Earnings Call Transcript - HIPO Q1 2023

Operator, Operator

Hello, everyone, and welcome to the Hippo Q1 2023 Earnings Call. My name is Chach and I'll be the coordinator for this conference. I would now like to hand over to Cliff Gallant to begin. Please go ahead.

Cliff Gallant, Moderator

Thank you, operator. Good morning, everybody, and thank you for joining Hippo's First Quarter Earnings Conference Call. Earlier, Hippo issued a shareholder letter announcing its results, which is available at investors.hippo.com. Leading today's discussions will be Hippo's Chief Executive Officer and President, Rick McCathron, and our Chief Financial Officer, Stewart Ellis. Following management's prepared remarks, we will open up the call to questions. Before we begin, I'd like to remind you that our discussion will contain predictions, expectations, forward-looking statements and other information about our business that are based on management's current expectations as of the date of this presentation. Forward-looking statements include, but are not limited to, Hippo's expectations or predictions of financial and business performance and conditions and competitive and industry outlook. Forward-looking statements are subject to risks, uncertainties and other factors that could cause our actual results to differ materially from historical results and/or from our forecast, including those set forth in Hippo's Form 8-K filed today. For more information, please refer to the risks, uncertainties and other factors discussed in Hippo's SEC filings, in particular, in the section entitled Risk Factors. All cautionary statements are applicable to any forward-looking statements we make whenever they appear. You should carefully consider the risks and uncertainties and other factors discussed in Hippo's SEC filings. Do not place undue reliance on forward-looking statements as Hippo is under no obligation and expressly disclaims any responsibility for updating, altering or otherwise revising any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law. During this conference call, we will also refer to non-GAAP financial measures such as total generated premium and adjusted EBITDA. Our GAAP results and description of our non-GAAP financial measures with the full reconciliation to GAAP can be found in the first quarter 2023 shareholder letter which has been furnished to the SEC and is available on our website. And with that, I'll turn the call over to Rick McCathron, our President and CEO.

Rick McCathron, CEO

Good morning, everyone. 2023 is off to an excellent start for Hippo. We're growing, hitting our goals for operating efficiency, and we continue to have the financial strength to execute on our plans with confidence. We have made significant strides towards profitability and remain on track for achieving adjusted EBITDA profitability by the end of 2024. As I mentioned on our fourth quarter call, Hippo's long-term success comes down to two simple things. First, we need to make the experience of being a Hippo customer the best around. One of our most significant projects in 2023 is building a differentiated consumer agency business. Our aim is to offer the superior Hippo experience to all of our customers, whether they are buying a Hippo home insurance policy or a product from one of our partner carriers. Currently, just over 10% of our customers are buying more than one product through the Hippo agency, and we expect this percentage to grow substantially over time. Our goal is to delight our customers by exceeding their expectations as their partner in proactively protecting their homes. One tangible example of this strategy is our Hippo Home Care service. I'm happy to report that our new Home Care app is now available for download through both the Apple and Android app stores for all U.S. homeowners, even if they are not yet a Hippo customer. Through the app, a homeowner can receive a Hippo Home Care health score, along with maintenance checklists of activities and simple DIY instructions on how to improve their score. You should give it a try. The second key component of long-term success is continuing to use our technology to execute at a high level on the financial and operational fundamentals of insurance. As we've discussed previously, our top priority is improving the loss ratio for our Hippo home insurance program. In the quarter, the U.S. home insurance industry was impacted by high winter weather activity, including 17 atmospheric rivers in California, our second largest state. However, looking beyond the bad weather, our current accident year gross loss ratio, excluding PCS-defined catastrophes, was 60%, a substantial improvement versus Q1 2022 comparable of 78%. The primary drivers of this improvement were our recent actions in rate and pricing, improved geographical diversification and our continued success in attracting our generation of better customers. And this is just the beginning. In 2023, we've submitted filings impacting 46 of our managed products covering 81% of our premium volume, with 30 of those already receiving regulatory approval, covering half of all of our premiums. And this is just the first quarter. We expect these filings to continue our momentum, further improving our rate segmentation and accuracy. Cumulatively, we have introduced 18 new data-driven rating variables into our rating plans over the last two years. These variables continue to move us down our path of creating a differentiated pricing plan that partners with customers on risks to their home and provides the customers a financial incentive to make improvements. Finally, our technology platform also allows us to benefit from operating leverage as we scale. Operating expenses, excluding loss and loss adjustment expense, were essentially flat versus the prior year quarter, falling as a percentage of TGP from 44% last year to 29% for this quarter. As we've said in the past, much of the heavy development costs of our platform are behind us, and we're rapidly moving towards a period of sustainable, profitable growth. Thank you. Now I'll turn the call over to our CFO, Stewart Ellis.

Stewart Ellis, CFO

Thank you, Rick, and good morning, everyone. We have continued our execution momentum from last year and are off to a great start in 2023. Top line growth remained strong with TGP and revenue growing at 59% and 62%, respectively, year-over-year. We continue to improve our underlying loss ratios with the Hippo home insurance program core loss ratio coming in at 60%, an 18-percentage point improvement over the comparable figure from a year ago. And we are achieving expected increases in operational efficiency as we scale with operating expenses roughly flat year-over-year while growing TGP and revenue. Our adjusted EBITDA was negative $52.1 million versus negative $48.5 million in the prior year quarter, driven by excess PCS catastrophic weather losses and higher-than-normal non-cat weather that had a net impact of $7.5 million on our P&L during the quarter. As we discussed last quarter, we're excited to begin reporting our financials in three segments to align with how we are managing the business in 2023. In the Hippo home insurance program segment, we continued to expand the size of our policy portfolio while making significant progress on our path to profitability. TGP and revenue grew quickly in the quarter, up 17% and 48%, respectively, year-over-year. As we said last quarter, we expect the pace of 2023 TGP growth to be restrained in this segment relative to other parts of our business, as we continue to focus on improving our loss ratio. For revenue, we expect strong growth for the remainder of 2023, as our 2023 reinsurance treaty drives higher earned premium volumes as we realize the benefit of higher yields on our investment portfolio. The Hippo home insurance program-specific gross loss ratio was 101%, including 41 percentage points of PCS-defined catastrophic weather losses. The quarter included unusually heavy rain and snow in parts of California, our second largest market. The core non-cat gross loss ratio of 60% was an 18-percentage point improvement versus the prior year quarter reflecting the benefits of the pricing and underwriting actions that we took in 2022. We expect significant continued improvement as these actions have more time to earn into our financial results. We are continuing to leverage our nimble technology platform to fine-tune and calibrate our rating plans and have submitted filings already in 2023 that impact 46 of our managed products, covering 81% of our premium volume. As we have previously stated, we expect our gross loss ratio to reach the mid-60% range by the end of 2024. Our segment operating expenses, excluding losses and loss adjustment expense, have improved materially as a percentage of TGP to 27% versus 40% in the prior year quarter. We are showing a flattening in sales and marketing spend and lower technology and development costs as we continue to focus on expense discipline and expect ongoing improvements as we grow. Our Hippo homeowners insurance program reported an adjusted EBITDA loss in the quarter of $44.3 million versus $39.7 million a year ago, primarily due to the excess catastrophic weather in the quarter. In our Services segment, which includes our Hippo agency, First Connect, and our Hippo Home Care business, we delivered TGP of $97.9 million, up 29% over the prior year quarter while revenue was up 32% to $9.8 million. Our Services businesses are fast-growing and fee-oriented with high LTV characteristics. We continue to invest aggressively in our platforms to provide differentiated services for our customers across all our businesses. Within the Hippo agency, builder partnerships are driving both new and renewal business, and we're excited about the launch of our program for small homebuilders through our recently launched homebuilder insurance agency. At First Connect, we continue to sign up new agencies and insurers to the platform and now support access to over 70 carriers and insurers for thousands of independent agents. As Rick mentioned earlier, Hippo Home Care recently launched our Hippo Home Care app nationwide for all U.S. homeowners. Services also demonstrated favorable operating leverage during the quarter. The adjusted EBITDA loss was $10.8 million in the quarter, reflecting continued investments in brand advertising and technology but an improvement from the $11.4 million adjusted EBITDA loss a year ago as our operating expenses declined by 46 percentage points of revenue. In our Insurance as a Service segment, we leverage the capital and insurance licenses of our fully owned Spinnaker carrier to provide capacity to third-party MGAs, creating diversified income through fees, underwriting profits, and investment income. This segment had a great start to the year with record growth rates and a positive $3.2 million contribution to adjusted EBITDA. Total generated premiums were $104 million, up 156%, driven by both new and existing programs. Revenue growth was also strong at $12.9 million, up 84% versus a year ago. Turning to our strong balance sheet. Our cash and investments were $620 million at the end of the quarter, down $20 million from the end of December. And Spinnaker statutory surplus was $169 million at the end of the quarter, up $4 million from the end of December. We also announced a $50 million share repurchase program in late March and were able to repurchase a little over 25,000 shares through the end of the quarter. In the month of April, we continued the program repurchasing almost 44,000 additional shares. Finally, I'd like to review our 2023 guidance. With Q1 behind us, we are comfortable increasing our TGP guidance for the year. We now expect to exceed $1 billion of TGP in 2023 versus our previous statement of nearing $1 billion. We now expect revenues to be up over 45% for the year versus prior guidance of over 40%. And we continue to expect an adjusted EBITDA loss of $147 million for the full year 2023. And finally, I'd like to reiterate our expectation of turning adjusted EBITDA positive, which I’ll note definitionally excludes our investment income by the end of 2024. Thank you, everyone. Now we'd be happy to take your questions.

Operator, Operator

Our first question today comes from Thomas McJoynt from KBW.

Thomas McJoynt-Griffith, Analyst

The first one, in terms of the rating actions that you guys have filed and implemented, where do you stand on that progress? If you could sort of distinguish between filed win rate that is meant to just keep pace with whatever your assumptions are for the ongoing inflationary loss trend versus other actions that you think are kind of outside of this inflationary environment, as you get towards that mid-60s goal.

Rick McCathron, CEO

Yes. No, thanks, Tommy. It's Rick here. It's a bit of a loaded question, but I'll go ahead and answer it from my perspective. Based on our current view of rate adequacy, we really do think the actions we took last year that continue to work themselves into the book and the actions that we're taking this year. By the way, of our actions this year, more than half have been approved from a regulatory perspective. So we think based on our current view, we think that things are exactly on pace for what we plan to hit our guidance and our target to profitability. That said, we also believe that sort of being rate adequate is never really done. Our view changes as we get additional data sources, refine our rating algorithms, and gain a further view of what's going on with the weather. So we think it's an ongoing process, frankly. And one of the significant advantages that Hippo has versus others is our tech stack and our ability to take that current view and quickly bring it to market, which gives us a very competitive advantage in an ever-changing world. So we think we're on track for everything that we currently have planned, but our actuarial team continues to bring new underwriting sources, new data sources, and new views on rate. I mean, we'll take the actions quickly. It is the combination of both what we're doing for underlying inflation and what we view as things that are changing in the environment.

Thomas McJoynt-Griffith, Analyst

Got it. Thanks. And then looking at the operating expense lines on the income statement. Could you walk through which pieces there are more variable and which pieces should we think of as more flat line from here?

Stewart Ellis, CFO

Sure. Thanks, Tommy. This is Stewart. I'll try to take your question and happy to have Rick join in if he has things to add. Obviously, within the expense line, the most variable one will be loss and loss adjustment expense, that's related both to the volume as well as the underlying weather, which as we saw in this quarter was a bit higher than normal for our business due to the weather in California. Insurance-related expenses are also going to be volume-related. That reflects some of our distribution and underwriting costs. The remaining items, such as development, sales and marketing and SG&A will be more fixed. Sales and marketing will grow over time relative to the others, but we've been very focused on expense discipline over the past year in sales and marketing. I think that we'll see efficiencies there as we progress through the rest of the year. We did have a little bit higher G&A expense in the first quarter, but the majority of that was related to a one-time repricing of options, which drove higher stock-based compensation in the quarter. I wouldn't look at that as an ongoing increase, and it also is not a cash item.

Operator, Operator

The next question on the line is from Alex Scott of Goldman Sachs.

Alexander Scott, Analyst

First one I have for you is on the net loss ratio. I know it's not a perfect metric, and there's a lot of issues we're looking at it. But at the same time, it's been high. I think under the new reinsurance program, it's expected to trend down to something that's more aligned with the gross loss ratio. And this quarter, I think that takes a few quarters or a handful of quarters to earn in. But this quarter seems to go the opposite direction. I just wanted to see if you could help us understand why that happened and if it changes anything about the trajectory of where it will go over the next few quarters?

Stewart Ellis, CFO

Yes. Happy to take that one. Alex, this is Stewart. So you're exactly right. It did go up a bit year-over-year in the first quarter. That's primarily due to the excess catastrophic weather in California due to the rain and snow. But the broader comment is exactly on point. It is a function of the business model change from 2022 to 2023. And by that, I mean we are ceding off a lot more of the premium in 2022 than we will be in 2023. And so we're just looking at a very small denominator of earned premium in 2022 as the new treaty earns in over the course of the year, that problem addresses itself and that number will come down into line with the gross loss ratio as that three years in. The way to think about this, I think, is when a business is ceding off as much of the risk as we are as an MGA, if you're really looking at the underlying economics, you've got to look at the commission we're getting from the reinsurers. Since we participate a bit in the loss and loss adjustment expense on business that we don't retain in the 2022 treaty. You need to look at both of those things together. But that will get easier to understand, and that effect will lessen dramatically over the course of 2023.

Alexander Scott, Analyst

Got it. Okay. I guess that comment on the commissions and so forth. Should we take that to most of what's affected the net loss ratio at the moment has more to do with catastrophe losses from last year as opposed to attritional losses? Or is it some combination? Just trying to think through how to take that with the attritional loss ratio information you've given us to understand what things would look like under the new treaty.

Stewart Ellis, CFO

Yes, it's a great question. I think as you pointed out, we've had strong improvement in the attritional loss ratio every year, especially in the Hippo home insurance program segment, specifically, down 18 points year-over-year or an improvement of 18 points year-over-year. In the first quarter, the reason the net loss ratio went up despite the improvement in the underlying core loss ratio is the weather. And our 2022 treaty, which penalizes us a little bit more than in other treaties in 2021 or 2023 for weather-related losses is the one that is the primary earning treaty in the first quarter of this year. The first quarter of last year is primarily the 2021 treaty. So the 2022 treaty became more prominent over the course of 2022. The 2023 treaty will become more prominent over the course of the rest of this year. So as I said before, we should see that net loss ratio come down dramatically and be under 100% by the end of the year.

Rick McCathron, CEO

Yes, Alex. One thing that I would add is that I fully agree with Stewart, and thanks for identifying it. The core attritional loss ratio really has come down. Weather for the quarter was more than the quarterly forecast, but still in line with our annual forecast. So when we look at what we believe our weather pick and our catastrophe loads will be for the year, we do so in a very detailed way. And then we try to best match weather from historical patterns and time it with what month or what quarter it will impact. Despite the heavy rains in California, we still stand very consistent on our annual pick for weather. It was just a simple fact of the matter that before storms come, they don't check the calendar to see what months they're in or what quarter they're necessarily. But we still feel very good about our annual pick for weather.

Operator, Operator

The next question on the line is from Matt Carletti from JMP.

Matthew Carletti, Analyst

I was hoping, particularly in a quarter where our top line and loss ratio, both are very good. Maybe you could kind of zoom out a little bit and just talk a bit about how you think about balancing those two? Balancing the opportunity for growth alongside profitability or loss ratio improvement?

Stewart Ellis, CFO

I’m glad to take that question. I believe that the first quarter clearly illustrates that in our business, it's not always about balancing growth and loss ratio. In our case, I don’t think that growth exceeding our initial expectations at the start of the year impacts our improvement in loss ratio. We see this reflected in our financial results. Several factors contribute to this. First, there are significant areas of our business where the loss ratio is either completely unrelated to the business’s economics or only loosely connected. In our Services segment, we have no loss ratio exposure, and in our Insurance as a Service segment, while there is some loss ratio exposure, it is not the main factor driving profitability. In the Hippo home insurance program, we aim to reach our long-term target loss ratio as swiftly as possible. In this aspect, we do not compromise on loss ratio in pursuit of faster growth. However, one of our advantages is that many growth areas actually contribute positively to our long-term loss ratio. Our strong partnerships with builders mean that the more builder business we engage in, the quicker our loss ratio improves. Therefore, I want to emphasize that we are confident in our ability to grow while also enhancing the loss ratio. The first quarter serves as a good example—apart from the weather factors we’ve discussed. We are committed to reducing the loss ratio and will not sacrifice this goal for quicker growth, but we believe we can achieve both.

Rick McCathron, CEO

Yes, Matt, I just want to reiterate that our two primary focuses as a company. The first primary focus is getting our loss ratio as quickly as possible to our long-term goal. Our second commitment is getting to EBITDA profitability by Q4 2024. So neither one of those are we wavering on at all, and we're continuing to drive towards those with great confidence.

Operator, Operator

The next question on the line is from Yaron Kinar from Jefferies.

Andrew Andersen, Analyst

This is Andrew on for Yaron. Premium retention has been pretty strong here. But if we think about it on a customer retention level, I assume there's some offset just given the strong pricing in the premium retention from perhaps customer. But can you kind of help us think about some of the initiatives there to keep the customer count and retention pretty strong despite the pricing increases?

Stewart Ellis, CFO

Yes, I'm happy to address that, and then Rick can elaborate. As we consider customer and premium retention, our primary focus is to provide our customers, whether they are part of the Hippo program or our broader agency clientele, a high-quality and unique customer experience. The services we are developing around the agency experience are distinct within the industry. We are proactively engaging with our customers to assist them in maintaining and protecting their homes. Additionally, we are providing third-party products such as auto insurance to better satisfy their overall insurance requirements. While we generally hope that insurance is something we never need to use, when the situation arises, we want to support our customers during their times of need. Therefore, our overarching strategy is to strengthen our relationship with customers through the non-insurance services we offer, while also providing third-party products where appropriate.

Rick McCathron, CEO

Yes, Andrew, the few things I would add to that is, historically, sort of the atomic unit of a Hippo customer was a Hippo policy. And that is changing. We're taking much more of a view around the particular customer, the cross-sell components of other products we're adding and the addition of Hippo Home Care. So as Stewart said, our view is very simple. We want to maximize the needs for those customers and really start to shift more of a sort of a revenue-per-user mindset as opposed to how much revenue we're getting from a particular Hippo policy with a particular customer. We have just started to scratch the surface on these cross-sell components, and we're gaining real traction, and we think that will continue over time.

Andrew Andersen, Analyst

Great. And it sounds like there's a lot of progress, and we're seeing it in the expense control, but we're not really seeing it materialize yet in adjusted EBITDA. Can you help us think about why we're not seeing that yet in the bottom line and perhaps look for the rest of the year?

Stewart Ellis, CFO

Yes, Andrew. I'm happy to take that. The first point we discussed previously is that without considering the weather impacts, adjusted EBITDA would have shown improvement both quarter-over-quarter and year-over-year. However, other factors come into play, particularly how our reinsurance treaties earn throughout the year. As we mentioned during the annual guidance, the increase in EBITDA is expected to be more pronounced in the latter part of the year. This is due to two main reasons: first, many of the rate adjustments we implemented last year, as well as those taken this year, have yet to be fully reflected in the financial statements. Second, the 2022 reinsurance treaty, which has less favorable terms compared to the 2023 treaty, needs more time to be fully factored out of the financials. Consequently, we anticipate a diminishing loss ratio over the remainder of the year as the effects of our pricing and rate strategies begin to materialize. At the same time, the financial benefits from the 2023 reinsurance treaty will start to dominate. These two elements combined should lead to significant improvements in adjusted EBITDA losses as we progress into the second half of the year, with a noticeable decline expected in that period.

Andrew Andersen, Analyst

Great. And did you share the level of rate taken for those 46 products and 81% of premium year-to-date?

Stewart Ellis, CFO

Yes. I think we've said publicly before that we're planning for a kind of high teens level of rate this year. And that would be independent of the underlying increases in coverage that we talked about earlier or increases in rebuilding costs and other things. One of the advantages we have is the way our filings work. Those are automatically factored in as we rerun the rebuilding cost estimate every time we renew a policy. And so we should be more current than most on inflation-related items, but beyond that is the rate that we're taking.

Rick McCathron, CEO

Yes, sort of back to Tommy's question earlier, that high teens that Stewart quoted is a combination of our view of inflationary trends and what we need to take to continue to improve the underlying results.

Operator, Operator

The next question is from Pablo Singzon from JPMorgan.

Pablo Singzon, Analyst

Stewart, just wanted to follow up on your comment about incorporating ceding commissions and evaluating Hippo net loss ratio. I think you disclosed that number annually. And if you compare that against ceded earned, that's about a 7% ratio, pieces I'm looking at '21 and '22. Is that a fair number to you this quarter and in subsequent periods?

Stewart Ellis, CFO

Yes. I believe your question pertains to the connection between ceded written premium and ceded earned premium, which relates similarly to the ceding commission. In the 2022 treaty, we ceded about 90%, retaining around 11% of the risk before adding the cat excess-of-loss structure. In the 2023 treaty, that retention is closer to 40%. The key is to consider what percentage of the policies pertain to each treaty over the year. On January 1, none of the policies are under the 2023 treaty. By the end of the quarter, approximately 8% will be because not all policies are written on January 1. You will see a gradual transition to a higher level of retained premium throughout the year. If you need more specifics, we can discuss it offline. However, if you examine the written premium in 2022 alongside the renewal book we have for 2023 and the new business, you should observe convergence by the end of the year.

Pablo Singzon, Analyst

Okay. And then my second question was about your new disclosure on the loss ratios for consolidated Hippo and the Hippo home insurance program. I presume the gap there is explained by other programs in Spinnaker. I was just wondering if you could just talk through that other non-Hippo home insurance program and Spinnaker or is that gap from other types of programs? And if yes, what are the two or three major programs that you can call out?

Stewart Ellis, CFO

Yes, I'm glad to address that. You're correct that the difference between the loss ratio of the Hippo home insurance program and the consolidated gross loss ratio is connected to business written on Spinnaker by non-Hippo programs. As we've mentioned before, the financial performance of those programs reflects more of a fronting fee-based structure, as in some instances we retain no risk, and in other situations it's slightly more. We also utilize strong catastrophic reinsurance to mitigate volatility in the results. Our goal is to achieve a net fronting fee at the insurance as a service level. While you may observe fluctuations in the loss ratio based on developments in those specific programs, we are focused on underwriting the program as a whole, not the individual policies, which explains the minimal risk we retain. Therefore, I don't believe this significantly impacts our segment level economics in Insurance as a Service or our overall financial results. We can certainly discuss this further, and Rick can provide insight into the types of programs we write on that platform.

Rick McCathron, CEO

Yes. One thing I would add is that when we discuss Insurance as a Service, we are not significantly exposed to underlying risk. While we have some exposure as a carrier, it is limited. It's important to understand how this works. Many of the programs, as Stewart mentioned, involve no risk on our part; we act merely as a fronting carrier. Some programs involve some risk, but each has its own reinsurance panel to manage that risk. Furthermore, if a situation arises that affects our Spinnaker loss ratio on a net basis, we have a corporate catastrophe policy that covers all programs, including the Hippo program, across the various Spinnaker programs. When we evaluate a particular program, we typically consider whether it provides a way to diversify the overall portfolio from a catastrophe purchase perspective. Many programs are not related to property. Although I may not be able to disclose specific programs without their permission, I want to emphasize that Insurance as a Service is not significantly affected by individual loss performance.

Stewart Ellis, CFO

Yes. Regarding the programs we support, we generally focus on larger MGAs that can scale effectively and have strong track records. We back some E&S programs that can quickly adjust rates in response to changing market conditions. Additionally, we have non-correlated programs that do not carry property exposure. We also strive to support insurtech startups and partners that align strategically with Hippo. This approach represents another way to monetize our current balance sheet. The key factors for us are the written premium and the fee income generated, along with a limited amount of risk that we retain.

Operator, Operator

We have no further questions. I'd like to hand back to the management team to conclude.

Rick McCathron, CEO

Well, we appreciate each of you joining us this morning, and we could not be more thrilled with the progress that we've made in such a short period of time, and we expect that progress to continue. So we're looking forward to sharing our Q2 results in the coming months. Thank you, everybody.

Operator, Operator

This concludes today's call. You may now disconnect your lines, and enjoy the rest of your day. Thank you.