Good morning, ladies and gentlemen. Thank you for standing by for Waterdrop Inc. First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen only mode. After the management's prepared remarks, there will be a Q&A session. As a reminder, today's conference call is being recorded. I would now like to turn the meeting over to your host for today's call, Ms. Xiaojiao Cui. Please proceed, Ms. Cui. Thank you.
Thank you, operator. Hello, everyone. Thank you for joining Waterdrop First Quarter 2021 Earnings Conference Call. Please note that the discussion today will contain forward-looking statements made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are subject to risks and uncertainties that may cause actual results to differ materially from our current expectations.
Potential risks and uncertainties include, but are not limited to, those outlined in our public filings with the SEC. The company does not undertake any obligation to update any forward-looking statements except as required under applicable law. This call includes discussion of certain non-GAAP measures. Please refer to our earnings release for a reconciliation between non-GAAP and GAAP. Joining us today on the call are Mr. Shen Peng, our founder, chairman and CEO. Mr. Yang Guang, co-founder, director and general manager of insurance marketplace. Mr. Kevin Shi , our CFO, and Mr. Jian Tan, our Head of Group Strategy. They will all be available for a Q&A session after their remarks. I would like to turn the call over to our CEO, Mr. Shen Peng. Please go ahead.
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Hello, everyone. Thank you for joining us on our first quarter 2021 earnings conference call today. We are pleased to report strong quarterly results in our first earnings release as a public company. Our net operating revenue reached over 880 million RMB in Q1, representing an adjusted comparable growth rate of 43.2% year-over-year. Our following results reflected the advantages of our operational efficiencies. Since our inception in 2016, we have benefited from the robust industry development and the peak of industry growth and have become a leading integrated insurance and healthcare service technology platform in China.
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Before I talk about the key highlights of the quarter, I want to briefly summarize our positioning and strategy and emphasize 3 keywords that represent our business: inclusivity, efficiency, and technological innovation. In recent years, the health insurance industry has enjoyed favorable policy support, and with the implementation of new regulations on internet insurance businesses, we expect the industry to continue prospering in a healthier environment. The COVID-19 pandemic has broadly increased people's demand for healthcare services and raised awareness for health insurance. While on a micro level, we at Waterdrop have also created multi-dimensional scenarios for insurance awareness education. We position ourselves as an important external force that supplements the government social medical insurance system and aspires to bring insurance and healthcare services to billions of people through technological innovation.
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Waterdrop is fully committed to the realization of social impact and the commercial value of insurance for all. Providing our customers with pre-illness insurance coverage through our Waterdrop insurance marketplace and post-illness crowdfunding support through our Waterdrop Medical Crowdfunding platform.
We continue to leverage all of our platforms to support the fight against the COVID-19 pandemic and to promote inclusive insurance programs throughout the industry. With a recent call from Chinese regulators to broaden health insurance products that contain wider coverage and better quality, our competitive advantages and influence as an inclusive online insurance provider allow us to rapidly roll out a series of upgraded products that give ordinary people affordable choices for their health insurance needs. Our Waterdrop Medical Crowdfunding as an online platform efficiently connects the patients who are seeking help to cover significant medical costs and the people who are willing to help. However, Waterdrop Medical Crowdfunding itself does not contribute any revenue to us. As of March 31st, 2021, through our Waterdrop Medical Crowdfunding platform, approximately 350 million people donated an aggregate of over RMB 40 billion to nearly 1.9 million patients.
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Our overall growth performance is driven by the advantages created by our platform's efficiencies, and we are pleased to see the contribution by Waterdrop to the overall improvement of efficiency of the industry. One of our core advantages is that we can interact with customers directly online, which allows us to accumulate a massive amount of user profiles through the customer accounts, capture static and dynamic data, and gain invaluable insights into their behavior and demands. It also enables us to satisfy their needs more precisely by presenting the most relevant insurance products while conducting product iterations and upgrades accordingly. Our big data and customized intelligent marketing systems have allowed us to enjoy a competitive customer acquisition cost and operating efficiencies from our economies of scale.
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I want to talk about how we utilize technology to empower the entire value chain and improve efficiency and our latest developments in technology. In Q1, we made solid progress on our technology empowerment. We utilized our proprietary intelligent marketing system, intelligent user growth system, and intelligent online marketing and telemarketing system based on machine learning and deep learning algorithms to take a deeper dive into customer insights. We designed and developed a series of algorithms that personalize user experiences and provide targeted matches that best suit our users' needs across marketing, growth conversion, and online marketing scenarios. We constantly build and optimize our user profiles that currently contain roughly 3,000 tags to further boost efficiency for personalized prediction matching.
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We also developed an intelligent chatbot platform based on natural language processing technology. Our intelligent robot for policy renewal can carry out multi-round interactions with users powered by various AI technologies, including semantic analysis, ASR and TTS. This significantly enhances our renewal rates and operational efficiencies. Our AI-plus big data-powered auto-document examines users' intent attributes, behavior data, and medical records to identify categories of claim settlement documents, recognize various certificates, and collect standardized and digital data based on our proprietary knowledge base. We conduct intelligent risk management powered by big data and decision-making models to enable automatic claims verification, manage cost in insurance adjustments, and empower other steps throughout the claim settlement process. This enables us to shorten the claim processing cycle and increase our efficiency by 30%. Meanwhile, the accumulated claim data also facilitates our product design and enhances our actuarial capabilities.
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In a nutshell, we believe our trusted brand, comprehensive product offerings, and innovative technologies will allow us to maintain our position as a leading technology-driven insurance platform in China. We will continue to expand our user base, diversify our service offerings, and deepen our partnerships with healthcare institutions to build a larger health ecosystem.
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Let me pass to Guang, who will discuss some of our key developments in our insurance marketplace business.
Thanks. Hello, everyone. I'm going to walk you through our key highlights and some of the recent developments in our insurance marketplace business. I'll start with the product side, where we continued to launch more insurance products on our platform during the quarter, increasing the number to 240 at the end of March from 200 at the end of 2020. Over 90% of our FYP was contributed by customized insurance products, and we continue to enrich our product attributes on top of our existing product offering and provide full-life cycle coverage for a broader range of people. We have enhanced coverage for specific groups such as children, the elderly, and groups with chronic diseases, and increased or updated the insurance coverage for the customers. In the fourth quarter, the new definition of critical illness was officially put into effect.
Prior to its implementation, we have upgraded and designed our product offerings according to the new definition of critical illness. We moved early to better cater to customer needs rather than speculate with selling CI products under the old definition or simply pursuing short-term incremental volume. The FYP of CI insurance increased by 132% quarter-over-quarter, year-over-year, primarily contributed by the design and sales of products under the new definition of critical illness. We keep forward-looking research early on rules and regulations on the insurance industry and updated our online health insurance products and enhanced our information disclosure in order to comply with the new regulatory requirements and improve our customer experience. We also penetrated other categories such as inpatient medical products and certain types of life insurance products as necessary complements to cater to customers' needs.
In terms of long-term insurance, we kept strengthening our customer service capabilities and provided necessary online consultation support to enhance user stickiness. We reach out to customers for long-term products education through diversified scenarios and multiple channels, such as WeChat groups, live streaming educational courses, and one-on-one AI-supported consultation services. Through more accurate user matching, more effective product offering and better service capabilities, our long-term insurance retention has increased, and our business quality has further improved. In terms of organizational management, we optimized the team structure and onboard more talents. We also explore the opportunities of collaborating with other industry players and distribution channels to offer a wider range of coverage to an extended customer base. Let me talk about the development of our channel. In the first quarter, our external customer acquisition and conversion of repeat purchase both saw continuous improvement, excluding the mutual aid business.
FYP generated from internal traffic, third-party traffic channels, and the macro traffic and repeat purchasers increased by 65.2%, 51.6%, and 48.4% year-over-year respectively. For internal traffic, we saw higher conversion rates from our Waterdrop Medical Crowdfunding to insurance sales. We experimented with using new conversion strategies which greatly improved the conversion rates through optimizing the exposure of marketing. For macro traffic and repeat purchase, we continued to diversify the interest product categories for repeat purchase and enhance our cross-selling efforts. Our brand awareness continuously improved, thanks to our professional marketing and our brand reputation. During the first quarter, we dug deeper into our users' needs. We developed a membership system to increase our user retention and upgraded our product offering strategy for different types of product holders to promote cross-selling.
For external channels, we enjoyed a competitive customer acquisition cost among industry players, attributable to our competitive advantage, including firstly, a more diversified services portfolio within platforms. Secondly, a jointly built smart marketing model for customer acquisition with the third-party distribution channels to improve our efficiency. Thirdly, repeat purchase allocation. Fourthly, our back-end operation and after-sales service ensures an industry-leading user experience and renewal rate. Meanwhile, we also explored new traffic opportunities including live streaming, multi-channel network, and customer acquisition costs by campaign. Now regarding our service capabilities. We continue to educate insurance users through multi-short videos and live streaming accounts, which brought out interesting and informative content that address users' questions on choosing an insurance online.
We also leverage the WeChat enterprise tools so our sales consultant can frequently interact with users to ensure a smooth online transaction process, enhance our user stickiness during the post-sales process, and provide new opportunities for improving the LTV of a new consumer. During the mutual's claim process, our intelligent info system applies RPA, OCR, and NLP technology to identify image information uploaded by users. Currently, the system supports more than 90% of the prefectural and municipal levels public hospitals in China. The entire consuming process, until releasing a final payout conclusion can be completed at the millisecond level. The accuracy rate of Waterdrop smart claim has reached over 99.7%, speeding up the claims process from the previous per day, per hour, or even per minute level. Lastly, I want to brief you about our initiatives in healthcare services.
For microservices provided to people with disease, we continue to expand our partnership with pharmaceutical companies and hospitals and have started to develop a coordination mechanism for health management, physical examination, online consultation and treatment, and pharmaceutical sales. As of March, our pharmacy benefit management service, Waterdrop Medicine, has served more than 144,000 members through our cooperation with more than 1,400 pharmacies over 200 cities in China. We launched a platform named Waterdrop Health to provide services to healthy consumers, where we have also explored a series of health management services such as consultation and physical examination, dental cleaning, and quick access to microservices, et cetera, catering to various equipment needs in health management. With that, I will now turn over the call to Kevin Shi, our CFO, to discuss our first quarter financial performance.
Okay. Hello everyone. I will walk you through our financial highlights. Please be reminded that all numbers quoted here will be in RMB and please refer to our earnings release for detailed information about our comparative financial performance on a year-over-year basis. In the first quarter of 2021, our net operating revenue increased by 35.1% to RMB 883 million from RMB 654 million for the same period of 2020, primarily driven by the growth of insurance brokerage income and technical service income.
There has been a major business adjustment in the first quarter of 2021, which is the cessation of our Waterdrop Mutual Aid business which has already been disclosed in full in our IPO prospectus. To prepare for the cessation, we voluntarily covered the mutual aid participants' medical expenses arising from medical conditions that were before the end of March 2021, subject to certain procedural requirements and eligibility criteria that would have formerly been covered by the 5th mutual aid plan. In addition, we also offered a one-year complimentary health insurance policy to each participant with similar coverage.
As a result, we incurred a one-off cost for their medical expenses and the insurance coverage, among which around RMB 20 million was accounted for as a reduction of management fee revenue previously recognized for each participant to the extent of cumulative amounts earned until March 26, 2021, and around RMB 77 million was recorded as an expense. After this change, the forthcoming management fee income from mutual aid business, which contributed less than 5% of our total revenue in 2020, will no longer be a revenue stream for us. On a more comparable basis, excluding the management fee income, our adjusted net operating revenue has a year-over-year growth rate of 43.2%. Our operating costs and expenses for Q1 increased by 75.7% to RMB 1,344 million.
To break it down, the operating costs were around RMB 301 million, mainly driven by the one-off cost of RMB 27 million incurred in relation to the cessation of Waterdrop Mutual Aid business I just mentioned, and also attributable to labor cost as our insurance agents and consultants, payout investigation, and customer service teams greatly expanded to support our business growth. Sales and marketing expenses increased by 67.7% year-over-year to RMB 837 million, primarily due to the increase in marketing expenses with the third-party traffic channel as a result of our business expansion and branding promotions. G&A expenses increased by 87.2% in Q1 to RMB 171 million, while excluding service compensation expenses, the adjusted G&A expenses would be RMB 69.7 million, representing an increase of 25.1%, primarily due to the increase in professional fees and labor costs.
R&D expenses increased by 25.6% to RMB 84.7 million, and excluding service compensation, the adjusted R&D expenses would be RMB 72.8 million, implying an increase of 19.4%, mainly driven by the increase in R&D labor costs and related expenses as our R&D team continues to expand to enhance our competitive capabilities in technology. We incurred a GAAP net loss of RMB 70.2 million and an adjusted net loss of RMB 203 million. The adjusted net margin was negative 23.0% for Q1. For the second quarter of 2021, we expect our FYP to grow more than 50% year-over-year. Such outlook is based on the current market conditions and reflects our preliminary views and estimates, which are all subject to change. This concludes our prepared remarks. I will now hand over to the operator to open the call for Q&A. Operator, we are ready to take questions. Thank you.
Thank you. We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the key. To withdraw from the question queue, please press star then two. Just as a reminder, for those who speak Chinese, would you please ask your question in Chinese first, followed by the English translation by yourself. Thank you. At this time, we'll pause momentarily to assemble our roster. The first question today comes from Jenny Jiang with Morgan Stanley. Please go ahead.
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Jenny, please go ahead to translate your question in English, thank you.
Alright. This is Jenny from Goldman Sachs. First of all, congratulate on the successful IPO, and thank you for giving us this question to meet with management and talk about your results again. Two very simple questions from me. The first one is about acquisition costs. We noticed that some of the education segments have not been doing very well because of some policy changes. I remember that management mentioned before that this is our key competitor for online traffic in the past. Given this backdrop, have you started to see some of the decline in the acquisition costs? Do you think it's going to be sustainable? Is that going to be very positive to our business going forward? Second question is about the strategic in the health area. What kind of new strategy, what we're planning to implement in the future?
I know Yang Guang mentioned a few progress in the first quarter. Can you give us a little more update after first quarter, in April and May, what we have done to continue to push for an expansion in the healthcare? Thank you.
Thanks Jenny Jiang for the question. This is Yang Guang speaking. I will answer the first question regarding the marketing expense. I think our business is still at an expansion stage with the proportion of external traffic increasing. With our continuous exploring customer needs after we acquire users, I think the effects of wider investment begin to show, and we will further increase the investment with the customer acquisition cost. As long as the customer acquisition cost can be covered by the lifetime value of our customers, and continue to expand our customer base through supported user acquisition channels. I think currently social marketing expense account for a major part of our expenses, which is in line with our current strategy. In short term, our priority is to grow customer base.
The criteria for social marketing cost control are seriously lower than LTV to match cost and benefit, the LTV per user is also increasing at fast rate. For customers with higher LTV, we could expect a higher acquisition cost. I think the recent market dynamics, as you just mentioned, are favorable to control the increasing pace of the CAC, further expand our user base. Meanwhile, we will continue to enrich our product offering and improve our service capabilities to promote repeat purchase and attract micro-traffic. For the second question regarding the health business, I will hand it over to our CEO, Shen Peng, to answer that question.
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We at Waterdrop are providing members with cost-effective quality medical and healthcare services. Our healthcare and medical services focus on customer needs, offering different values for two types of customers.
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Our Waterdrop Health business serves healthy people with basic healthcare management services. Partnering with existing insurance products, we provide a range of services including consultation, telephone doctors, healthcare products, physical examinations, basic drugs, etc. This has generated synergies with our insurance business and helped the insurance business increase the differentiated value of users, accumulate more healthcare data, and enhance risk control capabilities. At present, we have more than 5 million healthcare members and nearly 1 million users of our healthcare app.
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Our Waterdrop medical business mainly serves patients, especially those with critical illness. Our long-term strategic goal is to build core competencies in the medical and pharmaceutical industry chain based on our millions of patient customers. Our current medical business is mainly divided into two segments. The first segment is our PBM service. Our Waterdrop Medicine enables patient acquisition, retention, and conversion. The number of new members for Waterdrop Medicine in the first quarter exceeded 17,000, bringing the total cumulative number of members to around 140,000. So far, we have established cooperation with 1,040 pharmacies.
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The second segment is our patient management platform. We have established a patient management platform outside the hospital system to help underserved patients with critical illness who need to be on medicine long-term after surgery. This platform works with Internet hospitals to provide patients with a range of services including prescription, healthcare management, medicine purchase, and nutrition supplies. With a community of hundreds of thousands of patients, the platform already has the basic functions and service capabilities of an Internet hospital. Meanwhile, we are testing the platform's commercial value on a small scale.
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In the first quarter, Waterdrop has made substantial progress and expects to provide more information in the second quarter earnings disclosure.
That's all for the questions. Thank you.
The next question comes from Michael Li. As a reminder, for those who speak Chinese, would you please ask your questions in Chinese first, then followed by the English translation. The next question comes from Michael Li from BofA. Please go ahead.
Thank you. [Non-English content] Thanks management.
This is Michael Li from Bank of America Securities. I have two questions. My first question is about the growth of FYP. We noticed that this year is very challenging for all of the insurers in China, and the growth of health insurance decelerated to about 16% in the first five months of this year. Waterdrop's above 40% FYP growth is definitely a better result than sector average or its peers. Can you give us some explanation why Waterdrop could outperform? Also, in terms of the sector growth, what are the reasons behind this kind of deceleration, and do you see any turning points? The second thing is about product mix. Waterdrop improved the product mix in the past two years with higher mix of long-term insurance.
Can you give us some breakdown of long-term versus short-term in first quarter this year, and also the outlook of the product mix changes in the next few quarters? Thanks.
Thank you, Michael, for your important question. I'll try to address your questions about industry as well as the growth of Waterdrop, and Mr. Yang Guang will address your second question. First, I think the reason for the slowdown in the Chinese health insurance market may be attributed to several factors. First of which, the ongoing challenge affecting the expansion of the traditional agency force industry-wide, and also intensified competition in tier 1 and tier 2 cities in China. Maybe also the speculative marketing of CI policies under new regulatory definition in the fourth quarter that have distorted the pace of sales of health insurance products throughout China in the second quarter, maybe even into the third quarter of 2021.
About ourselves, first I want to highlight the fact that our health insurance business segment delivered very strong growth throughout the full year 2020 and also in the first quarter of 2021. We believe that the Chinese health insurance market has huge growth potential as always, especially in lower tier cities where efficient distribution model and attractive product offerings are often lacking. Also, I want to address that so far, based on what we have seen, there have been no signs of weakening demand for health insurance protection products in China. About the reason why Waterdrop managed to grow faster than the peers, I think the biggest reason is because we have a highly technologically advanced and efficient business model.
Based on data insight and strong knowledge of operation know-how, we're able to distribute insurance policies completely online so that we have access to the mass market in China in a cost-efficient way. We focus relentlessly on lower tier cities, which have huge growth potential for insurance protection products, especially the health protection, but at the same time often underserved by existing insurance players. I would also like to highlight the fact that we always focus on delivering the true value to our customers, which really will help us to grow our customer base in the longer term. For instance, we didn't do the speculative marketing of old CI policies in January, even though most of our peers did. We switched to the new CI policies long before the cut date set by the regulators because we believe that new products offered better value to our customers.
With that, I address your question, and Mr. Yang Guang will address the other question.
Thanks. I think with respect to the product mix, our long-term regular payment insurance grew 132% year-over-year in first quarter, with the growth coming mainly from product under the new definition post CI products. As mentioned by Mr. Jian Tan, we didn't participate in the speculation of the sales of the old products. The other categories also maintained robust growth while we continue to diversify and scale out our product offering and most of our products remain exclusive and customized products. I think in the short term, we still mainly focus on life and health insurance, including health, life, annuity, accidental, and et cetera. The specific product composition may change at any time according to the changing needs of users. In the future, we do not exclude experimenting with other types of insurance and property. That's all for questions. Thank you.
The next question comes from Thomas Wang with Goldman Sachs. Please go ahead.
[Non-English content] Yeah. Two questions from my side. First one, relative simple restricted cash balance increased quite a bit versus full year position. Just trying to understand why, what's driving that increase. Secondly, policies retention rate in the first quarter. Can you give me a bit color how does it look versus year-on-year versus last year first quarter and Q-on-Q versus fourth quarter 2020? Thank you.
Thank you. two questions. Regarding your first question, our restricted cash primarily consists of premiums collected from the insurance consumers in a particular capacity and to disperse the insurance carriers. The balance of restricted cash usually increase in line with the increase of FYP, and the relevant balance of payable was recorded as insurance premium payable in our balance sheet. The settlement period of short-term and long-term insurance brokerage income is generally M + 1 and M + 2 respectively. In terms of your question regarding our retention rate, there was some change in our user acquisition channel mix for the short-term insurance product in the first quarter, where our investment in the external user acquisition channels increased, and the retention rates likely dropped accordingly as our user base expanded. We expect our retention rate of long-term product to keep stable.
There might be some fluctuations in the near term, but it depends on the quality and the scale of our users. We expect the retention rate for long-term to keep stable.
Got it. Thank you.
The next question comes from Jingjing Mei with CICC. Please go ahead.
[Non-English content] Hi, management. This is Jingjing Mei from CICC. Thanks for taking my question. Firstly, congrats to the robust performance this quarter. I have two questions. For the first one, I'd like to know the company's future development and the strategy of long-term products. For the second one, could you please share more information about the remainder of management fee income in Q1 and the total expenses incurred in relation to the cessation of Mutual Aid? Thank you.
Thanks, Jingjing. Very good question. I think we have achieved very strong growth in long-term insurance and short-term insurance business respectively. I think our strategy to promote the future growth of our long-term insurance is that we will provide users with more valuable products by continuing to enrich the categories of long-term insurance product offerings, including innovating new products ourselves and cooperating with new insurance carriers, especially for those large brands, life insurance companies in China. We also plan to reach a large number of existing users, which is close to 100 million users, through our online channels to convert them to long-term insurance users. By leveraging our massive user data to intelligently match users and outcomes through our algorithm, we keep improving the conversion rate of long-term insurance business.
We started the initiative in April. We will run a test in May and expect to see the results in the 2nd quarter. We also have technology-empowered online sales consultants improve the quality of customer service so as to improve the efficiency of long-term insurance conversion. We are also testing the business model of promoting the long-term insurance product via insurance brokerage from O2O, from online to offline channels. Hopefully, by doing all these channel implications, we are able to further expand our long-term insurance business. Regarding the management fee from the Waterdrop Mutual Aid program, I will hand it over to Kevin Shi to answer the question.
Yes. Thank you. Two questions. Regarding your question about management fee. Please find a reminder of management fee income in quarter one. In connection with the cessation of Mutual Aid, we momentarily cover Mutual Aid participant medical expenses arising from medical conditions diagnosed by March 31st, 2021 that would have been covered by the Mutual Aid plan. In addition, we offer a one-year complimentary health insurance policy to each participant with a similar coverage as the participant's original Mutual Aid plan. As of April 30, 2021, a total of 2.71 million people has applied for this complimentary health insurance policy. The estimated medical expenses and the one year health insurance coverage will be partially accounted for as a reduction of management fee income that was previously recognized for each participant to the extent of the cumulative amount current until March 26, 2021.
In quarter 1, we recorded RMB 2.7 million of management fee income. Well, our cost amounted to RMB 96.7 million, including two parts. The first part is the related medical expenses are expected to RMB 15 million, and the cost of one year complimentary health insurance policies are expected to be RMB 81.7 million. As of March 26, 2021, the deducted cumulative management fee income was RMB 19.9 million, and the related cost recognized in the first quarter was RMB 76.8 million.
Okay, very clear. Thanks.
Thank you.
We are now approaching the end of our conference call. Thank you for your participation in today's conference.