Root (NASDAQ: ROOT) stock is up some 100% yesterday and postmarket as a rumour emerges of a bid for the car insurer. That the rumoured bid is well in advance of the starting stock price - a premium of well over 300% in fact - is in itself interesting. But then when we add in the 20% of market capitalisation short position the bounced in the ROOT stock price becomes clear. Even a rumour will do this if those shorts then have to scramble to cover their short positions.
The background here is that Root is one of a series of new insurance companies that came to market a few years back. The claim was that AI - by which back then they meant just better analysis of the market, not ChatGPT-style stuff - would enable greater segmentation of the market. It would be possible to be more selective about the customer base - more information would allow better slicing and dicing of who was a good risk and who would not. Of course all car insurers have done this, always, rates for under 21, for men and women, for those with bad driving records, do vary. But the claim was that better technology would do this better.
As it turned out it didn't. Claims rates actually rose at these new insurers. Which, rather, you know, damaged their financials. As to why, one common thesis is that while better knowledge could lead to better underwriting the dash for growth meant that greater risk was taken anyway.
Root stock price from NASDAQ
There is another issue here too - inflation. A number of insurers have been caught out by this. Car insurance largely resolves itself within the one year- premiums are paid this year, crashes happen this year, claims are paid out this year. But when inflation is 12% - and it was much worse than that for some car parts - then premiums set at the beginning of the year won't cover claims at the end of it. Underwriting losses have risen substantially recently. So, there's a cyclical as well as structural aspect to the current underperformance.
The Wall Street Journal then reports: “Closely held Embedded Insurance, run by insurance-technology entrepreneur James Hall, has made multiple approaches and offered to acquire Carvana -backed Root for $19.34 a share, the people said. That would be a significant premium to Root's closing price Tuesday of $6.02,” Yep, that'll do it. When there's a short position of some 20%, add in a bid - a possible bid - at that sort of premium then yes, the stock will soar.
Depending on how many of those shorts feel they've got to take their losses and run we could in fact see ROOT stock rise above that potential bid price today and tomorrow. But be aware that any position here is a speculation.
