by insurance regulators, under which the regulator will examine its conduct towards policyholders including, but not limited to, complaint handling, marketing, claims, rate and form filing, nonrenewal and cancellation practices, and customer service. Metromile Insurance Company is also subject to a financial examination by the Delaware Department of Insurance every five years, under which it will review the company’s financials, including its relationships and transactions with affiliates. Metromile Insurance Company completed its first financial examination, covering the period January 1, 2013 through December 31, 2017, by the Delaware Department of Insurance, which was accepted, adopted, and filed effective January 22, 2019, with “no significant findings or material adjustments to the Company’s financial statements” (the “2017 Examination”). In addition, the Delaware Department of Insurance may conduct special or targeted examinations to address particular concerns or issues at any time. Specifically, by memorandum dated December 3, 2018, the Delaware Department of Insurance identified several exceptions that were noted during the course of the 2017 Examination which were not deemed significant enough to be included in its January 22, 2019 report. As a follow-up to the memorandum, the Delaware Department of Insurance conducted two targeted examinations to which Metromile Insurance Company provided responses that were accepted by the regulator. The Delaware Department of Insurance is currently conducting Metromile Insurance Company's second financial examination covering the period January 1, 2018 through December 31, 2020. Insurance regulators of other states in which Metromile Insurance Company is licensed may also conduct examinations of the company, and such examinations have been completed by Illinois, Pennsylvania, Virginia, Washington and California (the California exam was limited to the Special Investigative Unit's compliance). Additionally, there are ongoing examinations by the California Department of Insurance and the New Jersey Department of Banking and Insurance. The results of each examination can give rise to fines and monetary penalties as well as regulatory orders requiring remedial, injunctive, or other corrective action.
Statutory Accounting Principles
A licensed insurance carrier’s financial statements must be completed in accordance with statutory accounting principles, or SAP. SAP was developed by U.S. insurance regulators as a method of accounting used to monitor and regulate the solvency of insurance companies. In developing SAP, insurance regulators were primarily concerned with evaluating an insurer’s ability to pay all its current and future obligations to customers. As a result, statutory accounting focuses on conservatively valuing the assets and liabilities of insurers, generally in accordance with standards specified by the insurer’s domiciliary jurisdiction.
Uniform statutory accounting practices are established by the NAIC and generally adopted by regulators in the various U.S. jurisdictions. These accounting principles and related regulations differ somewhat from GAAP principles, which are designed to measure a business on a going-concern basis. GAAP gives consideration to matching of revenue and expenses and, as a result, certain expenses are capitalized when incurred and then amortized over the life of the associated policies. Other assets such as goodwill are accounted for under GAAP financial statements but not SAP. As a result, the values for assets, liabilities, and equity reflected in financial statements prepared in accordance with GAAP may be different from those reflected in financial statements prepared under SAP.
Credit for Reinsurance
As of December 31, 2021, Metromile Insurance Company commuted all reinsurance. Subsequent to the balance sheet date, the Company signed an agreement under which it has ceded a portion of the risk it is insuring to various reinsurers. State insurance laws permit U.S. insurance companies, as ceding insurers, to take financial statement credit for reinsurance that is ceded, so long as the assuming reinsurer satisfies the credit for reinsurance laws of the ceding insurer’s state of domicile. Once an insurance carrier has received credit for reinsurance it does not need to hold separate admitted assets as reserves to cover claims on the risks that it has ceded to the reinsurer. There are several different ways in which the credit for reinsurance laws may be satisfied by an assuming reinsurer, including being licensed in the state, being accredited in the state, or maintaining certain types of qualifying collateral. We ensure that all of Metromile Insurance Company’s reinsurers, and the related reinsurance and other agreements, qualify for credit for reinsurance so that Metromile Insurance Company is able to take full financial statement credit for its reinsurance.
Most states require personal property and casualty insurers to file rating plans, policy or coverage forms, and other information with the state’s regulatory authority. In certain cases, such rating plans, policy forms, or both must be approved prior to use.
We currently have products on file and approved in the following states: Arizona, California, Illinois, Oregon, New Jersey, Pennsylvania, Virginia, and Washington.
The speed with which an insurer can change rates in response to competition or increasing costs depends, in part, on whether the rating laws are (i) prior approval, (ii) file-and-use, or (iii) use-and-file. In states having prior approval laws, the regulator must approve a rate before the insurer may use it, and this process can often take multiple months. In states having file-and-use laws, the insurer does not have to wait for the regulator’s approval to use a rate, but the rate must be filed with the regulatory authority before being used. A use-and-file law requires an insurer to file rates within a certain period of time after the insurer begins using them. Many states, including California, have prior approval laws. Under all three types of rating laws, the regulator has the authority to disapprove a rate filing.
An insurer’s ability to adjust its rates in response to competition or to changing costs depends on an insurer’s ability to demonstrate to the regulator that its rates or proposed rating plan meet the requirements of the rating laws. In those states that significantly restrict an insurer’s discretion in selecting the business that it wants to underwrite, an insurer can manage its risk of loss by charging a rate that reflects the cost and expense of providing the insurance. In those states that significantly restrict an insurer’s ability to charge a rate that reflects the cost and expense of providing the insurance, the insurer can manage its risk of loss by being more selective in the type of business it underwrites. When a state significantly restricts both underwriting and pricing, it becomes more difficult for an insurer to maintain its profitability.
From time to time, the personal lines insurance industry comes under pressure from state regulators, legislators, and special-interest groups to reduce, freeze, or set rates at levels that do not correspond with our analysis of underlying costs and expenses. In particular, auto insurers have come under increasing pressure and in some states have been required to refund a portion of their premium to their policyholders due to decreasing auto claims arising from the COVID-19 pandemic. Whether this pressure continues to exist depends on the persistence of COVID-19 generally, and on other political, social, and health issues that may arise. State regulators may interpret existing law or rely on future legislation or regulations to impose new restrictions that adversely affect profitability or growth. We cannot predict with precision the impact on our business of possible future legislative and regulatory measures regarding insurance rates.
In addition, insurers are restricted in their ability to use telematics-based data to set premium rates in California, Metromile’s largest market. Proposition 103, which was passed by referendum in 1988, limits the factors that insurers can use to set auto insurance rates to, in decreasing order of importance: (i) the insured’s driving safety record; (ii) the number of miles he or she drives annually; (iii) the number of years of driving experience the insured has had; and (iv) those other factors that the Commissioner of the California Department of Insurance may adopt by regulation and that have a substantial relationship to the risk of loss. Under current California regulation, the use of telematics-based data beyond miles driven, including when, where or how the car is driven, is prohibited. In addition, other states in which Metromile operates, or may choose to operate in the future, similarly limit the use of telematics-based data beyond miles driven. Metromile Insurance Company is currently in discussions with the California Department of Insurance to revise its regulations to allow the use of telematics to a greater extent to underwrite and price insurance policies. Metromile cannot predict the outcome of these discussions, and there can be no assurance that the California Department of Insurance or other state regulators will revise regulations accordingly, if at all.
Insolvency/Guaranty Funds and Associations, Mandatory Pools, and Insurance Facilities
Most states require admitted property and casualty insurance companies to become members of insolvency or guaranty funds or associations for impaired or insolvent insurance companies, which each state funds through an annual assessment on all insurance companies doing business in the state. These funds cover payments of claims of state policyholders whose admitted insurance carriers have become insolvent. The annual assessments required in any one year will vary from state to state, and are subject to various maximum assessments per line of insurance. Our results of operations and financial condition could be adversely affected by any such assessments.
In addition, most states require private passenger automobile insurers to participate in mandatory pools, insurance facilities, or similar markets of last resort. These pools allocate to all licensed auto insurers those drivers who are required by law to have automobile insurance but because of their risk profile cannot obtain coverage from the voluntary markets. Allocations are based on market share in each state.
Metromile Insurance Company is subject to Delaware’s rules and regulations governing the investment of its assets. Delaware’s laws generally require that an insurance company invest in a diverse portfolio, and limit its investments in certain asset categories. Failure to comply with these laws and regulations would cause non-conforming investments to be treated as non-admitted assets for purposes of measuring statutory surplus and, in certain circumstances, Metromile Insurance Company would be required to dispose of those investments.
Insurance companies and producers are subject to regulation on how they may sell, solicit, or negotiate insurance and conduct their business, with state laws prohibiting certain unfair trade practices. Such practices include, but are not limited to, false advertising, making false statements to regulators, unfair discrimination including against protected classes, and rebating premium to policyholders above certain de minimis amounts. Metromile and its affiliates set business conduct policies and provide training to ensure employee-agents and other customer service personnel are aware of these prohibitions and understand that they are required to conduct their activities in compliance with these laws. In addition, the NAIC and several states, including California, Connecticut, and New York, have indicated an increased desire and intent to examine scoring and other models used for rating and underwriting. We are not currently able to predict with precision what impact these laws, initiatives, or actions in this respect might have on our business.
Unfair Claims Practices
Insurance companies, third-party administrators, and individual claims adjusters are generally prohibited by state laws from engaging in unfair claims practices. Unfair claims practices include, but are not limited to, misrepresenting pertinent facts or insurance policy provisions, failing to acknowledge and act reasonably promptly upon communications with respect to claims arising under insurance policies, failing to adopt reasonable standards for the investigation and settlement of a claim, and attempting to settle a claim for less than the amount to which a reasonable person would have believed such person was entitled. Metromile and its affiliates set business conduct policies to make claims adjusters aware of these prohibitions and to require them to conduct their activities in compliance with these laws.
Insurance producers cannot share insurance commissions with any person for selling, soliciting, or negotiating insurance unless such person holds an insurance producer license. There is a well-recognized, limited exception to this prohibition on commission sharing for the payment of referral fees to unlicensed persons, provided that the fee is a flat fee that is not contingent on the purchase of insurance and the referral does not involve the discussion of the terms or conditions of the policy.
The use of non-public personal information in the insurance industry is subject to regulation under the privacy provisions of the Gramm-Leach-Bliley Act and the NAIC Insurance Information and Privacy Act, to the extent adopted and implemented by the various state legislatures and insurance regulators, including through the California Financial Information Privacy Act. Pursuant to these laws and regulations, among other things, an insurance carrier or producer must disclose its privacy policies to all of its applicants and policyholders and must also provide either an opt-in or opt-out, depending on the state, to the sharing of non-public personal information with unaffiliated third parties.
We are also subject to the CCPA, which took effect on January 1, 2020, and its implementing regulations which took effect in August 2020. The CCPA and related regulations give California residents the right to access and request deletion of their personal information, opt out of certain personal information sharing, and receive detailed disclosures about how their personal information is used and shared. The CCPA exempts certain information that is collected, processed, sold or disclosed pursuant to the California Financial Information Privacy Act, the Gramm-Leach-Bliley Act, the Fair Credit Reporting Act, or the federal Driver’s Privacy Protection Act, which also apply to us. However, the definition of “personal information” in the CCPA is broad and encompasses other information that we process beyond the scope of these exemptions. In addition, on November 3, 2020, Californians approved Proposition 24, a ballot measure that created the California Privacy Rights Act ("CPRA"). As of January 1, 2023, the CPRA will add new obligations on Metromile Insurance Company’s use, protection, and disclosures regarding personal information. We are not currently able to predict with precision what impact these laws and regulations might have on our business.
Under the Gramm-Leach-Bliley Act, insurance companies and producers must also establish a program of administrative, technical, and physical safeguards designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazards to the security or integrity of customer information, and protect against unauthorized access to or use of customer information that could result in substantial harm or inconvenience to the customers.
Additionally, in response to the growing threat of cyber-attacks in the insurance industry, certain jurisdictions have begun to consider and adopt new cybersecurity regulations. On October 24, 2017, the NAIC adopted the Insurance Data Security Model Law, intended to serve as model legislation for states to enact to govern cybersecurity and data protection practices of insurers, insurance agents, and other licensed entities registered under state insurance laws. Alabama, Connecticut, Delaware, Iowa, Louisiana, Maine, Michigan, Mississippi, New Hampshire, North Dakota, Delaware, Indiana, South Carolina and Virginia, have adopted versions of the Insurance Data Security Model Law, each with a different effective date and some substantive differences. In addition, certain other states, including New York, have adopted their own cybersecurity laws with material differences from the NAIC Model Law. The CCPA also indirectly requires businesses to implement and maintain reasonable security procedures and practices appropriate to the nature of the personal information processed. Metromile Insurance Company takes steps to comply with financial industry cybersecurity regulations and believes it complies in all material respects with their requirements. Its board of directors oversees cybersecurity risk management and delegates oversight of its information security program to executive officers and a chief information security officer, who is responsible for the day-to-day management of our information security program and provides updates to the audit committee of the board of directors at each of its meetings. Metromile Insurance Company’s incident response team reports material information security incidents to executive officers, who in turn report them to the Board.
The regulation of insurance companies is principally a matter of state law, and the federal government does not directly regulate the transaction of insurance. However, federal statutes, regulations, and other initiatives do have an impact on the insurance industry. In particular, the Federal Insurance Office ("FIO") was established within the U.S. Department of the Treasury (“Treasury”) by the Dodd-Frank Act in July 2010 to monitor and coordinate the regulation of the insurance industry across the United States.
Although the FIO has limited direct regulatory authority over insurance companies or other insurance industry participants, it does represent the U.S. on prudential aspects of international insurance matters, including at the International Association of Insurance Supervisors (“IAIS”). In addition, the FIO serves as an advisory member of the Financial Stability Oversight Council, assists the secretary of the Treasury with administration of the Terrorism Risk Insurance Program, monitors trends in the insurance industry, and advises the secretary of the Treasury on important national and international insurance matters. The FIO has the ability to make a recommendation to the Financial Stability Oversight Council to designate an insurer as “systemically significant,” subjecting the insurer to regulation by the Federal Reserve as a bank holding company, which could lead to higher capital requirements.
In addition, a number of federal laws affect and apply to the insurance industry, including various privacy laws, false advertising laws, anti-money laundering laws, the FCRA, and the economic and trade sanctions implemented by the Office of Foreign Assets Control (“OFAC”). OFAC has imposed civil penalties on persons, including insurance and reinsurance companies, arising from violations of its economic sanctions program.
Our website address is www.metromile.com. We make available, free of charge through the Investor Relations portion of our website, annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Information contained on our website or connected thereto does not constitute part of, and is not incorporated by reference into, this Annual Report on Form 10-K.
ITEM 1A. RISK FACTORS
Investing in our securities involves risks. Before you make a decision to buy our securities, in addition to the risks and uncertainties discussed above under “Cautionary Note Regarding Forward-Looking Statements,” you should carefully consider the specific risks set forth herein. If any of these risks actually occur, it may materially harm our business, financial condition, liquidity and results of operations. As a result, the market price of our securities could decline, and you could lose all or part of your investment. Additionally, the risks and uncertainties described in this Annual Report on Form 10-K or any supplement are not the only risks and uncertainties that we face. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may become material and adversely affect our business.
Risks Relating to Our Business Due to the Pending Acquisition of Metromile by Lemonade
On November 8, 2021, we entered into an Agreement and Plan of Merger (the “merger agreement”), by and among Metromile, Lemonade, Inc. (“Lemonade”), and two subsidiaries of Lemonade, pursuant to which, upon completion of the two mergers contemplated by the merger agreement, Lemonade will acquire Metromile and Metromile will become a wholly-owned subsidiary of Lemonade.
The announcement and pendency of the mergers may result in disruptions to our business.
The merger agreement generally requires us to operate our business in the ordinary course pending completion of the mergers and restricts us from taking certain specified actions without Lemonade’s consent until the mergers are completed or the merger agreement is terminated. These restrictions may affect our ability to execute our business strategies and attain financial and other goals and may impact our financial condition, results of operations and cash flows.
Further, in connection with the mergers, our current and prospective employees may experience uncertainty about their future roles with us following the consummation of the mergers, which may materially adversely affect our ability to attract, motivate and retain key personnel.
The pendency of the mergers could also result in disruptions to our business relationships with customers, suppliers and other business partners, which could have an adverse impact on our revenues, cash flows and results of operations. Parties with which we have business relationships may choose to delay or defer certain business decisions, seek alternative relationships with third parties or seek to alter their present business relationships with us while the mergers are pending. Parties with whom we otherwise may have sought to establish business relationships may seek alternative relationships with other parties.
The pursuit of the mergers may place a significant burden on our management and internal resources, and will divert management’s time and attention from our day-to-day operations and the execution of our other strategic initiatives. This could adversely affect our financial results. In addition, we have incurred and will continue to incur other significant costs, expenses and fees for professional services and other transaction costs in connection with the mergers, and many of these fees and costs are payable regardless of whether or not the mergers are consummated.
Any of the foregoing could adversely affect our business, financial condition, and results of operations.
The mergers may not be completed within the intended timeframe, or at all, and the failure to complete the mergers could adversely affect our business, results of operations, financial condition, and the market price of our common stock.
There can be no assurance that the mergers will be completed in the intended timeframe, or at all. The merger agreement contains a number of conditions that must be satisfied or waived prior to the completion of the mergers, including, among others, applicable regulatory approvals and consents. There can be no assurance that all required approvals will be obtained or that all closing conditions will otherwise be satisfied. Even if all required approvals are obtained and all closing conditions are satisfied, we can provide no assurance as to the terms, conditions, and timing of such approvals or that the mergers will be completed in a timely manner or at all. Many of the conditions to completion of the mergers are outside of our control, and we cannot predict when or if these conditions will be satisfied. Even if regulatory approval is obtained, it is possible that conditions will be imposed that could result in a material delay in, or the abandonment of, the mergers or otherwise have an adverse effect on us.
If the mergers are not completed within the intended timeframe or at all, we may be subject to several material risks. The price of our common stock may decline to the extent that current market prices reflect a market assumption that the business combination will be completed. In addition, some costs related to the mergers must be paid whether or not the mergers are completed, and we have incurred, and will continue to incur, significant costs, expenses and fees for professional services and other transaction costs in connection with the mergers. In addition, the mergers have resulted in the diversion of management’s attention and other resources, for which we will have received little or no benefit if the mergers are not completed. We may also experience negative reactions from our investors, customers, partners, suppliers, and employees related to the mergers.
Risks Relating to the Ongoing Business
The following risks are risks facing our business assuming that we continue as a stand-alone business, i.e. assuming the business were to continue without the acquisition by Lemonade (other than the risk factor relating to net operating losses).
Risks Related to Financial Performance and Capital Requirements
We have a history of net losses and could continue to incur substantial net losses in the future.
We have incurred recurring losses on an annual basis since our incorporation in 2011. We incurred net losses of $216.5 million and $120.1 million the years ended December 31, 2021 and 2020, respectively. We had an accumulated deficit of $583.0 million as of December 31, 2021.
The principal driver of our losses to date is our insured losses paid associated with accidents and other insured events by our customers. Establishing adequate premium rates is necessary to generate sufficient revenue to offset losses, LAE and other costs. If we do not accurately assess the risks that we underwrite, the premiums that we charge may not be adequate to cover our losses and expenses, which would adversely affect our results of operations and profitability. Moreover, as we continue to invest in our business, we expect expenses to continue to increase in the near term. Such expenses may occur in the areas of telematics, digital marketing, brand advertising, consumer-facing technologies, core insurance operations services and lines of business not presently offered by us. These investments may not result in increased revenue or growth in our business. If we fail to manage our losses or to grow our revenue sufficiently to keep pace with our investments and other expenses, our business will be seriously harmed.
In addition, we will incur additional expenses to support growth. As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. We may encounter unforeseen or unpredictable factors, including unforeseen operating expenses, complications or delays, which may also result in increased costs. Further, it is difficult to predict the size and growth rate of our market or demand for services and success of current or potential future competitors. As a result, we may not achieve or maintain profitability in future periods.
We may require additional capital to support business growth or to satisfy our regulatory capital and surplus requirements, and this capital might not be available on acceptable terms, if at all.
We intend to continue to make investments to support our business growth and may require additional funds to respond to business challenges, including the need to develop new features and products or enhance our existing products and services, satisfy our regulatory capital and surplus requirements, cover losses, improve our operating infrastructure or acquire complementary businesses and technologies. Many factors will affect our capital needs as well as their amount and timing, including growth and profitability, regulatory requirements, market disruptions and other developments. If our present capital and surplus is insufficient to meet current or future operating requirements, including regulatory capital and surplus requirements, or to cover losses, we may need to raise additional funds through financings or curtail our growth. We evaluate financing opportunities from time to time, and our ability to obtain financing will depend, among other things, on our development efforts, business plans and operating performance, as well as the condition of the capital markets at the time we seek financing. We cannot be certain that additional financing will be available to it on favorable terms, or at all.
If we raise additional funds through future issuances of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issues could have rights, preferences and privileges superior to those of holders of our common stock. As an insurance company, we are subject to extensive laws and regulations in every jurisdiction in which we conduct business, and any such issuances of equity or convertible debt securities to secure additional funds may be impeded by regulatory approvals or requirements imposed by such regulatory authorities if such issuances were deemed to result in a person acquiring “control” of our company under applicable insurance laws and regulations. Such regulatory requirements may require potential investors to disclose their organizational structure and detailed financial statements as well as require managing partners, directors and/or senior officers submit biographical affidavits which may deter funds from investing in us. Moreover, any debt financing, in addition to our outstanding credit facilities, that we secures in the future could subject it to restrictive covenants relating to our capital raising activities, our ability to make certain types of investments or payments, and other financial and operational matters, which may increase the difficulty to obtain additional capital or to pursue business opportunities, including new product offerings and potential acquisitions. We may not be able to obtain additional financing on terms favorable to it, if at all. If we are unable to obtain adequate financing or financing on terms satisfactory to it when we require it, our ability to continue to support business growth and to respond to business challenges could be impaired, and our business, revenue, results of operations and financial condition may be materially harmed.
Further, we are restricted by covenants in our credit agreements. These covenants restrict, among other things, the ability to incur additional debt without lender consent or grant liens over our assets, which may limit our ability to obtain additional funds.
Risks Related to General Business Operations
We may lose existing customers or fail to acquire new customers.
We believe that growth of the business and revenue depend upon our ability to continue to grow our business in the geographic markets that we currently serve by retaining existing customers and adding new customers in our current as well as new geographic markets. Expanding into new geographic markets takes time, requires that we navigate and comply with extensive regulations and may occur more slowly than we expect or than it has occurred in the past. If we lose customers, our value will diminish. In particular, while loss performance has improved over time as more customers renew their policies and remain policyholders for longer, a future loss of customers could lead to higher loss ratios or loss ratios that cease to decline, which would adversely impact our profitability. If we fail to remain competitive on customer experience, pricing, and insurance coverage options, our ability to grow the business may also be adversely affected. In addition, we may fail to accurately predict risk segmentation of new customers or potential customers, which could also reduce our profitability.
While a key part of our business strategy is to retain and add customers in our existing markets and into our current product offerings, we also intend to expand operations into new markets and new product offerings. In doing so, we may incur losses or otherwise fail to enter new markets or offer new products successfully. Our expansion into new markets and product offerings may place us in unfamiliar competitive environments and involve various risks, including competition, government regulation, the need to invest significant resources and the possibility that returns on such investments will not be achieved for several years or at all.
There are many factors that could negatively affect our ability to grow our customer base, including if:
• we lose customers to new market entrants and/or existing competitors;
• we do not obtain regulatory approvals necessary for expansion into new markets or in relation to our products (such as underwriting and rating requirements);
• we fail to effectively use search engines, social media platforms, digital app stores, content-based online advertising, and other current and emerging online sources for generating traffic to our website and our mobile app;
• our digital platform experiences disruptions;
• we suffer reputational harm to our brand including from negative publicity, whether accurate or inaccurate;
• we fail to expand geographically;
• we fail to offer new and competitive products, to provide effective updates to our existing products or to keep pace with technological improvements in the industry;
• customers have difficulty installing, updating or otherwise accessing our app or website on mobile devices or web browsers as a result of actions by it or third parties;
• customers prefer less technological solutions or are unable or unwilling to adopt or embrace new technology;
• the perception emerges that purchasing insurance products online is not as effective as purchasing those products through traditional offline methods;
• technical or other problems frustrate the customer experience, particularly if those problems prevent us from generating quotes or paying claims in a fast and reliable manner; or
• we are unable to address customer concerns regarding the content, privacy, and security of our digital platform.
The inability to overcome these challenges could impair our ability to attract new customers and retain existing customers, and could have a material adverse effect on our business, operating results and financial condition.
The COVID-19 pandemic has caused disruption to our operations and may negatively impact our business, key metrics, and results of operations in numerous ways that remain unpredictable.
Our business has been and may continue to be impacted by the effects of the COVID-19 pandemic. This pandemic and related measures taken to contain the spread of COVID-19, such as government-mandated business closures, orders to “shelter in place” (“SIPs”) and travel and transportation restrictions, have negatively affected the U.S. and global economies, disrupted global supply chains, and led to unprecedented levels of unemployment. Beginning in the second quarter of 2020, our business was favorably impacted by the SIPs as our customers drove less. While our premiums collected declined due to per-mile billing, we had a corresponding material decline in incurred losses. Our business has also been impacted by certain state regulations related to COVID-19 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. We continue to assess and update our business continuity plans in the context of this pandemic, including taking steps in an effort to help keep our employees healthy and safe. The spread of COVID-19 has caused us to modify our business practices (including employee travel, employee work locations in certain cases, and cancellation of physical participation in meetings, events, and conferences), and we expect to take further actions as may be required or recommended by government authorities or as we determine are in the best interests of our employees and customers. Furthermore, COVID-19 has impacted and may further impact the broader economies of affected countries, including negatively impacting economic growth, the proper functioning of financial and capital markets, foreign currency exchange rates, and interest rates. The COVID-19 pandemic has caused, and is continuing to cause, significant disruption to the global economy. If the COVID-19 pandemic continues to spread or re-emerges, economic slowdown of a potentially extended duration, as well as a global recession, may occur. This could result in an increase in costs associated with claims under our policies, as well as an increase in the number of customers experiencing difficulty paying premiums, any of which could have a material adverse effect on our business and results of operations. It is also possible that working from home or other remote work arrangements adopted during the SIPs become permanent on a widespread basis, thereby resulting in further reduction in premiums collected due to per-mile billing, or a permanent reduced need for auto insurance. Furthermore, due to COVID-19’s negative impact on driving, regulators in many states continue to mandate or request that auto insurance companies refund a portion of their premium to their policyholders to reflect the insurer’s decrease in projected loss exposure due to the virus. In all of the states in which we operate, state insurance regulators have either encouraged, strongly suggested or mandated insurers to provide COVID-19-related consumer relief. Regulators in several states in which we operate or into which we plan to expand have, in the past, placed a mandatory moratorium on non-pay cancellations and could revive, add to, extend, or expand the scope of such moratoriums, providing consumers grace periods ranging from 60 days to indefinite (based on the term of emergency orders) in duration, during which premium did not need to be paid in a timely fashion. These moratoriums resulted in an increase of premium write-offs. Premium write-offs have been immaterial to date, but could be significant in the future. Although there were still several states with bulletins effective after December 31, 2020, our process of removing all moratorium and non-payment cancellation was completed in mid-2021. Depending on the unpredictable nature of the pandemic and SIPs such moratoriums could be revived, added to, or extended. These mandates and similar regulations or suggestions could negatively impact our ability to charge or increase premiums to adequately cover losses and could result in continued increased premium write-offs. Though we continue to monitor the COVID-19 pandemic closely, including the speed with which it continues to develop, the global breadth of our spread, the range of governmental and community reactions thereto, the extent to which people become vaccinated and the emergence of new variants, such as the delta and omicron variants, there is considerable uncertainty around its duration and ultimate impact. The impact of the pandemic may also exacerbate the other risks described in these Risk Factors, and additional impacts may arise of which we are not currently aware, any of which could have a material effect on us. In addition, if additional variants of COVID-19 emerge, these negative impacts on our business may be further exacerbated. As a result, the full extent of the impact of the pandemic on our overall financial and operating results, whether in the near or long term, cannot be reasonably estimated at this time.
Our future growth and profitability depend in part on our ability to successfully operate in an insurance industry that is highly competitive.
Many of our primary competitors have well-established national brands and market similar products. Our competitors include large national insurance companies as well as up-and-coming companies. Several of these established national insurance companies are larger than us and have significant competitive advantages, including better
name recognition, strong financial ratings, greater resources, easier access to capital, and offer more types of insurance than we do, such as homeowners and renters, which are often bundled together to help attract and retain customers. Our business model and technology are also still nascent compared to the established business models of the well-established incumbents in the insurance market. In addition, the insurance industry consistently attracts well-capitalized new entrants to the market. Our future growth will depend in large part on our ability to grow our insurance business in which traditional insurance companies retain certain advantages. In particular, unlike us, many of these competitors offer customers the ability to purchase multiple other types of insurance coverage and “bundle” them together into one policy and, in certain circumstances, include an umbrella liability policy for additional coverage at competitive prices. Moreover, we may in the future expand into new lines of business and offer additional products beyond automobile insurance, and as we do so, we could face intense competition from traditional insurance companies that are already established in such markets. These new insurance products could take months to be approved by regulatory authorities or may not be approved at all. We have invested in growth strategies by utilizing unique customer value propositions, differentiated product offerings and distinctive advertising campaigns. If we are unsuccessful through these strategies in generating new business, retaining a sufficient number of customers or retaining or acquiring key relationships, our ability to maintain or increase premiums written or the ability to sell our products could be adversely impacted. Because of the competitive nature of the insurance industry, there can be no assurance that we will continue to compete effectively within the industry, or that competitive pressures will not have a material effect on our business, results of operations or financial condition.
Our expansion within the United States will subject us to additional costs and risks, and our plans may not be successful.
Our success depends in significant part on our ability to expand into additional markets in the United States and abroad. We are currently licensed in the District of Columbia and 49 states of the United States, with licenses active in 46 states and the District of Columbia, and write business in eight of those states. We plan to have a presence in almost all states in the future but cannot guarantee that we will be able to provide nationwide coverage on a specific timeline or at all. Moreover, one or more states could revoke our license to operate, or implement additional regulatory hurdles that could preclude or inhibit the ability to obtain or maintain our license in such states. As we seek to expand in the United States, we may incur significant operating expenses, although our expansion may not be successful for a variety of reasons, including because of:
• barriers to obtaining the required government approvals, licenses or other authorizations;
• failures in identifying and entering into joint ventures with strategic partners, both domestically and internationally, or entering into joint ventures that do not produce the desired results;
• challenges in, and the cost of, complying with various laws and regulatory standards, including with respect to the insurance business and insurance distribution, capital and outsourcing requirements, data privacy, tax, claims handling, and local regulatory restrictions;
• difficulty in recruiting and retaining licensed, talented and capable employees;
• competition from local incumbents that already own market share, better understand the local market, may market and operate more effectively and may enjoy greater local affinity or awareness;
• differing demand dynamics, which may make our product offerings less successful; or
• currency exchange restrictions or costs and exchange rate fluctuations, or significant increases to import tariffs.
Expansion into new markets in the United States will also require additional investments both in marketing and with respect to securing applicable regulatory approvals. These incremental costs may result from hiring additional personnel, from engaging third-party service providers and from incurring other research and development costs. If we invest substantial time and resources to expand operations while our revenues from those additional operations do not exceed the expense of establishing and maintaining them, or if we are unable to manage these risks effectively, our business, results of operations and financial condition could be adversely affected. If we fail to grow our geographic footprint or geographic growth occurs at a slower rate than expected, our business, results of operations and financial condition could be materially and adversely affected.
Our brand may not become as widely known or accepted as incumbents’ brands or the brand may become tarnished.
Many of our competitors have brands that are well-recognized. As a relatively new entrant into the insurance market, we have spent, and we expect will for the foreseeable future continue to spend, considerable amounts of money and other resources on creating brand awareness and building our reputation. We may not be able to build brand awareness to levels matching our competitors, and the efforts at building, maintaining and enhancing our reputation could fail and/or may not be cost-effective. Complaints or negative publicity about business practices, our marketing and advertising campaigns (including marketing affiliations or partnerships), compliance with applicable laws, the integrity of the data that we provide to consumers or business partners, data privacy and security issues, and other aspects of our business,
whether real or perceived, could diminish confidence in our brand, which could adversely affect our reputation and business. As we expand our product offerings and enter new markets, we will need to establish our reputation with new customers, and to the extent we are not successful in creating positive impressions, our business in these newer markets could be adversely affected. While we may choose to engage in a broader marketing campaign to further promote our brand, this effort may not be successful or cost effective. If we are unable to maintain or enhance our reputation or enhance consumer awareness of our brand in a cost-effective manner, our business, results of operations and financial condition could be materially adversely affected.
We may not continue to grow at historical rates or achieve or maintain profitability in the future.
Our limited operating history may make it difficult to evaluate our current business and future prospects. While revenue has grown in recent periods, this growth rate may not be sustainable and should not be considered indicative of future performance, and we may not realize sufficient revenue to achieve or maintain profitability. As we grow the business, we expect revenue growth rates may slow in future periods due to a number of reasons, which may include slowing demand for service, increasing competition, a decrease in the growth of our overall market, and failure to capitalize on growth opportunities or the maturation of the business. We have incurred net losses on an annual basis since inception, and may incur significant losses in the future for a number of reasons, including insufficient growth in the number of customers, a failure to retain our existing customers, and increasing competition, as well as other risks described in these Risk Factors, and we may encounter unforeseen expenses, difficulties, complications and delays and other unknown factors. We expect to continue to make investments in the development and expansion of our business, which may not result in increased or sufficient revenue or growth, as a result of which we may not be able to achieve or maintain profitability.
We rely on highly skilled and experienced personnel and if we are unable to attract, retain or motivate key personnel or hire qualified personnel, our business may be seriously harmed. In addition, the loss of key senior management personnel could harm our business and future prospects.
Our performance largely depends on the talents and efforts of highly-skilled and experienced individuals. Our future success depends on our continuing ability to identify, hire, develop, motivate and retain highly skilled and experienced personnel and, if we are unable to hire and train a sufficient number of qualified employees for any reason, we may not be able to maintain or implement our current initiatives or grow, or our business may contract and we may lose market share. Moreover, certain of our competitors or other insurance or technology businesses may seek to hire our employees. We cannot assure you that our equity incentives and other compensation will provide adequate incentives to attract, retain and motivate employees in the future, particularly if the market price of our common stock does not increase or declines. If we do not succeed in attracting, retaining and motivating highly qualified personnel, our business may be seriously harmed.
We depend on our senior management, including Dan Preston, our Chief Executive Officer, as well as other key personnel. We may not be able to retain the services of any of our senior management or other key personnel, as their employment is at-will and they could leave at any time. If we lose the services of one or more of our senior management and other key personnel, including as a result of the COVID-19 pandemic, we may not be able to successfully manage our business, meet competitive challenges or achieve growth objectives. Further, to the extent that our business grows, we will need to attract and retain additional qualified management personnel in a timely manner, and we may not be able to do so. Our future success depends on our continuing ability to identify, hire, develop, motivate, retain and integrate highly skilled personnel in all areas of our organization.
Severe weather events and other catastrophes, including the effects of climate change, are inherently unpredictable and may have a material adverse effect on our financial results and financial condition.
Our business may be exposed to catastrophic events such as tornadoes, tsunamis, tropical storms (including hurricanes), earthquakes, windstorms, hailstorms, severe thunderstorms, wildfires and other fires, as well as non-natural events such as explosions, riots, terrorism, or war, which could cause operating results to vary significantly from one period to the next. We may incur catastrophe losses in our business in excess of: (1) those experienced in prior years, (2) the average expected level used in pricing, (3) current reinsurance coverage limits, or (4) loss estimates from external tornado, hail, hurricane and earthquake models at various levels of probability. In addition, we are subject to customer insurance claims arising from weather events such as winter storms, rain, hail and high winds.
The incidence and severity of weather conditions are largely unpredictable. There is generally an increase in the frequency and severity of customer insurance claims when severe weather conditions occur. The incidence and severity of severe weather conditions and catastrophes are inherently unpredictable and the occurrence of one catastrophe does not render the possibility of another catastrophe greater or lower. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. In particular, severe weather and other catastrophes could significantly increase our costs due to a surge in claims following such events and/or legal and regulatory changes in response to catastrophes that may impair our ability to limit liability under our policies. Severe weather conditions and catastrophes can cause greater losses for us, which can cause our liquidity and financial condition to deteriorate. Given our current state mix and performance of our book, we do not currently carry event
reinsurance coverage for severe weather events. In addition, reinsurance placed in the market also carries some counterparty credit risk.
Climate change may affect the occurrence of certain natural events, such as: an increase in the frequency or severity of wind and thunderstorm events, and tornado or hailstorm events due to increased convection in the atmosphere; more frequent wildfires and subsequent landslides in certain geographies; higher incidence of deluge flooding; and the potential for an increase in severity of the hurricane events due to higher sea surface temperatures. Additionally, climate change may cause an impact on the demand, price and availability of insurance, as well as the value of our investment portfolio. Due to significant variability associated with future changing climate conditions, we are unable to predict the impact climate change will have on our business.
Denial of claims or our failure to accurately and timely pay claims could materially and adversely affect our business, financial condition, results of operations, brand and prospects.
Under the terms of our policies, we are required to accurately and timely evaluate and pay claims. Our ability to do so depends on a number of factors, including the efficacy of our claims processing, the training and experience of our claims adjusters, including third-party claims administrators, and our ability to develop or select and implement appropriate procedures and systems to support our claims functions. We believe that the speed at which our technology-based claims processing platform allows us to process and pay claims is a differentiating factor for our business relative to our competitors, and an increase in the average time to process claims could lead to customer dissatisfaction and undermine our reputation and position in the insurance marketplace. If our claims adjusters or third-party claims administrators are unable to effectively process our volume of claims, our ability to grow the business while maintaining high levels of customer satisfaction could be compromised which, in turn, could adversely affect our operating margins. Any failure to pay claims accurately or timely could also lead to regulatory and administrative actions or other legal proceedings and litigation against us, or result in damage to our reputation, any one of which could materially and adversely affect our business, financial condition, results of operations, brand and prospects.
Unexpected increases in the frequency or severity of claims may adversely affect our results of operations and financial condition.
Our business may experience volatility in claim frequency from time to time, and short-term trends may not continue over the longer term. Changes in claim frequency may result from changes in mix of business, miles driven, distracted driving, macroeconomic or other factors. A significant increase in claim frequency could have an adverse effect on our results of operations and financial condition.
Changes in bodily injury claim severity are impacted by inflation in medical costs, litigation trends and precedents, regulation and the overall safety of automobile travel. Changes in auto property damage claim severity are driven primarily by inflation in the cost to repair vehicles, including parts and labor rates, the mix of vehicles that are declared total losses, model year mix as well as used car values. While actuarial models for pricing and reserving typically include an expected level of inflation, unanticipated increases in claim severity can arise from events that are inherently difficult to predict. Although we pursue various loss management initiatives to mitigate future increases in claim severity, there can be no assurances that these initiatives will successfully identify or reduce the effect of future increases in claim severity.
We may be unable to prevent, monitor or detect fraudulent activity, including policy acquisitions or payments of claims that are fraudulent in nature.
If we fail to maintain adequate systems and processes to prevent, monitor and detect fraud, including fraudulent policy acquisitions or claims activity, or if inadvertent errors occur with such prevention, monitoring and detection systems due to human or computer error, our business could be materially adversely impacted. While we believe past incidents of fraudulent activity have been relatively isolated, we cannot be certain that our systems and processes will always be adequate in the face of increasingly sophisticated and ever-changing fraud schemes. We use a variety of tools to protect against fraud, but these tools may not always be successful at preventing such fraud.
Instances of fraud may result in increased costs, including possible settlement and litigation expenses, and could have a material adverse effect on our business and reputation. In addition, failure to monitor and detect fraud and otherwise comply with state Special Investigation Unit requirements can result in regulatory fines or penalties.
If our customers were to claim that the policies they purchased failed to provide adequate or appropriate coverage, we could face claims that could harm our business, results of operations and financial condition.
Although we aim to provide adequate and appropriate coverage under each of our policies, customers could purchase policies that prove to be inadequate or inappropriate. If such customers were to bring a claim or claims alleging that we failed in our responsibilities to provide them with the type or amount of coverage that they sought to purchase, we could be found liable for amounts significantly in excess of the policy limit, resulting in an adverse effect on our business, results of operations and financial condition. While we maintain errors and omissions insurance coverage to protect us against such liability, such coverage may be insufficient or inadequate.
If we are unable to underwrite risks accurately or charge competitive yet profitable rates to our customers, our business, results of operations and financial condition will be adversely affected.
In general, the premiums for our insurance policies are established at the time a policy is issued and, therefore, before all of our underlying costs are known. The accuracy of our pricing depends on our ability to adequately assess risks, estimate losses and comply with state insurance regulations. Like other insurance companies, we rely on estimates and assumptions in setting our premium rates. We also utilize the data that we gather through our interactions with our customers, as evaluated and curated by our technology-based pricing platform.
Establishing adequate premium rates is necessary, together with investment income, if any, to generate sufficient revenue to offset losses, LAE, and other costs. If we do not accurately assess the risks that we underwrite, the premiums that we charge may not be adequate to cover our losses and expenses, which would adversely affect our results of operations and profitability. Moreover, if we determine that our prices are too low, insurance regulations may preclude us from being able to cancel insurance contracts, non-renew customers, or raise premiums. Alternatively, we could set our premiums too high, which could reduce our competitiveness and lead to fewer customers and lower revenues, which could have a material adverse effect on our business, results of operations and financial condition.
Pricing involves the acquisition and analysis of historical loss data and the projection of future trends, loss costs and expenses, and inflation trends, among other factors, for each of our products in multiple risk tiers and many different markets. In order to accurately price policies, we must:
• collect and properly analyze a substantial volume of data from our customers;
• develop, test and apply appropriate actuarial projections and rating formulas;
• review and evaluate competitive product offerings and pricing dynamics;
• closely monitor and timely recognize changes in trends;
• project both frequency and severity of our customers’ losses with reasonable accuracy; and
• in many states obtain regulatory approval for these processes and the resulting rates.
There are no assurances that we will have success in implementing our pricing methodology accurately in accordance with our assumptions. Our ability to accurately price our policies is subject to a number of risks and uncertainties, including:
• insufficient or unreliable data;
• incorrect or incomplete analysis of available data;
• uncertainties generally inherent in estimates and assumptions;
• our failure to implement appropriate actuarial projections and rating formulas or other pricing methodologies;
• incorrect or incomplete analysis of the competitive environment;
• regulatory constraints on rate increases or the use of certain types of data; and
• failure to accurately estimate investment yields and the duration of our liability for loss and loss adjustment expenses, as well as unanticipated court decisions, legislation or regulatory action.
To address the potential inadequacy of our current business model, we may be compelled to increase the amount allocated to cover policy claims, increase premium rates or adopt tighter underwriting standards, any of which may result in a decline in new business and renewals and, as a result, could have a material adverse effect on our business, results of operations and financial condition.
Our product development cycles are complex and subject to regulatory approval, and we may incur significant expenses before we generate revenues, if any, from new products.
Because our products are highly technical and require rigorous testing and regulatory approvals, development cycles can be complex. Moreover, development projects can be technically challenging and expensive, and may be delayed or defeated by the inability to obtain licensing or other regulatory approvals. The nature of these development cycles may cause us to experience delays between the time we incur expenses associated with research and development and the time we generate revenues, if any, from such expenses. If we expend a significant amount of resources on research and
development and our efforts do not lead to the successful introduction or improvement of products that are competitive in the marketplace, this could materially and adversely affect our business and results of operations. Additionally, anticipated customer demand for a product We are developing could decrease after the development cycle has commenced. Such decreased customer demand may cause us to fall short of our sales targets, and we may nonetheless be unable to avoid substantial costs associated with the product’s development. If we are unable to complete product development cycles successfully and in a timely fashion and generate revenues from such future products, the growth of our business may be harmed.
Litigation and legal proceedings filed by or against us and our subsidiaries could have a material adverse effect on our business, results of operations and financial condition.
From time to time, we are subject to allegations, and may be party to litigation and legal proceedings relating to our business operations. Litigation and other proceedings may include complaints from or litigation by customers or reinsurers, related to alleged breaches of contract or otherwise. We expect that as our market share increases, competitors may pursue litigation to require it to change our business practices or offerings and limit our ability to compete effectively.
As is typical in the insurance industry, we continually face risks associated with litigation of various types arising in the normal course of business operations, including disputes relating to insurance claims under our policies as well as other general commercial and corporate litigation. Although we are not currently involved in any material litigation with our customers, members of the insurance industry are periodically the target of class action lawsuits and other types of litigation, some of which involve claims for substantial or indeterminate amounts, and the outcomes of which are unpredictable. This litigation is based on a variety of issues, including sale of insurance and claim settlement practices. In addition, because we employ a technology platform to collect customer data, it is possible that customers or consumer groups could bring individual or class action claims alleging that our methods of collecting data and pricing risk are impermissibly discriminatory. We cannot predict with any certainty whether we will be involved in such litigation in the future or what impact such litigation would have on our business. If we were to be involved in litigation and it was determined adversely, it could require us to pay significant damages or to change aspects of our operations, either of which could have a material adverse effect on our financial results. Even claims without merit can be time-consuming and costly to defend, and may divert management’s attention and resources away from our business and adversely affect our business, results of operations and financial condition. Additionally, routine lawsuits over claims that are not individually material could in the future become material if aggregated with a substantial number of similar lawsuits. In addition to increasing costs, a significant volume of customer complaints or litigation could also adversely affect our brand and reputation, regardless of whether such allegations have merit or whether we are liable. We cannot predict with certainty the costs of defense, the costs of prosecution, insurance coverage or the ultimate outcome of litigation or other proceedings filed by or against us, including remedies or damage awards, and adverse results in such litigation, and other proceedings may harm our business and financial condition.
The utilization of our net operating loss carryforwards may be limited.
As of December 31, 2021, we had gross U.S. federal income tax net operating losses (“NOLs”), of approximately $475 million available to offset our future taxable income, if any, prior to consideration of annual limitations that may be imposed under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), or otherwise. Of the NOLs, $142 million of losses will begin to expire in 2031 through 2041 and $334 million of losses can be carried forward indefinitely.
As a result of the mergers, Lemonade generally will succeed to our NOLs, but Lemonade may be unable to fully use such NOLs, if at all. Under Section 382 of the Code, if a corporation undergoes an “ownership change” (very generally defined as a greater than 50% change, by value, in the corporation’s equity ownership by certain stockholders or groups of stockholders over a rolling three-year period), the corporation’s ability to use its pre-ownership change NOLs to offset its post-ownership change income may be limited. We have experienced ownership changes in the past, and we will experience an ownership change as a result of the mergers. In addition, Lemonade may experience an ownership change in the future as a result of subsequent shifts in its stock ownership, some of which may be outside of its control. Future regulatory changes could also limit the ability to utilize its NOLs. To the extent our NOLs are not utilized to offset future taxable income, Lemonade’s net income and cash flows may be adversely affected. The Tax Cuts and Jobs Act (the “Tax Act”), as modified by the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), among other things, includes changes to U.S. federal tax rates and the rules governing NOL carryforwards. For U.S. federal NOLs arising in tax years beginning after December 31, 2017, with certain exceptions, including for insurance companies that are not life insurance companies, the Tax Act as modified by the CARES Act limits a taxpayer’s ability to utilize NOL carryforwards in taxable years beginning after December 31, 2020 to 80% of taxable income. In addition, U.S. federal NOLs arising in tax years beginning after December 31, 2017, with an exception for insurance companies that are not life insurance companies, can be carried forward indefinitely. For U.S. federal NOLs for insurance companies that are not life insurance companies subject to taxation under Part 2 of subchapter L of the Code, NOLs may be carried forward for 20 taxable years regardless of when they arise. The income of insurance companies that are not life insurance companies is generally not subject to a percentage limitation for offset by group NOLs. Deferred tax assets for NOLs will need to be measured at the applicable tax rate in effect when the NOLs are expected to be utilized. The new limitation on use of NOLs may significantly impact Lemonade’s ability to utilize the our NOLs to offset taxable income in the future. In addition, for state
income tax purposes, there may be periods during which the use of net operating loss carryforwards is suspended or otherwise limited, which could accelerate or permanently increase state taxes owed. For example, California recently imposed limits on the usability of California state net operating losses to offset taxable income in tax years beginning after 2019 and before 2023.
The insurance business, including the market for automobile, renters’ and homeowners’ insurance, is historically cyclical in nature, and we may experience periods with excess underwriting capacity and unfavorable premium rates, which could adversely affect our business.
Historically, insurers have experienced significant fluctuations in operating results due to competition, frequency and severity of catastrophic events, levels of capacity, adverse litigation trends, regulatory constraints, general economic conditions, and other factors. The supply of insurance is related to prevailing prices, the level of insured losses and the level of capital available to the industry that, in turn, may fluctuate in response to changes in rates of return on investments being earned in the insurance industry. As a result, the insurance business historically has been a cyclical industry characterized by periods of intense price competition due to excessive underwriting capacity as well as periods when shortages of capacity increased premium levels. Demand for insurance depends on numerous factors, including the frequency and severity of catastrophic events, levels of capacity, the introduction of new capital providers and general economic conditions. All of these factors fluctuate and may contribute to price declines generally in the insurance industry.
We cannot predict with certainty whether market conditions will improve, remain constant or deteriorate. Negative market conditions may impair our ability to underwrite insurance at rates we consider appropriate and commensurate relative to the risk assumed. Additionally, negative market conditions could result in a decline in policies sold, an increase in the frequency of claims and premium defaults, and an uptick in the frequency of falsification of claims. If we cannot underwrite insurance at appropriate rates, our ability to transact business will be materially and adversely affected. Any of these factors could lead to an adverse effect on our business, results of operations and financial condition.
Reinsurance may be unavailable at current levels and prices, which may limit our ability to underwrite new policies. Furthermore, reinsurance subjects us to counterparty risk and may not be adequate to protect us against losses, which could have a material effect on our results of operations and financial condition.
Reinsurance is a contract by which an insurer, which may be referred to as the ceding insurer, agrees with a second insurer, called a reinsurer, that the reinsurer will cover a portion of the losses incurred by the ceding insurer in the event a claim is made under one or more policies issued by the ceding insurer, in exchange for a premium. Our regulated insurance subsidiary, Metromile Insurance Company, obtains reinsurance to help manage its exposure to property and casualty insurance risks. Although its reinsurance counterparties are liable to it according to the terms of the reinsurance policies, it remains primarily liable to its policyholders as the direct insurers on all risks reinsured. As a result, reinsurance does not eliminate the obligation of its regulated insurance subsidiary to pay all claims, and we are subject to the risk that one or more of our reinsurers will be unable or unwilling to honor our obligations, that the reinsurers will not pay in a timely fashion, or that our losses are so large that they exceed the limits inherent in our reinsurance contracts, limiting recovery. We are also subject to the risk that under applicable insurance laws and regulations we may not be able to take credit for the reinsurance on our financial statements and instead would be required to hold separate admitted assets as reserves to cover claims on the risks that we have ceded to the reinsurer. Reinsurers may become financially unsound by the time they are called upon to pay amounts due, which may not occur for many years, in which case we may have no legal ability to recover what is due to it under our agreement with such reinsurer. Any disputes with reinsurers regarding coverage under reinsurance contracts could be time consuming, costly, and uncertain of success.
Market conditions beyond our control impact the availability and cost of the reinsurance we purchase. No assurances can be made that reinsurance will remain continuously available us it to the same extent and on the same terms and rates as is currently available, as such availability depends in part on factors outside of our control. A new contract may not provide sufficient reinsurance protection. Market forces and external factors, such as significant losses from weather and seismic events (like hurricanes or earthquakes) or terrorist attacks or an increase in capital and surplus requirements, impact the availability and cost of the reinsurance it purchases. If we are unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts that we consider sufficient at acceptable prices, we would have to either accept an increase in catastrophe exposure, reduce insurance underwritings, or develop or seek other alternatives.
The unavailability of acceptable reinsurance protection would have a materially adverse impact on our business model, which depends on reinsurance companies to absorb any unfavorable variance from the level of losses anticipated at underwriting. If we are unable to obtain adequate reinsurance at reasonable rates, we would have to increase our risk exposure or reduce the level of our underwriting commitments, each of which could have a material adverse effect upon business volume and profitability. Alternatively, we could elect to pay higher than anticipated rates for reinsurance coverage, which could have a material adverse effect upon profitability unless policy premium rates could also be raised, in most cases subject to approval by state regulators, to offset this additional cost.
Reinsurance subjects us to risks of reinsurers and may not be adequate to protect it against losses arising from ceded insurance, which could have a material effect on our results of operations and financial condition.
The collectability of reinsurance recoverables is subject to uncertainty arising from a number of factors, including changes in market conditions, whether insured losses meet the qualifying conditions of the reinsurance contract and whether reinsurers, their affiliates, or certain regulatory bodies have the financial capacity and willingness to make payments under the terms of a reinsurance treaty or contract. Any disruption, volatility and uncertainty in the financial reinsurance markets may decrease our ability to access such markets on favorable terms or at all. In addition, we are subject to the risk that one or more of our reinsurers will not honor its obligations, that the reinsurers will not pay in a timely fashion, or that our losses are so large that they exceed the limits inherent in the reinsurance contracts, limiting recovery. Reinsurers may become financially unsound by the time that they are called upon to pay amounts due, which may not occur for many years, in which case we may have no legal ability to recover what is due to us under our agreement with such reinsurer. In addition, any disputes with reinsurers regarding coverage under reinsurance contracts could be time consuming, costly, and uncertain of success. Our inability to collect a material recovery from a reinsurer could have a material effect on our results of operations and financial condition.
We are subject to payment processing risk.
We currently rely exclusively on one third-party vendor to provide payment processing services, including the processing of payments from credit cards and debit cards, and our business would be disrupted if this vendor refuses to provide these services to us and we are unable to find a suitable replacement on a timely basis or at all. If we or our processing vendor fail to maintain adequate systems for the authorization and processing of credit card transactions, it could cause one or more of the major credit card companies to disallow our continued use of their payment products. In addition, if these systems fail to work properly and, as a result, we do not charge our customers’ credit cards on a timely basis or at all, our business, revenue, results of operations and financial condition could be harmed.
The payment methods that we offer also subject us to potential fraud and theft by criminals, who are becoming increasingly more sophisticated, seeking to obtain unauthorized access to or exploit weaknesses that may exist in the payment systems. If we fail to comply with applicable rules or requirements for the payment methods we accept, or if payment-related data are compromised due to a breach of data, we may be liable for significant costs incurred by payment card issuing banks and other third parties or subject to fines and higher transaction fees, or our ability to accept or facilitate certain types of payments may be impaired. In addition, our customers could lose confidence in certain payment types, which may result in a shift to other payment types or potential changes to our payment systems that may result in higher costs. If we fail to adequately control fraudulent credit card transactions, we may face civil liability, diminished public perception of our security measures, and significantly higher credit card-related costs, each of which could harm our business, results of operations and financial condition.
Our success depends upon the insurance industry continuing to move online at its current pace and the continued growth and acceptance of online and mobile app-based products and services as effective alternatives to traditional offline products and services.
We provide automobile insurance products through our website and online and mobile apps that compete with traditional offline counterparts. We do not offer insurance through traditional, offline brokers or agents. We believe that the continued growth and acceptance of online products and services as well as those offered through mobile devices generally will depend, to a large extent, on the continued growth in commercial use of the internet and mobile apps, and the continued migration of traditional offline markets and industries online.
Purchasers of insurance may develop the perception that purchasing insurance products online or through a mobile app is not as effective as purchasing such products through a broker or other traditional offline methods, and the insurance market may not migrate online as quickly as (or at the levels that) we expect. Moreover, if, for any reason, an unfavorable perception develops that telematics, mobile engagement, a technology-based platform and/or bots are less efficacious than traditional offline methods of purchasing insurance, underwriting, and claims processing, or if it is perceived that our processes lead to unfair outcomes, our business, results of operations and financial condition could be adversely affected.
We may be required to take write-downs or write-offs, restructuring and impairment or other charges that could have a significant negative effect on our financial condition, results of operations and our stock price.
Although INSU conducted due diligence on us in connection with the INSU SPAC transaction, this diligence may not have surfaced all material issues present in our business. Moreover, factors outside of our business and outside of our control may later arise. As a result of these factors, we may be forced to write down or write off assets, restructure operations, or incur impairment or other charges that could result in losses. Further, unexpected risks may arise and previously known risks may materialize in a manner not consistent with our risk analysis. Even though these charges may be non-cash items and not have an immediate impact on our liquidity, the fact that we report charges of this nature could contribute to negative market perceptions about us or our securities. Accordingly, our securities could suffer a reduction in value. Our security holders are unlikely to have a remedy for such reduction in value, unless stockholders are able to successfully claim that the reduction in stock value was due to the breach by our officers or directors of a duty of care or
other fiduciary duty owed to them, or if they are able to bring a private claim that the proxy statement relating to the INSU SPAC transaction contained an actionable material misstatement or material omission.
Our actual incurred losses may be greater than our loss and loss adjustment expense reserves, which could have a material adverse effect on our financial condition and results of operations.
Our financial condition and results of operations depend on our ability to accurately price risk and assess potential losses and loss adjustment expenses under the terms of the policies we underwrite. Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what the expected ultimate settlement and administration of claims will cost, and the ultimate liability may be greater than or less than the current estimate. In our industry, there is always the risk that reserves may prove inadequate since we may underestimate the cost of claims and claims administration.
We base our estimates on the assessment of known facts and circumstances, as well as estimates of future trends in claim severity, claim frequency, judicial theories of liability, and other factors. These variables are affected by both internal and external events that could increase our exposure to losses, including changes in actuarial projections, claims handling procedures, inflation, severe weather, climate change, economic and judicial trends and legislative and regulatory changes. We regularly monitor reserves using new information on reported claims and a variety of statistical techniques to update our current estimate. Our estimates could prove to be inadequate, and this underestimation could have a material adverse effect on our financial condition.
Recorded claim reserves, including case reserves and incurred but not reported (“IBNR”), claims reserves, are based on our estimates of losses after considering known facts and interpretations of the circumstances, including settlement agreements. Additionally, models that rely on the assumption that past loss development patterns will persist into the future are used. Internal factors are considered including our experience with similar cases, actual claims paid, historical trends involving claim payment patterns, pending levels of unpaid claims, loss management programs, product mix, state mix, contractual terms, industry payment and reporting patterns, and changes in claim reporting and settlement practices. External factors are also considered, such as court decisions, changes in law and litigation imposing unintended coverage. We also consider benefits, such as the availability of multiple limits for a single loss occurrence. Regulatory requirements and economic conditions are also considered.
Because reserves are estimates of the unpaid portion of losses and expenses for events that have occurred, including IBNR losses, the establishment of appropriate reserves, including reserves for catastrophes, is an inherently uncertain and complex process that is regularly refined to reflect current estimation processes and practices. The ultimate cost of losses may vary materially from recorded reserves and such variance may adversely affect our results of operations and financial condition as the reserves and reinsurance recoverables are re-estimated.
If any of our insurance reserves should prove to be inadequate for the reasons discussed above, or for any other reason, we will be required to increase reserves, resulting in a reduction in our net income and stockholders’ equity in the period in which the deficiency is identified. Future loss experience substantially in excess of established reserves could also have a material adverse effect on future earnings and liquidity and financial rating, which would affect our ability to attract new business or to retain existing customers.
Performance of our investment portfolio is subject to a variety of investment risks that may adversely affect our financial results.
Our results of operations depend, in part, on the performance of our investment portfolio. We seek to hold a diversified portfolio of investments in accordance with our investment policy, which is routinely reviewed by the Investment Committee of Metromile’s Board of Directors (the “Board”). However, our investments are subject to general economic and market risks as well as risks inherent to particular securities.
Our primary market risk exposures are to changes in interest rates. See Item 7A “Quantitative and Qualitative Disclosures about Market Risk.” In recent years, interest rates have been at or near historic lows. A protracted low interest rate environment would continue to place pressure on our net investment income, particularly as it relates to fixed income securities and short-term investments, which, in turn, may adversely affect our operating results. Future increases in interest rates could cause the values of our fixed income securities portfolios to decline, with the magnitude of the decline depending on the maturity of the securities included in our portfolio and the amount by which interest rates increase. Some fixed income securities have call or prepayment options, which create possible reinvestment risk in declining rate environments. Other fixed income securities, such as asset-backed securities, carry prepayment risk or, in a rising interest rate environment, may not prepay as quickly as expected.
The value of our investment portfolio is subject to the risk that certain investments may default or become impaired due to deterioration in the financial condition of one or more issuers of the securities we hold, or due to deterioration in the financial condition of an insurer that guarantees an issuer’s payments on such investments. Downgrades in the credit ratings of fixed maturities also have a significant negative effect on the market valuation of such securities.
Such factors could reduce our net investment income and result in realized investment losses. Our investment portfolio is subject to increased valuation uncertainties when investment markets are illiquid. The valuation of investments is more subjective when markets are illiquid, thereby increasing the risk that the estimated fair value (i.e., the carrying amount) of the securities we hold in our portfolio does not reflect prices at which actual transactions would occur.
Risks for all types of securities are managed through the application of our investment policy, which establishes investment parameters that include, but are not limited to, maximum percentages of investment in certain types of securities and minimum levels of credit quality, which we believe are within applicable guidelines established by the NAIC as it relates to the portfolio of Metromile Insurance Company. The maximum percentage and types of securities we may invest in are subject to insurance laws and regulations, which may change. Failure to comply with these laws and regulations would cause non-conforming investments to be treated as non-admitted assets for purposes of measuring statutory surplus and, in certain circumstances, we would be required to dispose of such investments.
Although we seek to preserve our capital, we cannot be certain that our investment objectives will be achieved, and results may vary substantially over time. In addition, although we seek to employ investment strategies that are not correlated with our insurance and reinsurance exposures, losses in our investment portfolio may occur at the same time as underwriting losses and, therefore, exacerbate the adverse effect of the losses on us.
Unexpected changes in the interpretation of our coverage or provisions, including loss limitations and exclusions, in our policies could have a material adverse effect on our financial condition and results of operations.
There can be no assurances that specifically negotiated loss limitations or exclusions in our policies will be enforceable in the manner we intend, or at all. As industry practices and legal, judicial, social, and other conditions change, unexpected and unintended issues related to claims and coverage may emerge. For example, many of our policies limit the period during which a customer may bring a claim, which may be shorter than the statutory period under which such claims can be brought against our customers. While these limitations and exclusions help us assess and mitigate our loss exposure, it is possible that a court or regulatory authority could nullify or void a limitation or exclusion, or legislation could be enacted modifying or barring the use of such limitations or exclusions. These types of governmental actions could result in higher than anticipated losses and loss adjustment expenses, which could have a material adverse effect on our financial condition or results of operations. In addition, court decisions, such as the 1995 Montrose decision in California, could read policy exclusions narrowly so as to expand coverage, thereby requiring insurers to create and write new exclusions. Under the insurance laws, the insurer typically has the burden of proving an exclusion applies and any ambiguities in the terms of a loss limitation or exclusion provision are typically construed against the insurer. These issues may adversely affect our business by either broadening coverage beyond our underwriting intent or by increasing the frequency or severity of claims. In some instances, these changes may not become apparent until sometime after we have issued insurance contracts that are affected by the changes. As a result, the full extent of liability under our insurance contracts may not be known for many years after a contract is issued.
We have ceased to be an “emerging growth company” and have incurred and will continue to incur significant additional costs and obligations as a public company.
Effective on December 31, 2021, we ceased to be an “emerging growth company” as defined in the JOBS Act and, as a result, we have incurred and expect to continue to incur additional legal, accounting and other compliance costs as a public company, which will reduce our ability to operate profitably. In addition, new and changing laws, regulations and standards relating to corporate governance and public disclosure for public companies, including Dodd Frank, the Sarbanes-Oxley Act, regulations related thereto and the rules and regulations of the SEC and Nasdaq, have increased the costs and the time that must be devoted to compliance matters. We expect these rules and regulations will increase our legal and financial costs and lead to a diversion of management time and attention from revenue-generating activities.
Failure to maintain adequate financial, information technology and management processes and controls could result in material weaknesses which could result in material misstatements in our financial statements, and adversely affect our business.
Maintaining effective internal control over financial reporting is necessary for us to produce reliable financial reports and is important in helping to prevent financial fraud. If we are unable to maintain adequate internal controls over financial reporting, our ability to produce reliable financial reports could be harmed. Management has determined that our internal control over financial reporting was ineffective as of December 31, 2021 due to a material weakness in information technology general controls ("ITGCs"). For more information, see Item 9A within Part II of this Form 10-K. There is no assurance that we will be able to remediate and maintain effective internal controls over financial reporting. Any failure to maintain effective internal controls over financial reporting could adversely affect our ability to produce reliable financial reports.
We are taking steps to remediate the identified material weakness by, among other things, devoting significant effort and resources to the remediation and improvement of our internal control over financial reporting as it relates to our information technology change management policies. However, we cannot be certain that such measures will remediate the identified material weakness or that we will not identify additional material weaknesses in our internal control over financial reporting in the future.
Any such failure could negatively affect the market price of our common stock, cause investors to lose confidence in our reported financial information, subject us to litigation or investigation by the SEC or other regulatory authorities and generally materially adversely impact the business and results of operations. Notwithstanding our compliance with regulatory and accounting requirements in relation to internal controls and our conclusion over the effectiveness of internal control over financial reporting as of the date reported, there is a risk that our internal controls will prove ineffective and significant deficiencies or material weaknesses in internal controls may occur in the future.
We may be subject to securities litigation, which is expensive and could divert management attention.
Our share price may be volatile and, in the past, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Litigation of this type could result in substantial costs and diversion of management’s attention and resources, which could have a material adverse effect on business, financial condition, results of operations and prospects. Any adverse determination in litigation could also subject it to significant liabilities.
Technology and Security Risks
We rely on telematics, mobile technology and our digital platform to collect data points that we evaluate in pricing and underwriting our insurance policies, managing claims and customer support, and improving business processes. To the extent regulators prohibit or restrict the collection or use of this data, our business could be harmed.
We use telematics, mobile technology and our digital platform to collect data points that we evaluate in pricing and underwriting certain of our insurance policies, managing claims and customer support, and improving business processes. If federal, state or international regulators were to determine that the type of data we collect, the process we use for collecting this data or how we use it unfairly discriminates against a protected class of people, regulators could move to prohibit or restrict our collection or use of this data. In addition, if legislation were to restrict our ability to collect driving behavior data, it could impair our capacity to underwrite insurance cost effectively, negatively impacting our revenue and earnings. Due to Proposition 103 in California, our largest market, we are currently limited in our ability to use telematics data beyond miles-driven to underwrite insurance, including data on how the car is driven. This could hinder our ability to accurately assess the risks that we underwrite in other states if they were to pass similar laws or regulations. In three other states where we currently operate, we do not use behavioral telematics data because it is either (a) permitted, but we opted out given uncertainty regarding the impact such data would have on pricing, or (b) it is voluntary (meaning the policyholder has to opt in). As we aim to be a fully national provider of insurance across 49 states and the District of Columbia in the future, we will need to comply with the rules and regulations of each market. At this time, we do not know which of our target markets prohibit, permit with conditions, or fully permit the use of behavioral telematics to set premiums, and if permitted, if this will be of benefit to us in pricing. While we are currently in discussions with regulators to allow the use of telematics to a greater extent to underwrite and price insurance policies, we cannot predict the outcome of these discussions, and there can be no assurance that state regulators will revise regulations accordingly, if at all, nor that current permissive states will further restrict the use of such data.
Although there is currently limited federal and state legislation outside of California restricting our ability to collect driving behavior data, private organizations are implementing principles and guidelines to protect driver privacy. The Alliance of Automobile Manufacturers and Global Automakers established their Consumer Privacy Protection Principles to provide member automobile manufacturers with a framework with which to consider privacy and build privacy into their products and services while the National Automobile Dealers Association has partnered with the Future of Privacy Forum to produce consumer education guidelines that explain the kinds of information that may be collected by consumers’ cars, the guidelines that govern how it is collected and used, and the options consumers may have to protect their vehicle data. The Global Alliance for Vehicle Data Access is another organization that was formed to advocate for driver ownership of all vehicle data, particularly for insurance underwriting purposes. If federal or state legislators were to pass laws limiting our ability to collect driver data, such legislation could have a material adverse effect on our business, financial condition or results of operations.
Some state regulators have expressed interest in the use of external data sources, algorithms and/or predictive models in insurance underwriting or rating. Specifically, regulators have raised questions about the potential for unfair discrimination, disparate impact, and lack of transparency associated with the use of external consumer data. A determination by federal or state regulators that the data points we collect and the process we use for collecting this data unfairly discriminates against a protected class of people could subject us to fines and other sanctions, including, but not limited to, disciplinary action, revocation and suspension of licenses, and withdrawal of product forms. Any such event could, in turn, materially and adversely affect our business, financial condition, results of operations and prospects. Although we have implemented policies and procedures into our business operations that we feel are appropriately calibrated to our machine learning and automation-driven operations, these policies and procedures may prove inadequate to manage the use of this nascent technology, resulting in a greater likelihood of inadvertent legal or compliance failures.
In addition, the National Association of Insurance Commissioners (“NAIC”), announced on July 23, 2020 the formation of a new Race and Insurance Special Committee (the “Special Committee”). The Special Committee is tasked with analyzing the level of diversity and inclusion within the insurance sector, identifying current practices in the insurance
industry that disadvantage minorities and making recommendations to increase diversity and inclusion within the insurance sector and address practices that disadvantage minorities. The Special Committee may look into strengthening the unfair discrimination laws, such as prohibiting the use of credit scores in the underwriting of auto insurance. Any new unfair discrimination legislation that would prohibit us from using data that it currently uses or plans to use in the future to underwrite insurance could negatively impact our business.
Regulators may also require us to disclose the external data we use, algorithms and/or predictive matters prior to approving our underwriting models and rates. Such disclosures could put our intellectual property at risk.
Additionally, existing laws, such as the California Consumer Privacy Act (the “CCPA”), future and recently adopted laws, such as the California Privacy Rights Act (the “CRPA”), and evolving attitudes about privacy protection may impair our ability to collect, use, and maintain data points of sufficient type or quantity to develop and train our algorithms. If such laws or regulations were enacted federally or in a large number of states in which we operate, it could impact the integrity and quality of our pricing and underwriting processes.
We depend on search engines, social media platforms, digital app stores, content-based online advertising and other online sources to attract consumers to our website and mobile app both rapidly and cost-effectively. If these third parties change their listings or increase their pricing, if our relationship with them deteriorates or terminates, or due to other factors beyond our control, we may be unable to attract new customers rapidly and cost-effectively, which would adversely affect our business and results of operations.
Our success depends on our ability to attract consumers to our website and mobile app and convert them into customers in a rapid and cost-effective manner. We depend in large part on search engines, social media platforms, digital app stores, content-based online advertising and other online sources for traffic to our website and its mobile app, which are material sources for new consumers.
With respect to search engines, we are included in search results as a result of both paid search listings, where we purchase specific search terms that result in the inclusion of our advertisement, and free search listings, which depend on algorithms used by search engines. For paid search listings, if one or more of the search engines or other online sources on which we rely for purchased listings modifies or terminates their relationship with us, expenses could rise if we are required to pay a higher price for such listings or if the alternatives we find are more expensive, or we could lose consumers and traffic to our website could decrease, any of which could have a material adverse effect on our business, results of operations and financial condition. For free search listings, if search engines on which we rely for algorithmic listings modify their algorithms, our websites may appear less prominently or not at all in search results, which could result in reduced traffic to our websites, as a result of which we might attract fewer new customers.
Our ability to maintain or increase the number of consumers who purchase our products after being directed to our website or mobile app from other digital platforms depends on many factors that are not within our control. Search engines, social media platforms and other online sources often revise their algorithms and introduce new advertising products. If one or more of the search engines or other online sources on which we rely for traffic to our website and mobile app were to modify its general methodology for how it displays its advertisements or keyword search results, resulting in fewer consumers clicking through to our website and mobile app, our business and operating results are likely to suffer. In addition, if our online display advertisements are no longer effective or are not able to reach certain consumers due to consumers’ use of ad-blocking software, our business and operating results could suffer.
Additionally, changes in regulations could limit the ability of search engines and social media platforms, including but not limited to Google and Facebook, to collect data from users and engage in targeted advertising, making them less effective in disseminating our advertisements to target customers. For example, the proposed Designing Accounting Safeguards to Help Broaden Oversight and Regulations on Data (“DASHBOARD”) Act would mandate annual disclosure to the SEC of the type and “aggregate value” of user data used by harvesting companies, such as Facebook, Google and Amazon, including how revenue is generated by user data and what measures are taken to protect the data. If the costs of advertising on search engines and social media platforms increase, we may incur additional marketing expenses or be required to allocate a larger portion of our marketing spend to other channels and our business and operating results could be adversely affected. Similarly, changes to regulations applicable to the insurance brokerage and distribution business may limit our ability to rely on key distribution platforms, if the third-party distribution platforms are unable to continue to distribute our insurance products without an insurance producer license pursuant to applicable insurance law and regulations.
The marketing of our insurance products depends on our ability to cultivate and maintain cost-effective and otherwise satisfactory relationships with digital app stores, in particular, those operated by Google and Apple. As we grow, we may struggle to maintain cost-effective marketing strategies, and our customer acquisition costs could rise substantially. Furthermore, because many of our customers access our insurance products through a mobile app, we depend on the Apple App Store and the Google Play Store to distribute our mobile app.
Operating system platforms and application stores controlled by third parties, such as Apple and Google, may change their terms of service or policies in a manner that increases our costs or impacts our ability to distribute our mobile app, collect data through it, and market our products.
We are subject to the terms of service and policies governing the operating system platforms on which its mobile app runs and the application stores through which we distribute our mobile app, such as those operated by Apple and Google. These terms of service and policies govern the distribution, operation and promotion of applications on such platforms and stores. These platforms and stores have broad discretion to change and interpret their terms of service and policies in a manner that may adversely affect our business. For example, an operating system platform or application store may increase fees associated with access to it, restrict the collection of data through mobile apps that run on those platforms, restrict how that data is used and shared, and limit how mobile app publishers advertise online.
We rely on telematics to collect data points from an OBD-II device in customers’ vehicles. This data is used to accurately bill the miles they have driven, evaluate pricing and underwriting risks, manage claims and customer support, and improve business processes. Limitations on our ability to collect, use or share telematics and other data derived from the OBD-II device, as well as new technologies that block our ability to collect, use or share such data, could significantly diminish the value of our platform and have an adverse effect on our ability to generate revenue. Limitations or blockages on our ability to collect, use or share data derived from use of our mobile app may also restrict our ability to analyze such data to facilitate our product improvement, research and development and advertising activities. For example, in June 2020, Apple announced plans to require applications using its mobile operating systems to obtain an end-user’s permission to track them or access their device’s advertising identifier for advertising and advertising measurement purposes, as well as other restrictions that could adversely affect our business.
If we were to violate, or be perceived to have violated, the terms of service or policies of an operating system platform or application store, the provider may limit or block our access to it. It is possible that an operating system platform or application store might limit, eliminate or otherwise interfere with the distribution of our mobile app, the features we provide and the manner in which we market our mobile app, or give preferential treatment on their platforms or stores to a competitor. To the extent either or both of them do so, our business, results of operations and financial condition could be adversely affected.
Furthermore, one of the factors we use to evaluate customer satisfaction and market position is our Apple App Store ratings. This rating, however, may not be a reliable indicator of our customer satisfaction relative to other companies who are rated on the Apple App Store since, to date, we have received a fraction of the number of reviews of some of the companies we benchmark against, and thus our number of positive reviews may not be as meaningful.
Our technology platform may not operate properly or as we expect it to operate.
We utilize our technology platform to gather customer data in order to determine whether or not to write and how to price our insurance products. Similarly, we use our technology platform to process many of our claims. Our technology platform is expensive and complex, our continuous development, maintenance and operation may entail unforeseen difficulties including material performance problems or undetected defects or errors. We may encounter technical obstacles, and it is possible that we may discover additional problems that prevent our technology from operating properly. If our platform does not function reliably, we may incorrectly select customers, bill customers, price insurance products or incorrectly pay or deny insurance claims made by customers. These errors could result in inadequate insurance premiums paid relative to claims made, resulting in increased financial losses. These errors could also cause customer dissatisfaction with us, which could cause customers to cancel or fail to renew their insurance policies with it or make it less likely that prospective customers obtain new insurance policies from it. Additionally, technology platform errors may lead to unintentional bias and discrimination in the underwriting process, which could subject it to legal or regulatory liability and harm our brand and reputation. Any of these eventualities could result in a material adverse effect on our business, results of operations and financial condition.
We depend on one third-party technology provider to support our telematics data acquisition and rely on one third-party logistic provider to fulfill telematics hardware requests.
We utilize telematics technology to gather data that we use to underwrite insurance policies, bill customers, and manage claims and customer service. Our telematics hardware is designed and manufactured, and telematics data services are provided to us by a third party. This company may fail to provide us accurate or complete data due to technical or operating failures, their hardware may have errors that inaccurately collect or represent driver behavior, car location, or other sensor data, or they may stop offering their services to us. If we are delivered inaccurate or no data due to these failures, we may overpay claims, underbill customers, or create customer dissatisfaction that causes customers to cancel their insurance policies with us. Any of these eventualities could result in a material adverse effect on our business, results of operations and financial condition.
Additionally, our telematics technology hardware is currently sourced from a single vendor. If there is a shortage of one or more key components in their supply chain, the vendor ceases to exist, terminates their existing relationship with us, or otherwise, this could cause a significant disruption to our operations and ability to collect data from existing customers, acquire new customers, and may have a material adverse effect on our results of operations. If telematics
hardware cannot be easily sourced from a different supplier and/or significant expense is required to transition to another provider, we may be subject to considerable premium loss. Additionally, we may experience difficulties associated with utilizing a third-party logistics provider. All our physical inventory management process, as well as the shipping and receiving of our inventory, is performed by one third-party logistics provider. There is a possibility that the third-party logistics provider will not perform as expected and we could experience delays in our ability to ship, receive, and process telematics hardware inventory in a timely manner. As with our sole supplier, we could experience an interruption in our operations if the relationship with this company is compromised in any way. If we are unable to have our telematics hardware shipped in a timely manner, we may suffer reputational harm, and loss of premium revenue.
Security incidents, or real or perceived errors, failures or bugs in our systems, website or app could impair our operations, compromise our confidential information or our customers’ personal information, damage our reputation and brand, and harm our business and operating results.
Our continued success depends on our systems, applications, and software continuing to operate and to meet the changing needs of our customers and users. We rely on our technology and engineering staff and vendors to successfully implement changes to and maintain our systems and services in an efficient and secure manner. Like all information systems and technology, our website and mobile app may contain or develop material errors, failures, vulnerabilities or bugs, particularly when new features or capabilities are released, and may be subject to computer viruses or malicious code, break-ins, phishing impersonation attacks, attempts to overload its servers with denial-of-service or other attacks, ransomware and similar incidents or disruptions from unauthorized use of our computer systems, as well as unintentional incidents causing data leakage, any of which could lead to interruptions, delays or website or mobile app shutdowns.
Operating our business and products involves the collection, storage, use and transmission of sensitive, proprietary and confidential information, including personal information, pertaining to our current, prospective and past customers, staff, contractors, and business partners. The security measures we take to protect this information may be breached as a result of computer malware, viruses, social engineering, ransomware attacks, hacking and cyberattacks, including by state-sponsored and other sophisticated organizations. Such incidents have become more prevalent in recent years. For example, attempts to fraudulently induce our personnel into disclosing usernames, passwords or other information that can be used to access its systems and the information in them have increased and could be successful. Our security measures could also be compromised by our personnel, theft or errors, or be insufficient to prevent exploitation of security vulnerabilities in software or systems on which we rely. Such incidents have in the past resulted in unauthorized access to certain personal information, and may in the future result in unauthorized, unlawful or inappropriate use, destruction or disclosure of, access to, or inability to access the sensitive, proprietary and confidential information that we handle. These incidents may remain undetected for extended periods of time.
We rely on third-party service providers to provide critical services that help us deliver our solutions and operate our business. These providers may support or operate critical business systems for us or store or process the same sensitive, proprietary and confidential information that we handle. These service providers may not have adequate security measures and could experience a security incident that compromises the confidentiality, integrity or availability of the systems they operate for us or the information they process on our behalf. Such occurrences could adversely affect our business to the same degree as if we had experienced these occurrences directly and we may not have recourse to the responsible third-party service providers for the resulting liability we incur.
Because there are many different cybercrime and hacking techniques and such techniques continue to evolve, we may be unable to anticipate attempted security breaches, react in a timely manner or implement adequate preventative measures. While we have developed systems and processes designed to protect the integrity, confidentiality and security of us and our customers’ confidential and personal information under our control, we cannot assure you that any security measures that we or our third-party service providers have implemented will be effective against current or future security threats.
A security breach or other security incident of our systems, data, website or app has occurred in the past, and may occur in the future. For example, in January 2021, we discovered a security incident related to our online pre-filled quote form and application process, which resulted in unknown person(s) accessing personal information of certain individuals, including individuals’ driver’s license numbers. An actual security breach or incident, a material vulnerability, or the perception that one has occurred or exists, could: result in a loss of customer confidence in the security of our platform and damage to our reputation and brand; reduce demand for our insurance products; disrupt normal business operations; require us to expend significant capital and resources to investigate and remedy the incident, and prevent recurrence and comply with any breach notification obligations; and subject us to litigation (including class actions), regulatory enforcement action, fines, penalties, and other liability, which could adversely affect our business, financial condition and results of operations.
Even if we take steps that we believe are adequate to protect us from cyber threats, hacking against our competitors or other companies in our industry could create the perception among our customers or potential customers that our digital platform is not safe to use. Security incidents could also damage our IT systems and our ability to make the financial reports and other public disclosures required of public companies. These risks are likely to increase as we continue to grow and process, store and transmit an increasingly large volume of data.
We rely on technology and intellectual property from third parties for pricing and underwriting our insurance policies, handling claims and maximizing automation, the unavailability or inaccuracy of which could limit the functionality of our products and disrupt our business.
We use technology and intellectual property licensed from unaffiliated third parties in certain of our products, and we may license additional third-party technology and intellectual property in the future. Any errors or defects in this third-party technology and intellectual property could result in harm to our brand and business. In addition, licensed technology and intellectual property may not continue to be available on commercially reasonable terms, or at all.
Further, although we believe that there are currently adequate replacements for the third-party technology and intellectual property we presently use, the loss of its right to use any of this technology and intellectual property could result in delays in producing or delivering affected products until equivalent technology or intellectual property is identified, licensed or otherwise procured, and integrated. Our business would be disrupted if any technology and intellectual property we license from others or functional equivalents of this software were either no longer available to us or no longer offered to us on commercially reasonable terms or prices. In either case, we would be required either to attempt to redesign our products to function with technology and intellectual property available from other parties or to develop these components ourselves, which would result in increased costs and could result in delays in product sales and the release of new product offerings. Alternatively, we might be forced to limit the features available in affected products. Any of these results could harm our business, results of operations and financial condition.
New or changing technologies, including those impacting personal transportation, could cause a disruption in our business model, which may materially impact our results of operations and financial condition.
If we fail to anticipate the impact on our business of changing technology, including automotive technology, our ability to successfully operate may be materially impaired. Our business could also be affected by potential technological changes, such as autonomous or partially autonomous vehicles or technologies that facilitate ride, car or home sharing, or vehicles with built-in telematics features. Such changes could disrupt the demand for products from current customers, create coverage issues or impact the frequency or severity of losses, or reduce the size of the automobile insurance market, causing our business to decline. Since auto insurance constitutes substantially all of our current business, we are more sensitive than other insurers and more adversely affected by trends that could decrease auto insurance rates or reduce demand for auto insurance over time. We may not be able to respond effectively to these changes, which could have a material effect on our results of operations and financial condition.
Government Regulatory Risks
Regulatory changes may limit our ability to develop or implement our telematics-based pricing model and/or may eliminate or restrict the confidentiality of our proprietary technology.
Our future success depends on our ability to continue to develop and implement our telematics-based pricing model, and to maintain the confidentiality of our proprietary technology. Changes to existing laws, their interpretation or implementation, or new laws could impede the use of this technology, or require that we disclose our proprietary technology to competitors, which could negatively impact our competitive position and result in a material adverse effect on our business, results of operations, and financial condition. For example, the November 2020 ballot measure in California, which was formally adopted, will enact the CPRA, which mandates issuance of regulations providing California residents with the right to information about the logic of certain algorithmic decisions about them and the right to opt-out of such decisions. Such regulations, and similar laws that could be enacted in other states, could require disclosure of our proprietary technology, limit the effectiveness of our products and reduce demand for them.
New legislation or legal requirements may affect how we communicate with our customers, which could have a material adverse effect on our business model, financial condition, and results of operations.
State and federal lawmakers, insurance regulators, and advisory groups such as the NAIC are focusing upon the use of artificial intelligence broadly, including concerns about transparency, deception, and fairness in particular. Changes in laws or regulations, or changes in the interpretation of laws or regulations by a regulatory authority, specific to the use of artificial intelligence, may decrease our revenues and earnings and may require us to change the manner in which we conduct some aspects of our business. We may also be required to disclose our proprietary software to regulators, putting our intellectual property at risk, in order to receive regulatory approval to use such artificial intelligence in the underwriting of insurance and/or the payment of claims. In addition, our business and operations are subject to various U.S. federal, state, and local consumer protection laws, including laws which place restrictions on the use of automated tools and technologies to communicate with wireless telephone subscribers or consumers generally. For example, a California law makes it unlawful for any person to use a bot to communicate with a person in California online with the intent to mislead the other person about its artificial identity for the purpose of knowingly deceiving the person about the content of the communication in order to incentivize a purchase of goods or services in a commercial transaction. Although we have taken steps to mitigate our liability for violations of this and other laws restricting the use of electronic communication tools, no assurance can be given that we will not be exposed to civil litigation or regulatory enforcement. Further, to the extent that any changes in law or regulation further restrict the ways in which we communicate with prospective or current customers before or during onboarding, customer care, or claims management, these restrictions
could result in a material reduction in our customer acquisition and retention, reducing the growth prospects of our business, and adversely affecting our financial condition and future cash flows.
Failure to maintain our risk-based capital at the required levels could adversely affect our ability to maintain regulatory authority to conduct our business.
We are required to have sufficient capital and surplus in order to comply with insurance regulatory requirements, support our business operations and minimize our risk of insolvency. The NAIC has developed a system to test the adequacy of statutory capital and surplus of U.S.-based insurers, known as risk-based capital, that all states have adopted. This system establishes the minimum amount of capital and surplus necessary for an insurance company to support its overall business operations in consideration of its size and risk profile. It identifies insurers that may be inadequately capitalized by looking at certain risk factors, including asset risk, credit risk and underwriting risk with respect to the insurer’s business in order to determine an insurer’s authorized control level risk-based capital. An insurer’s risk-based capital ratio measures the relationship between its total adjusted capital and its authorized control level risk-based capital.
Insurers with a ratio falling below certain calculated thresholds may be subject to varying degrees of regulatory action, including heightened supervision, examination, rehabilitation or liquidation. An insurance company with total adjusted capital that is less than 200% of its authorized control level risk-based capital is at a company action level, which would require the insurance company to file a risk-based capital plan that, among other things, contains proposals of corrective actions the company intends to take that are reasonably expected to result in the elimination of the company action level event. Additional action level events occur when the insurer’s total adjusted capital falls below 150%, 100% and 70% of its authorized control level risk-based capital. Lower percentages trigger increasingly severe regulatory responses. In the event of a mandatory control level event (triggered when an insurer’s total adjusted capital falls below 70% of its authorized control level risk-based capital), an insurer’s primary regulator is required to take steps to place the insurer into receivership. As part of its regulatory review and approval of this transaction, the Delaware Department of Insurance required us to enter into a Capital Maintenance Agreement (the “CMA”). The CMA requires us, if the transaction closes, to ensure that the regulated insurance subsidiary, Metromile Insurance Company, will have and maintain total adjusted capital in an amount equal to at least 300% of the insurance company’s authorized control level risk based capital from the close of the transaction until a date to be determined by the regulator in mid-2025. Being required to maintain capital levels above the statutory requirement could put constraints on our ability to deploy capital to which our competitors are not subject.
In addition, the NAIC Insurance Regulatory Information System (the “IRIS”), is a collection of analytical tools designed to provide state insurance regulators with an integrated approach to screening and analyzing the financial condition of insurance companies operating in their respective states. If our ratios fall outside of the usual range for one or more ratios set forth by the IRIS for any number of reasons, it could subject us to heightened regulatory scrutiny or measures, or create investor uncertainty around the stability of our financial condition, which could harm our business.
Further, the NAIC has promulgated a Model Regulation to Define Standards and Commissioner’s Authority for Companies Deemed to be in Hazardous Financial Condition (the “Hazardous Financial Condition Standards”), which has been adopted by many states in whole or part. If our financial condition is deemed by state insurance regulators to meet the Hazardous Financial Conditions Standards, it could subject us to heightened regulatory scrutiny or measures, or create uncertainty around the stability of our financial condition, which could harm our business. As a relatively new entrant to the insurance industry, we may face additional capital and surplus requirements as compared to those of our larger and more established competitors. Failure to maintain adequate risk-based capital at the levels required by law and/or the Delaware Department of Insurance as described above could result in increasingly onerous reporting and examination requirements and could adversely affect our ability to maintain regulatory authority to conduct our business.
We are subject to stringent and changing privacy and data security laws, regulations, and standards related to data privacy and security. Our actual or perceived failure to comply with such obligations could harm our reputation, subject us to significant fines and liability, or adversely affect our business.
In the United States, insurance companies are subject to the privacy provisions of the federal Gramm-Leach-Bliley Act and the NAIC Insurance Information and Privacy Protection Model Act, to the extent adopted and implemented by various state legislatures and insurance regulators. The regulations implementing these laws require insurance companies to disclose their privacy practices to consumers, allow them to opt-in or opt-out, depending on the state, of the sharing of certain personal information with unaffiliated third parties, and maintain certain security controls to protect their information. Violators of these laws face regulatory enforcement action, substantial civil penalties, injunctions, and in some states, private lawsuits for damages.
advertising purposes. The CCPA excludes information covered by Gramm-Leach-Bliley Act, the Driver’s Privacy Protection Act, the Fair Credit Reporting Act (the “California Financial Information Privacy Act”) from the CCPA’s scope, but the CCPA’s definition of “personal information” is broad and may encompass other information that we maintain. Some observers have noted that the CCPA could mark the beginning of a trend toward more stringent privacy legislation in the U.S., and multiple states have enacted or proposed similar laws. There is also discussion in Congress of new comprehensive federal data protection and privacy law to which we likely would be subject if it is enacted.
In addition, California voters approved the November 2020 ballot measure which will enact the CPRA, substantially expanding the requirements of the CCPA. As of January 1, 2023, the CPRA will give consumers the ability to limit use of precise geolocation information and other categories of information classified as “sensitive”; add e-mail addresses and passwords to the list of personal information that, if lost or breached, would give the affected consumers the right to bring private lawsuits; increase the maximum penalties threefold for violations concerning consumers under age 16; and establish the California Privacy Protection Agency to implement and enforce the new law, as well as impose administrative fines. The effects of the CCPA, CPRA and other similar state or federal laws are potentially significant and may require us to modify our data processing practices and policies, incur substantial compliance costs and subject us to increased potential liability.
In addition to privacy and data security requirements under applicable laws, we are subject to the Payment Card Industry Data Security Standard (“PCI DSS”), a self-regulatory standard that requires companies that process payment card data to implement certain data security measures. If we or our payment processors fail to comply with the PCI DSS, we may incur significant fines or liability and lose access to major payment card systems. Industry groups may in the future adopt additional self-regulatory standards by which we are legally or contractually bound. If we expand into Europe, we may also face particular privacy, data security, and data protection risks in connection with requirements of the General Data Protection Regulation (E.U.) 2016/679 (“GDPR”) and other data protection regulations. Among other stringent requirements, the GDPR restricts transfers of data outside of the E.U. to countries deemed to lack adequate privacy protections (such as the U.S.), unless an appropriate safeguard specified by the GDPR is implemented. A July 16, 2020 decision of the Court of Justice of the European Union invalidated a key mechanism for lawful data transfer to the U.S. and called into question the viability of its primary alternative. As such, the ability of companies to lawfully transfer personal data from the E.U. to the U.S. is presently uncertain. Other countries have enacted or are considering enacting similar cross-border data transfer rules or data localization requirements. These developments could limit our ability to deliver our products in the E.U. and other foreign markets. In addition, any failure or perceived failure to comply with these rules may result in regulatory fines or penalties including orders that require us to change the way we process data.
Additionally, we are subject to the terms of our privacy policies, privacy-related disclosures, and contractual and other privacy-related obligations to our customers and other third parties. Any failure or perceived failure by us or third parties we work with to comply with these policies, disclosures, and obligations to customers or other third parties, or privacy or data security laws may result in governmental or regulatory investigations, enforcement actions, regulatory fines, criminal compliance orders, litigation or public statements against us by consumer advocacy groups or others, and could cause customers to lose trust in us, all of which could be costly and have an adverse effect on our business.
We rely on our mobile application to execute our business strategy. Government regulation of the internet and the use of mobile applications in particular is evolving, and unfavorable changes could seriously harm our business.
We rely on our mobile application to execute our business strategy. We are subject to general business regulations and laws as well as federal and state regulations and laws specifically governing the internet and the use of mobile applications in particular. Existing and future laws and regulations may impede the growth of the internet or other online services, and increase the cost of providing online services. These regulations and laws may involve taxes, tariffs, privacy and data security, anti-spam, content protection, electronic contracts and communications, electronic signatures and consents, consumer protection and social media marketing. It is at times not clear how existing laws governing issues such as property ownership, sales and other taxes and consumer privacy apply to the internet and the use of mobile applications in particular, as the vast majority of these laws were adopted prior to the advent of the internet and the use of mobile applications and do not contemplate or address the unique issues raised by the internet. It is possible that general business regulations and laws, or those specifically governing the internet and the use of mobile applications in particular, may be interpreted and applied in a manner that is inconsistent from one jurisdiction to another and may conflict with other rules or our practices. We cannot be sure that our practices have complied, currently comply or will comply fully with all such laws and regulations. Any failure, or perceived failure, by it to comply with any of these laws or regulations could result in damage to our reputation, a loss in business and proceedings or actions against us by governmental entities or others. Any such proceeding or action could hurt our reputation, force us to spend significant amounts in defense of these proceedings, distract our management, increase the costs of doing business and decrease the use of our mobile application or website by consumers and suppliers and may result in the imposition of monetary liability. We may also be contractually liable to indemnify and hold harmless third parties from the costs or consequences of non-compliance with any such laws or regulations.
We may be subject to compliance obligations arising from medical information privacy regulations.
By processing certain personal injury data on behalf of our clients, we may be subject to compliance obligations under privacy and data security-related laws specific to the protection of healthcare or medical information. Although we
may be subject to the Health Insurance Portability and Accountability Act (“HIPAA”), the Health Information Technology for Economic and Clinical Health Act (the “HITECH Act”) and comparable state laws, we do not have a process in place to assess or align our privacy and security practices specifically against requirements for protecting medical information.
We are subject to extensive regulation and potential further restrictive regulation may increase our operating costs and limit our growth.
We are subject to extensive laws by the individual state insurance departments in the states in which we transact business. These laws are complex and subject to change. Changes may sometimes lead to additional expenses, increased legal exposure, increased required reserves or capital and surplus, delays in implementing desired rate increases or business operations, and additional limits on our ability to grow or to achieve targeted profitability. Laws to which our licensed insurance carriers and producer subsidiaries are subject include, but are not limited to:
• prior approval of transactions resulting in a change of control;
• approval of policy forms and premiums;
• approval of intercompany service agreements;
• statutory and risk-based capital solvency requirements, including the minimum capital and surplus our regulated insurance subsidiary must maintain pursuant to applicable laws and the CMA entered into as required by the Delaware Department of Insurance described above;
• establishing minimum reserves that insurance carriers must hold to pay projected insurance claims;
• required participation by our regulated insurance subsidiary in state guaranty funds;
• restrictions on the type and concentration of our regulated insurance subsidiary’s investments;
• restrictions on the advertising and marketing of insurance;
• restrictions on the adjustment and settlement of insurance claims;
• restrictions on the use of rebates to induce a policyholder to purchase insurance;
• restrictions on the sale, solicitation and negotiation of insurance;
• restrictions on the sharing of insurance commissions and payment of referral fees;
• prohibitions on the underwriting of insurance on the basis of race, sex, religion and other protected classes;
• restrictions on our ability to use telematics to underwrite and price insurance policies, such as in California, our largest market, and other states in which we operate or may operate in the future;
• restrictions on the ability of our regulated insurance subsidiary to pay dividends to us or enter into certain related party transactions without prior regulatory approval;
• rules requiring the maintenance of statutory deposits for the benefit of policyholders;
• privacy regulation and data security;
• state-mandated premium rebates, refunds, or reductions as a result of potentially lower risk exposure due to the COVID-19 pandemic and related emergency orders;
• regulation of corporate governance and risk management; and
• periodic examinations of operations, finances, market conduct and claims practices; and required periodic financial reporting.
To the extent we decide to expand our current product offerings to include other insurance products, this would subject us to additional regulatory requirements and scrutiny in each state in which we elect to offer such products. Most states have also adopted legislation prohibiting unfair methods of competition and unfair or deceptive acts and practices in the business of insurance as well as unfair claims practices. Prohibited practices include, but are not limited to, misrepresentations, false advertising, coercion, disparaging other insurers, unfair claims settlement procedures, and
discrimination in the business of insurance. Noncompliance with any of such state statutes may subject us to regulatory action by the relevant state insurance regulator, and possibly private litigation. States also regulate various aspects of the contractual relationships between insurers and independent agents as well as, in certain states, insurers and third-party administrators.
Although state insurance regulators have primary responsibility for administering and enforcing insurance regulations in the United States, such laws and regulations are further administered and enforced by a number of additional governmental authorities, each of which exercises a degree of interpretive latitude, including state securities administrators; state attorneys general as well as federal agencies including the SEC, the Financial Industry Regulatory Authority, the Federal Reserve Board, the Federal Insurance Office, the U.S. Department of Labor, the U.S. Department of Justice and the National Labor Relations Board. Consequently, compliance with any particular regulator’s or enforcement authority’s interpretation of a legal issue may not result in compliance with another’s interpretation of the same issue, particularly when compliance is judged in hindsight. Such regulations or enforcement actions are often responsive to current consumer and political sensitivities, which may arise after a major event. Such rules and regulations may result in rate suppression, limit our ability to manage our exposure to unprofitable or volatile risks, or lead to fines, premium refunds or other adverse consequences. The federal government also may regulate aspects of our businesses, such as the protection of consumer confidential information or the use of consumer insurance (credit) scores to underwrite and assess the risk of customers under the Fair Credit Reporting Act (“FCRA”). Among other things, the FCRA requires that insurance companies (i) have a permissible purpose before obtaining and using a consumer report for underwriting purposes and (ii) comply with related notice and recordkeeping requirements. Failure to comply with federal requirements under the FCRA or any other applicable federal laws could subject us to regulatory fines and other sanctions. In addition, given our short operating history to-date and rapid rate of growth, we are vulnerable to regulators identifying errors in the policy forms it uses, the rates we charge, with respect to our customer communications. As a result of such noncompliance, regulators could impose fines, rebates or other penalties, including cease-and-desist orders with respect to our operations in an individual state, or all states, until the identified noncompliance is rectified.
In addition, there is risk that any particular regulator’s or enforcement authority’s interpretation of a legal issue or the scope of a regulator’s authority may change over time to our detriment. There is also a risk that changes in the overall legal environment may cause us to change our views regarding the actions we need to take from a legal risk management perspective. This would necessitate changes to our practices that may adversely impact our business. Furthermore, in some cases, these laws and regulations are designed to protect or benefit the interests of a specific constituency rather than a range of constituencies. State insurance laws and regulations are generally intended to protect the interests of purchasers or users of insurance products, rather than the holders of securities that we issue. For example, state insurance laws are generally prescriptive with respect to the content and timeliness of notices we must provide policyholders. Failure to comply with state insurance laws and regulations in the future could have a material adverse effect on our business, operating results and financial condition.
Additionally, the federal government could pass a law expanding its authority to regulate the insurance industry, expanding federal regulation over our business to our detriment. These laws and regulations may limit our ability to grow, to raise additional capital or to improve the profitability of our business.
Our ability to retain state licenses depends on our ability to meet licensing requirements established by the NAIC and adopted by each state, subject to variations across states. If we are unable to satisfy the applicable licensing requirements of any particular state, we could lose our license to do business in that state, which would result in the temporary or permanent cessation of our operations in that state. Alternatively, if we are unable to satisfy applicable state licensing requirements, we may be subject to additional regulatory oversight, have our license suspended, or be subject to the seizure of assets. Any such events could adversely affect our business, results of operations or financial condition.
A regulatory environment that requires rate increases to be approved and that can dictate underwriting practices and mandate participation in loss sharing arrangements may adversely affect our results of operations and financial condition.
From time to time, political events and positions affect the insurance market, including efforts to suppress rates to a level that may not allow us to reach targeted levels of profitability. For example, if our loss ratio compares favorably to that of the industry, state or provincial regulatory authorities may impose rate rollbacks, require it to pay premium refunds to policyholders, or challenge or otherwise delay our efforts to raise rates even if the property and casualty industry generally is not experiencing regulatory challenges to rate increases. Such challenges affect our ability to obtain approval for rate changes that may be required to achieve targeted levels of profitability and returns on equity. In particular due to the COVID-19 pandemic, state regulators and legislators are under increased political pressure to provide financial relief to policyholders through premium rebates or requiring insurers to pay claims arising from COVID-19 related losses, regardless of the applicable policy’s exclusions.
In addition, certain states have enacted laws that require an insurer conducting business in that state to participate in assigned risk plans, reinsurance facilities and joint underwriting associations. Certain states also require insurers to offer coverage to all consumers, often restricting an insurer’s ability to charge the price it might otherwise charge. In these markets, we may be compelled to underwrite significant amounts of business at lower-than-desired rates, possibly leading to an unacceptable return on equity. Laws and regulations of many states also limit an insurer’s ability to
discontinue writing some or all of our business or to withdraw from one or more lines of insurance, except pursuant to a plan that is approved by the state insurance department. Additionally, as addressed above, certain states require insurers to participate in guaranty funds for impaired or insolvent insurance companies. These funds periodically assess losses against all insurance companies doing business in the state. Our results of operations and financial condition could be adversely affected by any of these factors.
State insurance regulators impose additional reporting requirements regarding enterprise risk on insurance holding company systems, with which we must comply as an insurance holding company.
In the past decade, various state insurance regulators have increased their focus on risks within an insurer’s holding company system that may pose enterprise risk to the insurer. In 2012, the NAIC adopted significant amendments to the Insurance Holding Company Act and related regulations (the “NAIC Amendments”). The NAIC Amendments are designed to respond to perceived gaps in the regulation of insurance holding company systems in the United States. One of the major changes is a requirement that an insurance holding company system’s ultimate controlling person submit annually to its lead state insurance regulator an “enterprise risk report” that identifies activities, circumstances or events involving one or more affiliates of an insurer that, if not remedied properly, are likely to have a material adverse effect upon the financial condition or liquidity of the insurer or its insurance holding company system as a whole. As the ultimate controlling person in our insurance holding company system, we are required to file an annual enterprise risk report in one or more states. Other changes include the requirement that a controlling person submit prior notice to its domiciliary insurance regulator of a divestiture of control, having detailed minimum requirements for cost sharing and management agreements between an insurer and its affiliates and expanding of the agreements between an insurer and its affiliates to be filed with its domiciliary insurance regulator, including states in which the insurer is commercially domiciled. The NAIC Amendments must be adopted by the individual state legislatures and insurance regulators in order to be effective, and many states have already done so.
In 2012, the NAIC also adopted the Risk Management and Own Risk and Solvency Assessment Model Act (the “ORSA Model Act”). The ORSA Model Act, as adopted by the various states, requires an insurance holding company system’s Chief Risk Officer to submit annually to its lead state insurance regulator an Own Risk and Solvency Assessment Summary Report (“ORSA”). The ORSA is a confidential internal assessment appropriate to the nature, scale and complexity of an insurer, conducted by that insurer of the material and relevant risks identified by the insurer associated with an insurer’s current business plan and the sufficiency of capital resources to support those risks. The ORSA Model Act must be adopted by the individual state legislature and insurance regulators in order to be effective. We cannot predict the impact, if any, that any other regulatory requirements may have on our business, financial condition or results of operations.
There is also risk that insurance holding company systems may become subject to group capital requirements at the holding company level. The NAIC is currently working to develop a group capital calculation framework that regulators may use for informational purposes. As envisioned, the framework is intended to complement the current holding company analytics framework by providing additional information to the lead state regulator for use in assessing group risks and capital adequacy. The NAIC has not promulgated a model law or regulation on this subject.
The increasing adoption by states of cybersecurity regulations could impose additional compliance burdens on us and expose us to additional liability.
In response to the growing threat of cyber-attacks in the insurance industry, certain jurisdictions have begun to consider new cybersecurity measures, including the adoption of cybersecurity regulations. On October 24, 2017, the NAIC adopted its Insurance Data Security Model Law, intended to serve as model legislation for states to enact in order to govern cybersecurity and data protection practices of insurers, insurance agents, and other licensed entities registered under state insurance laws. Alabama, Connecticut, Delaware, Indiana, Iowa, Louisiana, Maine, Michigan, Mississippi, New Hampshire, North Dakota, Ohio, South Carolina and Virginia have adopted versions of the Insurance Data Security Model Law, each with a different effective date, and other states may adopt versions of the Insurance Data Security Model Law in the future. The New York Department of Financial Services has promulgated its own Cybersecurity Requirements for Financial Services Companies that is not based upon the Insurance Data Security Model Law and requires insurance companies to establish and maintain a cybersecurity program and implement and maintain cybersecurity policies and procedures with specific requirements. In addition, some jurisdictions, such as California, Colorado, Massachusetts, Nevada, and Virginia have enacted more generalized data security laws that apply to certain data that we process. Although we take steps to comply with financial industry cybersecurity regulations and other data security laws and believe we are materially compliant with their requirements, our failure to comply with new or existing cybersecurity regulations could result in material regulatory actions and other penalties. In addition, efforts to comply with new or existing cybersecurity regulations could impose significant costs on our business, which could materially and adversely affect our business, financial condition or results of operations.
Changes in law or regulations, or a failure to comply with any laws and regulations, may adversely affect our business, investments and results of operations.
We are subject to laws and regulations enacted by national, regional and local governments, including in particular, reporting and other requirements under the Exchange Act. Compliance with, and monitoring of, applicable laws and regulations may be difficult, time consuming and costly. Those laws and regulations and their interpretation and
application may also change from time to time and those changes could have a material adverse effect on our business, investments and results of operations. In addition, a failure to comply with applicable laws or regulations, as interpreted and applied, could result in fines, injunctive relief or similar remedies which could be costly to it or limit our ability to operate.
Intellectual Property Risks
Our intellectual property rights are valuable, and any inability to protect them could reduce the value of our products, services and brand.
Our trade secrets, trademarks, copyrights, patents, and other intellectual property rights are important assets for us. We rely on, and expect to continue to rely on, various agreements with our employees, independent contractors, consultants and third parties with which we have relationships, as well as trademark, trade dress, domain name, copyright, patent, and trade secret laws, to protect our brand and other intellectual property rights. Such agreements may not effectively prevent unauthorized use or disclosure of our confidential information, intellectual property or technology and may not provide an adequate remedy in the event of unauthorized use or disclosure of our confidential information, intellectual property or technology, and we may fail to consistently obtain, police and enforce such agreements. Additionally, various factors outside our control pose a threat to our intellectual property rights, as well as to our products, services and technologies. For example, we may fail to obtain effective intellectual property protection, or effective intellectual property protection may not be available in every country in which our products and services are available. Also, the efforts we have taken to protect our intellectual property rights may not be sufficient or effective in all cases. For example, governmental entities that grant intellectual property rights may deny our applications for such rights despite our best efforts.
Additionally, granted intellectual property rights are subject to challenge. Successful challenges may result in such rights being narrowed in scope or declared invalid or unenforceable. Despite our efforts to obtain and protect broad intellectual property rights, there can be no assurance our intellectual property rights will be sufficient to protect against others offering products or services that are substantially similar to ours and compete with our business, and unauthorized parties may attempt to copy aspects of our technology and use information that we consider proprietary. Competitors or other third parties may also attempt to circumvent or design around our intellectual property rights.
In addition to registered intellectual property rights such as trademark registrations, we rely on non-registered proprietary information and technology, such as trade secrets, confidential information, know-how and technical information. Certain information or technology that we endeavor to protect as trade secrets may not be eligible for trade secret protection in all jurisdictions, or the measures we undertake to establish and maintain such trade secret protection may be inadequate. To protect our proprietary information and technology, we rely in part on agreements with employees, investors, independent contractors and other third parties that place restrictions on the use and disclosure of this intellectual property. In some cases, these agreements may not adequately protect our trade secrets, these agreements may be breached, or this intellectual property, including trade secrets, may otherwise be disclosed or become known to Our competitors, which could cause us to lose a competitive advantage resulting from this intellectual property. However, our employees, independent contractors or other third parties with which we do business may nonetheless use intellectual property owned by others in their work for it, and disputes may arise as to the rights in related or resulting know-how and inventions. Current or future legal requirements may require it to disclose certain proprietary information or technology, such as our proprietary algorithms, to regulators or other third parties, including our competitors, which could impair or result in the loss of trade secret protection for such information or technology. The loss of trade secret protection could make it easier for third parties to compete with our products and services by copying functionality. In addition, any changes in, or unexpected interpretations of, intellectual property laws may compromise our ability to enforce our trade secret and intellectual property rights. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain protection of our trade secrets or other proprietary information could harm our business, results of operations and competitive position.
We have filed, and may continue in the future to file, applications to protect certain of our innovations and intellectual property. We do not know whether any of our applications will result in the issuance of a patent, trademark or copyright, as applicable, or whether the examination process will require us to narrow our claims or otherwise limit the scope of such intellectual property. In addition, we may not receive competitive advantages from the rights granted under our intellectual property. Our existing intellectual property, and any intellectual property granted to us or that we otherwise acquire in the future, may be contested, circumvented or invalidated, and we may not be able to prevent third parties from infringing our intellectual property rights. Therefore, the exact effect of the protection of this intellectual property cannot be predicted with certainty. Because obtaining patent protection requires disclosing our inventions to the public, such disclosure may facilitate our competitors developing improvements to our innovations. Given this risk, we may sometimes choose not to seek patent protection for certain innovations and instead rely on trade secret protection. Any failure to adequately obtain such patent protection, or other intellectual property protection, could later prove to adversely impact our business.
We currently hold various domain names relating to our brand, including Metromile.com. Failure to protect our domain names could adversely affect our reputation and brand and make it more difficult for users to find our website
and mobile app. We may be unable, without significant cost or at all, to prevent third parties from acquiring domain names that are similar to, infringe upon or otherwise decrease the value of our trademarks and other proprietary rights.
We may be required to spend significant resources in order to monitor and protect our intellectual property rights, and some violations may be difficult or impossible to detect. For example, infringement of patent rights related to internal software processes may be difficult to detect. Litigation to protect and enforce our intellectual property rights could be costly, time-consuming and distracting to management and could result in the impairment or loss of portions of our intellectual property. Our efforts to enforce our intellectual property rights may be met with defenses, counterclaims and countersuits attacking the validity and enforceability of our intellectual property rights or asserting that we infringe third-party intellectual property rights. The unauthorized copying or use of our proprietary technology, as well as any costly litigation or diversion of management’s attention and resources, could impair the functionality of our platform, delay introductions of enhancements to our platform, result in substituting inferior or more costly technologies into our platform or harm our reputation or brand. In addition, we may be required to license additional technology from third parties to develop and market new offerings or platform features, which may not be on commercially reasonable terms or at all and could adversely affect our ability to compete.
Although we take measures to protect our intellectual property, if we are unable to prevent the unauthorized use or exploitation of our intellectual property, the value of our brand, content, and other intangible assets may be diminished, competitors may be able to more effectively mimic our service and methods of operations, the perception of our business and service to customers and potential customers may become confused, and our ability to attract customers may be adversely affected. Any failure to protect our intellectual property could adversely impact our business, results of operations and financial condition. While we take precautions designed to protect our intellectual property, it may still be possible for competitors and other unauthorized third parties to copy our technology and use our proprietary brand, content and information to create or enhance competing solutions and services, which could adversely affect our competitive position in our rapidly evolving and highly competitive industry. Some license provisions that protect against unauthorized use, copying, transfer and disclosure of our technology may be unenforceable under the laws of certain jurisdictions and foreign countries. While we enters into confidentiality and invention assignment agreements with our employees and consultants and enter into confidentiality agreements with third-party providers and strategic partners, we cannot assure you that these agreements will be effective in controlling access to, and use and distribution of, our products and proprietary information. Further, these agreements do not prevent our competitors from independently developing technologies that are substantially equivalent or superior to our offerings.
Some of our products and services contain open source software, which may pose particular risks to our proprietary software, products, and services in a manner that could have a negative effect on our business.
We use open source software in our products and services and anticipate continuing to use open source software in the future. Some open source software licenses require those who distribute open source software as part of their own software product to publicly disclose all or part of the source code of such software product or to make available any derivative works of the open source code on unfavorable terms or at no cost, and we may be subject to such terms. The terms of certain open source licenses to which we are subject have not been interpreted by U.S. or foreign courts, and there is a risk that open source software licenses could be construed in a manner that imposes unanticipated conditions or restrictions on our ability to provide or distribute our products or services. Additionally, we could face claims from third parties claiming ownership of, or demanding release of, the open source software or derivative works that we develop using such software, which could include our proprietary source code, or otherwise seeking to enforce the terms of the applicable open source license. These claims could result in litigation and could require us to make our software source code freely available, purchase a costly license or cease offering the implicated products or services unless and until we can re-engineer such source code to eliminate use of such open source software. This re-engineering process could require us to expend significant additional research and development resources, and we may not be able to complete the re-engineering process successfully. In addition to risks related to license requirements, use of certain open source software can lead to greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties, assurance of title or controls on the origin or operation of the open source software, which are risks that cannot be eliminated, and could, if not properly addressed, negatively affect our business. We have established processes to help alleviate these risks, including a review process for screening requests from our development teams for the use of open source software, but we cannot be sure that all of our use of open source software is in a manner that is consistent with our current policies and procedures, or will not subject us to liability. Any of these risks could be difficult to eliminate or manage, and, if not addressed, could have a negative effect on our business, financial condition and operating results.
Claims by others that we infringe or have infringed their proprietary technology or other intellectual property rights could harm our business.
Companies in the internet and technology industries are frequently subject to litigation based on allegations of infringement or other violations of intellectual property rights. In addition, certain companies and rights holders seek to enforce and monetize patents or other intellectual property rights they own, have purchased or have otherwise obtained. As we gain an increasingly high public profile, the possibility of intellectual property rights claims against us grows. From time to time, third parties may assert claims of infringement of intellectual property rights against us. Although we may have meritorious defenses, there can be no assurance that we will be successful in defending against these allegations or
in reaching a business resolution that is satisfactory to us. Our competitors and others may now and in the future have significantly larger and more mature patent portfolios than us. In addition, future litigation may involve patent holding companies or other adverse patent owners who have no relevant product or service revenue and against whom our own patents may therefore provide little or no deterrence or protection. Many potential litigants, including some of our competitors and patent-holding companies, have the ability to dedicate substantial resources to the assertion of their intellectual property rights. Any claim of infringement by a third party, even those without merit, could cause us to incur substantial costs defending against the claim, could distract management from our business and could require us to cease use of such intellectual property. Furthermore, because of the substantial amount of discovery required in connection with intellectual property litigation, we risk compromising our confidential information during this type of litigation. We may be required to pay substantial damages, royalties or other fees in connection with a claimant securing a judgment against it, we may be subject to an injunction or other restrictions that prevent us from using or distributing our intellectual property, or from operating under our brand, or we may agree to a settlement that prevents us from distributing our offerings or a portion thereof, which could adversely affect our business, results of operations and financial condition.
With respect to any intellectual property rights claim, we may have to seek out a license to continue operations found or alleged to violate such rights, which may not be available, or if available, may not be available on favorable or commercially reasonable terms and may significantly increase our operating expenses. Some licenses may be non-exclusive, and therefore our competitors may have access to the same technology licensed to us. If a third party does not offer us a license to our intellectual property on reasonable terms, or at all, we may be required to develop alternative, non-infringing technology, which could require significant time (during which we would be unable to continue to offer our affected offerings), effort and expense and may ultimately not be successful. Any of these events could adversely affect our business, results of operations and financial condition.
We may be unable to prevent or address the misappropriation of our data.
From time to time, third parties may misappropriate our data through website scraping, bots or other means and aggregate this data on their websites with data from other companies. In addition, copycat websites or mobile apps may misappropriate data and attempt to imitate our brand or the functionality of our website or our mobile app. If we become aware of such websites or mobile apps, we intend to employ technological or legal measures in an attempt to halt their operations. However, we may be unable to detect all such websites or mobile apps in a timely manner and, even if we could, technological and legal measures may be insufficient to halt their operations. In some cases, particularly in the case of websites or mobile apps operating outside of the U.S., our available remedies may not be adequate to protect us against the effect of the operation of such websites or mobile apps. Regardless of whether we can successfully enforce our rights against the operators of these websites or mobile apps, any measures that we may take could require us to expend significant financial or other resources, which could harm our business, results of operations or financial condition. In addition, to the extent that such activity creates confusion among consumers or advertisers, our brand and business could be harmed.
We may become subject to intellectual property disputes or other claims of infringement, which are costly and may subject us to significant liability and increased costs of doing business.
We compete in a market where there are a large number of patents, copyrights, trademarks, trade secrets, and other intellectual and proprietary rights, as well as disputes regarding infringement of these rights. In particular, leading companies in the software industry own large numbers of patents, copyrights, trademarks and trade secrets, which they may use to assert claims against it. From time to time, third parties holding such intellectual property rights, including leading companies, competitors, patent holding companies and/or non-practicing entities, may assert patent, copyright, trademark or other intellectual property claims against us.
Although we believe that our products and services do not infringe upon the intellectual property rights of third parties, we cannot assure that third parties will not assert infringement or misappropriation claims against it with respect to current or future products or services, or that any such assertions will not require us to enter into royalty arrangements or result in costly litigation, or result in it being unable to use certain intellectual property. We cannot assure that we are not infringing or otherwise violating any third-party intellectual property rights.
Any intellectual property litigation to which we become a party may require us to do one or more of the following:
• cease selling, licensing, or using products or features that incorporate the intellectual property rights that we allegedly infringe, misappropriate, or violate;
• make substantial payments for legal fees, settlement payments, or other costs or damages, including indemnification of third parties;
• obtain a license or enter into a royalty agreement, either of which may not be available on reasonable terms or at all, in order to obtain the right to sell or use the relevant intellectual property; or
• redesign the allegedly infringing products to avoid infringement, misappropriation, or violation, which could be costly, time-consuming, or impossible.
Any of these events or any adverse result in any litigation claims against us could have a material adverse effect on our business, financial condition, and results of operations.
Enterprise Business Risks
Our enterprise software business unit has limited operating history, which makes it difficult to forecast operating results from the business unit, and we may not achieve the expected operating results in the future.
We established the enterprise software business unit in 2019 and signed our first customer in the year prior. Since then, we have seen a growth in revenue and deployments. However, as a result of its limited operating history, our ability to forecast future operating results from this business unit, including revenues, cash flows and profitability, is limited and subject to many uncertainties. The historical revenue growth in this business unit should not be considered indicative of its future performance.
Furthermore, the enterprise business unit’s revenue and customer growth could slow or decline for a number of reasons, including slowing demand for its products, increased competition, changes to technology, a decrease in growth in the overall market, or its failure, for any reason, to continue to take advantage of growth opportunities. Moreover, we have encountered and will continue to encounter a number of risks and uncertainties frequently experienced by growing companies in the technology industry. If our assumptions regarding these risks and uncertainties are incorrect or change due to changes in its market, or if we do not address these risks successfully, the enterprise business unit’s operating and financial results could differ materially from our expectations and this business unit could suffer.
Our enterprise software business has relied on, and is expected to continue to rely on, orders from a relatively small number of customers for a substantial portion of its revenue, and the loss of any of these customers would significantly harm its operating and financial results.
Its revenue is dependent on orders from customers in the property and casualty (“P&C”) insurance industry, which may be adversely affected by economic, environmental, social, and geo-political conditions. We currently charge customers a license fee for its enterprise software that is proportional to the size of their business. This means we can expect to make more revenue from one large-sized customer (as measured by the size of the customer’s business) than from several small-sized customers (as measured by the size of their business). We currently rely on and expect to continue to rely on a relatively small number of large-sized customers to account for a majority of our revenue. As a result, if we fail to successfully sell our products and services to one or more of these large-sized customers in any particular period or fail to identify additional potential large-sized customers, or such customers purchase fewer of its products or services, defer or cancel purchase orders for any reason, fail to renew their license or subscription agreements or otherwise terminate their relationship with us for any reason, the results of operations and financial condition of the enterprise business unit would be significantly harmed.
Our Metromile Enterprise business may cost more to operate than anticipated.
Metromile Enterprise has historically generated more cash than operating expenses due to prepaid revenue and service fees associated with signed deployments. As customer deployments increase, customers request new features, and upgrades and investments are required, we may need to accelerate our spend meaningfully and this could adversely impact our operating income.
The market in which the enterprise software business operates is highly competitive, and if we do not compete effectively, our business, our financial condition, and results of operations could be harmed.
The market in which the enterprise software business operates is rapidly evolving and highly competitive. As it continues to mature and evolve, existing competitors will continue to introduce new, innovative products, and new competitors will continue to enter, thereby further intensifying competition.
We face competition from a number of sources:
• Large, well-established, P&C software providers that have been selling into the P&C industry for quite some time seeking to introduce new features or launch product(s) that mimic the functionality of some of our product(s);
• Large, well-established, custom software development and professional services companies offering bespoke software that competes with some or all of our enterprise software products; and
• New or emerging entrants seeking to develop competing technology products.
We compete based on a number of factors, including innovativeness of our products, demonstrable breadth of use cases, maturity of software, speed of deployment, total cost of ownership of our products, customer service and support, brand recognition of the core our business and ease of implementation. Some of our competitors have substantially greater customer relationships, and financial, technical and other resources than we do, and may be able to respond more effectively than us to new opportunities, technologies and customer needs. As a result, competition may negatively impact our ability to attract new customers or retain existing ones, or put downward pressure on our prices, any of which could materially harm our business, results of operations and financial condition.
Our enterprise software products expose us to liability associated with customer contracts and the use of their customers data.
Metromile Enterprise is a cloud-based subscription software solution provided to global P&C insurers. Through the deployment of this service, insurers may share or provide us with customer data or aggregated data that reveals personally identifying information about the insurers’ customers. This data exposes us to material liability if it is publicly disclosed, copied, or used in an inadvertent way that violates the terms of our contract with the enterprise business unit’s customers, or their terms of service with their customers, or state or national laws.
A significant portion of our future operating profit gains are expected to arise from the growth in the enterprise software revenue, which may not be realized.
Our Metromile Enterprise business is a new and growing business. While we have several new customer deployments active or underway, there is no guarantee that these deployments will materially increase revenue if customers cancel their contracts, reduce their desired level of services, or new customers do not sign up for the services. Any of which could significantly harm our business, operating results and financial condition.
General Business Risks
If our performance does not meet market expectations, the price of our securities may decline.
If our performance does not meet market expectations, the price of our common stock may decline from the price of our common stock prior to the Closing. The trading price of our common stock could be volatile and subject to wide fluctuations in response to various factors, some of which are beyond our control. Any of the factors listed below could have a material adverse effect on our common stock and our common stock may trade at prices significantly below current trading prices.
Factors affecting the trading price of our common stock may include:
• actual or anticipated fluctuations in our quarterly financial results or the quarterly financial results of companies perceived to be similar to us;
• changes in the market’s expectations about us operating results;
• our operating results failing to meet market expectations in a particular period;
• changes in financial estimates and recommendations by securities analysts concerning us or the insurance industry and market in general;
• operating and stock price performance of other companies that investors deem comparable to us;
• changes in laws and regulations affecting our business;
• changes in the interpretation or enforcement of statutes and regulations affecting our business;
• commencement of, or involvement in, litigation involving us;
• changes in our capital structure, such as future issuances of securities or the incurrence of additional debt;
• the volume of shares of our common stock available for public sale;
• any significant change in our board or management;
• sales of substantial amounts of common stock by our directors, executive officers or significant stockholders or the anticipation of sales or lock-up expirations; and
• general economic and political conditions such as recessions, interest rates, fuel prices, international currency fluctuations and acts of war or terrorism.
Broad market and industry factors may depress the market price of our common stock irrespective of our operating performance. The stock market in general and Nasdaq have experienced price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the particular companies affected. The trading prices and valuations of these stocks, and of our securities, may not be predictable. A loss of investor confidence in the market for companies in the insurance industry or the stocks of other companies which investors perceive to be similar to us could depress our stock price regardless of our business, prospects, financial conditions or results of operations. A decline in the market price of our common stock also could adversely affect our ability to issue additional securities and our ability to obtain additional financing in the future.
Our ability to meet expectations and projections in any research or reports published by securities or industry analysts, or a lack of coverage by securities or industry analysts, could result in a depressed market price and limited liquidity for our common stock.
The trading market for our common stock is influenced by the research and reports that industry or securities analysts may publish about us, our business, the market, or our competitors. If no securities or industry analysts cover us, our stock price would likely be less than that which we would obtain if we had such coverage and the liquidity, or trading volume of our common stock may be limited, making it more difficult for a stockholder to sell shares at an acceptable price or amount. If any analysts do cover us, their projections may vary widely and may not accurately predict the results we actually achieve. Our share price may decline if our actual results do not match the projections of research analysts covering us. Similarly, if one or more of the analysts who write reports on us downgrades our stock or publishes inaccurate or unfavorable research about our business, our share price could decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, our share price or trading volume could decline.
We expect a number of factors to cause our results of operations to fluctuate on a quarterly and annual basis, which may make it difficult to predict our future performance.
Our revenue and results of operations could vary significantly from quarter to quarter and year to year, and may fail to match periodic expectations as a result of a variety of factors, many of which are outside of our control. Our results may vary from period to period as a result of fluctuations in the number of customers purchasing our insurance products and renewing their agreements with us as well as fluctuations in the timing and amount of our expenses. In addition, the insurance industry is subject to our own cyclical trends and uncertainties, including extreme weather which is often seasonal and may result in volatility in claims reporting and payment patterns. Fluctuations and variability across the industry may also affect our revenue. As a result, comparing our results of operations on a period-to-period basis may not be meaningful, and the results of any one period should not be relied on as an indication of future performance. Our results of operations may not meet the expectations of investors or public market analysts who follow us, which may adversely affect our stock price. In addition to other risks described in these Risk Factors, factors that may contribute to the variability of our quarterly and annual results include:
• our ability to attract new customers and retain existing customers, including in a cost-effective manner;
• our ability to accurately forecast revenue and losses and appropriately plan our expenses;
• our ability to develop and offer new products, including in a cost-effective manner;
• the effects of changes in search engine placement and prominence;
• the effects of increased competition on our business;
• our ability to successfully maintain our position in and expand in existing markets as well as successfully enter new markets;
• our ability to protect our existing intellectual property and to create new intellectual property;
• our ability to maintain an adequate rate of growth and effectively manage that growth;
• our ability to keep pace with technology changes in the insurance, mobile and automobile industries;
• the success of our sales and marketing efforts;
• costs associated with defending claims, including accident and coverage claims, intellectual property infringement claims, misclassifications and related judgments or settlements;
• the impact of, and changes in, governmental or other regulation affecting our business;
• the attraction and retention of qualified employees and key personnel;
• our ability to choose and effectively manage third-party service providers;
• our ability to identify and engage in joint ventures and strategic partnerships, both domestically and internationally;
• the effects of natural or man-made catastrophic events;
• the effectiveness of our internal controls; and
• changes in our tax rates or exposure to additional tax liabilities.
The trading price of our common stock is volatile, and the market price of our securities may decline.
The trading price of our common stock has been, and may continue to be, volatile and subject to wide fluctuations in response to various factors, some of which are beyond our control. Any of the factors listed below could have a material adverse effect on the trading price of our securities and our securities may trade at prices significantly below the price you paid for them. In such circumstances, the trading price of our securities may not recover and may experience a further decline.
Factors affecting the trading price of our securities may include:
• actual or anticipated fluctuations in our quarterly financial results or the quarterly financial results of companies perceived to be similar to us;
• changes in the market’s expectations about our operating results;
• the public’s reaction to our press releases, our other public announcements and our filings with the SEC;
• speculation in the press or investment community;
• success of competitors;
• our operating results failing to meet the expectation of securities analysts or investors in a particular period;
• changes in financial estimates and recommendations by securities analysts concerning us or the market in general;
• operating and stock price performance of other companies that investors deem comparable to it;
• our ability to market new and enhanced services on a timely basis;
• changes in laws and regulations affecting our business;
• commencement of, or involvement in, litigation involving us following the INSU SPAC transaction;
• changes in our capital structure following the INSU SPAC transaction, such as future issuances of securities or the incurrence of additional debt;
• the volume of securities available for public sale;
• any major change in the Board or management;
• sales of substantial amounts of securities by our directors, officers or significant stockholders or the perception that such sales could occur;
• the realization of any of the other risks described herein;
• additions or departures of key personnel;
• failure to comply with the requirements of Nasdaq;
• failure to comply with the Sarbanes-Oxley Act of 2002 or other laws or regulations;
• actual, potential or perceived control, accounting or reporting problems;
• changes in accounting principles, policies and guidelines; and
• general economic and political conditions such as recessions, interest rates, fuel prices, international currency fluctuations and acts of war or terrorism.
Broad market and industry factors may materially harm the market price of our securities irrespective of our operating performance. The stock market in general and Nasdaq have experienced price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of the particular companies affected. The trading prices and valuations of these stocks, and of our securities, may not be predictable. A loss of investor confidence in the market for the stocks of other companies which investors perceive to be similar to the post-combination company could depress our stock price regardless of our business, prospects, financial conditions or results of operations. A decline in the market price of our securities also could adversely affect our ability to issue additional securities and our ability to obtain additional financing in the future.
In the past, securities class action litigation has often been initiated against companies following periods of volatility in their stock price. This type of litigation could result in substantial costs and divert management’s attention and resources, and could also require us to make substantial payments to satisfy judgments or to settle litigation.
Our Certificate of Incorporation provides that the Court of Chancery of the State of Delaware and the federal district courts of the United States of America will be the exclusive forums for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.
Our Certificate of Incorporation provides that the Court of Chancery of the State of Delaware (or, if and only if the Court of Chancery of the State of Delaware lacks subject matter jurisdiction, any state court located within the State of Delaware or, if and only if all such state courts lack subject matter jurisdiction, the federal district court for the District of Delaware) is the exclusive forum for the following claims or causes of action under Delaware statutory or common law: (a) any derivative claim or cause of action brought on our behalf; (b) any claim or cause of action for breach of a fiduciary duty owed by any of our current or former directors, officers or other employees to us or our stockholders; (c) any claim or cause of action against us or any of our current or former directors, officers or other employees, arising out of or pursuant to any provision of the Delaware General Corporation Law (the “DGCL”), our certificate of incorporation or our Bylaws; (d) any claim or cause of action seeking to interpret, apply, enforce or determine the validity of our certificate of incorporation or our Bylaws; (e) any action or proceeding as to which the DGCL confers jurisdiction to the Court of Chancery of the State of Delaware; and (f) any claim or cause of action against it or any of our current or former directors, officers or other employees that is governed by the internal-affairs doctrine, in all cases to the fullest extent permitted by law and subject to the court having personal jurisdiction over the indispensable parties named as defendants. This provision would not apply to claims or causes of action brought to enforce a duty or liability created by the Exchange Act, or any other claim for which the federal courts have exclusive jurisdiction, or the Securities Act.
Furthermore, Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all such Securities Act actions. Accordingly, both state and federal courts have jurisdiction to entertain such claims. To prevent having to litigate claims in multiple jurisdictions and the threat of inconsistent or contrary rulings by different courts, among other considerations, our Certificate of Incorporation provides that the federal district courts of the United States of America will be the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act. While the Delaware courts have determined that such choice of forum provisions are facially valid, a stockholder may nevertheless seek to bring a claim in a venue other than those designated in the exclusive forum provisions. In such instance, we would expect to vigorously assert the validity and enforceability of the exclusive forum provisions of our Certificate of Incorporation. This may require significant additional costs associated with resolving such action in other jurisdictions and there can be no assurance that the provision will be enforced by a court in those other jurisdictions.
These exclusive forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, or other employees, which may discourage lawsuits against us and our directors, officers and other employees. If a court were to find either exclusive-forum provision in our Certificate of Incorporation to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving the dispute in other jurisdictions, which could seriously harm our business.
A significant portion of our total outstanding shares of our common stock are restricted from immediate resale but may be sold into the market in the near future. This could cause the market price of our common stock to drop significantly, even if our business is doing well.
Sales of a substantial number of shares of our common stock in the public market could occur at any time. We have filed a registration statement to register for resale the shares issued in the private placement that closed concurrent with
the INSU SPAC transaction, and certain other holders pursuant to a registration rights agreement. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. We are unable to predict the effect that sales may have on the prevailing market price of our common stock and Public Warrants.
To the extent our warrants are exercised, additional shares of our common stock will be issued, which will result in dilution to the holders of our common stock and increase the number of shares eligible for resale in the public market. Sales, or the potential sales, of substantial numbers of shares in the public market by certain selling securityholders, subject to certain restrictions on transfer until the termination of applicable lock-up periods, could increase the volatility of the market price of our common stock or adversely affect the market price of our common stock.
ITEM 2. PROPERTIES
Our corporate headquarters are located in San Francisco, CA, and consist of 26,164 square feet under a lease agreement that expires in April 2030. We maintain additional offices in Tempe, Arizona and Boston, Massachusetts. We lease all of our facilities and do not own any real property. All of the properties are used by one or both of our reporting segments, depending on the location. We believe our facilities are adequate and suitable for our current needs and that, should it be needed, suitable additional or alternative space will be available to accommodate our operations.
ITEM 3. LEGAL PROCEEDINGS
From time to time, we are involved in various legal proceedings arising from the normal course of business activities, some of which, to date, have related to fraudulent insurance claims made against us. For a discussion regarding Metromile's legal proceedings, see the information contained under “Litigation” in Note 12 - Leases, Commitments, and Contingencies of the Notes to Consolidated Financial Statements.
ITEM 4. MINE SAFETY DISCLOSURES
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our Common Stock and Public Warrants are currently listed on Nasdaq under the symbols “MILE” and “MILEW,” respectively. Prior to the consummation of the Merger, our Common Stock, units and Public Warrants were listed on Nasdaq under the symbols “INAQ,” “INAQU” and “INAQW,” respectively. As of February 23, 2022, the latest practicable date, there were there were 96 holders of record of Metromile common stock and 4 holders of record of Metromile warrants. We currently do not intend to list the Placement Warrants offered hereby on any stock exchange or stock market.
We have not paid any cash dividends on our Common Stock to date. We may retain future earnings, if any, for future operations, expansion and debt repayment and have no current plans to pay cash dividends for the foreseeable future. Any decision to declare and pay dividends in the future will be made at the discretion of our Board and will depend on, among other things, our results of operations, financial condition, cash requirements, contractual restrictions and other factors that the Board may deem relevant. In addition, our ability to pay dividends may be limited by covenants of any existing and future outstanding indebtedness we or our subsidiaries incur. We do not anticipate declaring any cash dividends to holders of the Common Stock in the foreseeable future.
Securities Authorized for Issuance Under Equity Compensation Plans
As of December 31, 2020, we did not have any securities authorized for issuance under equity compensation plans. In connection with the Merger, our stockholders approved the Metromile, Inc. 2021 Equity Incentive Plan (the “2021 Plan”) on February 9, 2021, which became effective immediately upon the Closing, and we assumed the Legacy Metromile options, which were issued under the MetroMile, Inc. 2011 Equity Incentive Plan, which was approved by its stockholders.
On June 3, 2021, we filed a registration statements on Form S-8 under the Securities Act to register the shares of Common Stock issued or issuable under the 2021 Plan and the assumed Legacy Metromile options.
Recent Sales of Unregistered Securities
Prior to the closing of our IPO, we completed the private sale of an aggregate of 6,666,666 private placement warrants to Insurance Acquisition Sponsor II, LLC, a Delaware limited liability company and Dioptra Advisors II, LLC, a Delaware limited liability company (the manager of each entity being Cohen & Company, LLC, a Delaware limited liability company, referred to collectively as our Sponsor) at a price of $1.50 per private placement warrant, generating total proceeds, before expenses, of $10,000,000. The private placement warrants have terms and provisions that are identical to those of the public warrants sold as part of the units in the IPO, except that the private placement warrants may be physical (cash) or net share (cashless) settled and are not redeemable so long as they are held by the Sponsor or its permitted transferees. If the private placement warrants are held by holders other than our Sponsor or its permitted transferees, the private placement warrants will be redeemable by us and exercisable by the holders on the same basis as the public warrants.
Information about additional unregistered sales of our equity securities in connection with the Business Combination is set forth under Items 2.01 and 3.02 of our Current Report on Form 8-K filed with the SEC on February 11, 2021.
The sales of the above securities were exempt from registration under the Securities Act, in reliance on Section 4(a)(2) of the Securities Act and/or Regulation D promulgated thereunder as transactions by an issuer not involving a public offering without any form of general solicitation or general advertising.
ITEM 6. [RESERVED]
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 our consolidated financial statements and the accompanying notes and other information included elsewhere in this Annual Report. This discussion and analysis below include forward-looking statements that are subject to risks, uncertainties and other factors described in “Risk Factors” that could cause actual results to differ materially from such forward-looking statements. Additionally, our historical results are not necessarily indicative of the results that may
be expected for any period in the future. A discussion of the year ended December 31, 2020 compared to the year ended December 31, 2019 has been reported previously under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our definitive proxy statement (DEFM14A) filed on December 29, 2021.
We started Metromile based on the simple observation that the physical world is being increasingly digitized, that this digital data can be used to better estimate the future, and that the best opportunity to create value for everyday customers in an increasingly predictable world is to reinvent insurance, one of the largest and most important global markets.
At its core, insurance financially protects the insured customer from the occurrence of specific future events. If these events can be more accurately estimated, using data and data science, then the insurance provided can be more accurately priced — lower likelihood events would cause the price of insurance to go down and higher likelihood events would cause the price of insurance to go up. The proliferation of sensor data, from cars, mobile phones, and elsewhere, means we have a greater ability to estimate the likelihood of future events and, thus, help many customers who are overpaying for insurance save money.
We founded Metromile in 2011 to realize this opportunity and tackle the broken auto insurance industry. With data science as our foundation, we offer our insurance customers real time, personalized auto insurance policies, priced and billed by the mile, with rates based on precisely how and how much they actually drive, instead of using the industry standard approximations and estimates that make prices unfair for most customers.
Through our digitally native offering, built around the needs of the modern driver, we believe our per-mile insurance policies save our customers, on average, 47% over what they were paying their previous auto insurer. We base this belief on data our customers self-reported in 2018 with respect to premiums paid to providers before switching to Metromile.
We believe the opportunity for our personalized per-mile insurance product is significant. Federal Highway Administration data indicates that approximately 35% of drivers drive more than half the total miles driven. We believe there is a correlation between the number of miles driven and the number of insurable losses. An October 2016 report by the Insurance Information Institute noted that the increase in claims frequency appears directly linked to the increase in the number of miles driven. Notwithstanding the relationship between miles driven and claims, auto insurance premiums have historically been priced based on a driver’s “class” — and drivers are charged the same basic premium rate as others in their class no matter the actual miles driven. In the traditional pricing model, a driver’s age, credit score, accident history, and geography influence the premium paid more than the actual miles driven. Thus, the 35% of drivers who account for more than half the total miles driven are not paying premiums based on how often they are behind the wheel and increasing the potential for an insurable loss claim. We believe the traditional pricing model is inherently unfair to the majority of drivers — the 65% of drivers who drive less than half the miles driven — as they are effectively subsidizing the minority of drivers who are high-mileage drivers. By offering auto insurance using a per-mile rate and then billing each customer monthly based on their actual miles driven, we are able to provide significant savings to the 65% of drivers who drive less than half the miles driven. Customers can simply use their connected car or use The Pulse to share their data with us — which includes miles driven, and in certain states where permitted by insurance regulators (four of the eight in which we currently operate), driving habits, such as phone use, speeding, hard-braking, accelerating, cornering, and location. Our customers are able to choose when and how to drive and share this information with us to realize these data driven savings every day.
The U.S. auto insurance market is massive, dominated by insurers stuck on legacy technology infrastructure who offer antiquated services. U.S. personal auto insurers write approximately $250 billion of premiums each year, with no carrier currently achieving more than 20% market share. We believe we are strategically positioned to succeed as industry incumbents struggle to meet the significant structural changes underway in an increasingly digital world. The advent of mobile phones has revolutionized modern mobility, while connected and autonomous technologies are drastically changing consumer relationships. As we scale and accumulate more data, we believe that we can deliver increasingly better service, pricing and experiences for customers across all stages of the policy lifecycle.
Additionally, with the per-mile insurance that Metromile provides, customers are incentivized to drive less and choose more environmentally friendly transportation methods. We found that after customers switch to per-mile insurance, they tend to decrease their overall miles driven. Not only does this equate to a lower bill, but also a significant reduction in carbon emissions.
On November 8, 2021, we entered into an Agreement and Plan of Merger (the “Agreement”) with Lemonade, Inc., a Delaware corporation (“Lemonade”), Citrus Merger Sub A, Inc., a Delaware corporation and a wholly-owned subsidiary of Lemonade (“Acquisition Sub I”) and Citrus Merger Sub B, LLC, a Delaware limited liability company and wholly owned subsidiary of Lemonade (“Acquisition Sub II”), pursuant to which (i) Acquisition Sub I will merge with and into Metromile (the “First Merger” and the effective time of the First Merger, the “First Effective Time”), with Metromile continuing as the surviving entity (the “Initial Surviving Corporation”), and (ii) the Initial Surviving Corporation will merge with and into Acquisition Sub II (the “Second Merger”), with Acquisition Sub II continuing as the surviving entity as a wholly owned subsidiary of Lemonade (the First Merger, the Second Merger and the other transactions contemplated by the Agreement, collectively, the “Proposed Transaction”). The Proposed Transaction implies a fully diluted equity value of approximately $500 million, or an enterprise value of about $340 million net of unrestricted cash and cash equivalents as September 30, 2021. In accordance with the Agreement, at the First Effective Time, each share of our common stock issued and outstanding immediately prior to the First Effective Time will be converted into the right to receive 0.05263 (the “Exchange Ratio”) validly issued, fully paid and non-assessable shares of common stock of Lemonade, par value $0.00001 per share (“Lemonade Common Stock”). Although the applicable waiting period for the Proposed Transaction under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, has expired and we have received approval of the Proposed Transaction from our stockholders, the Proposed Transaction is conditioned on certain additional customary closing conditions, including receipt of applicable regulatory approvals, and is expected to close in the second quarter of 2022.
For additional information related to the Proposed Transaction, please see Note 1, Basis of Presentation and Significant Accounting Policies to our consolidated financial statements included in Part II, Item 8, of this Annual Report on Form 10-K and our Current Report on Form 8-K filed with the SEC on November 9, 2021 as well as the proxy statement/prospectus filed with the SEC on December 29, 2021.
The traditional auto insurance industry is focused on charging customers static insurance rates based on a “class” of driver, which is determined based on a set of variables that approximate and estimate risk. The traditional approach requires little ongoing customer engagement and requires manual claims servicing, which results in lower gross margins. In contrast, our model is digitally native, automated, and built using predictive models. Our product provides customized rates for each individual driver, using telematics data and proprietary predictive models to assess risk and determine pricing for each customer, while billing customers based on their actual miles driven. We have automated the claims approval process, resulting in higher margins, and reduced fraud rates through real-time reporting from telematics devices, resulting in lower loss ratios.
We have experienced strong growth since inception; however, our focus has been on prioritizing unit economics rather than solely focusing on revenue growth through increased net losses. Our priority has been on developing a durable business advantage.
Total revenue increased from $35.1 million for the year ended December 31, 2020 to $104.9 million for the year ended December 31, 2021. Our gross profit/(loss), defined as total revenue as adjusted for losses and LAE, policy servicing expense and other and amortization of capitalized software, and which is impacted by our reinsurance arrangements, increased from $(14.1) million for the year ended December 31, 2020 to $(15.2) million for the year ended December 31, 2021. Our accident period contribution profit/(loss), a non-GAAP financial measure that excludes from gross profit/(loss) the results of prior period development on loss and LAE, decreased from $18.4 million for the year ended December 31, 2020 to $(3.5) million for the year ended December 31, 2021, largely due to an increase in losses, despite an increase in direct written and earned premium for both periods. Accident period refers to the period in which the loss occurs, and estimates are made to determine the ultimate expected cost of that loss. These estimates are reassessed each subsequent period, and the movement from the initial estimate of that accident period is known as prior period development. We view accident period contribution margin as the most relevant metric of current product profitability and use accident period contribution margin to consistently evaluate the variable contribution to our business from insurance operations from period to period based on the most current product profitability. Contribution profit/(loss), a non-GAAP financial measure that includes the results of prior period development accident period contribution profit/(loss), decreased from $11.9 million for the year ended December 31, 2020 to $(5.6) million for the year ended December 31, 2021 largely due to unfavorable prior period loss development. We use contribution profit/(loss) as a key measure of our progress towards profitability and to consistently evaluate the variable contribution to our business from insurance operations from period to period. See the section entitled “— Non-GAAP Financial Measures” for additional information regarding our use of
accident period contribution profit/(loss) and contribution profit/(loss)and a reconciliation to the most comparable GAAP measure.
We review our need to obtain reinsurance to help manage our exposure to property and casualty insurance risks.
The reinsurance arrangement covering the periods May 1, 2017 to April 30, 2018 and May 1, 2018 to April 30, 2019 covered 85% of our renewal policies and beginning May 1, 2019, the reinsurance arrangements expanded to also include new policies. In addition, under the reinsurance agreements from various years, LAE was ceded at a fixed rate ranging from 3% to 6% of ceded earned premium. In the first half of 2021, we commuted all of our reinsurance. We did not enter into new reinsurance agreements for the remainder of 2021. As management continuously monitors and seeks to maintain adequate capital levels at the insurance company level, a reinsurance agreement was entered into and effective January 01, 2022 with Swiss Reinsurance America Corporation. On a prospective basis, under the terms of the transaction, 25% of the Company's gross written premiums, losses, and LAE related to its business is ceded to the reinsurer through June 30, 2023. For more information, please see Note 22, Subsequent Events to our consolidated financial statements included in Part II, Item 8, of this Annual Report on Form 10-K
As we change our reinsurance arrangements, whereby the terms and structures may vary widely, our prior results, impacted by reinsurance, may not be a good indicator of future performance, including the fluctuations experienced in gross profit. Thus, we use accident period contribution profit/(loss) and contribution profit/(loss) as key measures of our performance.
Key Performance Indicators
We regularly review key operating and financial 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 financial and operational measures are useful in evaluating our performance, in addition to our financial results prepared in accordance with GAAP. See the section entitled “— Non-GAAP Financial Measures” for additional information regarding our use of accident period contribution profit/(loss), contribution profit/(loss), accident period loss ratio and accident period LAE ratio and a reconciliation to the most comparable GAAP measures.
The following table presents these metrics as of and for the periods presented:
|($ in millions, except for|
Direct Earned Premium
|Policies in Force (end of period)||98,416 ||92,635 |
|Direct Earned Premium per Policy (annualized)||$||1,166 ||$||1,092 |
|Direct Written Premium||$||110.7 ||$||100.6 |
|Direct Earned Premium||$||111.1 ||$||99.7 |
|Accident Period Contribution Profit/(Loss)||$||(3.5)||$||18.4 |
|Accident Period Contribution Margin||(3.1)||%||18.1 ||%|
|Contribution Profit/(Loss)||$||(5.6)||$||11.9 |
|Contribution Margin||(5.0)||%||11.8 ||%|
|Direct Loss Ratio||78.4 ||%||57.7 ||%|
|Direct LAE Ratio||14.0 ||%||17.7 ||%|
|Accident Period Loss Ratio||75.1 ||%||57.4 ||%|
|Accident Period LAE Ratio||15.3 ||%||11.5 ||%|
Policies in Force
We define policies in force as the number of current and active policyholders 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, increases brand awareness and market penetration, generates additional data to continue to improve the performance of our platform, and provides key data to assist strategic decision making for our company.
Direct Earned Premium per Policy
We define direct earned premium per policy as the ratio of direct earned premium divided by the average policies in force for the period, presented on an annualized basis. We view premiums per policy as an important metric because it is a reliable indicator of revenue earned in any given period, and growth in this metric would be a clear indicator of the growth of the business. However, as evidenced by the substantial reduction in miles driven during the COVID-19 pandemic, near-term fluctuations in miles driven can lead to fluctuations in direct earned premium. Thus, we refer to policies in force as a more stable indicator of overall growth. Direct earned premium excludes the impact of premiums ceded to reinsurers such that it reflects the actual business volume and direct economic benefit generated from our customer acquisition efforts. Additionally, premiums ceded to reinsurers can change based on the type and mix of reinsurance structures we use.
Direct Written Premium
We define direct written premium as the total amount of direct premiums on policies that were bound during the period. Direct written premium is a standard insurance metric and is included here for consistency. However, given that much of our premium is written and earned as customer miles are driven (i.e., customers are billed based on true use), unlike our competitors that write all premium up-front, we believe earned premium is a more meaningful comparison to other insurers. Direct written premium excludes mileage-based premium that has not yet been earned. It also excludes the impact of premiums ceded to reinsurers such that it reflects the actual business volume and direct economic benefit generated from our customer acquisition efforts. Additionally, premiums ceded to reinsurers can change based on the type and mix of reinsurance structures we use.
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 six months. We view direct earned premium as an important metric because it allows us to evaluate our growth prior to the impact of ceded premiums to our reinsurance partners. It is the primary driver of our consolidated GAAP revenues and represents the result of our sustained customer acquisition efforts. As with direct written premium, direct earned premium excludes the impact of premiums ceded to reinsurers to manage our business, and therefore should not be used as a substitute for net earned premium, total revenue, or any other measure presented in accordance with GAAP.
Gross profit/(loss) is defined as total revenue minus losses and LAE, policy servicing expense and other, and amortization of capitalized software. Gross margin is equal to gross profit/(loss) divided by total revenue. Gross profit/(loss) includes the effects of reinsurance, thereby increasing volatility of this measure without corresponding changes in the underlying business or operations.
Contribution Profit/(Loss) and Accident Period Contribution Profit/(Loss)
Contribution profit/(loss), a non-GAAP financial measure, is defined as gross profit/(loss), excluding the effects of reinsurance arrangements on both total revenue and losses and LAE and excludes enterprise software revenues, investment income earned at the holding company, amortization of internally developed software, and devices, while including bad debt, report costs and other policy servicing expenses. Accident period contribution profit/(loss), a non-GAAP financial measure, further excludes the results of prior period development on losses and LAE. We believe the resulting calculations are inclusive of the variable costs of revenue incurred to successfully service a policy, but without the volatility of reinsurance. We use contribution profit/(loss) as a key measure of our progress towards profitability and to consistently evaluate the variable contribution to our business from insurance operations from period to period because it is the result of direct earned premiums, plus investment income earned at the insurance company, minus direct losses, direct LAE, premium taxes, bad debt, payment processing fees, data costs, underwriting reports, and other costs related to servicing policies. Accident period contribution profit/(loss) further excludes the results of prior period development on loss and LAE, thereby providing the most accurate view of the performance of our underlying insurance product, which drives our growth investment decisions and is a strong indicator of future loss performance.
See the section entitled “— Non-GAAP Financial Measures” for a reconciliation of total revenue to accident period contribution profit/(loss) and contribution profit/(loss).
Contribution Margin and Accident Period Contribution Margin
Contribution margin, a non-GAAP financial measure, is defined as contribution profit/(loss) divided by adjusted revenue. Adjusted revenue, a non-GAAP financial measure, is defined as total revenue, excluding the net effect of our reinsurance arrangements, revenue attributable to our enterprise segment, interest income generated outside of our insurance company, and bad debt expense. We view contribution margin as an important metric because it most closely correlates to the economics of our core underlying insurance product and measures our progress towards profitability. Accordingly, we use this non-GAAP financial measure to consistently evaluate the variable contribution to our business from insurance operations from period to period. Accident period contribution margin, a non-GAAP financial measure, is defined as accident period contribution profit/(loss) divided by adjusted revenue. We view accident period contribution margin as an important metric as it excludes the results of prior period development on loss and LAE, thereby providing the most meaningful view of the performance of our current underlying insurance product, which drives our growth investment decisions and is a strong indicator of future loss performance.
See the section entitled “— Non-GAAP Financial Measures” for a reconciliation of total revenue to contribution profit/(loss) and accident period contribution profit/(loss).
Direct and Accident Period 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 losses and LAE separately prior to the impact of reinsurance.
We define accident period loss ratio as direct loss ratio excluding prior accident period development on losses. We view accident period loss ratio as an important metric because it allows us to evaluate the expected ultimate losses, including losses not yet reported, for the most recent accident period.
Direct and Accident Period LAE Ratio
We define direct LAE ratio expressed as a percentage, as the ratio of direct LAE to direct earned premium. We view the direct LAE ratio as an important metric because it allows us to evaluate losses and LAE separately prior to the impact of reinsurance. We actively monitor the direct LAE ratio as it has a direct impact on our results regardless of our reinsurance strategy.
We define the accident period LAE ratio as the direct LAE ratio excluding prior quarter development on LAE. We view accident period LAE ratio as an important metric because it allows us to evaluate the expected ultimate LAE, including LAE for claims not yet reported, for the most recent accident period.
Business Combination with INSU
In February 2021, we completed the Merger, pursuant to which Metromile Operating Company (formerly MetroMile, Inc.) became our wholly owned direct subsidiary. The Merger was accounted for as a reverse recapitalization in accordance with GAAP. Under this method of accounting, although INSU was the legal acquirer, INSU is treated as the “acquired” company for financial reporting purposes and Metromile Operating Company is treated as the accounting acquirer. This determination was primarily based on the fact that Metromile Operating Company’s stockholders prior to the Merger have a majority of our voting power, Metromile Operating Company’s senior management now comprise substantially all of our senior management, the relative size of Metromile Operating Company compared to our company, and that Metromile Operating Company’s operations comprise our ongoing operations. Accordingly, for accounting purposes, the Merger is treated as the equivalent of a capital transaction in which Metromile Operating Company issued stock for our net assets, which are stated at historical cost, with no goodwill or other intangible assets recorded, and Metromile Operating Company’s financial statements became the Company’s financial statements.
In connection with the Business Combination, we received approximately $310.0 million of cash, which we used to repay certain indebtedness as described herein. We expect to use our cash on hand for working capital and general corporate purposes. We may also use the proceeds for the acquisition of, or investment in, technologies, solutions, or businesses that complement our business.
In March 2020, the World Health Organization declared COVID-19 a global pandemic. We are closely monitoring the impact of the COVID-19 pandemic on all aspects of our business. We have taken measures in response to the ongoing COVID-19 pandemic, including closing our offices and implementing a work from home policy for our nationwide workforce; implementing additional safety policies and procedures for our employees; and suspending employee travel and in-person meetings. We may take further actions that alter our business operations as may be required by federal, state, or local authorities or that we determine are in the best interests of our employees, customers, and stockholders.
For the year ended December 31, 2021, we generated $111.1 million in direct earned premium, an increase of $11.4 million or 11%, as compared to $99.7 million for the year ended December 31, 2020. This increase was partially due to a year-over-year increase in direct earned premium per policy, which is a reflection of miles driven. Based on internal data, average daily miles driven increased by 19% from 2020 to 2021. We believe that the potential long-term impacts of COVID-19, as more companies embrace work from home policies, represent an opportunity for us to increase our customer base as drivers continue to look for value-driven insurance solutions that provide the same or a better quality product that aligns to their own driving behaviors.
The future impact of the COVID-19 pandemic on our operational and financial performance will depend on certain developments, including the duration and spread of the pandemic, impact on our customers and their spending habits, impact on our marketing efforts, and effect on our suppliers, all of which are uncertain. Public and private sector policies and initiatives to reduce the transmission of COVID-19 and disruptions to our operations and the operations of our third-party suppliers, along with the related global slowdown in economic activity, may result in decreased revenues and increased costs. Impacts on our revenue and costs may continue through the duration of this crisis. It is possible that the COVID-19 pandemic, the measures taken by federal, state, or local authorities and businesses affected and the resulting economic impact may materially and adversely affect our business, results of operations, cash flows and financial positions as well as our customers.
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. Our growth strategy is centered around accelerating our existing position in markets that we already serve, expanding into new markets nationally across the United States, developing new strategic partnerships with key players in the automotive industry, and growing our enterprise software sales.
Our Ability to Retain Customers
Turning our customers to lifetime customers is key to our success. We realize increasing value from each customer retained as a recurring revenue base, which forms a basis for organic growth for our new product offerings and improves our loss ratios over time. 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 our products.
Our Ability to Expand Nationally Across 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 licensed in 49 states and the District of Columbia, with licenses active in 46 states and the District of Columbia, and writing business in eight states. We plan to apply our highly scalable model nationally, with a tailored approach to each state, driven by the regulatory environment and local market dynamics. This will allow us to expand rapidly and efficiently across different geographies while maintaining a high level of control over the specific strategy within each state.
Our Ability to Introduce New and Innovative Products
Our growth will depend on our ability to introduce new and innovative products that will drive the organic growth from our existing customer base as well as from potential customers. Our insurance offerings as well as our technology platform offered to enterprise customers provides us with a foundation to provide a broad set of insurance products to consumers in the future.
Our Ability to Manage Risk Through Our Technology
Risk is managed through our technology, artificial intelligence, and data science, which we utilize to accurately determine the risk profiles of our customers. Our ability to manage risk is augmented over time as data is continuously collected and analyzed by our machine learning with the objective of lowering our loss ratios over time. Our success depends on our ability to adequately and competitively price risk.
Our Ability to Manage Risks Related to Severe Weather Events and Climate Change
Both seasonal and severe weather events impact the level and amount of claims we receive. These events, as well as climate change and its potential impact on weather patterns, include hurricanes, wildfires, coastal storms, winter storms, hailstorms, and tornados.
Components of Our Results of Operations
Revenues are generated primarily from the sale of our pay-per-mile auto insurance policies within the United States, revenue related to policy acquisition costs recovered as part of the reinsurance arrangement, and through sales of our proprietary AI claims platform. Revenue excludes premiums ceded to reinsurers (see the section entitled “— Reinsurance” for further information).
Premiums Earned, net
Premiums earned, net represents the earned portion of our gross written premium, less the earned portion that is ceded to third-party reinsurers under any reinsurance agreements. Revenue from premiums is earned over the term of the policy, which is written for six-month terms. The premium for the policy provides for a base rate per month for the entire policy term upon the binding of the policy plus a per-mile rate multiplied by the miles driven each day (based on data from the telematics device, subject to a daily maximum).
Investment income represents interest earned from our fixed maturity and short-term investments less investment expenses and is recorded as the income is earned. Investment income is directly correlated with the size of our investment portfolio and with the market level of interest rates. In the near future, we do not intend to pursue an aggressive investment strategy and therefore do not expect an increase in investment income. However, we intend to complement our underwriting results with investment profits on an opportunistic basis.
Other revenue consists of Enterprise revenue, revenue related to policy acquisition costs recovered as part of a reinsurance arrangement with reinsurance partners, reinsurance profit commissions based on performance of the ceded business, gain on reinsurance commutation and policy commissions earned from NGI. We have developed technologies intended for internal use to service our insurance business and have started offering our technologies to third-party insurance carriers. Enterprise revenue represents revenues generated from the licensing of such internally developed software on a subscription basis, and sales of our professional services, which includes customization and implementation services for customers. We also earned revenues from policy acquisition costs recovered for policies newly ceded to our reinsurance partners, and we earn commissions for policies underwritten by NGI prior to becoming a full-stack insurance carrier in 2016.
Costs and Expenses
Our costs and expenses consist of losses and LAE, policy servicing expense and other, sales, marketing, and other acquisition costs, research and development, amortization of capitalized software, and other operating expenses.
Losses and LAE
Our losses and LAE consist of the net cost to settle claims covered by the policies we issued. Losses consist of claims paid, case reserves, as well as claims incurred but not reported, net of estimated recoveries from salvage and subrogation. LAE consists of costs borne at the time of investigating and settling a claim. Losses and LAE represents management’s best estimate of the ultimate net cost of all reported and unreported losses occurred through the balance sheet date. Estimates are made using individual case-basis valuations and statistical analyses and are continually reviewed and adjusted as necessary as experience develops or new information becomes known. These reserves are established to cover the ultimate cost to settle insured losses.
Both losses and LAE are net of amounts ceded to reinsurers. We evaluate whether to enter into reinsurance contracts to protect our business from losses due to concentration of risk and to manage our operating leverage ratios, as well as to provide additional capacity for growth. Our reinsurance contracts have historically consisted of quota-share reinsurance agreements with our reinsurance partners under which risks are covered on a pro-rata basis for all policies underwritten by us. All reinsurance has been commuted as of December 31, 2021 (see the section entitled “— Reinsurance” for further discussion). As of January 1, 2022, the Company entered into a new reinsurance agreement. For additional information, see Note 22, Subsequent Events to our consolidated financial statements included in Part II, Item 8, of this Annual Report on Form 10-K.
Losses and LAE are a function of the size and term of the insurance policies we write and the loss experience associated with the underlying risks. Losses 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 adjusters’ salaries and benefits, employee retirement plan related expenses and stock-based compensation expenses (Personnel Costs); software expenses; and overhead allocated based on headcount (Overhead).
Policy Servicing Expense and Other
Policy servicing expense and other includes personnel costs related to our technical operations and customer experience teams, data transmission costs, credit card and payment processing expenses, premium taxes, and amortization of telematics devices. Policy servicing expense and other is expensed as incurred.
Sales, Marketing and Other Acquisition Costs
Sales, marketing, and other acquisition costs includes spend related to advertising, branding, public relations, third-party marketing, consumer insights, reinsurance ceding commissions, and expense recognized due to return of onboarding allowance as part of reinsurance commutations. These expenses also include related personnel costs and overhead. We incur sales, marketing and other acquisition costs for all product offerings including our newly introduced software as a service (“SaaS”) platform which provides access to our developed technology under SaaS arrangements, along with professional services to third-party customers (“Enterprise business solutions”). Sales, marketing and other acquisition costs are 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. We plan to continue investing in marketing to attract and acquire new customers and increase our brand awareness. We expect that sales and marketing expenses will vary from period-to-period as a percentage of revenue in the near-term. We expect that, in the long-term, our sales, marketing and other acquisition costs will decrease as a percentage of revenue as the proportion of renewals to our total business increases.
Research and Development
Research and development consist of costs that support our growth and expansion initiatives inclusive of website development costs, software development costs related to our mobile app and Enterprise business solution, and new product development costs. These costs include third-party services related to data infrastructure support; personnel costs and overhead for product design, engineering, and management; and amortization of internally developed software. Research and development costs are expensed as incurred, except for costs related to internally developed software that are capitalized and subsequently amortized over the expected useful life. We expect that research and development expenses will increase in both absolute dollars and percentage of revenues in future periods in the near-term. We expect
that, in the long-term, our research and development expenses will decrease as a percentage of revenue as these represent largely fixed costs.
Amortization of Capitalized Software
Amortization of capitalized software relates to the amortization recorded for the capitalized website and software development costs for the period presented.
Other Operating Expenses
Other operating expenses primarily relate to personnel costs and overhead for corporate functions, external professional service expenses and depreciation expense for computers, furniture, and other fixed assets. General and administrative expenses are expensed as incurred.
We expect to incur incremental operating expenses to support our operational growth and enhancements to support our reporting and planning functions.
We expect to incur significant additional operating expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC and the listing standards of the Nasdaq Capital Market, additional corporate, director and officer insurance expenses, greater investor relations expenses and increased legal, audit and consulting fees. We also expect to continue to increase the size of our accounting, finance, and legal teams to support our increased compliance requirements and the growth of our business. As a result, we expect that our other operating expenses will increase in absolute dollars and percentage of revenues in future periods in the near-term. We expect that, in the long-term, our other operating expenses will decrease as a percentage of revenue as these represent largely fixed costs.
Interest expense primarily relates to interest incurred on our long-term debt, the amortization of debt issuance costs.
Impairment on digital assets
Impairment on digital assets relates to losses that occur when the fair value of the digital asset at the time of measurement (the balance sheet reporting date) is less than its carrying value.
Increase in fair value of stock warrant liability
Increase in fair value of stock warrant liability primarily relates to changes in the fair value of warrant liabilities.
Results of Operations
Comparison of the years ended December 31, 2021 and December 31, 2020:
The following table presents our consolidated statement of operations for the years ended December 31, 2021 and 2020, and the dollar and percentage change between the two periods:
|2021||2020||$ Change||% Change|
|Premiums earned, net||$||75,601 ||$||12,464 ||$||63,137 ||507 ||%|
|Investment income||117 ||523 ||(406)||(78)||%|
|Other revenue||29,179 ||22,077 ||7,102 ||32 ||%|
|Total revenue||104,897 ||35,064 ||69,833 ||199 ||%|
|Costs and expenses|
|Losses and loss adjustment expenses||88,467 ||21,208 ||67,259 ||317 ||%|
|Policy servicing expense and other||20,304 ||16,813 ||3,491 ||21 ||%|
|Sales, marketing and other acquisition costs||102,989 ||5,483 ||97,506 ||1778 ||%|
|Research and development||16,027 ||8,211 ||7,816 ||95 ||%|
|Amortization of capitalized software||11,306 ||11,188 ||118 ||1 ||%|
|Other operating expenses||63,510 ||16,981 ||46,529 ||274 ||%|
|Total costs and expenses||302,603 ||79,884 ||222,719 ||279 ||%|
|Loss from operations||(197,706)||(44,820)||(152,886)||341 ||%|
|Interest expense||15,974 ||6,067 ||9,907 ||163 ||%|
|Impairment on digital assets||183 ||— ||183 ||NM|
|Increase in fair value of stock warrant liability||2,596 ||69,294 ||(66,698)||(96)||%|
|Total other expense||18,753 ||75,361 ||(56,608)||(75)||%|
|Net loss before taxes||(216,459)||(120,181)||(96,278)||80 ||%|
|Income tax benefit||— ||(84)||84 ||(100)||%|
|Net loss after taxes||$||(216,459)||$||(120,097)||$||(96,362)||80 ||%|
Premiums Earned, net
Net premiums earned increased $63.1 million, or 507%, from $12.5 million for the year ended December 31, 2020 to $75.6 million for the year ended December 31, 2021, which was primarily attributable to a $51.7 million decrease in premiums ceded to our reinsurance partners, and a $11.4 million increase in direct earned premium. The decrease of $51.7 million in premiums ceded to our reinsurance partners was driven largely by reinsurance commutation. Direct earned premium increased by $11.4 million from $99.7 million for the year ended December 31, 2020 to $111.1 million for the year ended December 31, 2021. The increase in direct earned premiums was primarily attributable to an increase in policies in force during the year ended December 31, 2021 as well as increase in miles driven during the same period due, in part, to COVID-19 shelter-in-place restrictions in the comparative period, which generally began in March 2020. We believe direct earned premium is the best measure of top-line revenue, as it excludes the impacts of reinsurance.
Investment income decreased $0.4 million, or 78%, from $0.5 million for the year ended December 31, 2020 to $0.1 million for the year ended December 31, 2021. The decrease was primarily due to lower interest rates, partially offset by a higher average level of fixed maturity investments.
Other revenue increased $7.1 million, or 32%, from $22.1 million for the year ended December 31, 2020 to $29.2 million for the year ended December 31, 2021. The increase was primarily attributable to a $19.4 million gain recognized on reinsurance commutation settlement in the first half of 2021, partially offset by a $11.2 million decrease in revenues from policy acquisition costs recovered for policies onboarded into our reinsurance program and reinsurance profit
commission. A substantial portion of Enterprise business solutions revenue was from one customer who was an investor and therefore a related party, as described in Note 20 of the consolidated financial statements included in Part II, Item 8, of this Annual Report on Form 10-K.
Costs and Expenses
Losses and LAE
Losses and LAE increased $67.3 million, or 317%, from $21.2 million for the year ended December 31, 2020 to $88.5 million for the year ended December 31, 2021. Ceded losses and LAE decreased $39.3 million as a result of commuting all of our reinsurance programs and thereby retaining more losses. Direct losses and LAE increased by $28.0 million, driven by an overall increase in claims costs due to an increase in claims severity observed industry-wide and a reserve adjustment. Additionally, losses in the year ended December 31, 2021 include the impacts from Hurricane Ida and severe storms in several regions of the United States.
Policy Servicing Expense and Other
Policy servicing expense and other increased $3.5 million, or 21%, from $16.8 million for the year ended December 31, 2020 to $20.3 million for the year ended December 31, 2021. The increase was primarily attributable to telematics device write-offs as a result of our upgrade from the use of 3G technology which accounted for $1.4 million of the increase and, to a lesser extent, an increase in our customer experience and other policy servicing personnel related expenses to support our growth objectives. Partially offsetting the increases, were decreased data costs in 2021 by $0.1 million as the upgrade to 4G corresponds to more economical hardware costs.
Sales, Marketing, and Other Acquisition Costs
Sales, marketing, and other acquisition costs increased $97.5 million from $5.5 million for the year ended December 31, 2020 to $103.0 million for the year ended December 31, 2021. Of this increase, $66.7 million was reinsurance-related including the commutation settlement and impact to the ceding commission offset. During the year ended December 31, 2021, we commuted all of our reinsurance programs. As a result of the commutations, we recorded a gain of $19.4 million recorded in Other Revenue as well as Sales, Marketing, and Other Acquisition Cost expense of $58.4 million related to a return of revenues from policy acquisition costs recovered for policies onboarded into our reinsurance program. Further resulting from the commutation settlement, was a decrease of $8.4 million in reinsurance ceding commission which serves as an offset to sales and marketing expense. Aside from reinsurance related impacts, as part of our typical marketing efforts, there was an increase of $26.4 million in both our online and offline marketing campaigns. On the sales side, there was a marginal increase in sales costs due to the use of independent agents for the first time in 2021.
Research and Development
Research and development increased $7.8 million, or 95%, from $8.2 million for the year ended December 31, 2020 to $16.0 million for the year ended December 31, 2021. The increase was primarily attributable to employee personnel costs related to our expansion initiatives in the engineering and technology areas of approximately $6.8 million, and an increase in stock compensation expense for related departments of $3.3 million, partially offset by a decrease of $2.2 million in capitalized software costs which serves as an offset to research and development expense.
Amortization of Capitalized Software
Amortization of capitalized software increased $0.1 million, or 1%, from $11.2 million for the year ended December 31, 2020 to $11.3 million for the year ended December 31, 2021. The increase was primarily related to the amortization of our website development costs and capitalized costs related to internal use software.
Other Operating Expenses
Other operating expenses increased $46.5 million, or 274%, from $17.0 million for the year ended December 31, 2020 to $63.5 million for the year ended December 31, 2021. The increase was primarily driven by an increase of $27.4 million in director’s, officers’, and employees’ stock-based compensation expense, $15.2 million increase in general and administrative costs as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC and the listing standards of the Nasdaq Capital Market, additional corporate, director and officer insurance expenses, and increased legal, audit and consulting fees, and $3.5 million transaction costs incurred in 2021 in connection with an intended merger with Lemonade.
Interest expense increased $9.9 million, or 163%, from $6.1 million for the year ended December 31, 2020 to $16.0 million for the year ended December 31, 2021. The increase was primarily attributable to a $14.1 million non-recurring write off of unamortized debt issuance costs and debt prepayment fees related to debt payoff during the year ended December 31, 2021. As of December 31, 2021, all debt had been repaid and no outstanding debt remains on the balance sheet.
Impairment on digital assets
Impairment on digital assets in the 2021 period relates to subsequent losses arising from changes in the fair market value on acquired digital assets initially accounted for at cost. For more information, see Note 8, Digital Assets, Net to our consolidated financial statements included in Part II, Item 8, of this Annual Report on Form 10-K.
Increase in fair value of stock warrant liability
Fair value of stock warrant liability decreased $66.7 million from $69.3 million for the year ended December 31, 2020 to $2.6 million for the year ended December 31, 2021. The decrease was primarily driven by the change in fair value of our preferred stock warrants issued in April 2020 and exercised in February 2021 and public and private placement warrants as described in Note 2 of the consolidated financial statements included in Part II, Item 8, of this Annual Report on form 10-K.
Non-GAAP Financial Measures
The non-GAAP financial measures below have not been calculated in accordance with 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, accident period contribution profit/(loss) and contribution profit/(loss) 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 these non-GAAP measures 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 use 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 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.
The following table provides a reconciliation of total revenue to contribution profit/(loss) and accident period contribution profit/(loss) for the periods presented:
|($ in millions)|
|Total revenue||104.9 ||35.1 |
|Losses and LAE||(88.5)||(21.2)|
|Policy servicing expense and other||(20.3)||(16.8)|
|Amortization of capitalized software||(11.3)||(11.2)|
|Less revenue adjustments:|
|Revenue Adjustments Related to Reinsurance||9.6 ||69.5 |
|Revenue from Enterprise Segment||(4.9)||(5.7)|
|Interest Income and Other||2.4 ||2.4 |
|Less costs and expense adjustments:|
|Loss and LAE Adjustments Related to Reinsurance||(14.7)||(54.0)|
|Loss and LAE Adjustments Related to Prior Period Development||2.1 ||6.5 |
|Bad Debt, Report Costs and Other Expenses||0.5 ||(1.1)|
|Amortization of Internally Developed Software||11.3 ||11.2 |
|Devices||5.4 ||3.7 |
|Accident period contribution profit/(loss)||$||(3.5)||$||18.4 |
|Prior Period Development||$||(2.1)||$||(6.5)|
|Contribution profit/(loss)||$||(5.6)||$||11.9 |
|Total revenue||$||104.9 ||$||35.1 |
|Revenue adjustments||7.1 ||66.2 |
|Adjusted revenue||$||112.0 ||$||101.3 |
|Accident period contribution margin||(3.1)||%||18.1 ||%|
|Contribution margin||(5.0)||%||11.8 ||%|
Liquidity and Capital Resources
We are a holding company that transacts a majority of our business through operating subsidiaries. Through our insurance subsidiaries, we sell pay-per-mile auto insurance policies to customers and through our Enterprise subsidiary, we sell our insurance solution technology to third-party insurance carriers. From inception through completion of the Merger, we financed our operations primarily through sales of insurance policies, sales of our Enterprise platform, and the net proceeds received from the issuance of preferred stock, debt, and sales of investments. As of December 31, 2021, we had $120.9 million in unrestricted cash and cash equivalents compared to unrestricted cash and cash equivalents of $19.2 million as of December 31, 2020. 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.
Insurance companies in the United States are also required by state law to maintain a minimum level of capital and surplus. Insurance companies are subject to certain RBC requirements as specified by NAIC. These standards for property and casualty insurers are used as a means of monitoring the financial strength of insurance companies. Under these requirements, the amount of capital and surplus maintained by an insurance company is to be determined based on the various risk factors related to it. Such regulation is generally for the protection of the policyholders rather than stockholders. As of December 31, 2021 and December 31, 2020, our capital and policyholders’ surplus exceeded the minimum RBC requirements. We believe that our existing cash and cash equivalents, marketable securities, and cash flow from operations 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 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.
Our principal sources of liquidity are funds generated by operating activities, and available cash and cash equivalents, subject to the limitations set forth in the merger agreement related to the Proposed Transaction.
The following table summarizes our cash flow data for the periods presented:
|($ in millions)|
|Net cash used in operating activities||$||(95.1)||$||(32.2)|
|Net cash (used in) provided by investing activities||$||(64.8)||$||1.8 |
|Net cash provided by financing activities||$||273.5 ||$||37.7 |
Net cash used in operating activities for the year ended December 31, 2021 was $95.1 million, which was an increase of net cash used of $62.9 million from $32.2 million for the year ended December 31, 2020. Cash used during this period included $144.3 million from net loss for the year ended December 31, 2021, excluding the impact of changes in fair value of our outstanding warrants, depreciation expense and stock-based compensation and other non-cash expenses. Net cash provided by changes in our operating assets and liabilities increased by $51.5 million, which is primarily attributable to ceded reinsurance premiums, reinsurance recoverable on unpaid losses, accounts payable and accrued expense, prepaid reinsurance premium, premiums receivable which outpaced reinsurance recoverable on paid losses, partially offset by an increase in paid claims on loss and LAE reserves year over year.
Net cash used in operating activities for the year ended December 31, 2020 was $32.2 million. Cash used during this period included $29.8 million from net loss for the year ended December 31, 2020, excluding the impact of changes in fair value of our outstanding warrants, depreciation expense and stock-based compensation and other non-cash expenses. Net cash provided by changes in our operating assets and liabilities decreased by $2.4 million, which is primarily attributable to ceded reinsurance premiums, reinsurance recoverable on unpaid losses, accounts payable and accrued expense, prepaid reinsurance premium, premiums receivable which outpaced reinsurance recoverable on paid losses, prepaid expenses and other, unearned premium reserve, and loss and LAE reserves.
Net cash used in investing activities for the year ended December 31, 2021 was $64.8 million compared to net cash provided by investing activities of $1.8 million during the year ended December 31, 2020, which was primarily driven by a change from net proceeds to net payments for securities, as well as continued investment in our website and software development, partially offset by a decline in investment in telematics devices, leasehold improvements, and other equipment.
Net cash provided by financing activities for the year ended December 31, 2021 was $273.5 million compared to $37.7 million in cash provided by financing activities for the year ended December 31, 2020. In February 2021, the Company completed a business combination (the “Merger”) with INSU Acquisition Corp. II (“INSU”), where the Metromile merged with a wholly-owned subsidiary of INSU, with Metromile surviving the Merger as a wholly-owned subsidiary of INSU. The increase in cash provided by financing activities is primarily due to cash received from the trust account and the private placements in connection with the Merger.
The following is a summary of material contractual obligations and commitments as of December 31, 2021:
|Total||2022||2023 – 2024||2025 – 2026||Thereafter|
|Long-term debt||$||— ||$||— ||$||— ||$||— ||$||— |
|Interest on long-term debt||— ||— ||— ||— ||— |
|Operating Leases||18.9 ||2.2 ||4.9 ||3.8 ||8.0 |
|3.3 ||3.3 ||— ||— ||— |
|$||22.2 ||$||5.5 ||$||4.9 ||$||3.8 ||$||8.0 |
Subordinated Note Purchase and Security Agreement
In April 2020, we entered into the Note Purchase Agreement with Hudson, which was amended in February 2021 to reflect the consummation of the Merger by adding INSU as a guarantor and reflecting our new corporate structure. An executive of Hudson is on our board of directors and is a related party, as discussed in Note 20 of the consolidated financial statements included in Part II, Item 8, of this Annual Report on Form 10-K.
Under the Note Purchase Agreement, we could issue up to $50.0 million in aggregate principal amount of senior secured subordinated PIK notes due in 2025 (the “Notes”). The Note Purchase Agreement further provided for additional funds of up to an aggregate of $15.0 million over time from Hudson, the timing of which was subject to reinsurance settlement timing. Notes issued under the Note Purchase Agreement were due on the fifth anniversary of their issuance, starting in April 2025, and bore interest at the following rates: 2% per annum payable quarterly in arrears in cash, and a varying interest rate of 9.0% to 11.0% PIK interest. The PIK interest was based on the aggregate outstanding principal balance as follows: (i) 11.0% if the outstanding balance was less than $5.0 million; (ii) 10.0% if the outstanding balance was greater than or equal to $5.0 million but less than $10.0 million, and (iii) 9.0% if the outstanding balance was greater than or equal to $10.0 million. PIK interest represents contractually deferred interest that was added to the principal balance outstanding each quarter and due at maturity. The Notes were secured by substantially all of our assets. We had the right to prepay the Notes at any time subject to payment of a fee. As of December 31, 2020, $31.6 million aggregate principal amount of the Notes was outstanding, along with $0.9 million of capitalized PIK interest. Subsequent to December 31, 2020, we issued additional Notes having an aggregate principal amount of $2.0 million. As of March 30, 2021, there was approximately $36.6 million of principal and PIK interest outstanding under the Hudson debt facility, which we repaid on such date, along with the prepayment fee of $0.4 million. Accordingly, there are no longer any Notes outstanding.
As part of the entry into the original Note Purchase Agreement, we issued warrants for up to 8,536,938 of Series E convertible preferred shares, which we estimated to have a fair value of $12.5 million at issuance, which was recorded as a discount to the debt and is being amortized to interest expense over the term of the debt. These warrants were net exercised immediately prior to the consummation of the Business Combination with INSU and are no longer outstanding.
Paycheck Protection Program Loan
In April 2020, we were granted a loan under the Paycheck Protection Program offered by the Small Business Administration under the CARES Act, section 7(a)(36) of the Small Business Act for approximately $5.9 million. The balance outstanding for the Paycheck Protection Program loan was $5.9 million at December 31, 2020. We repaid this loan concurrent with the consummation of the Business Combination with INSU and it is no longer outstanding as of December 31, 2021.
2019 Loan and Security Agreement
In December 2019, we entered into a Loan and Security Agreement (the “2019 Loan and Security Agreement”) with us, as borrower, certain of our subsidiaries, as guarantors and certain affiliates of Multiplier Capital, LLC and other financial institutions, as lenders and agent, providing for a term loan in aggregate principal amount of $25.0 million. Minimum payments of interest were due monthly through December 2021. Beginning in January 2022, equal payments of principal would have been due monthly in an amount necessary to fully amortize the loan by June 5, 2024. An end of term payment of $0.6 million was due at maturity or date of any prepayment. The loan was secured by substantially all of our and the guarantor’s assets. Lender’s consent was required to be obtained regarding certain dispositions, and changes in business, management, or ownership including mergers and acquisitions, such as the Merger, as more fully described in the 2019 Loan and Security Agreement. The balance outstanding net of debt issuance costs for the 2019 Loan and Security Agreement was $24.3 million as of December 31, 2020.
The loan could be prepaid in an amount equal to the outstanding principal, accrued interest, and the end of term fee, plus a prepayment charge of 3% if paid in the first two years after the effective date, 2% if paid in the third year after the
effective date, or 1% if prepaid after the third year subsequent to the effective date. Accordingly, we prepaid this loan in connection with the consummation of the Merger and is no longer outstanding.
At the time of origination, the lender was granted a warrant to purchase Series E convertible preferred stock, estimated to have a fair value of $0.5 million at issuance. These warrants were net exercised immediately prior to the consummation of the Business Combination with INSU and are no longer outstanding as of December 31, 2021.
Critical Accounting Policies
Our financial statements are prepared in accordance with GAAP. The preparation of the consolidated financial statements in conformity with GAAP 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 LAE, premium write-offs, and share-based compensation. 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 1, Basis of Presentation and Significant Accounting Policies, to the audited consolidated financial statements included elsewhere in this Form 10-K.
Unpaid Losses and LAE Reserves
Unpaid losses and LAE reserves are the difference between the estimated ultimate cost of losses and LAE and the amount of paid losses and LAE as of the reporting date. These reserves reflect our management’s best estimate for both reported claims and incurred but not reported claims and the reserves include estimates of all expenses associated with processing and settling all reported and unreported claims. Our management regularly reviews the reserve estimates and updates those estimates as new information becomes available or as events emerge that may affect the resolution of unsettled claims. Losses and LAE reserves are estimated based on the assumption that past-experience is an appropriate indicator of future events. Updates made to reserve estimates based on new information may cause changes in prior reserve estimates. These changes are recorded as Loss and LAE in the period such changes are determined. Estimating the ultimate cost of claims and claims expenses is an inherently complex process that involves a high degree of judgment. The estimate of unpaid losses and LAE reserves utilizes several key judgmental inputs:
•the determination of the appropriate actuarial estimation methods to be applied to outstanding claims,
•estimations of claims cycle times and claims settlement practices,
•estimates of expected losses through the use of historical loss data, and
•broader macroeconomic assumptions such as expectations of future inflation rates.
Claims are classified based the year in which the claims occurred ("accident year"). This classification is utilized within actuarial models to prepare estimates of required reserves for payments to be made in the future. Claim cycle times, or the speed of claim to claim settlement, vary and depend on the type of claim being reported; property damage as compared to personal injury claims. Claims involving property damage are generally settled faster than personal injury claims. It has been our management’s experience that the longer the cycle time, the more the ultimate settlement amount can vary. Historical loss patterns are then applied to actual paid losses and reported losses by accident year to develop expectations of future payments. Implicit within the actuarial models are the impacts of inflation, especially for claims with longer expected cycle times. See Note 9, Loss and Loss Adjustment Expense Reserves, to our audited consolidated financial statements included elsewhere in this prospectus for more information regarding the methodologies used to estimate loss and LAE reserves.
Considerable variability is inherent in these estimates, which may have a material impact on the ultimate liability. The aggregation of numerous estimates for each of the major components of losses and groups of states as well as other considerations such as trends in claim frequency and severity, regulatory and judicial environments, allocations of ceded amounts in accordance with reinsurance agreements, and driving behavior including miles driven, may impact reported losses and IBNR. Reserve estimates are inherently very complex to determine and subject to significant judgment, and do not represent an exact determination for each outstanding claim. Due to the inherent uncertainty in estimating reserves, we evaluated what the potential impact on consolidated results of operations, financial position, and liquidity would be based on a hypothetical 10% change in reserves described above. A 10% variance in estimated reserves net of reinsurance would be approximately $7.3 million as of December 31, 2021, and would result in an increase or decrease to Net loss of $7.3 million to a Net loss of $223.8 million or $209.2 million, respectively. This would also result in a change to Total stockholders’ equity of $7.3 million increasing or decreasing it to $193.7 million or $179.1 million, respectively. The reserve range represents a range of reasonably likely reserves, not a range of all possible reserves. Therefore, the ultimate liability may reach levels corresponding to reserve amounts beyond the stated figures. Given the growth since 2017, we believe evaluating sensitivity based on a hypothetical change of 10% is reflective of management’s best estimate and provides a range of variability in key assumptions.
The following table summarizes our gross and net reserves for loss and LAE:
|As of December 31, 2021|
|Loss and LAE reserves||Gross||% of Total||Net||% of Total|
|($ in millions)|
|Case Reserves||$||36.2 ||49.3 ||%||$||36.2 ||49.3 ||%|
|IBNR||37.2||50.7 ||%||37.2||50.7 ||%|
|Total Reserves||$||73.4 ||100 ||%||$||73.4 ||100 ||%|
|As of December 31, 2020|
|Loss and LAE reserves||Gross||% of Total||Net||% of Total|
|($ in millions)|
|Case Reserves||$||29.4 ||51.5 ||%||$||7.2 ||31.0 ||%|
|IBNR||27.7||48.5 ||%||16.0||69.0 ||%|
|Total Reserves||$||57.1 ||100 ||%||$||23.2 ||100 ||%|
Given the inherent complexity and uncertainty surrounding the estimation of our ultimate cost of settling claims, reserves are reviewed throughout the year with in-depth reviews quarterly by combining historical results and current actual results to calculate new development factors. In estimating loss and LAE reserves, our actuarial reserving group considers claim cycle time, claims settlement practices, adequacy of case reserves over time, and current economic conditions. Because actual experience can differ from key assumptions used in estimating reserves, there may be significant variation in the development of these reserves and the actual losses and LAE ultimately paid in the future. These adjustments to the loss and LAE reserves are recognized in our consolidated statement of operations in the period in which the change occurs.
The following table summarizes our gross losses and LAE, and net losses and LAE as of December 31, 2021 and 2020 respectively:
|Gross Ultimate Loss & LAE||Net Ultimate Loss & LAE|
|($ in millions)|
|2017 and prior||$||54.4 ||$||53.1 ||$||1.3 ||$||41.9 ||$||40.7 ||$||1.2 |
|2021||100.3||100.3 ||88.6||88.6 |
|Total||$||393.0 ||$||290.0 ||$||103.0 ||$||216.7 ||$||128.5 ||$||88.3 |
As of December 31, 2021, the Company had commuted all of its reinsurance agreements. Although no reinsurance arrangements were in place as of December 31, 2021, the impacts of non-loss related commutation expenses from previous arrangements created differences between gross and net ultimate loss and LAE.
Premiums Receivable and Reinsurance Recoverable and Related Expenses
Premiums receivable represents premiums written but not yet collected. Generally, a policyholder is given a grace period to pay the premium, can vary by state, before the coverage is canceled. Once a policy is canceled, the remaining unearned premium liability for that policy is written off along with the remaining premium receivable balance. We recognized premium write-offs of $2.0 million and $2.3 million for the years ended December 31, 2021 and 2020, respectively.
Reinsurance assets consist of reinsurance recoverable on paid and unpaid losses and LAE from our reinsurance partners of which the estimates are based on the same reserving practices as described above. Our use of reinsurance does not extinguish our primary liability under the policies written. In the event that any of our reinsurance partners might not be able to fulfill their obligations under our reinsurance contracts, we would be liable for the amounts defaulted. The amounts recoverable from our reinsurance partners are therefore exposed to the credit risk of our reinsurance partners. Therefore, we regularly evaluate the financial condition of our reinsurers, the sufficiency of collateral posted by our reinsurance partners, and establish provisions for uncollectible reinsurance as appropriate.
Capitalization of Internally Developed Software
We invest in research and development for the purpose of developing new functionality for our website, apps, and gathering and analyzing data received from the driving habits of our customers. We primarily develop software for internal use. For all internal use software, we account for software development costs under ASC 350-40, “Internal-Use Software; Computer Software Developed or Obtained for Internal Use.” With respect to internal use software, software and technology development activities generally fall into three stages:
1.Preliminary Project Phase includes activities, such as the determination of needed technology and the formulation, evaluation, and selection of alternatives of those needs;
2.Application Development Phase includes activities that focused on software design and configuration, coding, installation, testing, and parallel processing; and
3.Post-Implementation/Operating Phase includes activities that address training, administration, maintenance, and all other activities to operate developed software.
During the Preliminary Project Phase, we expense all costs to expense as incurred.
During the Application Development Phase, we capitalize costs for projects that we determine are probable of being completed.
During the Post-Implementation/Operating Phase we expense all costs related to such activities as incurred. However, upgrades and/or enhancements of existing software will be capitalized to the extent that we determine that such upgrades and/or enhancements will result in additional functionality. We define additional functionality as modifications that enable additional tasks that our software was previously incapable of performing which normally requires new software specifications or a change to all or a part of existing software. Internal costs incurred for upgrades and/or enhancements are expensed or capitalized based on the three stages of development noted above. We track projects individually, such that the beginning and ending of the capitalization can be appropriately established, as well as the amounts capitalized therein.
All capitalized software requires the ongoing assessment for recoverability which requires judgment by management with respect to certain external factors including, but not limited to, anticipated future gross revenues, estimated economic useful life, and changes in competing software technologies. We have determined that our internal-use software’s estimated useful life is three years.
For all software to be sold to third-party insurance carriers, we account for software development costs under ASC 985-20, “Costs of Software to be Sold, Leased, or Marketed.” Costs incurred to develop software to be sold to third parties are expensed as incurred until technological feasibility is reached. All costs incurred after technological feasibility is reached and prior to when the developed software is available for general release to our customers are capitalized. As of December 31, 2021, software costs to be capitalized under ASC 985-20 have not been significant.
Stock-Based compensation, inclusive of stock options with only a service condition and stock options with service and performance conditions, restricted stock awards, restricted stock units (“RSUs”), and performance awards ("PSUs"), are awarded to our officers, directors, employees, and certain non-employees through approval from the compensation committee of the Board of Directors.
We account for stock-based compensation in accordance with ASC Topic 718, “Compensation — Stock Compensation.” Stock-based compensation is measured at the grant date based on the fair value of the award. Stock-based compensation for stock options and RSUs with service conditions are recognized as expense over the requisite service period, which is generally the vesting period of the respective award. The expense recorded is based on awards ultimately expected to vest and, therefore, is reduced by estimated forfeitures. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. For stock options with performance-based metrics and PSUs, stock-based compensation is recognized when it is probable that the performance criteria are achieved.
We calculate the fair value of stock options using the Black-Scholes option pricing model and recognize expense using the straight-line attribution approach. The fair value of stock options is determined on the grant date using the Black-Scholes Merton (“BSM”), option-pricing model. The BSM option pricing model requires inputs based on certain subjective assumptions, including the fair value of our common stock, 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 options and our expected dividend yield.
• Expected Term — The expected term is the period of time when granted options are expected to be outstanding. In determining the expected term of options, we utilized the midpoint between the vesting date and contractual expiration date.
• Risk-Free Interest Rate — The risk-free interest rate is based on the U.S. Treasury yield curve for zero-coupon U.S. Treasury notes with maturities similar to the option’s expected term as of the grant date.
• Volatility — Because our stock is not traded in an active market, we calculate volatility by using the historical stock prices of public companies that we consider to be comparable to our business.
• Forfeiture Rate — The weighted average forfeiture rate of unvested options.
• Expected Dividends — We assumed the expected dividend to be zero as we have no current expectations to be paying dividends in the foreseeable future.
• Common Stock Valuation — Given the absence of a public trading market of our common stock for those options granted prior to the Merger, our board of directors considered numerous subjective and objective factors to determine the best estimate of fair value of our common stock underlying the stock options granted to our employees and non-employees. The grant date fair value of our common stock was determined using valuation methodologies which utilize certain assumptions, including probability weighting events, volatility, time to liquidation, a risk-free interest rate, and an assumption for a discount for lack of marketability. We used a weighted average value determined through the Option Pricing Model (OPM) and the Probability-Weighted Expected Return Method ("PWERM") for allocating our enterprise value. Application of these methods involves the use of estimates, judgments, and assumptions that are complex and subjective, such as those regarding our expected future revenue, expenses, and cash flows, discount rates, market multiples, the selection of comparable companies, and the probability of future events.
• Fair Value — our board of directors determines the fair value of the common stock based on the closing price of the common stock on or around the date of grant.
As defined by Staff Accounting Bulletin (“SAB”) 107, Share-Based Payment, the Company categorizes stock-based payment awards issued under the 2011 and 2021 Stock Plans as “plain vanilla” options.
RSUs and PSUs
As of February 9, 2021, the Company stopped issuing stock options under the 2021 Plan and only issues RSUs on a go-forward basis. As of December 31, 2021, the Company has granted RSUs with service conditions as well as RSUs with performance conditions and market conditions. Service conditions, as well as performance conditions, that affect whether or not an award vests or becomes exercisable are not directly incorporated into the estimate of fair value at the grant date whereas the effect of a market condition is reflected in estimating the fair value of an award at the grant date. Compensation cost thus is recognized for an award with a market condition provided that the good is delivered or the service is rendered, regardless of when, if ever, the market condition is satisfied.
Grants to Non-Employees
In determining who should be considered a non-employee rather than an employee, the Company considered ASC 718’s definition of an employee. The Company complies with this guidance in classifying its members of the BOD as employees. Treatment of non-employee awards are consistent with the accounting for employee awards. Please refer to the "Stock Options" and "RSUs and PSUs" sections above for more detail.
For more information, see Note 15, Stock Option Plans, to the audited consolidated financial statements included in Part II, Item 8, of this Annual Report on Form 10-K.
We classify warrants to purchase shares of our common stock that are contingently puttable or redeemable as liabilities. Such warrants are measured and recognized at fair value and are subject to remeasurement at each balance sheet date. The fair value of our private warrant liabilities is measured using a Black-Scholes ("BSM") option-pricing model whereas the fair value of our public warrants are measured using level 1 inputs. Under the BSM option-pricing model, the fair value is measured using the following assumptions and inputs: exercise price, fair value of the underlying preferred stock, expected term, expected volatility, and risk-free interest rate.
We classify the warrants as a liability on our consolidated balance sheets as of December 31, 2021 and 2020. The warrant liabilities are measured at fair value at inception and on a recurring basis, with changes in fair value presented within change in fair value of warrant liabilities in the consolidated statement of operations. Prior to Merger, we had warrants exercisable for convertible preferred stock which were exercised at the time of the Merger and no longer considered outstanding. These warrants were measured using the BSM option pricing-model.
The Company currently does not have any warrants for preferred convertible stock outstanding as of December 31, 2021 but does have 7,666,646 public warrants and 180,000 private placement warrants outstanding as of December 31, 2021. For more information, please see Note 14, Public and Private Warrants to the audited consolidated financial statements included elsewhere in this Form 10-K.
New Accounting Pronouncements
See Note 1, Basis of Presentation and Significant Accounting Policies, to our consolidated financial statements included in Part II, Item 8, of this Annual Report on Form 10-K.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO FINANCIAL STATEMENTS