Greetings, and welcome to Hagerty's Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jay Koval, Head of Investor Relations. Thank you. You may begin.

Thank you, operator. Good afternoon, ladies and gentlemen, and thank you for joining us for Hagerty's Third Quarter 2022 Earnings Conference Call. Please note that this call will be simultaneously webcast on the Investor Relations section of the company's corporate website at investor.hagerty.com. Our earnings release accompanying slides and quarterly letter to stockholders covering this period are also posted on the IR website. Joining the call today are McKeel Hagerty, Chief Executive Officer; and Patrick McClymont, Chief Financial Officer. Before we start, I would like to remind you that the discussion today may contain statements related to our business that can be considered forward-looking, including statements concerning our expected future business and financial performance, our ability to maintain existing and acquire new members, our plans to expand market share, including investments and partnerships, expectations regarding key operational metrics and other statements regarding our plans and prospects. Forward-looking statements are often identified with words such as we expect, we anticipate, we believe or similar expressions. These statements reflect our view as of today, November 10, and should not be considered our views as of any subsequent date. We do not undertake any obligation to update or revise any forward-looking statements. Forward-looking statements are not promises or guarantees of future performance and are subject to a variety of risks and uncertainties that could cause the actual results to differ materially from our expectations. For a discussion of material risks and other important factors that could affect our actual results, please refer to those contained in our filings with the SEC, which are available on Hagerty 's Investor Relations website and at sec.gov. Finally, during today's call, we will refer to certain non-GAAP financial measures. A discussion of these non-GAAP financial measures, along with a reconciliation to the most directly comparable GAAP measure is included in our press release, investor deck and Form 10-Q. Copies of which can be found on the Investor Relations section of our website and on the SEC's website at sec.gov. Unless otherwise noted in today's call, all comparisons are on a year-over-year basis. And with that, I'd like to turn the call over to McKeel Hagerty, our Founder and CEO.

Thanks, Jay, and good morning, everyone. Thank you for joining us to discuss our third quarter results. Before we get into the quarter, I want to welcome Patrick to his first Hagerty's earnings call as our new CFO. I also want to thank Fred Turcotte for a 1.5 decade of outstanding service and collaboration. We announced Fred's planned retirement 2 months ago and are excited for him as he moves into a strategic advisory role helping the company with special projects. Overall, we are very pleased with our third quarter results, which reflect the strength and resiliency of our highly differentiated business model addressing the auto enthusiast market. Let's start with Slide 3 of our investor deck, which shares some of the key year-to-date highlights through September 30, 2022. This includes written premium growth accelerated during the third quarter to 16%, resulting in 15% growth during the first 9 months. Written premium growth is the key metric that underpins Hagerty's total revenue growth today. The Hagerty brand is winning in the marketplace, pulling new customers into our ecosystem and supporting rate increases to offset inflationary pressures. In the third quarter, new business count contributed 8 percentage points of the 16% premium growth, while rate actions and evolving mix to include more modern enthusiast vehicles drove the other 8 points. Total revenue grew an impressive 29% in the third quarter and year-to-date revenue jumped 27%. In addition to the continued strong revenue growth of Hagerty Re, our membership business as well as our garage and social locations, Q3 was our first quarter fully consolidating broad Arrow Group into Hagerty Marketplace. During the quarter, under our ownership, Hagerty Marketplace contributed solid revenue and profits, including the very successful Motorlux auction in Monterey, California. Total active members grew 7% year-over-year to 2.6 million.…

Thank you, McKeel, and good morning, everyone. It's great to be here today as part of One Team Hagerty. I would like to thank McKeel and the Board for this opportunity and also thank Fred for the tremendous effort he has put into making this a smooth transition. Before digging into the quarterly financials, let me start by sharing some of my early thoughts on Hagerty, 2 months into the job. First, the auto enthusiast space is large and highly fragmented, and the market opportunity for Hagerty is compelling. With just 4% share of the insured market today, we see a long runway ahead as we use our powerful brand, trusted relationships and unique customer value proposition to take share in a growing space. This will be powered by double-digit organic growth as well as new incremental partnerships such as State Farm. Second, the ongoing evolution in Hagerty Re to assume more of the risk that we underwrite through Markel's Essentia platform should allow us to build our capital base and create a high-quality, fast-growing profit stream for the company. Third, Hagerty's Marketplace platform is just getting going in the transactional market for enthusiast vehicles. It's a large and profitable market, and our team can leverage Hagerty's trusted brand status and 2.6-million member community to quickly drive scale and profitability. And fourth, while we may be opportunistic when it comes to small bolt-on transactions, we can deliver our strategic growth ambitions without the need for additional sizable deals. Hagerty has made significant investments during the last several years, and our job now is to weave these together to drive synergies across our ecosystem of offerings for auto enthusiasts and deliver strong profit growth over the coming years, starting in 2023. Put simply, we are fortunate to have the wind at…

Thanks, Patrick. As we approach our first anniversary as a public company, I want to reflect on the great work that our amazing teams have accomplished. This includes managing through all of the potential challenges that come as a public company without missing a beat on executing against the sizable growth opportunities for the Hagerty brand as a leader in the auto enthusiast space. The addressable market is large, growing and highly fragmented, and we have never been better positioned to profitably grow our business and to fund our future growth ambitions. This pivot towards more profitable growth will require discipline, hard work and intense focus, but we've assembled great teams that are up to the task and are committed to our mission. In 2023, we expect to begin leveraging these high rates of top line growth into even faster bottom line growth and to drive outsized returns for shareholders. Thank you for joining us today, and we'd like to open up the call to your questions.

[Operator Instructions] Our first question comes from the line of Mark Hughes with Truist.

The 8% new business increase, you said the balance of the growth. I think this is in written premium was rate and evolving mix. How much of that was rate? And could you give us kind of some thoughts on what rate increases should be -- what you may be filing now relative to your increase in losses you described a little higher liability costs. What's the rate going to be? What do you see the loss trend as? So that's a few things, but if you could give us a few ideas there, that would be great.

Sure. Happy to. So the way to think about rates, we've filed in, I think, 35 states. So that's starting to flow through now and will continue to flow through in the fourth quarter and into 2023. And then we're planning on a subsequent rate filing as we get deeper into next year. And so we'll see increased rates filtering in over the course of the year. And you should think about that as high single digits, call it 8%, something like that. In terms of the impact between valuation and rate, it's a mix between the 2. Right now, it's more rate than it is valuation. That's contributing to the overall kind of mid-teens growth in written premium.

And how do you see the trend in loss costs? If you take frequency and severity, given the new liability severity that you're seeing, if your pricing is up 8%, what's the loss cost trend?

Mark, it's McKeel. I'll kind of take that because it's near and dear to my heart. The big thing that we're focused on is some elevated liability experience that we're seeing, and that's really where we kind of wanted to make that prudent adjustment on the -- in Hagerty Re. So this is I guess I would describe it as social inflation, often things kind of out of the direct underwriting control of the business. So our rate filings are really focused in the liability area, and that's what's starting to wash through the books and will for the next couple of quarters, so really manageable. The underlying business and the way the premiums are constructed for us are really heavily weighted on the physical damage side, which remains really, really positive for us.

If you look at what happened -- I was just going to add a little bit, and then we'll go back to your question. But if you look at what happened during the quarter and the reserve strengthening that we took and where we ended up in terms of loss ratio, the 46.8% on a year-to-date basis. If you put it off to the side, Ian, that's about 3.4 points and this increase in the U.S. reserves that we're talking about is about 2.2 points. And so when you think about those, you get right back down to the kind of 41%. And then as the rate filters through, we think we'll be in that 41% area on a go-forward basis.

Okay. And then the $10 million hit from Ian, was that your retention? Was the gross loss higher?

Yes. That's our retention. So the gross loss was higher and then we've got a $10 million cap in the program. And so that's our total exposure. And then the cost to reinstate the reinsurance program, but that's -- those 2 are pretty much and the reinstatement cost is around $1 million.

Yes. The -- any change in the State Farm timing? I think you said it was on cost and on schedule. Is there any change over the last 3 months?

Mark, McKeel again. No, we're tracking really well for that first half of the year next year. It's -- we're making our way through the complex testing. It's all technology and just wiring at this point, and the teams are working really well towards it. So positive outlook there.

And did you break out a dollar amount for the pre-spending, so to speak, the ramp-up costs associated with State Farm. I think you've done that in the past. Do you have any updates for this quarter.

It's in the Q. I'm not sure in the earnings but I know it's in the Q.

It is. It's -- I can follow up with you after the call to run through the numbers.

Okay. If it's in the Q, I'll get it there. And then just a final question. The paid Hagerty Drivers Club, I think your target was up 5% to 6%. You're in that range now. How is that trending any nuance here related to the economy or inflation, maybe inflation is going away. We can all feel better about that. But any update on where you think that growth is going to trend.

Well, if we're talking about just kind of our underlying Hagerty Drivers Club sort of rate of uptake because typically, you get a kind of a new customer through the front door, which is typically an insurance quote then we have this percentage of uptake. It's actually trended very positively this year. We've added some real, we think, value to the Hagerty Drivers Club program. We continue to merchandise it well. So it's kind of a low-cost, high-value package that works well for both our insurers as well for nonowners. So it's actually trying to very well, so holding well in there.

Mark, just on your questions on Page 10 of the earnings slides on the right-hand side, underneath adjusted EBITDA. We're at $24 million on a year-to-date basis for those items that you talked about. So the pre-revenue cost related to State Farm.

Okay. appreciate that.

Next question comes from the line of Greg Peters with Raymond James.

This is actually Sid on for Greg. First, just wanted to touch on the contingent commissions. I know it kind of trends with the loss ratio. And so just if you could remind us, is there a point with the loss ratio where it could [indiscernible] the contingents and -- if so, is that based on full calendar year loss ratio results? Or is it more on a quarterly basis?

Thank you, Sid. It's McKeel here. It definitely does track with the overall calendar year loss ratio. So it's a kind of a complex fully loaded year thing. So we -- but we have -- we've been at this a long time, and so we're able to be very predictive of how things work. And definitely, when you have some sliding of the loss ratio, it can take a little bit off of the top of the contingency underwriting commission. But is there a scenario where it could 0 out Yes, but it would be -- far beyond the scope of anything that I could imagine it would require just like a catastrophic change to the loss mix of the business. So yes, while there will be a slight change in the contingency underwriting commission for this year, we're anticipating it's fairly minimal relative to the fact that it's like a percentage point off of what CUC could be.

So if fully loaded CUC is 10% based upon how it's tracking right now, we're sort of in the 8.5% area, and we'll see how that shakes out for the balance of the fourth quarter. So it's a very modest impact. And then the impact of an event for CUC purposes is capped at $1 million. And so there would have to be to McKeel's point, multiple individual events before we really get into that.

Okay. Yes, that makes sense. And then maybe just pivoting back to the State Farm partnership. I know it's expected to start rolling out state by state early next year. And so just curious, is there a target date or time period you're shooting for to have the rollout completed in all states? Or I'm just trying to get a sense of maybe we should start to see the full benefits of the partnership at the beginning of 2024. So any insight there would be helpful.

Yes. It's a great question and one that we described this way. One difference between the State Farm program and our kind of underlying program, which -- by the way, the product and pricing mirror each other. But the one key difference is that State Farms programs are always 6-month policies, and we are -- we write 1-year policy. So typically, if you were to do a book roll, which is really -- this is going to perform like a book roll it would take 18 to 24 months to get the full benefit of getting all of those people on board. The benefit of the State Farm relationship and what we hope is this very -- once we get it up and running, very accelerated turning on to the rest of the states is that you should start getting further benefit of getting the full as we talked about that kind of 460,000 plus policies rolled on to the books during the latter half of 2023 and into 2024. So shorter than if it were a normal book roll for us. But it will definitely blend into 2024.

Our next question comes from the line of Paul Newsome with Piper Sandler.

Maybe just to step back Obviously, you're getting great growth rate. How do you think of sort of PIF count prospectively? And do you think you're relative to what you think the market is doing, do you think you're actually -- are you gaining actual customer PIF count over what you think the market is growing? Or is that -- any sort of view on what you think you are versus what's going over with the overall size of the market?

Yes. Well, nice to hear from you. Thank you. Yes, definitely, as we look at it, it's about an 8% kind of PIF count for us, which we don't spend a lot of time focused on the, say, regular auto insurance market, but we know from this year that with many of the very, very large insurers who are our partners slowing down their advertising spends in kind of the earlier part of the year that a lot of those companies are seeing pretty low PIF counts if kind of any at all in some cases. So 8% this year for us. We feel really strongly about it, given the kind of uncertainty of the overall environment. Our experience in previous economic slowdowns, both going all the way back to even the dot-com crisis and then the financial crisis and other kind of hiccups in the economy is that you'll see a little bit of a dip in the top line PIF growth, but not like a complete shutting down of it. When we reflect on, for example, the financial prices, it's kind of a confidence thing. People just aren't as focused and in our role as they might be during a normal time. And that's a little bit what we've seen this year. So we're quite happy with the 8%.

And part of the key for us is retention, right? So the 88% retention. And if you peel that back, the main reason we lose people is because they've sold the vehicle. It's not that they've decided to move to another provider. So if you strip out selling the vehicle, our retention is like 96%. And so we're growing and we're keeping people and so it's an incredibly stable book of business.

I was hoping you could return to the reserve change. And this quarter, we saw a number of auto insurers talk about potentially increased severity due to larger, more expensive accidents as well as bodily injury claims. And I was curious if you saw any of that because it sounds like the answer is no. But maybe you could talk to that as well. It seems to be your issues may be coming from a little bit different source than, say, a standard auto insurance company.

Yes. Thank you. And it's interesting when you look at the kind of long-term results of our program, when we see things, it almost tends to be the exact opposite of what happens in the regular auto insurance world. So we know that what's driving a lot of the changes in the challenges, I think the regular auto insurance industry has is those are costs related to physical damage claims and especially with used car vehicle prices being up the way they are in parts and supply chain stuff, that's what they're seeing. For us, it's almost purely liability settlements and things related to liability claims. And in some cases, because of on and underinsured motorists, these can be settlements that have nothing to do with the vehicle that we even insure. It's just the nature of the legal system as it stands today, and we get dragged into that stuff. And that's where that kind of $6.5 million came from and why we were topping up our reserves and taking extra -- probably the extra part of our rate taking right now is focused on that liability area, if that makes sense.

And Paul, just the numbers behind that. So for us in a typical year, the 70% of our losses are physical value and just 30% are our liability. And if you look at the industry, it's not quite the opposite, but pretty close, right? The industry is more like 40% when it comes to liability and 60% on physical damage. So we just have a very different profile.

The bodily injury that that's part of your liability? Or do you consider that probably so?

Yes. And the way that our rates are constructed, kind of any kind of bodily injury like MedPay or that's -- or PIP depending on the state, how you kind of look at that. That's a piece of it, but a lot of what we are challenged with and why that -- getting the rates right for us going forward, and we're -- that's why we're pretty confident in the year ahead is it's that on and underinsured motorists and again, it's on a state-by-state basis, but that's where you get the -- it's unfortunate from the customer perspective, but that's where you get the kind of jury trials, and we just kind of get dragged in as an extra insured in the person's household.

Okay. And then last topic I wanted to talk about all lots of excitement in the insurance industry about higher reinsurance costs. Your structure is a little bit different than others. Could you talk about how the higher reinsurance cost could or could not affect your business prospectively, if we do see that next year?

Well, thank you. And I know it's certainly talking to a lot of other insurers and going to insurance conferences and things like this. It's like everybody is holding their breath about what's going to happen to reinsurance costs next year. And we also know that cheap reinsurance is not a business model. It's maybe a benefit of running a good underlying business. But how we're thinking about it is this is the first year where we've actually penetrated our reinsurance layer. But I guess what I would say without being too specific because as we're still working through the losses related to Ian, is that even with that $10 million retention and the actual losses being a little bit higher than that, it was well below what our model had for us. So even then, we feel pretty confident in being able to go forward with while this was our first reinsurance hit that our ability to go forward in the next year for a renewal, confidently renegotiating for a favorable rate based on how we underwrite, how we price and how we control losses we feel pretty good about what we'll be able to do next year.

And you'll see in the Q, the gross that flows through is about $18 million. And so and then we're getting -- our retention on that is just the $10 million. And that $18 million is just what flows through to [indiscernible]. There's other risk in our book that is sitting on other papers. So the total for us was $27 million or so before salvage that's a fraction of what the model said it should have been with this event, and it speaks to the nature of the risks that we're underwriting. And we've done a lot of work. So our team is in the field before these events and helping people move their vehicles. And we've got stories where one member is offering to store vehicles of another member. So it's just a very different than daily drivers.

Again, I was just actually going to sort of the cost structure within your system [indiscernible] loss. I think the hurricane Ian losses, it is what it is. [indiscernible] picks up that too hard with respect to the company?

We're actually feeling pretty good about what that renewal will look like in the spring.

Our next question comes from the line of Pablo Singzon with JPMorgan.

Just one for me. I wanted to follow up on your comments regarding expense management. I was curious if you could frame for us given that you do provide a breakout of fixed operating expenses as well as contribution margin? Where should we see that expense benefit filtering through? And any comments on the magnitude and basis improvement there?

Yes. So we're right in the budgeting process now. And the approach that we took was really to look up and down the P&L across all different businesses. And so we've challenged people really to look at it with a fresh set of eyes and me being new, I think, is helpful with that. And so the areas that we're focused on, one would just be the cost of labor. And so there are opportunities for us to automate and make sure that we're building an operating leverage. And so on a go-forward basis, we won't have to increase headcount at the same rate that we're increasing revenue. And so there'll be a fair bit around the labor side of things where we think we can do things better. I think G&A is another area. As I mentioned, some -- on the call, some of these are unavoidable, and they come with the structure of being a public company. But I do think there's other opportunities where we could be a bit more efficient and a bit more lean. So we'll be really looking at that. And then even on the sales cost side, there's some sales costs that are going to increase, and we feel great about that, right? So broker expense and the things that are driving the top line, but there's others where there may be an opportunity -- there is an opportunity for us to do things a little differently, so that could be advertising events, sponsorships. So we're really going up and down. And the main framework is we've got this incredibly robust business on the written premium side that can grow in the mid-teens. And then we've added things like Marketplace. -- that are small, but they're going to grow much faster than that. So that's going to pull our overall growth rate up from the mid-teens. And we've just got to make sure that the underlying resources grow at a discount to that, right? And over the last couple of years, they've been growing at the same rate. And so we're just -- we're going to bend that curve on the cost side to make sure that we get to profitability pretty quickly.

There are no further questions in the queue. I'd like to hand the call back over to McKeel Hagerty for closing remarks.

Well, thanks again. I love having the questions here today. I really appreciate the time and attention. And please reach out if you have any other further questions for us. Rest assured, we're going to keep focusing on the future and our mission of saving driving a car culture for future generations. And hopefully, you see that we think we have a highly differentiated business model that really taps into that automotive passion, but also taps into a pretty special part of the insurance and other parts of the business model that will allow us to both build in a business that's more efficient, but also enhance profitability over time. So we're excited about this work, excited to be able to build this plan with our team and deliver for our shareholders. We appreciate all of your support. So keep on driving.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.