A: At a macro level, it is very difficult for pet owners to budget for veterinary expenses if/when their pets become sick or injured. What compounds this problem is:

1. Pet owners do not know how to budget for the “average” cost of medical care for their pets, which varies dramatically by geography and pet breed.

   Our cost-plus model is designed to spread the risk evenly within each category of pets. Our goal is to charge each pet the appropriate amount for their specific circumstances (e.g., breed, age at enrollment, geography, etc.) so that, in aggregate, the extra amount paid by lucky pets covers the veterinary costs incurred by unlucky pets. Some categories of pets tend to be more expensive, on average, than others, and our goal is to adjust pricing within each category to reflect those differences.

   Once we understand the “average” cost for each sub-category, we add 30%, which results in Trupanion spending 70% of a pet owner’s monthly costs paying veterinary invoices for pets that have become sick or injured. A Trupanion member should have the same value proposition if one of their pets is $20 per month (e.g., a domestic short-haired cat in Boise, Idaho) and the other is $200 per month (e.g., an English Bulldog in Manhattan, NY).

   “I liken our value proposition to the Costco model, where Costco members inherently understand that whether they are purchasing a large flat screen TV, a bottle of Bordeaux, a can of tuna, or a roll of toilet paper, they are always getting the best value.” – Darryl Rawlings
   



2. Pet owners don’t know whether their pet will be “average”, lucky or unlucky, so being able to budget for the “average” is not an effective solution for an individual pet owner.

   As noted above, we spread the risk among thousands of pet owners so that, in aggregate, the extra amount paid by lucky pets covers the veterinary costs incurred by unlucky pets.

   Said another way - Any pet owner could get a quote for their specific breed or location and multiply their monthly quote by 70% to determine the average monthly veterinary costs for accidents and illness. They could put this money in a piggy bank every month, revisit it annually to understand the impact of inflation and utilization in their geographical area, and follow this pattern for their pet’s entire life. If their pet ends up being “average” they will have zero money in their piggy bank at the end of their pet’s life.

   The problem with this piggybank approach is that nobody knows whether their pet will be “average”, “lucky” or “unlucky”.



3. Even if a pet ends up being “average” over its life, the timing of its accidents or illnesses may not align with its owner’s budgeting approach.

   To an informed, responsible and loving pet owner, Trupanion is a 30% hedge to help them budget for the unexpected cost of veterinary care if/when their pet becomes sick or injured.

A: Trupanion provides high-quality medical insurance for the life of a cat or dog. Our product is simple and fair. Our key tenets are as follows:

1. We cover all unexpected illnesses and injuries. This includes the things most likely to happen to a particular breed of pet, frequently excluded in other providers’ fine print as “congenital or hereditary”.


2. We pay 90% of actual veterinary costs if a pet becomes sick or injured, this includes all diagnostic tests, surgeries and medications.


3. The only medical issues we do not cover are the problems that the pet had prior to being protected by Trupanion.


4. We provide coverage for the pet’s entire life. Medical problems don’t start or stop on birthdays or anniversaries and we do not believe that annual plans make sense due to pre-existing conditions not being covered (in an annual plan, a condition in one year could be considered a pre-existing condition in the following year). Pet owners want to know what will be covered over their pet’s life.


5. Pets need care or treatment outside of normal business hours so we make ourselves available 24/7, 365 days a year.


6. Trupanion members can use any veterinarian in the United States and Canada, including any referral or specialty hospital.


7. We aim to pay veterinarians directly, within five minutes or sometimes seconds, of the invoice being created, and prior to the pet owner checking out – thus eliminating the traditional reimbursement model.

   The rest of the industry operates on a reimbursement model that requires the pet owner to pay out of pocket at the time of checkout, complete paperwork related to the veterinary procedure, and then wait for confirmation that the procedure will be covered, and ultimately what the determined reimbursement amount will be. We believe this old fashioned method is flawed.

   Through our proprietary patented software, we integrate directly with a hospital’s practice management software to pay the hospital directly and timely. Upon check-out, the pet owner is then responsible only for their 10% of the veterinary invoice plus any deductible. For example, for a $1,000 veterinary bill in covered costs, Trupanion would pay $900 and the pet owner would only owe the veterinarian $100.



8. Trupanion exists to help one budget for the unexpected. Trupanion does not cover things a responsible pet owner can budget for on their own, which would include food, vaccinations or wellness visits. Trupanion does not pay for veterinarian exam fees or most taxes.

A:

1. Trupanion’s pricing promise is to share risks equally and fairly among the “lucky,” “unlucky,” or “average” pet. We accomplish this promise by putting an individual pet into a group or sub-category of pets. The main factors we use today are:


1. Breed


2. Local cost of Veterinary care down to a zip/postal code level


3. Age of the pet when they are enrolled with Trupanion


4. Selected deductible


2. Trupanion does not attempt to control the cost of veterinary care in any way. We simply understand the “average” cost across each category of pets and add a 30% margin.


3. Trupanion does not try to predict the future cost of veterinary care.


4. The average annual increase in veterinary care for the past 15 years has been +5% to +10%. Trupanion members should anticipate their monthly subscription to reflect these averages. In addition to inflation, these increases reflect advancements in care, diagnostic tests and the utilization of more advanced treatment. These advancements have greatly improved the care for our beloved pets and expect them to continue for decades to come.


5. We encourage customers to enroll their pets as puppies and kittens so they remain in this pricing category for the life of their pet. Once enrolled, the monthly cost for an individual pet will not go up or down based on pet aging. Enrolling a pet as a puppy would be based on an average cost for age 0-13 years, while enrolling at 5 years would be based on the average cost for age 5-13. Essentially, pricing at the time of enrollment translates into a loyalty discount. As an example, a pet owner who enrolls a 12-week old mixed breed dog would pay about $54 per month, compared to about $89 per month if that same owner were to enroll that same pet at 8-years old.


6. Once we have a sub-category like “Golden Retrievers” we learn/monitor the average cost for the group and add our 30% margin to determine the group’s pricing. Inside any group there will be a fair distribution between “lucky” pets, “unlucky” pets and the “average” pets:
   


7. Once enrolled, the monthly cost for an individual pet will not go up or down based on its specific situation. For example, rates will not go up if a pet becomes “unlucky” and we have paid out thousands of dollars for care of unexpected accidents and/or illnesses. We do not penalize unlucky pets!


8. As Trupanion receives more data from an increasing number of pets (which is constantly happening!), our ability to accurately price sub-categories improves. When we split a sub-category into two, one side will go up and the other down. In these scenarios members may experience changes outside the average annual +5 to +10%. When Trupanion started over 15 years ago, we had 4 pricing sub-categories; today, we have millions.

A: We believe we have the largest number of pets enrolled in North America with high-quality lifetime coverage if their pets become sick or injured. We have been collecting this data for over 20 years. The data from these pets, we believe, provides us with a significant strategic advantage. For example, we believe our understanding of the anticipated veterinary costs across more sub-categories is of substantially greater accuracy than others. In addition, we understand the lifetime value for each of these pet sub-categories, allowing us to spend a targeted amount of money to acquire new pets while optimizing our IRR (internal rate of return).

We have been building a team of actuaries and data scientists in this area for over a decade. We believe our team, working with our granular data, not only allows us to price our policies much more accurately than other companies in the industry, but also detect fraud more effectively.

Traditional pet insurance companies historically did not cover items such as congenital and hereditary conditions and / or used benefit schedules and, therefore have not accumulated the data required to differentiate the expected costs between the hundreds of different dog and cat breeds in North America. Additionally, traditional pet insurance companies tend to price to the state level vs. zip-code, so their data did not capture the difference in, for example, pet care in Beverly Hills vs. Bakersfield, California.

1. Our medical plans reduce economic euthanasia.


2. Trupanion reduces paperwork.


3. Trupanion increases their bottom line profit percentage by an estimated 15% by reducing credit card fees when we pay the invoice directly before the pet owner checks out.


4. Trupanion does not dictate or control fees.


5. Trupanion and veterinarians are aligned. Trupanion does not dictate the cost or control the standard of care. Rather, we support accurate care for a pet, and maintain our value proposition through all levels of care and pricing.

A: Our goal is to build this category by providing the highest possible value in our product. We currently target and spend approximately 70% of subscription revenue on paying veterinary invoices. By comparison, we believe that our competitors target to spend approximately 50%-60%, though they may underprice at times to drive shorter-term growth – we do not view this as a sustainable long-term strategy. More importantly, while most would deem a lower payout as better, we think differently. We will continually evaluate opportunities to reduce frictional costs and further enhance our value proposition as long as we can achieve our targeted 15% adjusted operating margin.

Remember, a payout ratio underpins our value proposition, but it does not stand alone. Our comprehensive product coverage, 24/7 customer service, efforts to pay veterinarians directly before checkout, and efforts to improve pricing accuracy, all combine to provide what we believe is the best value proposition to pet owners.

A: ‘Traditional pet insurance’ providers have historically focused on keeping costs low, primarily by excluding many events and illnesses most likely to be experienced by our beloved pets, failing to provide them with much-needed care. Here are some specific examples:

1. ‘Traditional pet insurance’ excluded congenital and hereditary conditions – the things most likely to happen to that particular pet. Cancer and other conditions likely to occur also were excluded.


2. ‘Traditional pet insurance’ is a reimbursement model. The pet owner pays out of pocket when picking up their pet from the veterinarian, then fills out some paperwork and then waits by their mailbox for 2-4 weeks hoping they get reimbursed something. In short, they front the costs of care without certainty of repayment.


3. ‘Traditional pet insurance’ is an annual policy. Annual policies don’t make sense for cats and dogs for the following reasons:
1. They have start and stop dates, which is not helpful if your pet has a condition that lasts beyond the arbitrary dates.
2. They have the ability to limit or change policy coverage based on a pet’s current or past health, which is not helpful if your pet has a condition that lasts through such a change in coverage.
3. A pet re-enrolling each year is forced to pay a higher monthly cost based on its current age, therefore not benefiting from their foresight for enrolling years prior. Often, pet owners will see their monthly cost rise 2x-4x, not including inflation, as their pet ages.


4. ‘Traditional pet insurance’ dictates a reimbursable amount for specific types of veterinary treatments based on what the insurance company, rather than the veterinarian, considered to be appropriate for such procedures. This often meant that conditions were only partially reimbursed and implied that that the veterinarian was charging an excessive amount. The pet owner received less than they were expecting, reducing their loyalty. By suggesting that the veterinarian was overcharging, the experience also reduced the likelihood that the veterinarian would recommend insurance in the future.


5. ‘Traditional pet insurance’ imposes caps on the maximum amount of benefit the pet owner can recover under the policy. As a result, if a condition qualified for coverage but the cost of treatment exceeded an annual or lifetime maximum allowable amount, the pet owner would only receive a partial reimbursement.


6. ‘Traditional pet insurance’ sometimes only offered accident-only coverage, representing just a small portion of the unexpected things that could cause a pet to need medical care.

A: A wellness plan usually allows pet owners to finance the cost of expected, routine care for their pet, such as vaccinations, dental cleanings, annual examinations, etc. They are sold based on a ROI; for example, annual routine care is budgeted at approximately $300, but if you purchase a wellness plan, you’ll pay the veterinarian $20 per month or $240 per year.

We believe wellness plans offered by veterinarians are a win for both the veterinarian (creates a sticky client) and a win for the pet owner.

Pet owners are often confused between “wellness plans offered by their veterinarian” and “medical insurance offered by a 3^rd party”. To add the confusion, in North America the terminology “pet insurance” is often mistaken for wellness plans offered by a veterinarian.

We believe the combination of medical insurance for your pet, and wellness plans offered by a veterinarian, when explained together, often presents a good value proposition to the pet owner.

A: We estimate the number of household dogs and cats in the United States and Canada at 180 million. In the U.S. alone, pet owners spent over an estimated $103 billionⁱⁱ caring for their pets.

The penetration rate for medical insurance for cats and dogs in North America is approximately 2%, while Western Europe has ranged between 5% and 25%ⁱ. We believe that, given enough time, the same penetration rates are achievable in North America by providing a high value medical plan and member experience.

At our average revenue per pet, every 1% of penetration would equal approximately $1.3 billion in revenue for the industry each year (As of December 31, 2020: $60.37 ARPP * 1.8M pets *12 = $1,304M).

A: Broadly, we view our biggest competitor as credit cards and the choice pets owners make to self-fund their veterinary procedures. At the branded level, at any time in our operating history, we have competed against 12 – 20 brands, or over 40 brands in aggregate. Our competitors generally fall into two segments: traditional providers that are unlikely to cover the things most likely to happen to pets (i.e., congenital and hereditary conditions) and higher-value providers that do cover most hereditary and congenital conditions in some form of an annual plan.

Trupanion’s revenue was $502M at the end of 2020, making us the second largest player to VPI, now a division of Nationwide, when compared to other 3rd party companies providing insurance or wellness products for pets

A: Territory Partners are our team of individuals having face-to-face visits with veterinarians and their staff. The model is similar to the early Coca Cola model, whereby independent entrepreneurs owned the bottling rights for an exclusive territory. Similar to Coca Cola, where the bottlers drove around in Coca Cola trucks visiting and servicing corner stores and vending machines, our Territory Partners drive around in Trupanion branded vehicles visiting veterinarians, shelters and other pet related businesses.

We fundamentally believe that support from veterinarians is critical to driving broader acceptance of medical insurance for pets in North America and we have built our success around this belief. This was also the primary strategy employed in the U.K., where penetration levels today are approximately 25%.

Since 2003, our Territory Partners have been cultivating direct veterinary relationships and building awareness of the benefits high-quality medical insurance offers both veterinarians and their clients. We estimate our Territory Partners have made over 900,000 visits to over 25,000 veterinarians in the United States, Canada and Puerto Rico.

Territory Partners cover exclusive geographic regions that often contain approximately 250 veterinary practices.

A: Veterinary practices represent our largest referral source, and combined with referrals from members, accounted for approximately 76% of our leads in 2018. Our Territory Partner model was designed to facilitate frequent, in-person, face-to-face communications with veterinarians and their staff about the benefits of Trupanion and high-quality medical insurance for the life of a pet.

The most important job of a Territory Partner is to build strong relationships with each veterinarian hospital, so the staff can trust and recommend Trupanion. Our data shows that when properly messaged, over 25% of Trupanion’s activated exam day offers convert into an enrolment. While there are state-by-state variations, the most common form of the exam day offer provides for 30 days of coverage on a trial basis and requires a medical examination by a veterinarian.

This is not just about new pet referrals however, as alignment with veterinarians is critical for a positive customer experience, long term retention and pet owner referrals. Similar to countries like the UK or Sweden, we strongly believe that earning the trust of veterinarians and their staff is the 1^st step to successfully building/creating our category in North America.

We view our Territory Partner model as a key moat around our business. The market for veterinary services is highly fragmented and includes many sole-owner veterinary practices and small veterinary practices that are difficult to reach. We believe that no other company in our space has a sales force that compares in scale to our Territory Partners and that it would be extremely difficult, costly and time consuming to replicate.

A: Territory Partners are independent contractors who are compensated through a combination of referral fees for new pet enrollment and residuals tied to pet retention within their territory. Referral fees for new enrollments are recorded as an acquisition cost in PAC (sales and marketing expense) while the ongoing residual fees are recorded as part of the variable expenses associated with maintaining our members (other cost of revenue). Our residual fees are a fixed dollar amount and therefore scale as our average monthly revenue grows. Their compensation is the same regardless of how the member enrolled.

A: Territory Partners generally do not sell or solicit Trupanion policies direct to consumers; rather their role is to create meaningful, long-term relationships with veterinarians and to educate those veterinarians about the benefits of high-quality medical insurance for the veterinarians’ base of clients. Trupanion sells insurance to pet owners online and through its telephonic service center via licensed representatives.

Some Territory Partners choose to become licensed, such as where they may engage separately in sales or solicitation activities. The licensing process, which all of our call center sales team goes through, typically involves a week of home study to pass a property & casualty test. Thereafter, licensing appointments are made and filing fees in applicable states are managed. In aggregate, it costs about $200 - $300 per year to maintain a property and casualty insurance license in 2-3 states.

A: Less than 10% of our leads are generated online. We have tested, and will continue to test, our acquisition through the direct-to-consumer channel such as TV, radio and social media channels. We carefully track the resulting metrics including leads, conversion and lifetime value and are disciplined in our spending to ensure we allocate our spending in these channels appropriately.

Historically, we have generated significantly higher conversion rates from leads sourced through our call center. As our brand awareness continues to grow, we believe we have a lot of potential to improve online, but we are early in our spending on this channel. Our primary focus has been and we expect it will remain in the veterinary channel. Each month, 1,000,000 puppies and kittens are added into veterinarians’ practice management software systems and we view this as our target market. In comparison, pet owners searching for pet insurance online may be doing so because their pet already has a problem, which could result in either adverse selection or a negative customer experience. We believe we are uniquely positioned to avoid these issues.

A: We do not need to own our own insurance entity. Rather, we choose to own our insurance entity! Trupanion’s operational structure is unique in our industry. Within the medical insurance for pets’ category, we are the only mono-line player that owns its own insurance entity. As the low cost operator, we can decrease unwanted frictional cost (estimated at 10% - 12% savings) that do not provide value to members. We pass these savings back to our customers in the way of a higher value proposition. In addition, owning our own insurance entity allows for direct relationships with individual state regulators. These direct relationships allow for improved communications and we believe present the opportunity to better serve our members.

In the United States, as well as most developed countries around the world, insurance products have regulatory oversight to make sure:

1. Consumers are treated fairly and all “like” groups are provided a reasonable value proposition.
2. That the insurance entity behind the product is adequately capitalized (i.e., holding cash or cash equivalents in a trust account to “ensure” there are sufficient funds available if most member pets were to become seriously sick or injured at the same time).

Similar to a public company, an insurance entity needs to file its own financials on a quarterly and annual basis. These filings are not done with in accordance with GAAP accounting, but rather are done on a statutory basis of accounting.

A: Trupanion is made up of over a half dozen wholly-owned subsidiaries that consolidate into one Delaware corporation (“Trupanion, Inc.”). One of the many companies in our corporate structure is an insurance entity named American Pet Insurance Company (APIC)

As required by American Pet Insurance Company’s primary regulator, the New York Department of Financial Services (NYDFS), American Pet Insurance Company files stand-alone statutory financial statements with the NAIC. The financial profile can be found here: APIC financials by searching under our NAIC # 12190. Information is presented based on the filing year and period (quarterly vs. annual).

American Pet Insurance Company’s stand-alone financials reflect our USA insurance operations, are prepared using the statutory basis of accounting and audited as such, and reflect inter-company agreements as applicable from time to time, including between American Pet Insurance Company and our USA operating entity Trupanion Managers USA, Inc. (Trupanion Managers). For example, our underwriting entity contracts with, and pays a commission to, our operating entity in exchange for certain services provided, such as claims, technology, sales and marketing and general and administrative services. These inter-company agreements change from time to time, which can make period-to-period comparisons difficult depending on a number of factors.

We focus our financial discussion on our consolidated financials, which we believe is most appropriate as it presents the complete, consistent financial picture of our business, including our loss and loss adjustment expenses (in our consolidated financials, we refer to these ‘losses’ as veterinary invoice expense in order to provide additional transparency regarding the nature of these expenses). Changes in historical American Pet Insurance Company loss and loss adjustment expense are primarily due to changes in statutory accounting classifications, as well as our inter-company agreements, and are not due to any significant increase in actual losses.

A: American Pet Insurance Company is Trupanion’s regulated insurance subsidiary in the U.S. Its financials consolidate into Trupanion, Inc. U.S. revenue from our subscription and other business segments flow through this entity. As mentioned above, we also have a U.S. operating entity for our subscription business, Trupanion Managers, where all U.S. employees reside, and the operating activities occur. This operating entity earns commissions from American Pet Insurance Company via a General Agency Agreement that is approved by the NYDFS. This agreement sets forth the profit percentage American Pet Insurance Company retains and the commission payments that American Pet Insurance Company makes to Trupanion Managers. It also provides for payment to Trupanion Managers in exchange for its provision of operations functions, including those relating to member care, claims administration, general administration and technology. On American Pet Insurance Company’s statutory financials, the payments to Trupanion Managers are classified as loss adjustment expenses (LAE) or other underwriting expenses, based on the nature of expenses incurred.

Similarly, we have an operating entity in Canada, Trupanion Brokers Ontario, Inc., which also consolidates into Trupanion Inc.’s financials, although our Canadian underwriting structure is different from that in the U.S. Specifically, Canadian revenue runs through Wyndham Insurance Company (SAC), Ltd. and is not part of American Pet Insurance Company’s financials.

Within the broader insurance industry, we view our structure as straightforward and common.

American Pet Insurance Company’s financials are prepared under the statutory basis of accounting, while our consolidated Trupanion Inc. financials are prepared under US Generally Accepted Accounting Principles (GAAP). American Pet Insurance Company’s statutory basis financials are audited in the same way as our consolidated financials.

In sum, American Pet Insurance Company’s financial statements reflect the activity related to the underwriting of its current products in the United States. The consolidated company financials reflect this activity in addition to our Canadian operations and investments to grow our business, including investments in Trupanion Express, claims automation, other pet products and direct-to-consumer efforts, among others.

A: Loss adjustment expenses (LAE) are an inter-company charge between APIC and one of our entities Trupanion Managers. The amount of the charge is intended to reflect an appropriate expense or charge for processing claims and related services, whether direct or indirect. Commission payments made to the operating entity that are used for claims processing (primarily salaries for claims employees) and indirect expenses (such as rent expense related to claims employees or technology expenses related to claims systems) are recorded as LAE on American Pet Insurance Company’s statutory financials with respect to our U.S. revenue from both business segments. Other commissions paid, regulatory fees, and premium taxes currently have been classified as other underwriting expenses.

The methodology in which we calculate and charge these expenses has changed multiple times over the years; therefore our consolidated statements provide the most accurate period over period comparisons.

A: Summary of our consolidated financial performance is shown below. In the table, we highlight adjusted operating income, which are the funds available to us before we invest in pet acquisition. At operational scale, which we define as total enrolled pets of between 650,000 to 750,000, we target an adjusted operating margin of 15%.

As we discuss above in greater detail, changes in inter-company agreements can make it difficult to look at the financials of one subsidiary such as this in isolation. In particular, changes to intercompany agreements complicate attempts to compare periods of a single subsidiary. The cost of veterinary invoices within APIC’s statements have remained relatively consistent over the periods presented above. In 2016, we changed the General Agency Agreement to calculate commission paid to Trupanion Managers on a percentage basis (i.e., after losses and American Pet Insurance Company’s profit margin). Previously, American Pet Insurance Company paid commissions to Trupanion Managers on a per pet basis. This change was done to align with American Pet Insurance Company’s agreements with unaffiliated brands it underwrites.

We also used the opportunity to better classify the commission payment between LAE (if the payment is used for claims processing) and other underwriting expenses. Previously the full commission was classified as other underwriting expenses. Beginning in 2016, this accounting change resulted in LAE expense increasing and other underwriting expenses decreasing (by a corresponding amount). We provide this information in an effort to be transparent about the operations of certain of our subsidiaries, particularly the regulated entity. We expect to continue to focus our financial discussion on our consolidated financials, which we believe is appropriate as it presents the complete, consistent financial picture of our business, including our loss and loss adjustment expenses. Trupanion, Inc. consolidated financial statements include all operations (USA + Canada) and all expenses incurred, without fluctuations caused by reasons other than changes to our business (such as changes to expense classification within inter-company agreements). We believe that focusing on our consolidated financials therefore also allows investors to more easily compare profit and loss items between periods.

A: We live and breathe in the Animal Health world. We help responsible loving pet owners budget for the cost of veterinary care if/when their pet becomes sick or injured by providing a high-quality medical insurance product that is designed for the pet’s entire life and that is aligned with veterinarians and their staff.

Our company is fairly unique and can be difficult to categorize for those looking to understand us by comparison. Specifically:

• We operate as a consumer-focused business that is heavily reliant on data and technology to drive a high value service for pet owners and veterinarians. We are focused on generating growth through cost-effective pet acquisition and by maximizing the lifetime value of our member pets.
• We are a cost-plus model. Our pricing is based on understanding the underlying average cost for a given pet with ~30 points of margin.
• We do not try to predict or control the cost of veterinary care. By contrast, we believe rising costs in veterinary care are likely to create greater demand for our product.
• We do not have an annual product where a consumer can easily switch from provider to provider. Our product is monthly and designed for the life of a pet.
• Our historical organic growth rates differ from what most insurance companies are accustomed to seeing. Unlike most consumer insurance markets, our market is approximately 1-2% penetrated and we believe growth is predominantly organic (i.e. make market) rather than competitive ( i.e., take market).
• We don't have "losses". We like to pay big veterinary invoices! In fact, we ring a bell when pay a big invoice because it reinforces our mission to help responsible pet owners care of their "unlucky" pet. Helping our members pay for their pet’s care is why we exist.
• We tend to have relatively high frequency (number of invoices) but relatively low severity (per invoice dollar amounts). By contrast, traditional consumer insurance companies (such as home/auto) tend to have low frequency but high severity of claims (in insurance lingo).
• We do not have a large claims reserve on our balance sheet (which represents claims reimbursements that have been incurred but where we have not yet received the invoice from our members). We are not a “float” business. Approximately 95% of invoices are paid within 3 months from the invoice date, and we continue to work towards the day when 95% of invoices are paid directly to veterinarians and in under 5 minutes (and most in seconds).
• Many insurance companies operate with a tight 0-5% margin, which they describe as a combined ratio. A 100% combined ratio means that such a company is making zero profit on its operations. A 95% combined ratio means a 5% margin on a book of business. It is the combination of operating margin plus investment gains that generate shareholder returns.

Trupanion’s business model is very different. Trupanion is focused on growing adjusted operating income, which are the funds available to us before we invest in pet acquisition. Trupanion targets to have 15% adjusted operating margin at operational scale, which we define as total enrolled pets of between 650,000 to 750,000, on its existing book of business, and to reinvest most its returns acquiring new pets with an outsized internal rate of return. (See Table 1).

In 2020, adjusted operating margin was 11.4%, an increase from 2.4% in 2015. Expansion in adjusted operating margin is largely derived from scale in our fixed expenses, which are comprised of our technology and general & administrative expenses. For more information on how we think about adjusted operating margin, please see our Annual Shareholder Letters which can be found Here.

• Many insurance companies do not know their true operating margin for several years after they report because estimates of the invoices that they are liable for in a given year do not materialize, or close, until future periods. The size and frequency of our invoices have been fairly predictable. In insurance terminology, this is known as a ‘short tail’ (no pet pun intended). We are not a float business.
• Most insurance companies have inherent non-execution risks associated with their business:
• We do not believe our member pets carry material rate risks as we can, and do, frequently adjust pricing of policies based on actual experiences. For this reason, we intentionally retain any ‘risk’ associated with our members’ pets and do not use third parties for risk transfer (such as reinsurance). This helps us avoid additional frictional costs that don’t benefit our members! We also do not believe that we have significant investment risk – our capital reserves generally are invested in government-backed money market accounts, short-term T-bills, and our home office.
• We do not believe that we are subject to catastrophic risks, which is unlike most traditional insurance companies, due in part to the nature of pet medicine and our geographic diversification.
• Our business is not particularly sensitive to credit ratings, unlike most traditional insurance companies.
• As a result, we believe that our ability to generate free cash flow is much higher than traditional insurance companies, whose businesses can be far more capital intensive and dependent on interest and investment income for their profits.

A: Trupanion’s structure in the pet insurance landscape is unique, in that we are the only mono-line player that owns its own insurance entity. The vast majority of our competitors are not vertically integrated, meaning they do not own their own insurance company. Rather, they are marketing companies that require the use of a third party to underwrite the policies they offer.

As the low cost operator, we can decrease unwanted frictional cost (estimated at 10% - 12% savings) that do not provide value to members. We pass these savings back to our customers in the way of a higher value proposition. In addition, owning our own insurance entity allows for direct relationships with individual state regulators. These direct relationships allow for improved communications and we believe present the opportunity to better serve our members.

In the United States, as well as most developed countries around the world, insurance products have regulatory oversight to make sure:

1. Consumers are treated fairly and all “like” groups are provided a reasonable value proposition.

Our value proposition is to return 70 cents on the dollar for an average pet, which we believe is among the highest in the industry. All of our rates are targeted on a cost plus model and we constantly analyze the appropriateness of our rates within each geographic region (and within each subcategory in that region). On average, rates generally increase to reflect the increasing cost and utilization of veterinary medicine.

In general, our rates in the Unites States are approved at the state-level. We strive to have good relationships with the state insurance regulators and to engage in constructive dialogue about our business. We generally file one or more rate adjustments within a particular state per year to adjust rates as appropriate based on the cost of care for each sub-category.

2. That the insurance entity behind the product is adequately capitalized (i.e., holding cash or cash equivalents in a trust account to “ensure” there are sufficient funds available if most member pets were to become seriously sick or injured at the same time).

In the United States, Trupanion is underwritten by its wholly-owned insurance company, American Pet Insurance Company (APIC). APIC must hold certain capital amounts in order to comply with the statutory regulations. APIC’s surplus requirements are included in our public filings.

For a more comprehensive discussion, please refer to our most recent SEC filings on Forms 10-K and 10-Q.

A: In the United States, Trupanion is underwritten by its wholly-owned insurance company, American Pet Insurance Company (APIC). APIC must hold certain capital amounts in order to comply with the statutory regulations. APIC’s surplus requirements are included in our public filings. As of December 31, 2020, APIC was required to maintain at least $79.1 million of risk-based capital to avoid additional regulatory oversight. As of December 31, 2020, APIC maintained $95.4 million of risk-based capital.

For purposes of a rough calculation, we anticipate holding capital to maintain a revenue to surplus capital ratio of approximately $4.5:$1 (on a consolidated basis, inclusive of both the US and Canada), which factors in APIC’s 10-year average loss ratio of 69%.

A: We continue to view our long-term revenue growth rate of 20 – 30% as an appropriate level of growth for this very large and under penetrated market. Our strategy is to invest in growth to the extent that we are able to cost-effectively acquire pets as measured by an acceptable rate of internal return (see more on IRR and our methodology below).

As noted in our 2016 Annual Shareholder Letter, the limiting factors on our growth rate are the time to become cash flow positive on the addition of a new pet and the fact that as we add revenue, we need to set aside cash for surplus capital. The first factor is self-imposed as a matter of financial discipline; the second is externally imposed by our regulators.

A: In our 2014 shareholder letter, we noted that our business model is “to spend X to acquire a new member and have the discretionary income to return substantially more than X over the life of the subscription” and “for these reasons we are most concerned with IRR for incrementally adding an average pet.”

Historically, we targeted a 5:1 LVP:PAC ratio to achieve our cash flow targets and also a favorable internal rate of return on our acquisition spend. More recently, we have reduced our target LVP:PAC ratio as our adjusted operating income has increased, to maintain an estimated 30-40% internal rate of return on our pet acquisition investment.

Our IRR methodology is illustrated below and is calculated assuming the new pets we enroll during the period will behave like an average pet, and represents the discount rate that results in the net present value of all estimated future cash flows generated over an average enrolled pet’s implied subscriber life, to be equal to zero. Cash outflows for an average pet include pet acquisition costs, estimated as the average pet acquisition cost for the four quarters preceding the period end date. Cash outflows also include a monthly capital charge, calculated as the average revenue per pet for the four quarters preceding the period end date, divided by 4.8 leverage and multiplied by five percent. Cash inflows from an average pet are calculated assuming monthly average revenue per pet, averaged for the four quarters preceding the period end date, less cost of goods, variable expenses and fixed expenses, on a per pet basis and averaged over the four quarters preceding the period end date.

The following table sets forth our 2018 calculation of IRR for a single average pet.

At operational scale, if we have a 15% adjusted operating margin, using the above methodology we would only require an LVP:PAC ratio of 3.2x to achieve a 45% IRR. Between now and when we achieve operational scale, we would expect to be targeting our IRR between 30 – 40%.

We have addressed this topic, and our pet acquisition strategy around IRR, further in the 2016 shareholder letter, in particular, in the section “Key Metrics for Today and the Future” beginning on page 20, as well as in our 2018 Shareholder Letter, in the section “Internal Rate of Return”.

A: Our adjusted operating income represents the cash we generate from our existing members in a given period of time. It also represents the cash we have available in that given period of time to acquire new pets. We believe this metric, along with our IRR on invested capital to acquire new pets, are the two most important metrics for driving shareholder value.

In our 2014 Annual Shareholder Letter we discussed operational scale, which we believe we will achieve at 650,000 to 750,000 total enrolled pets. At operational scale, we target an adjusted operating margin of 15%. To get to this target, we use a top down approach: Revenue, reduced by paying veterinary invoices (approximately 70%), less variable expenses, which are the expenses we incur to serve our existing members (approximately 10%). The difference (approximately 20% of revenue) is then further reduced by fixed expenses, which include general and administrative expenses and technology expenses, (approximately 5% at scale). The resulting amount (approximately 15% at scale) is what we internally refer to as our ‘adjusted operating income’ that we consider before we incur expenses related to pet acquisition, and excluding stock based compensation and depreciation expense

We have addressed this metric further in the 2015 shareholder letter, in the section titled “Adjusted Operating Income” beginning on page 2.

A: Increasing our intrinsic value consistently over 5 and 10 year spans is what drives our strategic thinking. Cash flow is our second consideration. Profitability is our third.

The key components that drive our intrinsic value model are our lifetime value of a pet, our adjusted operating income and the IRR we expect to earn when we acquire a new pet.

The lifetime value of a pet is driven by average revenue per pet, retention and contribution margin.

We have addressed this topic, and our strategy around IRR and LVP:PAC, further in the 2016 shareholder letter, in particular, in the section “Key Metrics for Today and the Future” beginning on page 20.

Our strategy is to invest in growth to the extent that we are able to cost-effectively acquire pets as measured by an acceptable rate of internal return. As a result, our profitability is a direct function of how quickly we grow and the rate at which we acquire pets.

A: We believe Trupanion has higher retention rates than any pet insurance provider in North America.

Our 10-year average monthly retention rate is 98.5%. As reported in our 60-month plan published in our 2020 Annual Shareholder Letter, within our core Trupanion brand, we are targeting a 99% retention rate, which we would view as perfection. Cancellations in 2020 broke down into the following cohorts.

As we grow and scale new products, distribution channels, and international markets, our mix of business should continue to evolve. Our metrics will reflect that progression.

A: Our other business segment contains pet revenue that has a business-to-business (B2B) component, as compared to our direct-to-consumer subscription business. Generally, these businesses are pursuant to contracts for multiple pets. For the full year 2020, our other business segment comprised 23% of our total revenue and 33% of our enrolled pets. Currently, we underwrite policies on behalf of veteran affairs programs, employer sponsored programs and other marketing companies that provide some form of health insurance for pets to consumers.

We have addressed this topic further in our 2016 shareholder letter, in particular, in the section “Growth” and beginning on page 16.

A:  We believe that over the next 10 to 20 years, Trupanion can be a major catalyst for growth in the category of medical insurance for pets in North America. If this is true, there should be other interesting product offerings and distribution models that will find their niche. Instead of sitting on the sidelines, our strategy is to participate through business-to-business partnerships. We are reasonably confident that we have the infrastructure, people, and data to help the companies behind these distribution models and niche products – without losing sight of our ultimate goal of building the category around the Trupanion brand and continuing to offer the highest value proposition in the industry while maintaining strong alignment with the veterinary community. Additionally, the profits generated from our other business can be re-invested in growing Trupanion.

We have addressed this topic further in our 2016 shareholder letter, in particular, in the section “Growth” and beginning on page 16.

A: In aggregate, as of June 30, 2021, Trupanion team members held 13% of total outstanding shares. CEO & Founder: As of June 30, 2021, Darryl Rawlings’ holdings represented approximately 5% of Trupanion’s fully diluted shares outstanding.

Every employee of the company has equity in the business. Equity ownership is an important part of our compensation philosophy.

(The fully diluted calculation used in this analysis is comprised of the number of shares issued and outstanding as of June 30, 2021, plus options, awards, and warrants granted and outstanding as of this same date. This calculation excludes shares available for issuance under our equity incentive plan and also excludes the number of shares available for purchase under a stock purchase plan that was setup but never activated.)

A: We are very focused on controlling dilution. We have created an equity compensation structure that, we believe, aligns the interests of shareholders with all employees by awarding equity primarily based on growth in our estimated intrinsic value year over year. We calculate intrinsic value using a discounted cash flow analysis.

Using this approach, there would be minimal dilution unless intrinsic value growth is at least 10%. Beyond 10%, more value is shared with the team in the form of an overall company performance pool.

For more context around our dilution strategy, we would direct you to our 2018 Proxy Statement and annual shareholder letters (and, in particularly, the 2016 letter), which include the following analysis:

*The above table is designed to be used as a guideline. The board may adjust at its discretion. The overall company performance pool is calculated from fully diluted weighted average shares outstanding.

**There likely will be some level of dilution when the increase in intrinsic value is below 10% due to new-hire and board grants, which may also increase other grant levels above what is stated in the table.

We address this topic further in the 2016 Annual Shareholder Letter, in the section titled “Financial Performance Per Share” beginning on page 3.

A: As the Trupanion brand has grown, we are increasingly recognized by pet owners and veterinarians alike for our high-quality pet medical insurance and our unrivalled member experience. We plan on leveraging this positive brand association and our industry expertise to support new entrants into the pet insurance market—brands looking for the best possible association with an expert partner.

In 2021, we were proud to extend the ‘Powered by Trupanion’ association to two new brands – Aflac and Chewy.

“Powered by Trupanion” will become a brand reference serving as a hallmark of quality indicating to pet owners and veterinarians that whenever Trupanion is involved, the pet owner should expect a best-in-class experience. This will include:

• Payment direct to the hospital at the time of invoice and access to our world-class claims team
• 24/7/365 customer care and support
• Retention support from Territory Partners

We are looking forward to expanding the reach of the Trupanion brand into new product lines to help provide assurance to more pets, pet owners and veterinarians.