(1) For more information about how we calculate total pets enrolled, total subscription pets enrolled, monthly average revenue per pet, lifetime value of a pet, including fixed expenses, average pet acquisition cost and average monthly retention, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Key Operating Metrics.”
We operate in two business segments: subscription business and other business. We currently generate revenue in our subscription business segment from subscription fees for our “Trupanion” branded products. Fees are paid at the beginning of each subscription period, which automatically renews on a monthly basis. We generate revenue in our other business segment primarily by writing policies on behalf of third parties. We do not undertake the marketing efforts for these policies and have a business-to-business relationship with these third parties. Our other business segment also includes revenue from other products and software solutions that have a different margin profile from our subscription business.
We generate leads primarily for our subscription business segment through a diverse set of member acquisition channels, which we then convert into members primarily through our contact center, website and other direct-to-consumer activities. These channels primarily include leads from third-parties such as veterinarians and referrals from existing members. Veterinary hospitals represent our largest referral source. We engage our "Territory Partners" to have face-to-face visits with veterinarians and their staff. Territory Partners are dedicated to cultivating direct veterinary relationships and building awareness of the benefits of high quality medical insurance to veterinarians and their clients. Veterinarians then educate pet owners, who visit our website or call our contact center to learn more about, and potentially enroll in, Trupanion. We also receive a significant number of new leads from existing members adding pets and referring their friends and family members. Our direct-to-consumer acquisition channels serve as important resources for pet owner education and drive new member leads and conversion. We monitor average pet acquisition cost to evaluate the efficiency of our sales and marketing programs in acquiring new members and measure effectiveness based on our targeted return on investment.
The impacts of COVID-19 and related economic conditions on our results are highly uncertain and in many ways outside of our control. The scope, duration and magnitude of the direct and indirect effects of COVID-19 are evolving rapidly and in ways that are difficult, if possible, to anticipate.
Lifetime value of a pet, including fixed expenses. Lifetime value of a pet, including fixed expenses, is calculated based on subscription revenue less cost of revenue from our subscription business segment for the 12 months prior to the period end date excluding stock-based compensation expense related to cost of revenue from our subscription business segment, sign-up fee revenue and the change in deferred revenue between periods. This amount is also reduced by the fixed expenses related to our subscription business, which are the pro-rata portion of general and administrative and technology and development expenses, less stock-based compensation, based on revenues. This amount, on a per pet basis, is multiplied by the implied average subscriber life in months. Implied average subscriber life in months is calculated as the quotient obtained by dividing one by one minus the average monthly retention rate. We monitor lifetime value of a pet, including fixed expenses, to estimate the value we might expect from new pets over their implied average subscriber life in months, if they behave like the average pet in that respective period. When evaluating the amount of sales and marketing expenses we may want to incur to attract new pet enrollments, we refer to the lifetime value of a pet, including fixed expenses, as well as our estimated internal rate of return calculation for an average pet, which also includes an estimated surplus capital charge, to inform the amount of acquisition spend in relation to the estimated payback period.
Average monthly retention. Average monthly retention is measured as the monthly retention rate of enrolled subscription pets for each applicable period averaged over the 12 months prior to the period end date. As such, our average monthly retention rate as of December 31, 2020 is an average of each month’s retention from January 1, 2020 through December 31, 2020. We calculate monthly retention as the number of pets that remain after subtracting all pets that cancel during a month, including pets that enroll and cancel within that month, divided by the total pets enrolled at the beginning of that month. We monitor average monthly retention because it provides a measure of member satisfaction and allows us to calculate the implied average subscriber life in months.
The following tables reconcile net acquisition cost to sales and marketing expense (in thousands) for the years ended December 31, 2020, 2019, and 2018, and for each of the last eight fiscal quarters:
We operate in two business segments: subscription business and other business. We currently generate revenue in our subscription business segment from subscription fees related to our “Trupanion” branded products. Our other business segment includes revenue from other product offerings that generally have a business-to-business relationship and different margin profiles than our subscription segment, including revenue from writing policies on behalf of third parties and revenue from other products and software solutions.
We generate revenue in our other business segment primarily from writing policies on behalf of third parties where we do not undertake the direct consumer marketing. This segment also includes revenue from other products and software solutions which have a different margin profile than our subscription business.
Comparison of the years ended December 31, 2020, 2019, and 2018
Year ended December 31, 2020 compared to year ended December 31, 2019. Total revenue increased by $118.1 million to $502.0 million for the year ended December 31, 2020, or 31%. Revenue from our subscription business segment increased by $66.6 million to $387.7 million for the year ended December 31, 2020, or 21%. This increase was primarily due to a 17% increase in total subscription pets enrolled as of December 31, 2020 compared to December 31, 2019 and increased average revenue per pet of 5% for the same period. Increases in pricing were due to the increased cost and utilization of veterinary care. Revenue from our other business segment increased by $51.5 million to $114.3 million for the year ended December 31, 2020, or 82%, primarily due to the increase in enrolled pets in this segment, as well as $1.2 million in revenue from the newly acquired software business in the fourth quarter of 2020.
Year ended December 31, 2019 compared to year ended December 31, 2018. Depreciation and amortization expense increased by $1.1 million, or 25%, primarily related to the depreciation associated with our home office building, which was purchased in August 2018.
Year ended December 31, 2020 compared to year ended December 31, 2019. Total other (income) expense, net increased by $1.1 million, primarily due to less interest income as a result of lower interest rates compared to the prior year.
As of December 31, 2020, we had $229.7 million in cash, cash equivalents and short-term investments. Most of the assets in our insurance subsidiary, American Pet Insurance Company (APIC), and our segregated cell business, Wyndham Insurance Company (SAC) Limited (WICL) Segregated Account AX, are subject to certain capital and dividend rules and regulations prescribed by jurisdictions in which they are authorized to operate. As of December 31, 2020, total assets and liabilities held outside of our insurance entities were $259.3 million and $29.4 million, respectively, including $6.7 million of cash and cash equivalents that were segregated from other operating funds and held in trust for the payment of veterinary invoices on behalf of our insurance subsidiaries. For further information, refer to "-Regulation".
Our primary sources of liquidity are our existing cash, cash equivalents and short-term investments, as well as cash provided by operations. We believe these sources are sufficient to fund our operations and capital requirements for the next 12 months. As we continue to grow and consider strategic opportunities, however, we may explore additional financing to fund our operations or to meet capital requirements. Financing could include equity, equity-linked, or debt financing. Additional financing may not be available to us on acceptable terms, or at all.
Our primary requirements for liquidity are paying veterinary invoices, funding operations and capital requirements, investing in new member acquisition, investing in enhancements to our member experience, and servicing debt. In December 2020, we elected to terminate our line of credit facility and repaid all then outstanding obligations.
We derive operating cash flows from the sale of our subscription plans, which is used to pay veterinary invoices and other cost of revenue. Additionally, cash is used to support the growth of our business by reinvesting to acquire new pet enrollments and to fund projects that improve our members' experience. Net cash provided by operating activities was $21.5 million for the year ended December 31, 2020, compared to cash provided by operating activities of $16.2 million for the year ended December 31, 2019. The change was primarily driven by increased pet count and scale in our operating departments, as well as timing differences between collections from members and payments of veterinary invoices and payments to vendors. Changes in accounts receivable and deferred revenue were primarily related to annual policies with monthly payment terms within our other business segment.
For the year ended December 31, 2020, we paid $18.8 million for veterinary invoices dated on or before December 31, 2019, including related processing costs. Our reserve estimate for these expenses was $21.2 million as of December 31, 2019. As of December 31, 2020, we reevaluated the remaining reserve for those periods prior to December 31, 2019 and recorded an adjustment to our income statement to increase it by $0.1 million.
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Description of the Matter The Company’s reserve for veterinary invoices totaled $28.9 million as of December 31, 2020. As discussed in Note 1 to the financial statements, the Company’s reserve for veterinary invoices is based on an actuarial analysis of the Company’s historical experience including the number of veterinary invoices it expects to receive, the average cost of those veterinary invoices, the length of time between the date of the veterinary invoice and the date the Company receives the veterinary invoice, the members’ chosen deductibles and the Company’s expected cost to process and administer payments.
How We Addressed the Matter in Our Audit We evaluated the design and tested the operating effectiveness of controls over the reserve for veterinary invoices process, including controls over the completeness and accuracy of the data used in management’s actuarial projections and the review and approval processes that management has in place for the methods and assumptions used by management’s actuaries in estimating the reserves.
Description of the Matter During 2020, the Company completed its acquisition of Aquarium Software Limited (Aquarium) for consideration of $48.3 million, as disclosed in Note 3 to the consolidated financial statements. The transaction was accounted for as a business combination.
Auditing the Company's accounting for its acquisition of Aquarium was complex due to the estimation uncertainty in the Company’s determination of the fair value of identified intangible assets of $19.5 million, which principally consisted of developed technology and customer relationships. The estimation uncertainty was primarily due to the sensitivity of the respective fair values to underlying assumptions about the future performance of the acquired business on which those assumptions were based. The Company used a discounted cash flow model to measure the developed technology and customer relationships intangible assets. The key assumptions used to estimate the fair value of the intangible assets included discount rates and certain assumptions that form the basis of the forecasted results (e.g., revenue growth and attrition rates). These significant assumptions are forward looking and could be affected by future economic and market conditions.
How We Addressed the Matter in Our Audit We tested the Company's controls over its accounting for acquisitions. Our tests included controls over the estimation process supporting the recognition and measurement of consideration transferred, and technology and customer-related intangible assets. We also tested management’s review of assumptions used in the valuation models.
The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. At times, cash on deposit may be in excess of the applicable federal deposit insurance corporation limits.
Long-lived assets, including property, equipment, and intangible assets, are reviewed for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Should an impairment exist, the impairment loss would be measured as the amount the asset's carrying value exceeds its fair value. The Company has recognized no impairment loss on long-lived assets for the years ended December 31, 2020, 2019, and 2018.
Reserve for veterinary invoices is an estimate of the future amount the Company will pay for veterinary invoices that are dated as of, or prior to, its balance sheet date. The reserve also includes the Company's estimate of related internal processing costs. To determine the accrual, the Company makes assumptions based on its historical experience, including the number of veterinary invoices it expects to receive, the average cost of those veterinary invoices, the length of time between the date of the veterinary invoice and the date the Company receives it, the member's chosen deductible, and the Company's expected cost to process and administer the payments. As of each balance sheet date, the Company reevaluates its reserve and may adjust the estimate for new information.
Deferred revenue is primarily related to the Company’s other business segment where the Company generates revenue from underwriting policies through unaffiliated general agents. These policies are typically annual policies, with monthly payment terms through the end of the twelve-month period. Deferred revenue also consists of subscription fees received or billed in advance of the subscription services within the Company's subscription business.
Technology and development expenses primarily consist of personnel costs and related expenses for the Company's technology staff, which includes information technology development and infrastructure support and third-party services. It also includes expenses associated with development of new products and offerings.
General and administrative expenses consist primarily of personnel costs and related expenses for the Company’s finance, actuarial, human resources, legal, regulatory, and general management functions, as well as facilities and professional services.
Advertising costs are expensed as incurred, with the exception of television advertisements, which are expensed the first time each advertisement is aired. Advertising costs amounted to $13.4 million, $7.8 million and $6.3 million, in the years ended December 31, 2020, 2019 and 2018, respectively.
The Company uses the asset and liability approach for accounting and reporting income taxes. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities, and their respective tax bases, operating loss, and tax credit carryforwards.
The Company’s consolidated financial statements are reported in U.S. dollars. Assets and liabilities denominated in foreign currencies were translated to U.S. dollars, the reporting currency, at the exchange rates in effect on the balance sheet date. Revenue and expenses denominated in foreign currencies were translated to U.S. dollars using a weighted-average rate for the relevant reporting period. Cumulative translation adjustments of $(2.1) million, $0.4 million, and $0.7 million were recorded in accumulated other comprehensive loss as of December 31, 2020, 2019, and 2018, respectively.
Effective January 1, 2015, the Company formed a segregated account in Bermuda as part of Wyndham Insurance Company (SAC) Limited (WICL), and entered into a revised fronting and reinsurance arrangement with Omega General Insurance Company (Omega) to include its newly formed segregated account. The Company maintains all risk with the business written in Canada and consolidates the entity in its financial statements. Dividends are allowed subject to the Segregated Accounts Company Act of 2000, which allows for dividends only to the extent that the entity remains solvent and the value of its assets remain greater than the aggregate of its liabilities and its issued share capital and share premium accounts.
On October 30, 2020, the Company completed an acquisition of 100% of the equity of Aquarium Software Limited (Aquarium), a U.K.-based insurance software provider, for approximately $48.3 million in net cash. The acquired technology from Aquarium focuses on the pet space and, along with the acquired personnel, is intended to enable the Company to improve its back-end software to help facilitate growth opportunities. The Company incurred $0.5 million of acquisition related costs that were included in general and administrative expenses during the year ended December 31, 2020.
Acquired intangible assets included trade name, developed technologies, and customer relationships. These definite-lived intangible assets had weighted-average estimated useful lives of approximately 5.3 years. The goodwill recognized is attributable primarily to going concern value such as assembled workforce, future technology development, future customers, and expected synergies from incorporating the operations into Trupanion’s portfolio. None of the goodwill associated with this acquisition is expected to be deductible for income tax purposes.
The results of Aquarium’s operations have been included in the consolidated financial statements since the acquisition date, but were immaterial to the Company's consolidated financial statements.
As of December 31, 2020, expected amortization expense relating to purchased intangible assets for each of the next five years and thereafter is as follows (in thousands):
The Company measures the fair value of restricted cash, money market funds, and foreign deposits based on quoted prices in active markets for identical assets. The fair value of the municipal bond is based on either recent trades in inactive markets or quoted market prices of similar instruments and other significant inputs derived from or corroborated by observable market data. Short-term investments are carried at amortized cost and the fair value and changes in unrealized gains (losses) are disclosed in Note 6, Investments. The fair value of these investments is determined in the same manner as for available-for-sale securities and is considered a Level 1 measurement.
The Company recognizes transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer. There were no transfers between levels for the year ended December 31, 2020 and 2019.
The following summarizes the Company's contractual commitments as of December 31, 2020 (in thousands):
Summarized below are the changes in the total liability for the Company's subscription business segment (in thousands):
The Company’s reserve for the other business segment increased $3.4 million from $5.7 million at December 31, 2019 to $9.0 million at December 31, 2020. This change was comprised of $72.1 million in expense recorded during the period less $68.8 million in payments of veterinary invoices. This $72.1 million in veterinary invoice expense incurred included a reduction of $0.2 million to the reserves relating to prior years, which was the result of ongoing analysis of recent payment trends. The Company's adjustments to decrease prior year reserves were $0.4 million and $0.3 million as a result of analysis of payment trends in each of the years ended December 31, 2019 and 2018, respectively.
In the following tables, amounts are by year the veterinary invoice relates to, referred to as the year of occurrence. Amounts in these tables are presented on a constant currency basis to remove the impact of changes in the foreign currency exchange rate. The cumulative amounts paid as of the end of each year are revalued using the currency exchange rate as of December 31, 2020. Information for years 2017 through 2019 is provided as required supplementary information.
The below table summarizes the Company’s restricted stock award and restricted stock unit activity for the years ended December 31, 2020, 2019 and 2018:
The following table summarizes the Company's future rental payments to be received from non-cancellable leases in place as of December 31, 2020 (in thousands):
The Company has two reporting segments: subscription business and other business. The subscription business segment currently includes revenue from subscription fees related to our “Trupanion” branded products, while the other business segment is comprised of revenue from other product offerings that generally have a business-to-business relationship and different margin profiles than our subscription segment, including revenue from writing policies on behalf of third parties and revenue from other products and software solutions.
The Company's insurance subsidiary in Bermuda is regulated by the Bermuda Monetary Authority. Under the Bermuda Companies Act of 1981, as amended, a Bermuda company may not declare or pay a dividend or make a distribution out of contributed surplus if there are reasonable grounds for believing that: (a) the company is, or would be after the payment, unable to pay its liabilities as they become due; or (b) the realizable value of the company’s assets would thereby be less than its liabilities. The Segregated Accounts Company Act of 2000 further requires that dividends out of a segregated account can only be paid to the extent that the cell remains solvent. The value of its assets must remain greater than the aggregate of its liabilities, issued share capital, and share premium accounts. Per our contractual agreements with Wyndham Insurance Company (SAC) Limited, the allowable dividend is equivalent to the positive undistributed profit attributable to the shares. This insurance subsidiary paid the Company a dividend of $4.7 million, $3.9 million, and $2.2 million during the years ended December 31, 2020, 2019 and 2018, respectfully.
The statutory net income for 2020, 2019 and 2018 and statutory capital and surplus at December 31, 2020, 2019 and 2018, for the Company’s insurance subsidiary in New York were as follows (in thousands):
As of December 31, 2020, the Company had $6.7 million on deposit with various states in which it writes policies.
Income (loss) before income taxes was as follows for the years ended December 31, 2020, 2019 and 2018 (in thousands):
A valuation allowance is required to reduce the deferred tax assets reported if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. After consideration of all the evidence, both positive and negative, the Company has recorded a full valuation allowance against its U.S. Federal deferred tax assets as of December 31, 2020 and 2019 because the Company’s management has determined that it is more likely than not that these assets will not be fully realized.
For the year ended December 31, 2020, the Company recognized a net increase of $8.6 million in valuation allowance against its net deferred tax assets associated with U.S. federal and certain state jurisdictions, primarily attributable to current year activity.
The Company is open to examination by the U.S. federal tax jurisdiction for the years ended December 31, 2017 through 2020. The Company is also open to examination for 2007 and forward with respect to net operating loss carryforwards generated and carried forward from those years in the United States. The Company is subject to taxation in various states and foreign jurisdictions, and may be subject to audit or examination by the relevant authorities in respect to those particular jurisdictions primarily for 2016 and thereafter.
The Company is booking Global Intangible Low-Taxed Income ("GILTI") on a current basis and is not booking deferred taxes related to GILTI.
The following table contains quarterly financial data for the years ended December 31, 2020 and 2019 (in thousands, except per share data). The unaudited quarterly information has been prepared on a basis consistent with the audited consolidated financial statements and includes all adjustments that the Company considers necessary for a fair presentation of the information shown. The operating results for any fiscal quarter are not necessarily indicative of the operating results for a full fiscal year or any future period and there can be no assurances that any trend reflected in such results will continue in the future.