Welcome back to the 2024 Financial Services Conference. If you're looking to learn about Trupanion, you're in the right room. For this session, we have the President of Trupanion, Margi Tooth, who's here, as well as the new CFO, Fawwad Qureshi. Margi's been with the company, I think, 11 years this fall.
Coming up to 11, yeah.
Coming up to 11 years. And Fawwad's a newbie. He's, I think, September was your, you joined September?
end of September, yeah.
End of September. Previously, he was at Expedia as a CFO of brands before that Nike.
Yep.
We're really happy to have you here. Obviously, last week, earnings were reported, and the long-awaited decline in the medical loss ratio happened. That was a positive thing for Trupanion, but it was also announced that there were two material weaknesses in the financial controls of the company, and the stock reacted quite poorly to that news.
Mm-hmm.
There's some of, although it was included in the press release and in obviously spoke about it on the earnings call, there's still a lot of confusion and a lack of information about what exactly is happening with the financial controls, how quickly it will be resolved, how serious it is. Maybe you can tell us a lot more and fill us in on what we need to know about that development of the company.
Yeah. I mean, certainly, it's unfortunate and disappointing from our perspective. So as we said in the call, our expectation is that when we complete the 2023 audit, there will be two material weaknesses. So one is related to IT controls. So I would think of that more in line of things like change management, access to systems, just making sure that the right people have the right levels of access, as well as given that we're a digital company, ensuring that we have really good change management controls over, you know, any change in data, if we're pushing a new feature through, etc.
So, you know, part of SOX compliance is making sure you have those redundancies in place. So that's the first part. The second part was related to the other business, and it has to do with specific reporting.
So with our partner, we receive reports, as you'd expect. And, you know, a foundation of SOX is that you have multiple ways to validate and verify that the integrity of the data. So the controls there are controls there, but when our auditors looked at that, they felt that, well, the sufficiency of those controls, given the need for redundancy, wasn't sufficient. And so that led to the finding of the second material weakness. You know, there's nothing good about this. You know, obviously, me coming in as the new CFO, I take it super seriously. If there's anything that I would take away from a positive perspective, it gives us an opportunity to invest in controls, in our infrastructure. You know, this company and part of what attracted me to the role is it has grown very quickly.
It doubled in size over three years. And, you know, sometimes with that rapid growth, the infrastructure of the process, the operational discipline, doesn't quite keep pace. And so we will be making investments to not only remediate these issues. That remediation will happen over the course of this year, as I think anyone who's gone through an audit knows. There's a period of remediation that includes testing. So you have to then test the new controls to make sure that they're stable over a period of time. But also going forward, you know, it gives us a platform on which we can put, hopefully, the next $1 billion of growth and growth beyond that. I think it's just a it's an important moment for the company. It's now a big company. It's no longer a, a small company.
With that comes increased scrutiny and an expectation that we get this right.
How long could the 10-K filing be delayed due to resolving of these issues?
Yeah. It's an open audit, so I'm somewhat limited in what I can say. I would say that, you know, we're optimistic. We're working day and night to ensure that we're resolving these issues. You know, the way it works, of course, with auditors is you provide data, they test the controls, and then we obviously can react to that. So, you know, we're optimistic that we're narrowing the aperture as the day has gone on. We're making progress every day. That's what we're focused on. And then when we're able to describe more in the 10-K some of the specifics around these issues, including the remediation, hopefully that gives investors a better perspective. We know this creates uncertainty. We're working through it as fast as we can.
I'm just understanding. Can the 10-K be published while the weaknesses are still present, or does the publication of the 10-K mean that they found a resolution?
Yeah. The publication of the 10-K is dependent on the opinions of the auditors. So those opinions have to be commensurate with the filing of the 10-K. So we release the 10-K, and almost simultaneously, we have the two letters, the opinion that they provide on controls and then the opinion they provide on the financials. So, yeah, all of that has to happen at once.
The second item that was interesting in the last quarter's earnings call, at least to some investors, was the significant increase in revenue in the other insurance segment at the same time as the number of pets enrolled declined. Some people thought that was unusual. There you know, in terms of thinking about unit economics, it suggests that the pets who are at the company are more valuable in terms of revenue than they were previously. Can you address whether that was a surprise, how whether that's a trend, how an investor should think about the disconnect between unit volume going down while revenue goes up?
Yeah. So, this was a question that was asked on the call. It was, I think, a relatively simple question. I think even the person asking said it was a simple question, and we made it more complicated than we needed to. Yeah. So the question was, revenue is going up in the other business. Volume is going down. So it is the difference ARPU?
And the answer, of course, is yes. So, when you look at it on a sequential basis, pet months was down a little over 2%. It was down 2.04%. Revenue was up 1.53%. So the difference there was the ARPU. ARPU was up north of 3.5%. I think the exact number was 3.65%. So when you take the 3.65% increase in ARPU against the 2% roughly 2% decline in pet months, that's what led to the revenue increase.
Kind of the broader point that I think we wanted to emphasize is that is the first month-over-month quarter-over-month reduction in pet count going back I went back as far as 2021. So think of it as 11 quarters of quarter-over-quarter comparison. So that's the first time it's gone negative. And then from a revenue perspective, that 1.53% is the smallest revenue increase sequentially. So the point being is that business is decelerating, as we've talked about. Our expectation for 2024 is it will still contribute some growth, but that growth will be modest relative to what has been in the past. So, no, we were not surprised by that. Rates have been going through. So that was sort of in line with what we were expecting to see.
Just to flesh this out, being that the first quarter that the unit volume declined for other that should be an ongoing experience. You are disengaged to some extent with the Pets Best product, which makes up the majority of the unit volume in the other. And over the next three years, it's going to get significantly smaller. This was the first quarter, but not that it's a blip. It's that is the new trend.
Absolutely right. So, like, from an investment thesis perspective, I sort of think of it, again, as the new guy. I think of it as, subscription accelerating. Because of the nature of the subscription business and the high retention, you expect revenue growth. But I think what was notable is if you compare second half of 2023 to second half of 2022, you started seeing accelerating growth when you do the year-over-year comparison. It's the opposite happening in the other business. So, yeah, we expect that to decline. It'll still contribute year-over-year revenue growth, but it'll be very modest. But, yeah, that is a business that, from a secular perspective, we expect to continue to decline.
So if we go all the way back to 2021, and there was, this is when, I guess, the drumbeat of inflation started getting talked about, and some people thought that pet care was rising. And by, I think, May, June of 2021, you agreed that was the case. Regulators take time to approve pricing changes, and you only increase the price on your customers once a year, when at the anniversary of their enrollment with the company. So there's a delay effect on this coming through. So, I mean, I always think about it as, like, a roller coaster. You may have gone already over the hill, but the car's not really moving until the majority of the car is over the hill. Along those lines, where are we right now in terms of the rate increase?
How much have been taken up to this point? What is the current amount of, price that is in that's rolling through the anniversaries of people who are customers today? And, how much more do you expect to put through, until we address this loss trend that we're in right now?
Yeah. So we currently we've had 300,000 of our members. So around a third of our book has received a rating increase of over 20%. So that's ahead of what we would typically be looking to do. So if we think about the industry overall, the average increase from a veterinary inflation perspective is somewhere between 5%-7%. That was before 2021.
To your point, there was a little bit of inflation poking up in 2021. 2022, we saw it in four quarters. We didn't see the quarter one increase and then nothing else, which is what we typically see. We saw the quarter one increase. We saw quarter two increase. We saw quarter three and quarter four. So we had four quarters on the chart in 2022 that led to us being behind the curve in terms of that rate catch-up.
When we went into 2023, we assumed 12% because that was what we saw in 2022. We actually saw a 15% level of inflation, which meant that we were already behind the curve, and we had to catch up again. We started in earnest putting through some heavy rate increases in 2022. They continued through 2023. We're now at 26% overall, on average, for rate flowing through our book of business for our members today, as effective as of last week. So what that means is, on average, our members will receive a 26% increase. It doesn't mean everybody will get that level of increase. Some will get much higher. But overall, we think that 26% will be good for our catch-up as well as what we see coming through this year as well.
So far in the quarter and we are only halfway through this quarter, obviously, we've seen a 15%. So it still holds true. We expect that to continue through the year. And if it does, we expect the shape of the year to be at our target margin by the end of Q4.
Some states make the regulatory burden pretty easy. You just file a rate, and it gets accepted, and you take it. Other states the regulator typically, in the larger states, they have a lot of infrastructure, and they want to know a lot of information. California is obviously our largest state and is one of the most difficult states in terms of the regulatory burden on insurers. But you did get the large rate increase through in California. Excluding California, how much rate has gone through the book, and how far are we in terms of renewing the book in California? Is there a lot of rate to come through in California alone that's going to change, I guess, the direction of the book overall?
Yeah. I mean, that 26% doesn't account for any, any new rate that we would get from California. So nor does our guidance for the year. So when we think about the sort of the run rate to get to our margin target by the end of Q4, that's not assuming any more rate from California comes through there. So it's all upside. In terms of the overall, I don't think we've disclosed necessarily the percentage of book, but it, it does it adds a couple of points in terms of the overall rate, just given the size of California, which we have not been growing excessively in for the last 18 months. We've really been dialing back that growth level deliberately because we want to make sure we're priced appropriately for every member that we enroll.
So the book that was once a bigger part of our business has now a smaller impact on our business, which is very deliberate and helpful. I mean, in terms of additional rate need, right now, we don't think that we need more rate. We'll continue to hold at that 26% as we look at rate flow. It will vary by geography or very, very much by market. So we're looking at that in a high level of detail.
But California, we're having good conversations with. To your point, you know, they want to understand the data. They want to understand the trends. Trupanion Product is a very comprehensive product. We get a lot of use. It's designed so there is no barrier to care. And so as a result of that, it does behave differently to some of the competitor products.
By and large, you know, everybody is seeing the same level of rate increase. So for them, they are California are aware of this company. They just need to understand it a little bit more.
I always have a little bit of a, is the goal, by the way, in Medical Loss Ratio 71%, or is it 72%?
71. 71 right now.
71% moving, I think. Three years ago was 71% moving to 72% over the next five years. We're already three years into that five-year plan, though.
Yeah. That was before inflation.
Before inflation, okay.
You know, our goal will always be to maximize the amount we can pay out to our members over a sustained period and targeting that 71%-72%. Hopefully, at some point, it'll be 75%. You know, we just need to find ways to continue to drive efficiencies to get that value proposition higher.
I think the current guidance is to exit 2024 with 71%.
Correct.
Right. I think the fourth quarter of 2023 was 73.6% or.
The fourth quarter?
Fourth quarter, yeah.
72.7%.
72.7%. I'm sorry.
Yeah. Which is flat year-over-year.
Flat year-over-year. And.
But a significant improvement, obviously.
Significant improvement. You have 26% rate flowing through. Loss cost inflation is somewhere in the mid-teens. That's about 800, 700, 800, 900 basis points of a gap between price.
Yep.
That's not a lot of improvement. But, you know, I realize that things are not one-to-one. It's not easy. But my math suggests to me that we should be getting a lot more improvement over the coming year than merely exiting at a 71% target. That it might overshoot the target.
It's very possible, you know, what we would expect to see at the beginning of the year, the Q1, you know, that high rate increase, if it was before 7% and it's 15%, you're going to see the big delta from Q4 to Q1. So sequential movement is a 15% increase on what we're seeing in the quarter, in quarter four. So we'd expect to see a pretty sequentially flat loss ratio in Q1 to Q2, but absolutely expect that acceleration in the back half of the year, so Q3 and Q4.
To your point, if we do see you know, we are able to take more of the rate so we don't see any change in mix, so we don't see deductible buy down or any of the changes that happen to take that 26% to whatever it ends out to be, then we'll get there faster. At the moment, we haven't seen a change in the cost of goods and that inflation from a veterinary perspective. But if that does come below 15%, then we would reach our target.
Seasonally, one Q is the highest benefit.
Yeah.
Medical loss ratio quarter of the year.
Yes.
How much does that tend to vary from the full-year average?
A good few basis. I assume probably somewhere you know, we would expect it somewhere between, say, 50-50 or so basis points. So it's pretty big. It's a pretty big swing because you're jumping up that 15%. So if you think that, you know, on you, you see a maybe 3% differential between the two. So I think, you know, we have yet to see kind of how it's going to impact overall while we go through this quarter. But it's a pretty big difference because, purely, you get the rate increase in the first quarter.
Unfortunately or fortunately, we know Trupanion's numbers. We don't know much of your competitors' numbers. They're all private companies, or they're bound up in an inland marine filing that comes out five months after the end of the year.
Right.
Obviously, you don't completely know your competitors' experience right now, but you have better information about it than I do.
Mm-hmm.
What do you think is going on industry-wide, in terms of your experience versus the experience of other companies that you can beat directly against? Are there companies that are happily underwriting at a loss right now to take share? Are you seeing in publicly available rate filings, the actions of your competitors are similar to your own?
Yeah. They are, by and large. I mean, I think it took a little while for some of our competitors to see what they were seeing in the data trends. It took us longer than it should have done. It certainly took them a lot longer, I think. Overall, we've seen competitors with pricing increases. The highest I've heard of is over 70%, for one of our competitors in the California market that was filed and approved. That is, you know, indicating exactly the same levels of severity in terms of that inflation that they're seeing there. Across the board, there have been a handful of competitors who have been putting in significantly higher rate increases than normal. Your point around loss ratio, you know, everybody targets a very different loss ratio.
For Trupanion, we are very steadfast on that $0.71 over the life of the pet, not just, you know, thinking about, "We'll change it this year to the next year." Competitors have a different approach to that. Some will be happy coming in at a much higher loss ratio and then starting to bring that down over time. And that's why you see a difference in retention rate. So that does happen. I don't believe there's anyone doing that to a great degree at the moment. There's a lot of quiet in the market as people get their rates through, make sure they've got confidence in their losses and seeing what we're seeing with the expense ratios. And from there, I think, you know, we'll start to see people build back up again. But everyone's been under pressure.
There has never been a greater need for medical insurance for pets than there is today. More and more of that burden comes through the vet channel. As the veterinarians are having conversations with pet parents who are not in a position to pay for the cost of care, they have a solution: insurance. So, you know, it's really a case of us making sure, as a category, that we're priced appropriately to help grow the overall category. And as a reminder, we're still only 3% penetrated. So a significant runway ahead of us. And hopefully, a lot of people will get the pricing right, and we can all move up together.
The founder of Trupanion, Darryl, often likes to say, "I've been doing this a long time." And there's.
Yes, he does.
Nothing's really new. I don't think that's exactly right. I think the events of the last couple of years have been something different.
He would agree with that. Yes.
So what lessons have been learned during this whole inflationary thing? Have you learned something that, if you had been able to go through this with preparation, could you have avoided some of the losses? I mean, you can't, the regulators don't want to give you relief before you need it and whatnot. What are sort of the takeaways on what happened over these past couple of years, and how could Trupanion have been more prepared for them?
Yeah. I mean, I think some of it could obviously have been avoided. I think some of it we just no one could predict quite how high those losses were going to come in. I think, at the early stages of inflation, we were slow to react. We were slow to spot it. The data datasets were there. But when you combine that with mixing in the pandemic patterns of visits to hospitals, how frequently are people going in there, what is the overall cost of an average invoice, everything was changing. And so the team didn't necessarily recognize what was happening as quickly as they could have done. What we've learned from that is, you know, the teams have done a fantastic job over the last year in terms of execution.
They have proven that, I think, quarter-over-quarter, certainly from Q2 to Q3 to Q4, we've seen continued build and record months of performance. But I think for them—excuse me. They've, we've learned to look at the data in very different dimensions. We've learned to have other teams looking at the data.
So when we think about the nuances of a market or a geography, having people who are working and based in that market assessing the data with our actuarial team, with our finance team, and having more eyes on that just helps us to get more confident. I think in terms of, you know, overall communication processes, you know, as Board mentioned, a Material Weakness for us is a big lesson. It's disappointing for the team to have this off the back of, you know, a frankly, a very strong back half of the year.
It does give us a moment to pause and reflect and assess, "Okay, how are we thinking about our next stage of development?" This is a big shift for us as a company. And it puts more barriers to entry in there, and it makes us better. We recognize that, you know, we didn't do everything that we could have done before. But I would say in Q3 and Q4 of 2023, the lessons we learned started to come into effect as you see those results really start to come up.
Some of the detractors of the Trupanion business model, they have a concern that, people with sickly pets are likely to be maintain their relationship with Trupanion, while people with healthy pets are more likely, in a price increase environment, to non-renew the policies, causing the average benefits ratio to go up for everybody. I've looked at the data, and it does seem to me that, although you had a spike in new pets during the pandemic, about 30% of your pets are new pets. And that's been pretty consistent for a while. Does that matter? Does, does the business model require, 30% of the, the population to be new pets?
Or, you know, as we get to Trutopia, which the goal would be to have a very longevous group of pets and a much more penetrated business where it's hard to get 30% growth year-over-year, how do you address those concerns that a slowdown at some point in the proportion of the book being puppies and kittens, we don't want to leave out kittens, isn't required for the math to work?
No, it's not. No. So, the way that there are a couple of things here that if we think about the Trupanion member, someone who joins Trupanion is, first of all, they're not price sensitive. They're coming to us largely through their veterinarian, through a recommendation. We are not the cheapest in the market. So when someone goes to look for insurance for their pet, more and more often than not, will be the most expensive. So we know already these people are value sensitive. Our job is to make sure that we're pricing according to the cost of care for that pet, weighted cost of care for that pet over its lifetime. So we price at the age of enrollment.
If we stopped enrolling pets tomorrow, which we will not do, we have millions of data pet months that we can assess to be able to determine what that average cost of care would be. So it doesn't change our ability to be able to price. And to that point, we're not losing healthy pets. Again, you know, people that choose Trupanion choose Trupanion because they've done their homework. They've done their research.
They've had their recommendation. They are protecting their pet as a member of their family. They're not people who are going to just drop it if the price goes up. So that's an important component to differentiate between the two there. But, you know, we're not seeing that trend happening either. And we're continuing to add pets. And many of the pets that we're enrolling naturally are puppies and kittens.
When we enroll puppies and kittens, it helps us with our retention rate because they have no preexisting conditions. And so that overall experience is much better. So, you know, based on how we, we create our model, it, it's absolutely not the case.
Yeah. I think, Josh, one thing I would add, just coming in new to the company, you know, I'm used to looking at digital consumer services with relatively high churn rates. Like, you don't necessarily see a business that has retention, whether it's measured monthly or annually, in the 90s or high 80s, low 90s. We've had the experience, at least from what I've seen so far, where we put price increases through that are greater than 20%. You know, we watch those cohorts. Generally, we retain those people. So I kind of come from a background where consumers vote with their feet. If you're not offering value, they will let you know pretty quickly. So there's a resiliency in terms of ability to price.
I think the other thing is, when we think about percentages, some of the percentages can be pretty big. But if you look at it on a dollar basis per month, you know, somebody getting a 20% increase on a $60 a month, you know, it's $12 more. I don't mean to minimize that in the economic environment we're in. People are price sensitive.
But, you know, at the end of the day, it's something they're providing for their pet. It's health care for their pet. And so in terms of priority, we feel like that, that's a good indicator, that there's a resiliency in the ability to price. So that, that's been a learning for me. I'm not used to seeing retention that starts with a 9. If I told you what I'm used to, it would be much lower.
terms of the retention, the retention is quite good, although it is slightly lower than it's been historically because all this rate is pushing through.
Right.
Can we believe or do we, in theory, that the post-rate increase retention will be higher than it's been in the past? If somebody A, was a Trupanion customer and a higher payer to begin with, and two, they were put a 26% rate increase through them, and they stayed, that person's actually potentially the book that remains is more price insensitive to the book that was there before?
It's more price sensitive.
More price sensitive.
I mean, it's insensitive. That they really weren't going to leave. They're, you know, and so the price—it's probably the price-sensitive shoppers who are leaving, even if they're going to self-insure at this point. And there aren't many price-sensitive Trupanion members for those reasons that I described before, the way that they find us in the first place, because there is a delta between the way that we are priced at time of enrollment versus a competitor. Yes, that's a fair point. I think, you know, one of the things that we have always reported on every year in our annual shareholder letter is the different buckets, different cohorts, the way we assess our retention. First-year retention, under 20% increase, and over 20% increase.
We've always had members in that over 20% increase, typically because, maybe we've seen cost of care in an area rise, but maybe we're taking a new cohort and creating a new, new set of rates for specific pet parents. I think in any of those instances, we, the team has always done a very good job of understanding, "What is the behavior when X happens?" So we have data points to say, "We would expect to see you'd naturally expect to see that churn rate get a little higher the higher up that curve goes." So 20%, 30%, you'd expect to see higher churn. The team does a very good job of saving people. So they'll be calling in and having conversations to understand the why. And to your point, they tend to be the stickiest.
They also tend to be people who will refer more friends because they believe in what they have purchased. They've done their homework, and they can't be without it. And to Fawwad's point, this is a family member that you're not going to turn down care for. So, it doesn't mean that we're not absolutely focused on it day in, day out. Every pet that we lose is a life that we can't save. And that's how the team feels about it. And that's the reality of a situation. So for us, I think it's just really a case of making sure that the messaging is right, that people understand, both from the hospital level and also member level.
You know, we would fully expect to see a far stickier and higher referring book once this has flowed through.
So let's talk about some of the reasons why people are Trupanion customers. The recommendation of a trusted advisor in the form of a veterinarian, the minimal out-of-pocket costs at the veterinarian is something attractive, and the high amount of coverage for what the policy offers.
Yeah.
One of those things that you have a lot of patents to defend your relationship with the veterinarian. Have you had to defend those patents? And what do those patents cover that give confidence to the uniqueness of the Trupanion value proposition that it can't be duplicated?
Yeah. So we have defended our patents for our software. So our software allows us to be able to pay the veterinarian directly at the time of invoice, as you mentioned. So that, for us, is something that we invested in years ago. And we have had to defend them, not recently. You know, I think you know, we've been pretty fierce about that and our moats around the veterinary channel.
What the patents cover, you know, without going into too much detail, is specifically the relationship between the practice management system and our ability to naturally pay. We have got so much data as a result of that that the ability for a competitor to come in when their products are more narrow in scope and this is an important part when you have a broad coverage, you get every line invoice.
You see everything that that pet has in terms of treatment costs. When your product is narrow, you don't see that. So in terms of the dataset, it's harder to be able to determine what is in and out of scope. So from our perspective, we cover virtually everything. So the AI and machine learning that we've been able to do, which we've been doing since 2016. This is not because machine learning is a buzzword. You know, we have millions of pet months of data ahead of our competition. And that continues to grow as we have different products and different product sets. So we're not only looking at the specifics for the product, we're also looking at the member as well, which is a huge competitive moat for us.
Not to mention the fact that, you know, our retention rate is double the competitor average. Even with our 98-28 that we refer to with our 300,000 members that have received this bigger increase, our retention rate is double everyone else's. That comes through, again, lots of data, lots of insight, lots of intelligence to help make sure that we can maintain that level.
In terms of thinking about those other products, one of the things that makes Trupanion unique is that software system in the veterinarian. That's not offered in the other products.
It is for two of them.
It for and.
Anything that's powered by. No, the other two. So Chewy and Aflac, we can pay the vet directly.
Oh, but Chewy, yes.
Furkin and PHI, we do not.
No.
Do you get the data, though? Is there information that's coming from the veterinarian, even if you don't know?
No.
Okay.
No. No.
So how is Furkin doing? How is PHI Direct doing? It's still sort of in incubation mode. Is it anywhere in the United States at this point?
No.
No, it's all selling in Canada.
It's all selling in Canada. The team has done a really good job. The big focus in 2023, as it was, frankly, across the board, was to really bring, bring down that efficiency, make sure we're being super operationally tight with it. They made some very good strides in the year, I think, and are really happy with where that finished at the end of Q4. For us, the focus is going to be on our core business, you know, managing that to make sure the margin gets to target. You know, our hope is absolutely to bring that to the U.S. market, both of those products, the U.S. market over time. They appeal to a very different consumer. They are a direct-to-consumer brand. So we're not going through the veterinary channel.
Much lower levels of coverage, much lower price tag, still needing to have rate increases flowing through just because, naturally, again, we're seeing the inflation across the board. But they're good products. They're still small. You know, I think we'll probably get to scale some somewhere between 15,000-20,000 pets. And you know, once we have confidence in our ability to make sure we're running them as efficiently as possible, we have the right margin profiles, we look across the P&L, we'll be coming in to have them as an additional string to our bow in the U.S. market.
And that would mean a 15% operating margin on both those businesses?
Correct. Correct. Yeah.
Are you confident that both of them are capable of achieving that?
If you'd asked me that question 18 months ago, I would have said, "I'm not sure." I am very confident they can achieve it now. Yeah.
Okay. And let's talk about Chewy product and the Aflac product. Where I mean, we don't know about the numbers, and I think, but are they already at obviously, right now we have the inflation problem. But in general, is it already in working order that they can be at 15%?
Yeah, they can. They're making good progress. They've been in market less time than PHI and Furkin. So, you know, they're across the U.S. Both are very different product sets. You know, we think about Aflac. That's the product Worksite Benefits. So kind of really looking at that long-tail, you know, work through with Aflac. So you're speaking to the benefits advisors. You're getting the purchasing decision-makers. That, you know, that takes some time. That's making good progress. It's not yet at scale, but it's on the pathway to it. And same thing with Chewy. You know, great to have these big brands behind the concept and the category. And we've seen them sort of lead to others coming into the market, which has helped to normalize it and give it some credibility.
So, they're a great addition to the distribution strategy and doing as we would hope that they would do and lots of opportunity with them.
In California, can you sell the Chewy product in California?
We cannot. No.
You cannot.
No, we're making progress with Chewy on what they want to do there. But currently, we're not live in California with Chewy.
Are any of your competitors able to sell a product through Chewy in California?
Lemonade. Yeah.
Lemonade, yes.
Yes.
Because the same product that's on the Lemonade website.
That's right. Yeah. Yeah.
Yeah. Okay. That makes sense. So in terms of, thinking about, capital, I think of a big development from the prior year was the capital facility. There's obviously a cost to that. But you did deliver on your promise of ending the year generating your own cash flow.
Mm-hmm.
What is the path to restoring the funds in the credit facility? And to the extent of, when are you going to be generating enough capital that you can accept all new pets that you're generating on the P&L without having to draw down on anything?
Yeah, I think there's a couple of things I'd say just on kind of the topic of capital. So, one is the new metric that we put in place in Q3, the free cash flow as a percent of revenue at 2.5% on an annual basis. I was really happy to see that because it gives us a guardrail that we can anchor to. I think, as we had talked about in the call, there's a seasonality to that.
So we expect lower free cash flow in first half, higher in second half. I went back and looked over the last 10 years. It's roughly that. There was a few years where there were some one-time things. But generally speaking, there's enough of a trend there to say, "Yeah, that reality is probably a reasonable one." So I think that's one.
I think the other is just our ability to continue to grow. So when we look at the over-capitalization in our insurance entity relative to the risk-based capital requirement, I think we've said $64.1 million represents that over-capitalization. There's an opportunity, obviously, for us to have continued conversations with our regulators in terms of, "What is the appropriate level for a company that is now of our size and scale in terms of future contributions to that and what we could potentially do in terms of using more to drive, you know, investments and operations?" And then I think just sort of generally speaking, the roll-off of the other business, that other business has a higher capital threshold. And so just from a capital efficiency perspective, it'll give us an opportunity to have some more flexibility there.
So, you know, kind of overall, as we looked at it, I, I think our position is our plan doesn't call for us to do anything in terms of a capital raise. We do, obviously, have the debt outstanding. And I believe the, the first repayments on that, I, I think, are in 2027 or so. But we'd like to just sort of think strategically, widen the aperture to the next best dollar. Where, where's the next best investment, for that next dollar? So, you know, it could be in PAC. It could be in product and innovation. It could be in technology to improve customer experience. It could be in financial things. It could be either, you know, to your point, paying down some of the, the debt or, there have been questions today even about buying back shares.
So I feel like we have a mechanism within the company that I really like, which is a framework that allows us to measure every investment and do as best as we can an apples-to-apples comparison, the IRR. So, yeah, we would sort of look at it from that perspective as to what's the best place to invest the next dollar.
I can't tell whether it's going to happen or whether it'll happen one day far away, the changing of categorization within the NAIC for a carve-out for pets.
Mm-hmm.
What do you think the timeline might be? How much capital could that free up for the company if it were to happen?
Well, it's making progress. I mean, I think this year, in January, we got recognized as our own line. So pet insurance now is reportable in terms of pet insurance, pet insurers. So they will be reporting on that specifically for the category, which is a big step forward.
For the 2024 financials?
Yeah.
So we'll see a one-year.
Yeah. So we'll see it in a year. And I think that, for us, it's a massive step forward to recognize how different we are to the mainstream. And that's been 15 years in the making. We also saw model law adopted by a handful of states. That's going to take several years before that's adopted fully, if it is ever adopted fully across the board. But that also kind of helps to give a little bit more of a sense of reason. And I think, you know, from a pet owner perspective, it just helps them to get some confidence in the product developments and designs. You know, we're talking probably another three-five years where we see that kind of really fully bedded out. At that point, we'll probably be 5%, 6%, 7% penetrated.
I think in terms of cost savings, the challenge that we have is we're currently in a category that means that we're being compared to some very catastrophic, potential catastrophic, areas. So, you know, in the marine, clearly, there are some high, high catastrophe, low-frequency, very high-severity cases that come through there. So the Risk-Based Capital that you have to hold back is much higher than we would have to. For pet, we'd be more akin to dental insurance, which is a very different ratio. So it would be a saving of millions to all of the, you know, it'd be a very significant saving to all of the pet insurers out there. At this point in time, you know, we are in the position we're in. It's helpful to us.
You know, at the end of the day, it is a barrier to entry for competition. We've been doing this for a long time. We've built up a nice forward set. We've got a nice capital, a risk-based capital in New York. You know, we'll continue to work with regulators. But we're involved in those conversations. It's important for us to be able to move it forward. And it's going to be a little while before we get there.
We're almost out of time. If there are any questions, you want to give anyone a chance to ask them. People are very shy. No one, almost no one, ever asks questions. It's very strange. Well, I want to thank you for being here, Margi Tooth. Welcome. It's a you're now an insurance guy. You know, you had a.
Yeah. I didn't plan to be in insurance.
Neither did I.
In my career, but.
30 years later. So, I mean, we're kind of doing it.
I'm happy to be here.
Thank you very much. And have a good day.
One thing, if I may just add.
Yes.
Quickly, a bit of a sneak peek. So I mentioned on the earnings call that we were just about to cross the 1 million pet milestone. We did just cross that. We crossed it last night. So we now have over 1 million sub pet insurer pet Trupanion pet subscribers, which is a big milestone for the company and, I think, testament to the team for really helping to kind of drive that focus.
Just that is Trupanion North America. It does not include the European pets?
Correct. Yeah.
Correct.
Yeah.
Okay. 1 million pets in Trupanion, North America. Congratulations.
Thank you very much.
Thank you. Where is the second competitor? Like, how, how far are you, or how far ahead are you with whoever is the next competitor?
I guess how big is the second competitor, I guess, would.
In terms of live pets, we would need to see that at a spike. So that's pretty far ahead, in terms of live pets that we have on the books. But we're not looking at it from a competitive landscape. It's really just a milestone for us to be able to demonstrate that, you know, we've focused on moving that needle. And that's a big step up from three years ago. You know, when you double the rate of the business, it's nice to be able to achieve that milestone.
Thank you.
Thank you.