Greetings and welcome to the Trupanion Inc. Second Quarter 2022 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Ms. Laura Bainbridge, Investor Relations. Thank you. Please go ahead.

Good afternoon and welcome to Trupanion's second quarter 2022 financial results conference call. Participating on today's call are Darryl Rawlings, Chief Executive Officer; Margi Tooth, President and Drew Wolff, Chief Financial Officer. Similar to prior earnings calls, Tricia Plouf, Chief Operating Officer will be available for the Q&A portion of today's call. Before we begin, I would like to remind everyone that during today's conference call, we will make certain forward-looking statements regarding the future operations, opportunities and financial performance of Trupanion within the meaning of the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. These statements involve a high degree of known and unknown risks and uncertainties that could cause actual results to differ materially from those discussed. A detailed discussion of these and other risks and uncertainties are included in our earnings release which can be found on our Investor Relations website as well as the company's most recent reports on Forms 10-K and 8-K filed with the Securities and Exchange Commission. Today's presentation contains references to non-GAAP financial measures that management uses to evaluate the company's performance, including without limitation variable expenses, fixed expenses, adjusted operating income, acquisition costs; internal rate of return, adjusted EBITDA and free cash flow. When we use the term adjusted operating income or margin, it is intended to refer to our non-GAAP operating income or margin before new pet acquisition and development expense. Unless otherwise noted, margins and expenses will be presented on a non-GAAP basis which excludes stock-based compensation expense and depreciation expense. These non-GAAP measures are in addition to and not a substitute for measures of financial performance prepared in accordance with the U.S. GAAP. Investors are encouraged to review the reconciliations of these non-GAAP financial measures to the most directly comparable GAAP results which can be found in today’s press release or on Trupanion’s Investor Relations website under the Quarterly Earnings tab. Lastly, I would like to remind everyone that today’s call is also available via webcast on Trupanion’s Investor Relations website. A replay will also be available on the site. With that, I will hand the call over to Darryl.

Thanks, Laura. Good afternoon. Q2 revenue was up 30% year-over-year. More importantly, our adjusted operating income or the profits we earned from our existing pets before we invested in growth grew approximately 13% or 16% on a constant currency basis. We invested about $20 million acquiring new pets at an estimated 31% internal rate of return, an additional $2 million in development expenses and nearly $6 million repurchasing shares of our common stock. With the strength of our balance sheet and available cash, we are well capitalized to invest in areas where we can achieve strong rates of returns. In our large underpenetrated market, investing compounding amounts of adjusted operating income at our high internal rates of return is the key to our value creation. In the quarter, we added over 61,000 new pets. For context, this is up about 10% year-over-year and up about 14% from year-end. Growth was driven by leads and a modest improvement in conversion. In the quarter, we also soft launched Chewy, rolled out the Aflac offerings to brokers serving larger companies and made progress internationally. We're humbled by the trust these partners have placed in us and are excited to see how these partnerships play out over time. But what I'm most excited about is that after years of shouting from the rooftops that veterinarian should be raising the prices faster, we are finally starting to see it in our data. This is very good news, most notably for veterinarians and their staff but also for Trupanion. I'll elaborate. Over the course of the past year, we've been monitoring veterinary inflation at an extremely granular level. Earlier in the year, we highlighted a return to pre-pandemic frequency or the number of veterinary visits per pet for accident and illness. In the past month or…

Thank you, Darryl and good afternoon, everyone. I want to take a moment to elaborate on Darryl's commentary around why our trusted partnership with veterinarians is critical to the opportunity we have in this large underpenetrated market. There are times when something happens in the world that exacerbates the problem we, Trupanion, are trying to solve. And we faced an even greater duty to step in and make a difference. Today's inflationary environment with mounting economic uncertainty and increasing pressure on our veterinary partners is one of those times. We partner with veterinarians to ensure that pet parents are able to provide for their pets unexpected care. Today, those trusted stewards of veterinary teams are struggling more than ever before, burdened with the rising cost of care, overweight, tired and stressed, veterinarians have been pushed the point of burnout. Couple this with a backdrop of rising inflation and the fact that today, the majority of pet owners cannot afford more than $1,400 in unexpected veterinary costs. The threshold to economic use in Asia is that low. The rising cost of care will make it only more difficult for the average pet owner to budget for the unexpected and veterinarians still need to raise their prices. We're starting to see early signs of this increase come through in our data. But it's not enough. And we need to be prepared for this to be much higher. As Darryl noted, in the next 3 to 4 years, veterinarians are going to need to raise their prices in aggregate by 30% to 50%. A few pet owners can afford unbudgeted veterinary bills today, fewer will be able to in the future. With this as a backdrop, let me take a moment to walk you through how our value proposition is more relevant than…

Thanks, Margi and good afternoon, everyone. Today, I'll share additional details around our Q2 performance as well as share some thoughts on how we're tracking against our annual goals. Total revenue for the quarter was $219.4 million, up 30% year-over-year, driven by strong pet additions and sustained high levels of retention in our subscription business, along with continued growth within our other business. Within our subscription business segment, revenue was $145.8 million, up 21% over last year. In the quarter, the U.S. to Canadian foreign exchange rate had a larger than typical impact. On a constant currency basis, subscription revenue would have been $147.3 million. Total enrolled subscription pets increased 20% year-over-year to over 770,000 pets. Average monthly retention which is calculated on a trailing 12-month basis, was 98.74% equating to an average life of 79 months. This is compared to 98.72% or an average life of 78 months in the prior year period. Monthly average revenue per pet was $64.26, an increase of 0.9% year-over-year. On a constant currency basis, monthly average revenue per pet increased 1.8% year-over-year and continues to be impacted by the mix of business dynamics that we've previously discussed. Our loss ratio expanded 170 basis points from the prior quarter to 72.8%. While some level of variability is expected, this move is larger than typical and the result of 3 factors all occurring in the same quarter. I'll explain. First, frequency was the largest driver of the increase in our loss ratio, as we've discussed at the shareholder meeting. Secondly, elaborating on Darryl's point regarding timing, we had higher claims processing costs as we continued to staff up for business expansion that will yield cost efficiencies in the back half of the year as we bring on new business. And finally, at the end of…

By the numbers, it was a mixed quarter for execution. As I've said before, execution is tough. But when I look at the thousands of public companies one can invest in during times of uncertainty and inflation and given current market sentiment, I believe our love affair with our 4-legged family members, our large and underpenetrated market, high retention and lifetime value of a pet make us stand out from the crowd. And with that, I'll open it up for questions.

[Operator Instructions] Our first question today is coming from John Barnidge of Piper Sandler.

I wanted to talk about the subscription loss ratio came in about 170 basis points above the target of 71%. And I know you talked about getting down to the 14% to 15% AOI margin for the fourth quarter. But I know, Drew, you had talked about some scale economies have maybe offset some of that elevation in the loss ratio. So I wanted to circle back to that target. Are you expecting to exit 4Q ‘22 close to 71% again?

Yes, we're expecting to get closer to 71% with additional cost action across fixed variable and loss adjustment expense to produce that 14% to 15% adjusted operating margin.

Okay. And then what was curbside versus a quarter ago in vet clinics, please?

Could you repeat that again?

Yes; so curbside only at vet clinics. I know that’s a dynamic that certain vet practices have decided to keep even in a post-pandemic world. Can you maybe talk about vet hospitals or clinics that you’re in that maybe have your software? What percent of those remained curbside only versus a year ago or a quarter ago?

John, this is Margi. So Curbside definitely is still -- we see it an evidence across hospitals across all of our markets. So obviously, it's more the exception than the rule, certainly than a year ago. And what hospitals have times have adapted their processes as we've seen from with patents to make sure their workflow now can bring in the introduction of the opportunity to talk about the high-quality medical insurance. We haven't seen an increase in the number of people leveraging curbside recently. What I will tell, you is our software, our vet portal, as we now have been referring to it is increasing. Our utilization rate throughout the quarter went up 20% year-over-year. So we're seeing more bets with not only taking the software adopting it, they're using it more often than they were before. And people are now getting back into the hospital so curbside is very much less of it, like I said, an exception as opposed to rules this at this stage.

Now, just one thing to add on that, John. Curbside is one thing that affected pet owners. And as Margi said, that's largely diminished. The bigger part for us is our territory partners. We're often not able to walk into the hospitals. And they're now able to walk through the doors and that's been a big benefit to the company.

And maybe one last question, if I can. Are you seeing any sign in the wake of inflation that insurers are choosing to maybe move from lower deductible, higher monthly ARPU to higher deductible lower monthly ARPU?

I can certainly start that and others want to add to it. We've actually been looking at our deductible trend as we always see across the board for everything on a very regular basis. Our deductibles have actually been trending down. We've seen that coming through throughout the quarter, the back end of Q1 into Q2; so that means both on phone and web people are taking a lower deductible which is obviously contrary to the high deductible that you just questioned about there. So people are seeing the value. As we’ve said before that people are very value sensitive. And there is no difference across markets or different channels using our deductible point is coming down.

The next question is coming from Shweta Khajuria of Evercore ISI.

Okay. Let me try a couple, please. So what is the adjusted operating income growth rate guidance included in terms of the cost. So could you please break it down in terms of your expectations, whether it is investments, loss ratio, et cetera? Just a little bit more? And then the second question is, how should, we think about the contribution from the lower-priced products in the back half of this year as well as contribution from Chewy partnership and other incremental growth channels.

Sure. I'll start on the first question and then hand off the second one. But the guidance on adjusted operating margin includes action across the board. We're going to have to -- our loss adjustment expense will have to come down. We’ll get additional scale on fixed and some work in variable as well as taking pricing action on the revenue side to produce – get back towards our target loss ratio. And that’s embedded in the 14% to 15%.

Okay. And then the second question, so it's Margi. In terms of contribution from lower class products in the second half, so PHI and the products that we have in market right now that have been everything we've expressed before, been pretty disappointed with the overall progress of those products in general. We have changed our overall positioning in terms of having 2 general managers that now are responsible for having that growth. We don't anticipate a significant impact from them in the back half of the year. What I will say Chewy and Aflac they've launched a market where we're very happy with the overall -- the early stages of that. There are 2 products that were -- very honored and I think Darryl touched on this in his prepared remarks. We're humbled by the fact that we've got the trust of these 2 brands to be able to partner with Trupanion. We don't anticipate seeing anything more than single-digit growth in the back half of the year with these 2 products. As a reminder, as the monthly subscription revenue product, we're not going to see the bulk of that impact coming through as we just start to get those rolled out early stages. But we do anticipate seeing some impact, albeit minimal in Q3 and Q4.

The next question is coming from Josh Shanker of Bank of America.

So during the Annual Shareholders Meeting, you threw out a statistic in about May installation 352 software installs in May. I don't think you want to go updating that number every month. But maybe we can talk about whether that sort of trend is continuing, whether that was a blip or not? And what’s happened – you mentioned briefly in one of the questions. But what’s going on in terms of face-to-face interactions? How is that trending with the territory partners in the veterinarian clinics?

Yes. So you're right, Josh. We won't go into details about how that number, that 352 has continuing to scale. But I can tell you it continues on that same trajectory. So we've been very happy to have that visits back at the levels that we were seeing back in 2019. We have more people in the field than we ever have had before. And they can now walk in the doors of hospitals and rekindle those relationships so we have face to face. But we're seeing a result of that not only, as more people adopting the use of our software, using it on a regular basis. We're also seeing an increase in leads volume and paying that veterinarian directly at the time of checkout which we know resolves a lot of the problems, as we referred to in our prepared remarks. When we think about a face-to-face interaction, what that does is it just reinforces the need for high-quality medical insurance and just reinforces how we can be there at the time of need, whether it's boost on the ground locally which has helped to understand that market. That information helps to inform our pricing team. It also helps to drive our higher lead volume which in turn has a high conversion rate which means we have a more efficient PAC. So that's why we'll start to kind of really come together nicely. So we're very happy with the fact that we've been able to get back into the hospitals. That trend started at the back end of Q1 has been maintained through Q2. And we continue to see that happening in Q3 as well.

Yes. And I'll just add that with the -- all of the general talk of inflation for non-veteran and being even more acute in the veterinary space and us seeing that in some of the numbers, it gives real strong talking points for our territory partners, creates a level of urgency and having them walk through the door that has been great for the business and super happy to have them back in the field.

And then if I look at the Investor Relations on customer acquisition cost at 31% getting close to your lower bound of 30% which suggests maybe the efficacy of customer acquisition spend is weakening? Look, the growth is great in terms of subscription pets. But do we get to a point – are we at that point maybe where some of the ad spend doesn’t make as much sense some of the marketing spend because you just can’t get that 30% return?

So IRR, we got it or between 30% and 40% and that doesn't change quarter-over-quarter. So we were at 31% as you commented. And when we think about the impact of that, we still margin compression through the quarter. So what we were doing is we saw that coming through the team for reacting they're communicating with each other and adjusting their spend profile. So it did put pressure on it and bring it closer to the 30% mark. Overall, though, when we look at our channels and the efficacy, it’s strong as ever. The volume is strong, conversion rates are high. So we don’t have any concerns there.

The next question is coming from Katie Saki of Autonomous Research.

Inflation is rising and your ARPU isn't growing much sequentially. So can you just walk us through why you think you'll get back to a 71% loss ratio?

Yes. Katie, this is Tricia. I can talk about this one. I mean at a high level, what ARPU shows up on our consolidated financials is an output. And it's an output of pricing to as close as we can to that value proposition, that 71% like you mentioned. Now day-to-day and I talked about this at a geography level at the shareholder meeting. We are constantly looking at the data at a granular level, geo, neighborhood, breed, Asia enrollment and updating pricing very frequently. We have many regions and neighborhoods that were pricing that are receiving increases in the 5% to 10% range, some higher than that. Now we have some regions where we actually are running below our loss ratio target. And so we've been decreasing those prices. So the ARPU that you see on our financials is the blend of that. And where we're really targeting is to hit the target of 71%. And then as Drew mentioned, have that flow through then to getting us filter to our 15%. Now based on the data that we see, we are increasing the prices in more areas than we were 6 months ago to keep up with these rising costs, not only the frequency of that invoices but now, as Darryl mentioned, in some areas, not all. But in some areas, we are seeing average invoice size start to go up more than we have in the past. So the key for us is we'll never be absolutely perfect. But we are looking at this at a very granular level, more multiple times a month. We have pricing action going through at all times, about 1/2 of our book every single month sees price changes at a granular level to get them close to or pursue our value proposition. So we have pricing that is going through currently. And then we're looking at additional filings to reflect the inflationary period that we're seeing as well to get us closer. And we feel -- we've been doing this for a long time. And so we feel confident while timing may move around that we can absolutely get close back on track to our value prop.

As a follow-up, with inflation running, say, 8% to 12% in the vet channel, can you give us an idea of what Trupanion’s rate increases are looking like today on like a nationwide headline rate?

Well, I mean, at a macro level, we're seeing in the first half of the year, our ARPU is going up 1.4% and our claims per pet is going up 1.5%. So we've been doing -- while there's some timing variation between quarters, we've been doing a good job of keeping that up, although we need to make up about a 1% delta. Now in general, when we're filing the rate increases, as I said, the vast majority of our book is seeing rate increases between 5% and 10%. It's just offset on a blended basis with certain regions and breeds that were decreasing prices. So that's where you get the blend. But when we peel back the onion and look at it, we're, we are putting through larger rate increases that you would expect in many areas. I'll also say that some of the rate action that we've taken over the past 2 years to decrease prices in certain regions to get closer to our value proposition. We are at the tail end of that. So really think about it a little bit more as a reset to being closer to our target which is the right thing to do. And as we mentioned, being closer to our target have enabled those regions to grow faster because it's a better value proposition as well. But you'll see -- now that what goes through in the future; doesn't most likely would not, reflect so many rate decreases as opposed to keeping up with inflation more on a vent-blended basis. But I would add. It really is important to look at these various metrics, because as we add more products into the mix as certain geographies grow faster or slower, you’re going to see more of a blended ARPU. If we start growing faster in products that have a lower ARPU hypothetically, that would impact our overall blended ARPU as well. So mix of business is key here as well Dell.

Yes. And Katie, I mentioned in my opening remarks, I mean, our blended ARPU is an output. It will be what it will be. We hope that workplace and a bunch of other places really can start to make an impact in the back half of the year. Some of these were expecting that lower ARPU. So on a blended basis; you may see that it's not tracking what you might otherwise expect with these inflationary comments. What matters is to look at our adjusted operating margin and that's our ability to execute. And then in our comments on here, we’re expecting to see some margin expansion in the back half of the year. And if we execute well, that’s what you’ll see.

Our next question today is coming from Maria Ripps of Canaccord.

If we are indeed going to see 10% to 15% increase per year in like-for-like cost of vet care over the next 3 or 5 years, I think you said. And that obviously compounds over the years. How do you think about your capacity to increase prices for your members without impacting retention?

Well, we've been doing this for over 20 years, Maria. And we know and we've been tracking in our shareholder letter. If we're seeing rate increases in the 10% to 15%, our retention rates and conversion rates remain the same. When we see it over 20% year-over-year, we see it degrade slightly. When I said it's going to be 10% to 15%, that's what I'm hoping the veterinary community will do so that they can pay their employees and the veterinarians appropriately compared to other medical professional. I'm not guaranteeing it's going to happen. But we certainly hope that they will. And we know that members can afford to pay for that care when it's budgeted and broken into monthly payments. And we have no concerns with it and excited to see if it happens.

That's very helpful. And then secondly, on your recently announced partnership with ezyVet, could you maybe provide some additional context on how this offering is different from the core software integration? And I guess what other hang is being addressed by these partnerships so that thousands of additional hospitals are now able to integrate the software?

Maria, this is Margi. So the partnership with ezyVet is essentially a full integration within their overall platform within the practice management system. So what that does is many folks migrated to ezyVet a couple of years ago that had been working with Trupanion historically. And we didn't have that full integration embedded. And now we do have. So we have access to hospitals we've historically worked with. We do have quite a lot of members to Trupanion members as well as those that have on-boarded with the cloud-based software that ezyVet is. So it gives us access to hospitals that have partnered with us for a long time and some of them are very large and some are new. So when we think about our practice management approach and how our penetration rates are increasing across the North American market, ezyVet is one that really gives us access to an awful lot of hospitals. So it just enables us to be able to pay the pay directly and really solve that problem and very much with the veterinary profession that we can offer them a solution that they didn't otherwise have if they had ezyVet previously. So it just reinvigorated those hospitals that are already supportive of us.

Our next question is coming from Jon Block of Stifel.

Maybe just 2 for me. Just first on sort of sort on the gross adds. I just want to look back the past 6 quarters or so, it looks like the gross adds trend line has somewhat flattened out, 55,000 to 58,000 give or take, for 2021 normalized for a quarter and then to 61,000 in the first half of '22. So Darryl, there's sort of that anecdotal chatter that pet adoptions might be starting to subside from, call it, pandemic highs? I think a good amount, maybe 70% or 80% of your, gross adds come from puppies or kittens. Just want to love your thoughts on that. And more importantly, that trend line going forward, I think as a growth company, people really have that inflecting in '23-'24. So how do we think about that gross add trend line going forward, while arguably adhering to your 30% to 40% Investor Relations?

Jon, I think when I looked at; we're a monthly recurring revenue business. And if I think about our total subscription pets which is how we get our revenue, if I look at it over a period of time, '17, '18 and '19, our growth rates were about 15%. In 2020, it grew to 17%. And then '21 and '22, it's going to be between 21% and 22% and total subscription pets. Now with monthly recurring revenue, sometimes you're accelerating new faster, sometimes retention is faster or slower. But when I look out and go into '23, '24, '25 for the company, we not only have the strong growth that will be driven by the veterinary inflation and our territory partners walking through the door. In our 60-month plan, we talked about these additional channels that are coming online, a couple that launched last quarter and will start to make an impact in Q3 and Q4. I'm really excited about the work we're doing internationally that we expect will start to take hold in '23 and '24 as well. So as a company, when I look at it, I look at the total subscription pass. But really, I monitor by year-over-year increase in adjusted operating income. And can we compound that? Now as I've said before, our goal is to grow that 25% a year for each year in our 60-month plan which started in '21 and will end at the end in '25. In the first year, in '21, we grew that greater than 25%. We were over 30%. As Drew mentioned, we think our adjusted operating income which is the closest proximity to intrinsic value will probably not hit our growth target. It will be probably 15% to 20%. But we do think that as a goal internally as a company, 25% will be the goal we'll be setting in '23, '24 and '25. And we'll see how we do. I mean some years, we might grow faster. I've mentioned in my shareholder letters, anytime we're growing 20% to 25% as a shareholder, I'll be thrilled. I'm happy there. If it's over 25%, I'm ecstatic doing backflips. And I think we’ve got a lot of things in the pipeline and a lot of things that have been flow. So I’m super encouraged about the future.

Can I add as well to that, Jon, just in terms of the future. Just when we think about the vet traffic specifically and what we've been able to do, we're coming off the back of a tough comp year-over-year with the overall pet count. But to Darryl's point, we've seen things moving in a very positive direction from an overall trend for both retention and acquisition, being back in the hospital being able to offer some very high-quality products through the vet channel having a territory partner side there. This is a market that we trust impressively, the partnership with the veterinarians being able to offer them unrivaled levels of support and service, so, the time when they absolutely need it to be pushing the strength that we've been talking about from an inflationary perspective. I am very confident in the numbers that we're seeing coming through in the early stages of Q3 and the back end of Q2, that means that the vet channel traffic which is our real driver of the growth that we see both from a retention and acquisition perspective is looking very strong and fine all than ever.

And then just a second question, maybe a little long. And it's going to end with more of your opinion on something, Darryl. But ARPU is up 1%-ish year-over-year, so modest, well below the rate of inflation which I think you said is now 8% to 12% in the veterinary world. Just try to catch up on that on the pricing I get it. But you said hey, look, there’s not a direct walk across to ARPU because there’s a million moving parts and part of that is mix. So I just want to be clear because I’ve been confused in the past. I think what you were saying, Darryl, when you were giving examples is that the newer pets coming on, maybe puppies or kittens or alternative channels, those are lower ARPU pets. The ones that are coming on are call it, below corporate ARPU. Let me sort of pause there. Is that correct?

Well, there's 2 things I want to just correct, Jon. So I said there's 8% to 12% increases in some of the veterinarian hospitals, not all. So we are starting to see larger -- and that's not on invoices paid, that's on total invoices. So that's the first place we look for inflation is of all the invoices we're seeing our veterinarians taking larger price. Historically, for the last 20 years, that's been about 5% to 6% for insured clients with Trupanion the total invoice dollars are going up 5% to 6%. There was a question earlier today saying, as deductible has gone up. They haven't. They've actually been going down. But if deductibles were going up, that would change your cost of claims and then what we're charging as well. So the blended business really is an impact. It is often true that we are largely enrolling under pet. That has been the same for year after year. But if we take a city, for example and let's say, in a city, we were -- had 2 -- we cut the city in half. And half the city, we are running at an 80% loss ratio and the other half of the city, we were running at a 60% loss ratio. But in general, we had 70% on average. What has been happening before is we would have been growing faster where there was an 80% and slower when there was a 60% than if we made them both 71%. And so you've seen accelerated growth in the lower price one, the lower priced neighborhood and you see a slowdown in the higher price neighborhood in comparison to what you were doing beforehand. Now, Progressive is a company that an insurance that was more accurately pricing risk than other…

Okay. Maybe I'll follow up offline. But just more of the opinion one was Darryl. Just at a high level, when you're running that internal rate of return, why is that dictated by the ARPU of the entire subscription base rather than the cohort that you're bringing on in the current quarter? In other words, you’re doing the PAC dollars, right? But the internal rates were returned or predicated on, is that a cohort that is a $50 ARPU, bringing on the books or 75%. Why has it always run over the entire 770,000 pets that are already on the books? And hoping that make sense, if not we could take it off-line but I just wanted to throw that out there from more an opinion standpoint.

Yes. Well, the IRR is actually not driven by ARPU. It's driven by the adjusted operating income or margin. So you take the adjusted operating income and you multiply it by the number of months that gives you the stream of cash flow. And then you say, how much are you spending? What we use on calculating it is what is, our blended adjusted operating income, for all of our pets when we report it. But in aggregate, when we’re behind the scenes, we are spending much less for a cat than we are in a dog. And the way that we calculate the internal rate of return does not assume that we’re going to have larger adjusted operating income 2, 3, 4, 5 years in advance. So it’s actually conservative and understated, assuming that on average, the adjusted operating income is going to go up over time. But that’s how we – that’s how we run it. And if you have further questions, we can jump on it off-line.

And Jon also when we set that up, I mean, it's important that people can replicate our numbers. And so it was set up. So you could take our financials and back into that without having to know new ARPU. So another reason is set up that way.

Yes, I get the transparency. I just want to know if you’re spending the $300 pet to bring on $50 cohorts or $70 cohorts. I think that’s ultimately what matters. But I get it in terms of, I guess, investors being able to run it, all good, I’ll follow-up.

The next question is coming from Elliot Wilbur of Raymond James.

This may have been asked earlier. I might have just missed it. But just want to get your general sense of trends in ARPU and what the impact would be on churn? And more specifically thinking about the 2 buckets kind of, I guess, at each end, bucket where historically, you've not had experienced price increases which I think about 25% of your book and then smaller bucket where you -- where there's been in excess of 20% price increases. Curious as to whether or not you think that change in either of those buckets could have a more outsized impact given that we’re obviously looking at sort of much higher overall rates of inflation?

Yes, Elliot. It's a good point for people that haven't read the shareholder letter. But we report year after year about where our churn comes from and how it goes through. I'm not sure that how you articulated it exactly accurate. So we have largely 3 buckets that we report on. Those are new pets. And those new pets have not yet ever had a rate change. That's actually our lowest retention. So we have the highest churn there. Those are people kicking tires, people pet sign on and their dog was currently sick and they were disappointed we didn't cover pre-existing conditions. It could be people that we're going to get a spare, neutral or regular wellness and were confused on what our coverage was. That's in that first bucket. That is our highest churn level. The second bucket is where the majority of our pets are. And they're seeing rate changes that are less than 20% a year. And it could be -- the rates are going down, so they're going up 19%. That is our highest retention. And then we also have a bucket where people are seeing rate changes greater than 20%. That's the medium bucket of churn for us. And what you'll see over time is that third bucket will become a smaller percentage, unless veterinarians start to increase their rates, not what I'm hoping 10% to 15% but if they were to increase at 25% year-over-year. But as long as it's under 20%, you can look at historically how we -- what our churn rates have been. And I can tell you, we are at all-time retention right now that we reported on 98.74% I believe. And our conversion rates are slightly up. Referral and Adapet is also our record numbers of growth. So once again, we don't see the customers that we attract as being price-sensitive but they are certainly value sensitive. And in times of uncertainty of high inflation, the need for our product is greater than ever.

And I wanted to ask a question on the PAC number in the quarter and trends in PAC. Maybe just possible to give a little bit more, granularity on what's driving that. And I think you've provided some detail in the past and given us a rough split between allocation between lead generation and conversions and more dollars going to conversions over time. Wondering if the relative rate increase in those 2 categories is essentially equal or you’re seeing the cost of conversion go up at a higher rate than lead generation but maybe just a little bit more insight into the increase in the PAC number this period?

Yes, this is Margi. So when we think about PAC general, if we look at it over the last few quarters, it's been relatively flat. So in Q4 of '21, it was 3.06%, Q1 is 3.01% Q2 was at 3.09%. So when you think about that overall, there's really very little movement between the quarters. As we mentioned before, the real kind of guiding like for us is the guide of internal of returns. They've been between 30% and 40% at any given point in time. Our overall split between the convert and retention. So we do have an element of retention which is that first year, sort of the, dilutes now or the kind of reinforcement of the value proposition just after purchase. It all goes into PAC. This is a fully loaded cost, as a reminder, this is everybody that works within our acquisition space. And that lead didn't convert. But it hasn't really shifted significantly if there has by a couple of points. We're constantly looking at how do, we make sure that we are just as we do from a pricing perspective, we are focused on the right message at the right time with the right combination of different attribution points. So there's, a number of different elements to a journey that will pull someone through the funnel. So if you've got a vet lead, for example, we're going to see the overall lead cost is going to be the bulk of that. The conversion is very simple. It's very straightforward. It's a much cleaner lead for us because it's a stronger referral upfront. Similar with referred upfront but then you have different regions will have different mixes. So in general, it hasn't changed. They're all being as efficient as we would want them to be in various spaces. And we'll push hard on certain areas and we want on others. And like, we said, when we talked about internal rates of return specifically for this quarter, we really saw that pressure coming through from a margin compression point of view. And we want to make sure that we're always adhering to -- which is where you see that looking like it's kind of towards a 31% as opposed to the midpoint. But PAC in general, just really isn't moving a great deal over the last 3 quarters, as I mentioned. So the teams continue to invest at similar sort of levels between need and convert and we haven't seen a shift as well, particularly.

And then last question for Drew. Did you mention the uptick in the severity of claims; was that just within sort of the realm of the ranges that you see historically anything specific in terms of territory or what may have driven that this period that sort of led you to call that out?

Yes. As I mentioned, at the shareholder meeting, I talked about movements we're seeing in the loss ratio with frequency being the big driver coming out of COVID and then the change in loss adjustment expense. So those 2 were about 130 basis points of our move. So 40 basis points was that, we were pricing for inflation and it’s the acceleration that we saw really in the back half of June that was that extra 40 basis points. So that is the other part that we picked up. Now luckily, we were able to take action in the quarter and mitigate about 60 basis points of that move but that uptick in severity that I talked about. And it’s not in any specific region. It’s across the board.

Ladies and gentlemen, that's all the time we have today for questions. We would like to thank you for your participation and interest in today's Trupanion event. You may disconnect your lines and walk off the webcast and enjoy the rest of your evening.