Between the Lines

Pet Insurance Is the Only Working Health Insurance Market in the U.S.

There’s an opportunity to build a U.S. insurance business that actually prices according to risk

Photo: Tim Macpherson/Getty Images

TThe American health insurance market looks nothing like what you’d design if you were starting from scratch. The dominant payment scheme — employer-provided health care — is literally a vestige of regulatory arbitrage allowing companies to evade wage controls in World War II.

If you’ve ever wanted to redesign health insurance from scratch, good news! Pet health insurance operates under a completely different regulatory regime, and we’re in the early days of the market — the very early days, with pet insurance penetration in the United States close to 1%.

There are several reasons to expect the pet insurance market to grow:

  • Pet ownership is rising.
  • Spending per pet is rising — there’s a macro argument here, that pets act as a substitute for kids, and they’re increasingly favorably priced relative to the alternative.
  • Pet health care is advancing, just like human health care is, and in modern economies advanced health care mostly consists of expensive health care. There’s a back-and-forth between regulations and budgets here; surgery that’s economically viable for humans first can be viable for pets later, while medications that are illegal for humans can be cheaply available for pets. (For an example that’s endearing until you consider the risks of antibiotic overuse, see here.)
  • For regulatory purposes, pets are property, so they’re covered under property and casualty rules rather than health insurance rules. This means underwriters can actually underwrite risk.

This is a nice combination of macro- and micro-scale opportunities. Anyone in the pet insurance business benefits from the secular tailwind of higher spending on more pets, and higher variance in pet health care costs. But it’s also an opportunity to build a business that doesn’t exist in the United States: a provider of actual health insurance that prices according to risk.

The pet insurance business is a beautiful arbitrage: Pet owners treat pets like members of the family, and insurance regulators treat them like property.

The macro view: pets and pet spending

Pet ownership in the United States is somewhere between 50% and 70% of households, depending on which surveys you trust. The data is surprisingly controversial. Most surveys do show a gradual rise in pet ownership. But what’s much less controversial is the rise in pet spending: The American Pet Products Association estimates around $75 billion in pet spending in the United States in 2019, up 4% year over year, and rising a bit over 5% annualized over the last five and 10 years.

Within that spending, most categories are rising at similar rates; food spending (42% of the total) is growing a bit faster, thanks to the availability of healthier options, but vet spending (25% of all pet-related spending) has risen at a healthy 4.7% clip over the last decade.

There’s a sound macroeconomic reason for this: High housing costs, high tuition costs, and young people’s perception of a dicey job market makes people reluctant to form a family. A job that might have provided enough money for one kid 20 years ago might pay enough for 0.8 kids today, so if that prospective parent buys a dog instead, their caring-for-a-living-thing budget is enormous.

There is, luckily for us, some late-breaking news on this topic: Researchers at Cambridge recently used surveys to estimate the statistical value of a dog’s life at around $10,000. But that’s using methodologies similar to the way we estimate the value of a human’s life at around $10 million — look at situations where people can choose to spend money to reduce risk, see how much they choose to spend, and multiply accordingly. That gets at the theoretical value, but people are very irrational when they make individual health care decisions — especially because spending a large multiple of the statistical value of a dog’s life is well within the reach of people who couldn’t do the same for humans. If a given surgery could save your life for $5 million, it’s a moot point without the $5 million, but if a $5,000 surgery could save a dog’s life, people start making real-world trade-offs — if you phrase the trade-off in terms of skipped vacations and deferred laptop upgrades, many people will accept treatments that exceed the bounds of the utilitarian calculus.

The pet insurance business is a beautiful arbitrage: Pet owners treat pets like members of the family, and insurance regulators treat them like property.

The really interesting question is not just how mean pet care expenses are trending, though: It’s the shape of the distribution. Some pet problems used to be fatal — spinal injuries, stomach torsion, certain tumors — but now, there’s surgery. Which means that bad outcomes are being replaced with hard choices. Prices for individual procedures are not growing fast, but that’s in part due to the low penetration of pet insurance.

As pet insurance becomes more widely used, and as the cost of kids persuades more young city-dwellers to get dogs instead, the average cost and the variability of cost in pet health care should rise. In other words, as pet insurance becomes more popular, it will become effectively mandatory. That’s great news for pet insurance providers.

Who’s active where?

There are a little over a dozen pet insurance providers in the United States. Here, there are two models: actually underwriting insurance, and operating as a managing general agent (MGA). MGAs are the most common model. They partner with an existing property and casualty insurance company, which handles the risk; the MGA brands and markets the product. For example, my dog Ringo is insured by Petplan, but Petplan is actually insured by XL Specialty Insurance. Petplan’s marketing focuses on dogs; XL’s marketing involves stock photos of people in suits and container ships.

It’s a good division of labor. Building an actuarial table is nontrivial, especially because the insurance industry cycle is defined by bad underwriting, followed by growth, followed by years of unpleasant surprises.

However, there’s another, bolder option: Trupanion is a publicly traded pet insurance company that actually offers the insurance itself, rather than outsourcing. It’s a controversial stock. In one sense, it’s a subscription business with a customer acquisition cost of $164 and a lifetime value of $710, which is not bad at all. In another sense, it’s a property and casualty insurance company with $124 million in tangible equity and a market capitalization of $1.2 billion, compared to a more typical prop-cat price/book ratio of 1.4.

The debate is not easy to resolve. Trupanion is growing fast, with enrolled pets compounding at 22% since 2014, and monthly revenue per pet rising 5% over the same period. Retention has been stable, with 1.5% monthly churn, implying that pet owners stick with them for about five and a half years on average. Typical loss ratios are just over 70%, and other costs of sales are about 10%, giving them a high-teens gross margin.

There are some regulatory limitations: They need to keep $54 million in capital for their U.S. business, which is 81% of the total. That implies regulatory capital of roughly $125 per pet. Their customer acquisition cost is $165, and trending up.

So the right way to think about this business is that for a capital outlay of $165 + $125 or $290, they get a gross profit stream worth a bit over $700. (Their current estimated lifetime value of a pet is $710, which is the undiscounted gross profit they’ll get over the five-year life of the contract. Given that this LTV includes the impact of churn, and that churn has been steady, it’s a fair guess.)

Is it fair to include the regulatory capital needs in the customer acquisition cost metric? You could argue this either way, and it’s an important point because it makes the difference between an LTV:CAC ratio of over 4:1 (extremely good) and 2.4:1 (decent, but not extraordinary). I’d argue that you should include it: The regulatory capital does get released when the policy ends, but LTV:CAC measures how much spending is required for incremental growth. It might be possible for Trupanion to play some games with its financial structure to mitigate the issue — a levered parent company borrowing to buy the equity of an insurance-operating company with a pristine balance sheet —but insurance regulators increasingly frown on this model.

The opportunity: what could be built

The market is growing fast, but under-penetrated, with only about 1% of dogs and cats in the United States currently insured. This is well below the rates in Sweden, where pet insurance has been available since 1890 and the first dog was insured in 1924. Today, 90% of Swedish dogs have health insurance. The United States started later. (The first dog insurance policy here was sold in 1982; it covered Lassie.)

Even if the United States doesn’t reach Swedish levels — which, even if you assume the same regulatory and cultural environment, took a century — the industry does represent a growth opportunity.

What could exist is a company that uses insurance as part of a monetization model, but really focuses on improving pet health.

What’s missing, though, is a fuller-stack company. Trupanion is full-stack in the sense that it owns the brand name, the risk, and the operations, but it’s still underwriting based on limited criteria, and missing opportunities to further improve the model.

What could exist is a company that uses insurance as part of a monetization model, but really focuses on improving pet health. Dog root canals cost thousands of dollars; brushing a dog’s teeth is cheap. If you can insure people who brush their dog’s teeth, you can offer cheaper rates. (And let’s not forget the higher LTV from giving the dog a longer expected lifetime; sedating an older dog for dental surgery is pretty safe, but sometimes things go wrong.)

There are other options as well:

  • Breeders keep detailed records of what happened to dogs on both sides of the family tree; this information could allow insurers to more accurately underwrite congenital risks.
  • There are some breed- and size-specific issues that correlate with health problems. (Big dogs get hip dysplasia; small dogs get back problems.) But some of these risks can be measured by early X-rays, and some can be mitigated through lifestyle changes like not letting dogs go up and down stairs.
  • Some dog foods have contaminants; many more have suboptimal micro- or macro-nutrient profiles that lead to health problems.

The simple underwriting approach just looks at breed, age, preexisting conditions, and zip code (with zip code mostly a proxy for cost). But a good insurer can 1) sort risk groups more finely and 2) encourage lifestyle changes that further reduce risks. There isn’t a HIPAA for pets, at least not yet, so a dominant player can hoover up data and continuously improve their systems. In fact, if they wrap data-sharing into claims payment (for example, your vet automatically shares what treatment your dog got and what the blood test results looked like whenever you make a claim) they can soak up even more information.

And since the insurer is profiting from the health outcome rather than the input, they have a cost advantage — Chewy can make a little money selling you chicken-flavored toothpaste, but the company insuring your dog can make a lot more money by selling you the same stuff at breakeven.

Distribution is another angle: Trupanion offers insurance mostly through vets, while other providers sell through breeders. But most breeders don’t offer dog health insurance. If Trupanion pays $165 per lead, that’s a good price point to start at — giving a breeder a chance to capture another $100 or so with 100% gross margin from 30 seconds of effort sounds like an easy win.

The pet insurance story is early, but it’s an excellent case study in the potential to align incentives. And this isn’t just theoretical; insurance has already changed behaviors. The Hartford Steam Boiler and Inspection and Insurance Company insisted that boiler manufacturers use a new design that reduced explosion risk, which made them money and literally saved lives.

Right now, there are tens of millions of dogs and cats, and nobody is running the numbers on exactly how to keep them healthy. But as pet insurance grows, that will happen. And, who knows, maybe if the regulation-light world of pet health insurance produces better outcomes for patients, it might give someone in Congress a few ideas on how to get better outcomes from America’s $3.5 trillion in annual health care spending.

Author’s note: If you’re interested in working on a project in the pet insurance space, please reach out. The full-stack pet health business of the future isn’t going to build itself, but it’s definitely getting built. I’m working with founders and funders to get this off the ground, and we’re looking for people who want to join the early team.

I write about technology (more logos than techne) and economics. Newsletter: https://diff.substack.com/

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