Trupanion - Earnings Call - Q1 2025

Executive Summary

• Q1 2025 delivered revenue of $341.98M (+11.8% YoY; +1.4% QoQ), subscription AOI of $30.02M (+53% YoY), and adjusted EBITDA of $12.24M, while GAAP diluted EPS improved to $(0.03) from $(0.16) YoY.
• Both revenue and EPS beat Wall Street consensus: revenue by ~$4.17M (+1.2%) and EPS by ~$0.02; adjusted EBITDA also beat by ~$1.19M; management raised FY25 and Q2 guidance, citing stronger than expected performance and FX tailwinds (72% CAD conversion assumption).
• Subscription margins expanded YoY (value proposition improved to 71.8% vs 75.3% last year; subscription AOI margin 12.9% vs 9.7% YoY), supported by pricing actions and efficiencies from the Vision platform; sequential margin compression vs Q4 reflects normal seasonality.
• Retention inflected positively sequentially (98.28% vs 98.25% in Q4) as members moved out of the >20% rate increase cohorts; total pets declined, but subscription pets grew 5% YoY and gross adds improved with PAC held to a 31% IRR.
• Near-term stock catalysts: guidance raise, continued subscription margin expansion, sequential retention uptick, and capital surplus monetization optionality (APIC >3x overcapitalized).

What Went Well and What Went Wrong

What Went Well

• Subscription margin expansion: value proposition improved to 71.8% (vs 75.3% LY), subscription AOI margin rose to 12.9% (+320 bps YoY), driven by pricing actions and operating efficiencies; management: “overachievement on both total revenue and total adjusted operating income”.
• Operational improvements from Vision: “lower invoice processing costs… enhancing the member experience… reducing overall variable expenses”; claims inventory near record lows, faster invoice payments.
• Retention and growth optics: sequential retention improvement to 98.28% and “first meaningful sequential increase in net pet addition in 2 years,” with PAC investment kept at ~31% IRR.

What Went Wrong

• Seasonality and reserve development: subscription margin sequentially softened vs Q4; adverse reserve development of ~$1.7M (~70 bps of revenue) in Q1.
• Total pets declined 2% YoY (1,667,637 vs 1,708,017), and PAC rose to $267 (vs $261 in Q4 and $243 in Q3), reflecting reinvestment in pet acquisition and cost pressure.
• Fixed expenses increased to 6.2% of revenue (vs 5.3% LY) due to Canadian underwriting fees during transition, with leverage expected later in 2025.

Transcript

Speaker 3

Good day, and welcome to the Trupanion First Quarter 2025 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one, on your telephone keypad. To withdraw your question, please press star, then two. Please note that this event is being recorded. I would now like to turn the conference over to Gil Melchior, Director of Investor Relations. Please go ahead.

Speaker 4

Good afternoon, and welcome to Trupanion's First Quarter 2025 financial results conference call. Participating on today's call are Margi Tooth, Chief Executive Officer and President, and Fawwad Qureshi, Chief Financial Officer. For ease of reference, we've included a slide presentation to accompany today's discussion, which will be made available on our Investor Relations website under our Quarterly Earnings tab. Before we begin, please be advised that remarks today will contain forward-looking statements. All statements other than statements of historical facts are forward-looking statements. These include, but are not limited to, statements regarding our future operations, key operating metrics, opportunities in financial performance, pricing, and veterinary industry inflation. These statements involve a high degree of known and unknown risks and uncertainties that could cause actual results to differ materially from those discussed.

A detailed discussion of these and other risks and uncertainties is included in today's earnings release, as well as the company's most recent reports, including Form 10-K, 10-Q, and 8-K filed with the Securities and Exchange Commission. Today's presentation contains references to non-GAAP financial measures that management uses to evaluate the company's performance, including without limitation: cost of paying veterinary invoices, variable expenses, fixed expenses, adjusted operating income, acquisition costs, internal rate of return, adjusted EBITDA, and free cash flow. When we use the term adjusted operating income or margin, it is intended to refer to a non-GAAP operating income or margin before new pet acquisition and development expenses. Unless otherwise noted, all margins and expenses will be presented on a non-GAAP basis, excluding stock-based compensation expense and depreciation expense.

These non-GAAP measures are in addition to and not a substitute for measures of financial performance prepared in accordance with U.S. GAAP. Investors are encouraged to review the reconciliations of these non-GAAP financial measures to the most directly comparable GAAP results, which can be found in today's press release. Lastly, I would like to remind everyone that today's conference call is also available via webcast on Trupanion's Investor Relations website. A replay will also be available on the site. I will now hand over the call to Margi.

Speaker 2

Good afternoon, everyone. It's a pleasure to be with you today to discuss our first quarter results. The year is off to a strong start, and I'm pleased to report overachievement on both total revenue and total adjusted operating income in the quarter. Most notable was the increase in our subscription adjusted operating income, which increased 53% year over year to over $30 million. Across the business, we executed to or better than planned, with a delivery of steady improvements across key financial metrics and continued advancements in operating efficiencies in critical areas of the business. Within our core subscription business, revenue was $233 million, up 16% year over year. The majority of this growth was driven by increases in average revenue per pet, reflecting the pricing actions we've taken over the past two years and a modest additional lift from growth in enrolled pets.

Our meaningful step up in subscription adjusted operating income was driven by two key components: an improving loss ratio and efficiencies operationally. We made continued progress toward our annual target value proposition, with a substantial year-over-year increase of 350 basis points, ending the quarter at 71.8%. This, coupled with efficiencies stemming from our transition to our internal technology platform, Vision, has enabled some solid operational gains, allowing us to lower invoice processing costs while enhancing the member experience and reducing overall variable expenses. Since its rollout, we brought claims inventory to near record lows and meaningfully increased both the speed and frequency of invoice payments. As a monthly recurring revenue business, member retention is critical to our long-term sustainable growth. In Q1, reported monthly average retention improved quarter on quarter for the first time in 12 quarters to 98.28%.

This sequential uptick was largely driven by improvements within our core Trupanion product, especially among members who received rate increases greater than 20%. These rate changes were not taken lightly. They reflect a focused response to the rising cost of veterinary care and a commitment to maintaining long-term sustainability. Worth noting, while reported cost trends across the broader animal health industry suggest some pricing moderation, the costs we observe within our own book remain largely in line with our expectations. We continue to monitor trends very closely and partner with others across the industry to stay informed and to react as needed. That said, it is important to highlight that the Trupanion experience is fundamentally different. Our members visit the veterinarian more frequently and are more likely to follow their veterinarian's recommended treatment, which naturally results in a high use of our product.

Trupanion's cost of care has consistently indexed above the CPI norm for these reasons. Looking ahead, with the majority of pet parents transitioning out of our highest-rate cohorts and into more stable pricing tiers, we will be placing even more emphasis on the early-stage member experience. With this in mind, we've adjusted our pet acquisition investment to add resources and realigned our marketing structure to better integrate acquisition and retention. We're also expanding the use of our patented Vet Portal, which supports real-time payments directly to the veterinary hospital, helping members avoid out-of-pocket costs while pursuing optimal treatment solutions for their pets. With the average subscription pets staying with us for 58 months, there is a long way to go to return to our historical average retention rate. Yet I'm encouraged by our work on this front and its potential impact on member experience over time.

Retention is a significant growth catalyst. New pet acquisition is another, and here, too, we're quite pleased with our results. Pet acquisition investment, which is fueled by the healthy expansion in our adjusted operating income, increased 18% year over year in this first quarter and held between our guardrails at 31% internal rate of return. We saw a sequential increase in gross pet additions for the core Trupanion product, the direct benefit of compounding our investment in pet growth sequentially for the last three quarters. Disciplined acquisition spend, especially within our efficient veterinary channel, remains a priority, ensuring we maximize return on each dollar invested. The average profit per Trupanion pet was up 46% year over year, reflecting improved margins from focused pricing action and cost efficiencies.

This growth in profitability, combined with stable retention, gives us even greater flexibility to reinvest in high-quality growth opportunities in our large and under-penetrated addressable market, which is something discussed at length in this year's shareholder letter. When our pet deployment moves in line with our adjusted operating income growth, we see parallel growth curves and encouraging demonstration of the flywheel of our business. The combination of stronger retention and improved pet ads contributed to our first meaningful sequential increase in net pet addition in two years. In summary, Q1 was a strong start to the year. Performance is tracking largely ahead of our expectations. We're growing the dollars available for reinvestment and are beginning to see a return to growth in new pets. We'll continue to focus on the levers we can control, doubling down on member experience, operating efficiency, and disciplined growth.

As we look to the future, we're mindful of the broader macro environment. It is at times such as these that Trupanion comes into its own. We are designed to support pet parents during times of uncertainty, and we've proven time and again the resilience of our business model. Q1 was an encouraging indication that our strategy is working, and we look forward to building on our progress in the months and quarters ahead. Before handing it over to Fawwad, I'd like to briefly refer you to our recently published shareholder letter, which can be found on our IR website. I've referenced it during this call, and for good reason. It includes a comprehensive review of our 2024 performance, key strategic updates, and a deeper dive into some of the more nuanced elements of our business. With that, I'll hand the call over to Fawwad.

Speaker 3

Thanks, Margi, and good afternoon, everyone. Today, I will share additional details around our first quarter performance, as well as provide our outlook for the second quarter and full year 2025. Total revenue for the quarter was $342 million, up 12% year over year. Within our subscription business, revenue was $233.1 million, up 16% year over year, and up 18% on a constant currency basis. Total monthly average revenue per pet for the quarter was $77.53, up 11% over the prior year period. As expected, our pool for our core Trupanion brand expanded faster at 12% year over year and 13% on a constant currency basis. Total subscription pets increased 5% year over year to approximately 1,053,000 pets as of March 31st. This includes over 54,000 pets in Europe, a majority of which are currently underwritten through an MGA structure.

Average monthly retention for the trailing 12 months for all subscription pets was 98.28%, down versus Q1 last year, which was 98.41%, but up sequentially from Q4, which was 98.25%. The subscription business cost of paying veterinary invoices was $167.4 million, resulting in a value proposition of 71.8%, a healthy improvement from 75.3% in the prior year period, and particularly impressive given the higher seasonality that our invoice costs generally experienced during the first half of the year. The drivers of this improvement were margin expansion from our ongoing pricing actions and continued efficiency in our cost of processing invoices. These improvements more than offset adverse development from prior periods in the quarter, totaling $1.7 million, or approximately 70 basis points of revenue.

Assuming cost of care continues to trend in line with our expectations, we anticipate the pace of year-over-year margin expansion will moderate as our pricing and claims experience become more closely aligned. As a percentage of subscription revenue, variable expenses were 9.1%, down from 9.6% a year ago. The primary driver of this improvement has been the strong performance of our claims and contact center teams, supported by the technology and operating investments we have made. Fixed expenses, as a percentage of revenue, were 6.2%, up from 5.3% in the prior year period, in line with our expectations. The largest driver of this change was an increase in our Canadian underwriting fees that we highlighted last quarter. Our expectation is that we will see expense leverage throughout the year as we transition to our wholly owned underwriting entity for our Canadian business.

Our subscription business delivered adjusted operating income of $30 million, an increase of 53% from last year, and contributed over 96% of our total AOI for the quarter. Subscription adjusted operating margin was 12.9% of subscription revenue. This is up from 9.7% in the prior year and represents approximately 320 basis points of margin expansion. Now I'll turn to our other business segment, which is comprised of revenue from other products and services that have a lower margin profile than our subscription business. Our other business revenue was $108.9 million for the quarter, an increase of 4% year over year. We expect growth for this segment to continue to decelerate as we are no longer enrolling new pets in the majority of U.S. states for our largest partner, Petzvest. Adjusted operating income for this segment was $1.2 million.

Adjusted operating margin for the segment was 1.1%, down from 1.6% last year. The lower margin was a result of higher fixed expenses, offset to some extent by higher gross margins. In total, adjusted operating income was $31.2 million in Q1, up 46% from Q1 last year and above our expectations. We deployed $17.6 million of this AOI to acquire approximately 63,700 new subscription pets. Excluding the pets that are underwritten through an MGA structure, this translated into an average pet acquisition cost of $267 per pet in the quarter, up from $207 in the prior year period. The estimated internal rate of return on this spend was 31% in the quarter. We also invested $1.4 million in the quarter in development costs. Stock-based compensation expense was $9.5 million in the quarter.

As a result, net loss for the quarter improved to $1.5 million, or $0.03 per basic and diluted share, from a net loss of $6.9 million, or $0.16 per basic and diluted share in the prior year period. In terms of cash flow, operating cash flow was $16 million in the quarter, compared to $2.4 million in the prior year period. Capital expenditures totaled $1.9 million, down from $3.1 million in Q1 last year. As a result, free cash flow was $14 million, up from approximately break-even in the prior year's first quarter. We ended the quarter from a position of financial strength, with $321.8 million in cash and short-term investments. Now I'll turn to our outlook. While we cannot predict the future, especially during these uncertain times, the recurring nature of our business model provides us with a higher degree of visibility into our future performance than most.

For the full year of 2025, we are increasing our guidance to account for Q1 overperformance as well as favorable conversion rate movements. We now expect total revenue in the range of $1.39 billion-$1.425 billion. We now expect subscription revenue in the range of $966 million-$989 million, representing approximately 14% year-over-year growth at the midpoint. We now expect total adjusted operating income to be in the range of $122 million-$142 million, or 15% year-over-year growth at the midpoint. For the second quarter of 2025, total revenue is expected to be in the range of $344 million-$350 million. Subscription revenue is expected to be in the range of $238 million-$241 million, representing approximately 15% year-over-year growth at the midpoint. Total adjusted operating income is expected to be in the range of $27 million-$30 million.

This represents approximately 15% growth year-over-year at the midpoint. As a reminder, our revenue projections are subject to conversion rate movements, predominantly between the U.S. and Canadian currencies. For our second quarter and full-year guidance, we used a 72% conversion rate in our projections. Let me now pass it back to Margi.

Speaker 4

Thank you, Fawwad. Before we close, I'm pleased to announce that we'll be hosting our Investor Day again this year on September 17 at our headquarters in Seattle, Washington. This annual event is a great deep-dive opportunity for investors to hear directly from team members leading the execution of our 60-month plan in an open Q&A forum. More immediately, in just two days' time, on Saturday, May 3, Fawwad and I will be in Omaha for our annual investor Q&A to follow Berkshire Hathaway's annual shareholder meeting. This is an event I personally look forward to every year and one that presents a unique opportunity to meet with many long-term-minded investors in a highly informative setting. We hope to see many of you there. Information and registration for both events can be found on our investor relations website.

Finally, I'd like to close by reaffirming the solid results in the quarter. We achieved what we set out to do, and we go into the rest of the year with a healthy tailwind of strong adjusted operating income, leveling of member rate increases, improved retention, and an encouraging step-up in pet ads. With that, we'll open it up to questions.

Speaker 3

Thank you. We will now begin the question and answer session. To ask a question, please press * then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press * then 2. A request to all the participants, please restrict yourself to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. Our first question comes from Brandon Vazquez from William Blair. Please go ahead.

Speaker 2

Hi, everyone. Congrats on the quarter, and thanks for taking the question. I guess I'll start with one near-term first one and a follow-up on a bigger picture one. One thing, obviously, on everyone's mind now is, are you guys seeing any notable changes after Q1 ever since the macro noise that we've seen in April? Talk to us a little bit how the business is maybe trending. If you're seeing anything around inflation changes or retention rate changes or conversion changes, you know, anything like that, you could give us would be helpful.

Speaker 4

Yeah, thank you for the question, Brandon. I would say, as we've gone through the quarter, we've been monitoring things, as you can imagine, from a cost perspective and also performance overall, just to make sure that we're well on track. So far, we are seeing no changes in terms of what we're expecting. We are seeing strong volume continuing to come through the vet traffic. I think in Q1, there was a tiny dip down in February, which is somewhat consistent with what we've heard in the macro environment from animal health in general. That's picked up again in March. Q1 ended exactly where we expected, and Q2 is continuing in the same vein. Good lead volume, lots of opportunity ahead with conversion. We haven't seen it tank. We haven't seen it dip down. We've seen strength there, and we've seen even more strength coming through retention.

We feel good about that too. Nothing as yet, and continuing as expected.

Speaker 2

Great. Maybe as a follow-up, Margi, in the annual letter, you had, there were some slides in there or some details around different conversion rates in different territories. It sounds like you guys have done a lot of analysis there, kind of how you can close the gap in the "underperforming" conversion territories. Talk to us a little bit now, as you're redeploying more PAC spend, how do you kind of get all of these conversion territories to close the gap to perform higher? Just in general, where are these PAC spend dollars going to continue to improve ads through the year? Thanks.

Speaker 4

Right. Yeah. When we think about conversion, the reason we included that chart is really to help show the dynamic between more mature markets, some that are newer, some that have got different mixes in terms of media spend. Those particular markets were across the board in North America. We treat every single one of them as an independent territory. They are all led by a territory partner. We work with a territory partner to understand more about the lead volume coming through the channel. Is it coming from vet? Is it coming from breeder? We look at dovetailing into that. How do you convert that pet parent through? What we are looking at doing is making sure people understand specifically what is different about Trupanion. That is the case regardless, wherever you are.

It helps more when you have a higher referral rate from the vet channel, naturally, because that's something that people aiming into the endorsement from the white coat. For us, then it's really a question of understanding if you're in a rural U.S. area versus a metropolitan Canadian area, you've got very different messaging. Really being very centric to the location where the lead is coming from, helping to address the needs of that specific pet parent at that moment. It's different if you have a cat versus a dog or a Labradoodle versus a Yorkshire Terrier. It's very granular, and hopefully the letter conveys some of the ways in which we think about it.

Each time, regardless of the conversion rate we see, we are always leading into that internal rate of return, which means you can do more in some markets and less in others because the lifetime value will be different. That is the beauty and also the complexity of how we grow the business. Over the course of the next few months, I'm incredibly pleased with the fact that we've seen that adjusted operating income come up. It gives us a lot more fuel to do the testing, to push harder, and to see that growth come through, which we expect to see the back half of the year.

Speaker 3

Thank you. The next question comes from John Block from Stifel. Please go ahead.

Speaker 1

Great. Thanks, guys, and good afternoon. Margi, maybe the first one, if you could just talk about the move away from Accelerant in terms of the underwriter that was in the filing and maybe what that means for the company, what it means, why this one might be for both of you guys, what it means from a capital perspective needed to underwrite these pets and just how we should think about that throughout 2025.

Speaker 4

Yeah, I can kick that off, John, and hand over to Fawwad. Overall, our strategy in terms of underwriting has always been to try and become vertically integrated. We've had APIC in the U.S. for a number of years now. Canada was really a matter of time for us to build that muscle to be able to create GPIC, which is our Canadian underwriting entity. Really pleased to have that milestone behind us and to have this entity there and start to transfer the book of business over to our own underwriting unit. It really creates a reduction in frictional cost. That's the sole purpose of doing it. I'll let Fawwad speak to the details there.

Speaker 5

Yeah. Hi, John. We've been planning for this transition for a while. As Margi mentioned in her letter, it has been part of our strategy. From a capital perspective, there's kind of two components of it. The first is the existing reinsurance agreement that we have. We have some capital there. Within GPIC, we've already seeded that. There's existing capital that sits in the entity. At this point, just based on the kind of profile of the business, we don't anticipate having to put additional capital in. You'll see, and we talked about in the prepared remarks, in Q1, you see that step up in the underwriting charge. That was planned, and that was part of the negotiation and is obviously part of our guidance as well. From a capital perspective, we're not anticipating anything different.

Speaker 1

Got it. Very helpful. Maybe just to shift gears, the NAIC data that came out not too long ago seemingly shows another year of share losses for Trupanion. The rate of share loss in 2024 actually accelerated versus 2023. I think I get some of that, Margi. Maybe you sort of argue, "Look, we pulled back on the PAC spend until we right-sized the MLR, and now we're sort of going down that road." Maybe talk to the share losses. Is that sort of what you would lean on? Do you expect to have flat as share in 2025, gain some back? Sorry, just a quick tack on, I do not see the slides up yet. I do not know if you're still going to be providing that information or if you're pulling back on that.

Any comments too around some of your European initiatives and if those are still moving forward as was the plan under the 60 month? Thanks, guys.

Speaker 4

Yeah, there's a lot in there. Let me take the first one. Actually, I'll take the second point. I believe the slides are up, so they should hopefully be there for you to view. We've got that detail there. If we take a step back and think about our strategy, which has been very consistent. As a business, we've always stressed that we're looking to grow our adjusted operating income in a highly underpenetrated market and invest that money to increase our pet count. We always look to deploy that in the highest lifetime value product. We've always done it in our internal rates of return, so between that 30-40%. Now, to your point, we absolutely doubled down on margin expansion in 2023 and 2024. We really weren't pushing hard on growth while we tried to get that margin expansion back.

We have, I think, done a fantastic job of doing that. We've come into you in a really healthy position, and we're starting to dip our toe back into the water of growth. It's not surprising to me to see that market share is different this year than it was last year. We haven't been trying to grow. I would say the other thing for us is what really is driving this business is where do we drive intrinsic value over time. Market share is not a driver of our intrinsic value. It's why we don't chase it. Instead, we're committed to maintaining a discipline in our pricing, a discipline in our growth strategy. We, as well as the industry, pull back in general with growth.

You store significantly less money being pushed into pet insurance overall, which naturally does not satisfy the appetite of the pet parent. You're not seeing as many people come through. I think for us, it's something we're going to continue to focus on the highest value product. As I mentioned before, with Brandon, we've seen a good step up in leads, a good step up in retention, and conversion has made some solid improvements. Overall, we will continue to do what we've always done. We've seen people come in and grow faster than us time and time again, and they're not there now. That does not concern us. In terms of the other products from the 60-month plan, we're really doubling down our focus on the highest lifetime value products we have. That, of course, is the core Trupanion product.

Doesn't mean that we are not happy with the progress. It really just means we've been prioritizing where we're going to get the best return over the course of the year. I expect to see that slightly shift back to have focus on other areas as well. For now, we're looking at the core Trupanion business, and we'll give you more details as and when that changes.

Speaker 1

Thank you.

Speaker 4

Next question, please.

Speaker 3

Yes. The next question comes from John Barnidge from Piper Sandler. Please go ahead.

Speaker 2

Thank you for the opportunity. Question on the subscription loss ratio in the quarter. Seasonally, a more active quarter in the first half of the year, I believe. Was there any favorable reserve development in the quarter at all? How much was it seasonally elevated, would you say, from where it ordinarily would be without that seasonality?

Speaker 5

Yeah. From a reserve perspective, the impact was about $1.7 million in Q1. That is about 70 basis points of impact. In terms of just Q4 to Q1 linearity, it is actually down a little bit versus historical. Pretty much in line with what we expect. Vets put their rates in in Q1. We are always going to see that increase. I would say it was slightly lower than what we have seen kind of historically once you take into account the reserve impact.

Speaker 1

Do you think that's reflecting maybe a bit more dynamic pricing that can anticipate more vets with that annual calendar year change pricing?

Speaker 5

Yeah, I think maybe it's a two-part question. I think from our pool standpoint, we had talked about pricing peaking from a year-over-year standpoint in Q4, and it largely played out. Our expectation is entering this year that the rate of increase would start to diminish. I think I can turn to Margi in terms of anything that we've seen unique this quarter from a pricing perspective for vets.

Speaker 4

Yeah, I would say overall, it's pretty consistent with our expectations. We've had a big catch-up in 2024, as you know, from a rate perspective. That shortfall that we had in prior periods wasn't there from Q4 to Q1. I think in terms of the dynamic pricing, vets have been—there's been very erratic visit patterns. We're seeing wellness visits are down in general for them. For us, that hasn't impacted it. We haven't seen any changes in pricing. We're constantly looking at that cost of care and moderating it over the various invoice levels. For us, it's really just a case of making sure we can monitor it and stay in line with it. Seasonality is there, but we are just continuing to execute on our plan, get the pricing. It's a cost-of-goods model.

is in line with our—well, it is slightly ahead of our expectations, which is good news. We will keep monitoring for Q2 because there is a lot of noise out there in the industry and making sure that we are in a good position to support the veterinary industry and the members that choose us.

Speaker 1

Thank you for that. One last one. I may have missed it, but the amount of capital in excess of the minimums, what was that this quarter? I wasn't able to pick that up. Thanks.

Speaker 5

Yeah. Margi talked about it in the shareholder letter that we ended last year from an APIC standpoint at about $140 million of overcapitalization. That has continued to grow. One of the biggest factors that we talked about last year is the new NAIC risk factors are now in place. That has expanded even more. We were more than 2x overcapitalized versus the required amount. If you look at Q1, that continued to increase. We are now close to a 3x, a little bit over 3x overcapitalized. I think we are pivoting the conversation to focus more on how do we monetize that surplus. One of those avenues we talked about last year is the ordinary dividends that we have taken. We have taken two of those. One was in the latter part of Q4 of 2023, and then another one in the middle of last year.

As those conversations progress, of course, once we have something to announce, we will be happy to do so. We feel like we're in a good position. At the end, we want to be responsible, and being overcapitalized to the level we are, we view as a positive.

Speaker 1

Thank you.

Speaker 3

Thank you. Our next question comes from Katie Sakys from Autonomous Research. Please go ahead.

Speaker 6

Yeah. One quick clarification to start off. The 70 basis points of year-over-year reserve development, that was an adverse impact, correct?

Speaker 5

Yeah, that's right. It was an adverse impact.

Speaker 6

Okay. Maybe if we can just kind of circle back to that line of questioning and delve a little bit deeper. I mean, it would be helpful to understand what drove that adverse development. I mean, in commentary earlier in the call, it kind of seems like Trupanion is assuming loss trend in the vet channel, quite similar to what we saw last year. I am just kind of curious to know how confident are you that this quarter's significant improvement to the subscription loss ratio is being tipped at the right point and will ultimately result in adverse development in a year's time?

Speaker 5

Yeah. I think it's a two-part question. Just in terms of the reserve, I mean, there was no change to our process. There was nothing different in terms of the approach or methodology that led to that. Yeah, we've seen positive development, adverse development over the course of the last few quarters. That was well within what we would expect in terms of normal range.

Speaker 4

Yeah. I mean, I would just add to that, Katie. I think in terms of, to Fawwad's point, the ebb and flow, you're going to see some puts and takes through the year in terms of do we get that spot on. I think the actual reserving process is such that when you have the software, you have different arrival patterns of invoices. Also, what you see is as people start to focus on their dollars, they're going to send in those that are being reimbursed, they're going to send in invoices after the fact. It's a normal course of business for us. It's something that we're constantly managing to try and get closer and closer to the number. The reality is in insurance, you're always going to have a little bit of wiggle room there. Obviously, we will continue to improve on that.

Pleased, overall, with where our loss ratio ended up. It was definitely ahead of the curve. All in all, the quarter ended well.

Speaker 6

Thank you for that. Maybe shifting to the retention figure. I mean, great to see that that's sort of trending in the other direction this quarter. Obviously, it's a singular data point. Any reason to assume that this isn't a true inflection? You guys have spoken about seasonality on the subscription pet invoice ratio. Can we extrapolate any of that seasonality to expectations for retention? Are there any tailwinds that you guys might be expecting to see as the year progresses that could really help support continued retention improvements?

Speaker 4

Yeah. It's a great question. It's a big, big focus for us, retention and acquisition this year. We came into the year knowing that having just had such incredibly high increases for our members, retention was where we'd need to focus. We were doing so at the back end of this year. I think what you see is an inflection point. I think it's absolutely the result of the efforts of the team over the last few quarters to make sure that not only are we explaining why costs are going up, but helping to reinforce the value of Trupanion and making sure that our software is readily available, that people are using direct pay, and all the things that basically go into being a Trupanion member. We're definitely seeing a focus and results related to that. There is absolutely a tailwind.

Having had 20% plus for several years now, our members are now normalizing their rate adjustments, and many of them will be below 20%. In the shareholder letter, I refer to the table where you see that cohort massively jumped to over 20. That is naturally a pain point for us as a business, and it's one that we're pleased to see some recovery from this year. As we go through the year, we'll continue to really focus on this area as well as first-year retention because we expect that cohort to pick up as we add new pets. We anticipate we'll start making progress. It will be slow and steady, but we'll make progress toward what is our historical retention rate, which is higher than the 98.28% that we have at the moment. All things being considered, though, I think it's a very good result.

Pleased to see all those early green shoots of recovery.

Speaker 6

Thank you for your answers.

Speaker 4

Thank you.

Speaker 3

Thank you. Your next question comes from Wilma Burdis from Raymond James. Please go ahead.

Speaker 2

Hey, good afternoon. Could you talk a little bit about how you're thinking about getting additional rate throughout 2025? The loss ratio appears better than we would have expected for a Q1. Do you need a lot more rate this year, or how are you thinking about it? Thanks.

Speaker 4

Yeah. We are continuing to work with regulators to get rate. We have around 40% of our book, if not a little bit more, are priced ahead of the curve. What I mean by that is pet parents have got pricing in place that will not need to be massively adjusted over the next 12-18 months. There are areas, as usual for us, where we are now starting to refine that rate to continue to build on what is needed as a cost-of-goods model. We have had good conversations with regulators. We are working with them, as we always do, on a very regular basis to ensure we can get the rate we need. As such, we have not had anyone saying we cannot. We are still working with them to get rate.

That is really part of the course of insurance, making sure that we are constantly adjusting and refining it, as you know, and we will keep doing that. Our rate flow will come down. It will not be at the mid-20% as it has been for the last couple of years. Pleased to be returning to a more normal cadence. That will show up in our loss ratio through the year as we see continued expansion in that over the course of the next couple of quarters.

Speaker 2

The operating cash flow was pretty strong. Just curious if that's a run rate, if there's something unusual, or how it should trend throughout the year. Thanks.

Speaker 5

Yeah. We've been really happy with the progress on both operating cash flow and free cash flow. When you break it down, the majority of that progress is driven by AOI. We've talked in the past, but a lot of companies will try and reduce spending as a way to maximize cash flow. We have not taken that approach. More than two-thirds of that is coming directly from increased AOI. Yeah. Over the last, I think, four quarters, our team has done a great job. We've delivered more than $15 million of free cash flow. I think it's $53 million. If you compare that to the previous four quarters, it was about $12 million. Of course, this quarter going from what was effectively break-even to $14 million positive. We talk about it all the time that this gives us capacity to be able to make investments.

That is a good position for us to be in. We still have our guardrail and our focus on free cash flow as a percent of revenue for the full year of being at 2.5%. We feel good about the start to the year.

Speaker 2

Okay. Thank you.

Speaker 3

Thank you. Your next question comes from Josh Junker from Bank of America. Please go ahead.

Speaker 0

Yeah. Thank you. A few questions. Looking at the shareholder letter, I noticed that the cohort of customers who received a 20% or greater increase went from 33% in 2023 to 46% of the portfolio in 2024. Is there any timing on that when that happened? Is that number coming down now? I was actually surprised to see it up so significantly year over year.

Speaker 4

I know. It is testament to the team to have been able to retain those members at that level. It is coming down. It is coming down now. It comes down every week, every month as we start to put new rates through and normalize that for the consistent rate adjustments we have seen. As pricing has been at our level of 15%, we fully expect that now to be a somewhat average increase for our members because that is now sort of a normalized rate for us. It built over the course of 2024 where we started to see an incredible number of people move into that book as more of that rate flowed through, and we had the approvals. Now it is really a case of returning to what is normal for our members and for us.

I fully expect by the end of this year, you're going to see a big shift back towards that under 20%. It doesn't mean people won't be getting rate increases in the high teens. They absolutely will. We will be normalizing that. We know that that's a far more effective retention cohort for us. Pleased to be getting that tailwind and that benefit through the rest of the year.

Speaker 0

On the first-year customers, retention went down dramatically for first-year customers who did not see any rate change at all. I know for many reasons, they are historically the hardest customers to retain, and maybe you do not even want them. They are leaving for a reason. The retention dropped fairly sizably in that cohort. What is going on there?

Speaker 4

Yeah. It's purely a matter of execution. When we think about attention, there are only so many things that the teams can focus on at any given point in time. As you can see, there was such a shift into the over 20% group, that cohort. We were incredibly focused on making sure that we were paying attention to people who were getting those increases, helping them realize the value, understand the value proposition, understand what's happening in the industry that we really took our eye off the first year. A, because we weren't growing particularly quickly, and we didn't have such a large number. Also, for us, our greater good was looking at the majority of pet parents who were already with Trupanion.

There has been a shift since the beginning of Q4 last year where we realigned some of our marketing structure to make sure the conversion and retention teams work hand in hand. The messaging that someone hears when they sign up is aligned to what they hear as a member. Also, just really making sure we have resources to better educate the new pet parent, help getting them at times where there is typically buyer's remorse, and putting in tactics that will help to improve that. We are already seeing improvement in that space. I feel very good about the tactics we have started to deploy and expect that to improve as we continue to use more of our PAC dollars in that first-year bucket to see that move back into levels it was at historically.

Speaker 0

Mark, you included a graph in your letter about trying to show the relationship between PAC spend and increasing conversion for web versus phone-based customers. I looked at that chart, and I was not sure that I could see the correlation. I mean, obviously, the PAC spend was not on that chart, but it was spoken about rhetorically. I noticed two things. One is that even if there is a boost, it is hard to boost it for more than a month. It seems to pop and then fall. Can you go into a little bit about how that PAC spending works to increase the conversion and what that chart should be telling us?

Speaker 4

Yeah. You hit the nail on the head. I mean, the main thing is really the consistency of spend. When you have reduced acquisition dollars and we really were not spending a lot in the conversion space, we were turning it on and off. There are a couple of things at play here. One is when you deploy it, it is easier, or I would say easier is probably the wrong word. It is more natural for people on the phone to be able to listen to the response of a pet parent and help to learn and lean into how do you convert that member. They tend to get their conversion rate up higher quicker. From a web-based perspective, while you have a volume there, there is a lot of trial and error. There is a lot of testing.

If we do not keep consistency of our investment, you do not get to build on the things that you are learning. Really the key for that chart is helping people understand that if we turn on spend and turn it off the next month, we will turn it on and turn it off the next quarter, it has a small blip in terms of an improvement, but it does not stay there. We have to maintain the level of investment, which is what we were doing for 10 years prior to reducing our pet acquisition spend. We kept learning and kept building and kept increasing our conversion. It is really a lesson of, let us make sure we are being consistent. Let us make sure that our compounding AOI dollars are being deployed in the right ways, in the right format, and doing it in a manner that allows us to learn.

If we keep being erratic with it, we're not going to get that learning. That is essentially what that chart is trying to demonstrate.

Speaker 0

Okay. Thank you very much for the answers.

Speaker 4

Yeah, thank you.

Speaker 3

Thank you. The next follow-up question comes from Katie Sakys from Autonomous Research. Please go ahead.

Speaker 2

Yeah. Thank you for the follow-up. Just a quick one from me. Reading through this year's shareholder letter, you guys circle back on the subject of digital advertising and really make the point that a lot of online customer acquisition is frequently structured in a pay-to-play manner for the current pet insurance industry. In years past, that's been something that you've specifically eschewed and said that you would not be participating in. Is there any reason to think, as you realign your marketing strategy going forward, that online acquisition will continue to be something that you avoid? Or would there be a point at which Trupanion starts to invest more into DTC marketing and really competing for space in online search results?

Speaker 4

Yeah. We do. There's a lot to unpack here, actually. I think one thing that we are on, we do advertise online. We do have direct-to-consumer marketing. It really, as I mentioned in the shareholder letter, is very much more a conversion tool that helps to sort of find people where they are, helps to educate them, pull them through the funnel. I think in terms of the way that competitors spend, my point there was we are adhering to internal rates of return, which means we have to be very disciplined with acquisition costs. A lot of those sites or vehicles tend to be incredibly expensive on a CPC basis or a cost-per-click basis or cost-per-acquisition basis. If we layer that on with our lead costs as well, it tends to fall outside of our guardrail. We will do it. We'll test and refine it.

As a brand, as a company, we've been quite deliberate in our choice of the platforms and the vehicles that we operate with. In a fledgling market, it's incredibly important to make sure that we're being clear and transparent with how brands and products show up. Personally, I think sometimes that hasn't been clear. We choose to operate with vehicles that actually are more clear in the way that they're displaying results. The last thing that we would want to happen in this industry is have it commoditized before it's a commodity. I think sometimes people see things and they believe them to be true. If you see rankings, what they don't necessarily understand is that someone has paid a significant amount of money to be number one. That's fine. For Trupanion, we have to always adhere to the IRR.

That is why you do not see us across every vehicle everywhere. As the market picks up, I expect we will start to test a little bit more in some of these spaces to make sure the brand can be relevant and present. It always has to fit within the IRR. That tends to be a factor for us as we think about our strategy there.

Speaker 3

Thank you. This concludes our question and answer session. I would now like to turn the conference back over to Margi Tooth for closing remarks.

Speaker 4

Thank you, Saga. We do not usually have closing remarks, but I did want to just reiterate to everybody what a strong start we had to the year and just recognize our subscription margins expanded. We saw retention for the core Trupanion product improve, which demonstrates our pricing power. We have had an inflection point, I think, in net PAC growth, which is incredibly positive for us. It leads us to the rest of the year from a position of strength with compounding adjusted operating income that we will reinvest in growth. We look forward very much to updating you on our progress in up-and-coming quarters. As a reminder, Fawwad and I will be in Omaha, and we hope to see many of you there.

Speaker 3

Thank you.

Speaker 7

Thank you.

Speaker 3

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.