Lemonade is a fast-going property and casualty insurer. Their strategy is to target next generation customers with limited insurance needs today, delight them and then expand their insurance services as their insurance needs grow for nearly no incremental cost.
For example, Lemonade targets low premium and low acquisition cost renter’s insurance. These individuals tend to go on and purchase houses or condos. Along with a move from the city to suburbia, they may need an auto policy. A spouse may be concerned about paying off the mortgage, how about term life.
So how well is Lemonade executing on their strategy?
1. Acquire Next Generation Customers
The earliest data I have found on Lemonade is from their S-1 filing. At the end of 2018 they had 308k customers and as of Q1 2022 they have grown to an impressive 1.5 million customers. In a now dated blogpost by Lemonade, they indicated that 81% of customers were 25-44.
For me, the 70% CAGR over the 3.25 years in customers and demographic concentration suggests they are executing on this strategy.
2. Delight Customers *Jeff Bezos enters the chat*
I have basically not seen a bad thing about Lemonade’s platform. Take a look:
https://www.usnews.com/insurance/homeowners-insurance/lemonade
https://apps.apple.com/us/app/lemonade-insurance/id1055653645
https://play.google.com/store/apps/details?id=com.lemonadeinc.lemonade&hl=en_US&gl=US
In addition Lemonade made a splash in 2016 by winning a Guinness World Record by paying the fastest claim in histroy. https://www.lemonade.com/blog/lemonade-sets-new-world-record/
Most insurance companies go for the switch and save angle. Lemonade says come to us and we will give you super-fast service.
Awards and ratings are great, but the proof of delight is really in the last step.
3. Expand Insurance Products as Insurance Needs Grow
For me the best metric if customers are growing with Lemonade is simply premium per customer. This has been a torrid 24% per year moving from $145 to $279 over the past 3.25 years.
As of Q2, Lemonade has renter’s, condo, homeowners, auto, pet and life policies but not all policies are available in all states as they file the regulatory documents to open up shop. So far we have one full quarter of all policies available to all customers. Per the Q1 letter, “After only one complete quarter, we saw 40% higher bundle rates in Illinois versus the rest of the Lemonade market in the US.” In addition, 2 product customers spend 3:1 vs one product customers. 3 product is 7:1 and 4 product is 9:1.
For this leg of their strategy the jury is still out as customers haven’t had the opportunity to bundle. For example, they don’t offer auto insurance in my area, so I don’t use them. If you believe they are delighting customers in step 2, then step 3 should take care of itself as their product line matures.
Other Notes
In order to expand their newly launched auto policy and enable bundling in more states faster, Lemonade is closing its acquisition of Metro Mile later this year. In their most recent update they had 101,294 auto policies with annualized premiums of $116 million. More importantly this all stock deal give Lemonade access to Metro Mile’s ~$100 million cash hoard. Metro Mile currently sells for ~$133 million and has no debt on their balance sheet.
More on the deal here: https://s24.q4cdn.com/139015699/files/doc_financials/2021/q3/Lemonade-x-Metromile-Investor-Presentation.pdf
The Complicated Bit
As a young insurer, Lemonade is pitching that their ability to use artificial intelligence and machine learning to provide better pricing and lower cost services through automation. Right now Lemonade uses reinsurers and cedes their premiums to them at a 75/25 split. The reinsurer gets 75% of the premium and pays 75% of the claims, Lemonade keeps 25% of the premium and takes 25% of the risk of the policies underwritten. Lemonade is also responsible for handling all operational needs. This complicates their financials as GAAP accounting does not allow Lemonade to count the 75% of premium paid as Revenue. To that end, Lemonade tracks Gross Earned Premium which is the premium paid during a period before revenue is sent to the reinsurer.
I believe this is not the long-term plan of Lemonade and they are wise to use a reinsurer at this stage of their business. Since they are offloading 75% of the risk, they do not need to hold as much capital on their balance sheet as if they collected the whole premium. This allows them to invest more in their product and advertising. In addition, as a smaller insurer they are geographically more concentrated (to Texas and California) this means they will have more volatile results than a larger player. As they add more lines and more customers, the benefit the reinsurers provide will likely decrease. Additionally, as a fast-growing company, they are currently far from profitable but have a cash hoard of ~$1 billion to draw on.
A major part of their growth is due to their outsized sales and marketing budget. In 2021 they spent $134 million on marketing and sales with revenue of $128 million, yikes! Obviously, as they grow their ad budget will decline as a percentage of sales and perhaps in aggregate.
As mentioned previously, their premium per customer is $279. Progressive premium per customer is about $2,000 for their personal lines. Should Lemonade execute on their plan of getting customers to upgrade that is a significant amount of new premium with almost no incremental cost.
So what is the advantage of Lemonade?
For me the Artificial Intelligence and machine learning is likely to be replicated by major insurers and not a source of competitive advantage. To me the main advantage is Lemonade sells 100% of their insurance direct to consumer through one of their AI chat bots. The legacy insurance industry relies on a network of agents taking commissions and adding cost to the process. For this reason, should Lemonade execute and achieve scale, I believe they have the potential to be the low-cost provider by avoiding costs that legacy providers base their sales structure on. A similar example is Tesla sells cars at retail prices direct to consumer whereas legacy auto sells cars to dealers at wholesale prices.
In the 1950s Buffett invested in GEICO because he knew insurance was a product everyone needed and didn’t want to pay for. Most insurance companies of the day relied on agents to sell policies and they still do, GEICO sent out mailers. GEICO sent a mailer, an interested customers would fill out the form and mail it back, GEICO would send them a policy, sign send a check and boom, insurance coverage. They could undercut by doing things through the mail. Lower prices gave them scale and the ability to gobble up market share.
I see the same potential with Lemonade as they don’t have any of these legacy agent costs. Currently Lemonade offers 2,500 policies per employee. The next best ratio in the industry is State Farm at 1,200. https://www.lemonade.com/blog/two-years-transparency/
What do the critics say?
I have heard both that Lemonade’s use of AI is risky because its new and that the big boys can use AI better than Lemonade can. To that I say, how can both complaints exist and I don’t think that is the advantage. It is sexy marketing though.
Lemonade is unprofitable and bleeding aggressively. Sooner or later insurers need to be sound. I agree, pathway to profitability will be tough, probably no earlier than 3 or 5 years out!
Final Thoughts
There is a lot of uncertainty in Lemonade in terms of making formal projections given the timing of regulatory approvals the many lines and concentration of their business. Having said that, insurance is a pretty steady business though all phases of the economic cycle. When Lemonade was at ~$165 management wisely issued shares to cement their balance sheet for the foreseeable future. They are not likely to need cash for the next few years should this market continue down.
With the stock in the low $20s, a market cap of $1.3 billion and cash of $1 billion, this Lemon may be ripe for a squeeze.
As always, do your own due diligence.
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