What happens when Wall Street falls out of love with your sector?

Image Credits: Nigel Sussman

It’s been an awful week for public neoinsurance companies. A subsector of the larger insurtech world, neoinsurance providers tackled a number of insurance categories using a blend of modern app design and machine learning in hopes of creating more user-friendly and profitable insurance products.

The idea proved attractive to venture capitalists, who invested in a host of companies working on the problem space. And it went so well that in the last year or so we saw a number of U.S. neoinsurance companies go public.

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That’s the extent of the good news. Since the IPOs and SPAC combinations that took MetroMile, Hippo, Lemonade and Root public, the group has seen their values either decline sharply below their initial trading prices or far under their recent highs.

We’ve covered some of these declines in recent weeks and wondered if we should be worried about neoinsurance valuations and how they may impact startups. This morning, we’re examining what happened to neoinsurance companies this week, why, and which startups could be impacted.

Grounding our work is an interview that The Exchange held with Root CEO Alex Timm in the wake of his company’s earnings report. It’s a pretty illustrative example of where the sector finds itself today: Flush, busy and somewhat unloved.

Recent declines

Measuring from last Friday’s closing price to yesterday’s, here’s a digest of where the market is for public neoinsurance companies:

• Hippo: -20%.
• MetroMile: -30%.
• Root: -23%.
• Lemonade: -6%.

Declines from recent highs are more extreme for several of the now-public neoinsurance companies, something that we discussed last Friday. The point we made then has only become more acute. We could add names to this list, like Oscar Health, but health insurance feels sufficiently distinct from the above companies that I don’t want to muddy the waters.

What’s new in all of this is that the value of some of these companies is getting close to their cash balance. Or more simply, they are trending toward basement-level enterprise values. Here’s the data:

• Hippo: $3.25 billion market cap minus ~$1 billion cash (per CEO) = $2.25 billion (69% of market cap).
• MetroMile: $608 million market cap minus $202 million in cash (per Q2 report) = $406 million (67% of market cap).
• Root: $1.36 billion market cap minus $973 million in cash (per Q2 report) = $387 million (28% of market cap).
• Lemonade: $4.61 billion market cap minus $1.2 billion in cash (per Q2 report) = $3.41 billion (74% of market cap).

It’s a somewhat uneven set of examples, but you can easily see that the cohort’s valuations on a cash-adjusted basis are often unimpressive. Root and MetroMile, with their shared focus on auto insurance, appear to be taking the most stick. Hippo’s home insurance play seems to be doing a bit better. And Lemonade, the Teflon stock of the neoinsurance coterie, is doing reasonably well in comparison.

What’s going on? It’s hard to say, but my gut instinct is that neoinsurance companies were valued and funded like software-ish companies while private. But now public, with the brutal conversion of gross written premium to net revenue a regular feature of their earnings reports, it feels like the group is shedding its software-ish private market valuations for more normal, public-market insurance valuations. I haven’t run all the math on that yet, but it feels right from where I sit today.

But not all the news is bad. If the machine-learning work touted by neoinsurance companies does pay off over the long term in the form of better insurance economics, valuations could re-appreciate. To better understand that dynamic, let’s talk about Root.

Root’s quarter

Root’s work in the car insurance business hit some bumps in the second quarter that weren’t of its making. The cost of used cars shot higher and the price of labor inputs for repairs went up. Both of those dynamics hit the company’s loss ratios, harming what I think of as insurance gross margin, or premiums minus loss ratios and loss adjustment expenses.

And the company saw increased advertising costs, thanks to “industrywide increased cost and competition in the performance marketing channel.” Root adjusted its growth expectations in light of its market’s evolution.

To combat the negative market trends, Root is working to expand its channel partnerships in hopes of boosting new customer acquisition without the need to compete on advertising price with larger rivals. Its Carvana deal is a good example of this work.

Elsewhere in the positive column, Root’s most recent pricing model (UBI 4.0) is rolling out to more markets and, per the company’s CEO, it has another iteration cooking. Timm has always been bullish on the potential for technology to improve insurance underwriting, and his company is still finding places to improve its math.

Root also has a lot of cash, as we noted above. An industry shift away from using credit scores to price car insurance could also help Root in the long term. So, while Wall Street is hammering the firm to something close to an enterprise value breakeven point, the company’s larger model hasn’t changed too much. It’s still a tech-powered insurance play, just one currently dealing with a market that is more challenging than it was. That used to be more valuable!

Wall Street appears to have shifted its thinking about Root and other companies in its cohort, a point underscored by this week’s valuation declines.

Someone is right and someone is wrong. Either the neoinsurance companies’ long-term models will come to fruition thanks to large cash balances providing runway to prove their point, or Wall Street is correct — neoinsurance companies were always overvalued.

Who’s right? I don’t know. But I can say that at least from recent conversations, the CEOs in the former startup group are convinced. And I can say Wall Street is also pretty confident, given the way that public investors are cutting prices of neoinsurance companies.

For startups like Marshmallow, Next Insurance, Zego and others, the situation is hard. Their public comps are taking hits before they are capitalized like a public company. That could make further fundraising difficult, which may lead to more conservative spending and slower growth. But if they grow more slowly, will the venture class find them interesting? We’ll have to see whether Wall Street or neoinsurance founders prove to be right about the future of the sector.