Insurance Provider Lemonade Offers Stock in IPO
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There aren’t many trillion-dollar industries, let alone multi-trillion-dollar industries. One of the biggest industries in the world, insurance – property, casualty, and life – premiums amount to approximately $5 trillion globally, accounting for 11% of gross domestic product in the United States. We previously discussed how technology is reshaping the insurance industry and today we’re going to look at an insurtech company doing just that – and they’re having an initial public offering (IPO). Most of the below information was taken from the Lemonade prospectus filed with the SEC (also called an S-1 filing).
Lemonade Home and Renter’s Insurance
Founded in 2015, New Yawk startup Lemonade has taken in $480 million in funding so far from big names like Sequoia, Allianz, SoftBank, and Google. That money was spent developing “a full-stack insurance company powered by AI and behavioral economics and driven by social good.” The term “full stack” means they’re vertically integrated, building their highly-automated “learns as it goes” insurance platform from the bottom up. For example, their claims chatbot can manage a third of all cases from beginning to end without any human involvement. They’re currently licensed in 40 states of the United States and operate in 28 of those states offering homeowner’s insurance and renter’s insurance.
AI-Powered Insurance for Millennials
Lemonade is targeting “the next generation of consumers, whom incumbents struggle to serve.” In other words, millennials. (Around 70% of their current customers are under the age of 35, and about 90% said they were not switching from another carrier.) The appeal to the younger consumer can be summarized as follows:
- Delightful experience
- Aligned values
- Great prices
Let’s look at each of these factors from the perspective of an investor who is focused on maximizing the profitability of their investment in Lemonade shares.
The user interface layer is where the “cocktail of delightful experiences” are most apparent – three minutes to get insured, three minutes to get a claim paid. Lemonade’s easy-to-use interface integrates throughout their entire technology stack since it was built from the ground up.
Such an interface would be expensive for traditional insurance companies to duplicate if they were to try and integrate chatbot technology into legacy back-office systems.
Regarding “aligned values,” Lemonade has a business model that includes something called Lemonade Giveback which is best explained as follows:
Lemonade takes a flat fee and treats the rest of the money as yours, not ours. We use it to pay claims, and give what’s left to charities you choose, so we never fight over the same coin.
(The flat fee is currently 25% of premiums.) This is so customers don’t think of Lemonade as some big bad insurance company, but as an altruistic friend. We’re not big on subsidizing the world’s problems, but their customers find this appealing, so that’s great. What we are concerned about is how these incentives align with shareholders’ interests. Giving away up to 40% of a premium to a charity seems excessive.
They should have set this cap lower initially, perhaps at 10%. Should they ever try to lower the 40% number in the future, everyone will complain about what a big bad greedy insurance company they are.
As for great prices, this is appealing only if we’re certain they’re not subsidizing their way into growth, but choosing the best people to insure based on predictive analytics (same way Root insures only good drivers or Health IQ only insures healthy people.) The first time some major disaster strikes, that’s when we’ll be able to tell if they priced the product accordingly. (More on this later.)
Customer Lifetime Value
Lemonade is also spending a great deal of money to acquire their customers. Selling insurance requires a lot of marketing because the domain is so competitive, and Lemonade spends $1 in marketing for every $2 in premium they receive. With all the stars aligned, they expect to earn back the cost of acquiring a customer in about two years. (Their retention rate is about 75%, not that high when compared to most SaaS business models which should see 90% or above.) Lemonade’s business model is all about getting people to come for renter’s insurance and stay for the homeowner’s insurance.
The average renter pays Lemonade nearly $150 per year, and that jumps to around $900 for owners of homes and condos. Lifetime value goes up when you start selling them additional insurance offerings such as auto, life, travel, or even pet insurance.
The proof is in the pudding. The below table shows some quarterly key metrics for Lemonade which show how their premium-per-customer is increasing over time for their 730,000 customers.
There are somewhere around 80 million millennials in the United States alone, so Lemonade has a large total addressable market (TAM) which they’ve captured less than 1% of so far. (For the sake of simplicity, we’ve ignored all the millennials still living with their parents.)
Big Insurance Data
As we’ve learned over the years, an AI algorithm is only as good as the big data you’re training it with. What Lemonade seems to lack is historical data. An insurance company like Chubb might have 30 or 40 years of data to analyze using predictive analytics. Lemonade has only been in operation for five years.
Lemonade talks about “leveraging our closed-loop system, by which copious amounts of data we generate make our business ever faster, cheaper, and more precise.” That may be the case, but looking only internally is limiting the opportunity. Could it be that their investor – Allianz, probably the largest insurance company in the world – is sharing the data needed to perfect their algos?
Plenty of other companies are using predictive analytics and data exhaust to optimize the insurance industry. We counted at least nine insurtech startups improving underwriting and ten startups using AI to solve problems in the insurance industry. The winning algorithms will be the ones with access to large clean proprietary data sets.
What Would an MBA Do?
We’ve been long-time shareholders in a few large insurance companies, Aflac and Chubb, the latter of which is the largest publicly traded property and casualty company in the world. They haven’t had any problems increasing our dividend checks for 27 years, and with a payout ratio of around 30%, we don’t see that trend ending. From our perspective, we’re more interested in how Lemonade presents a competitive threat to insurance companies like Chubb. It appears that Lemonade is simply removing new customers out of the equation instead of stealing them from other insurance companies. Chubb is likely keeping a watchful eye on them, and poring over the Lemonade prospectus as we type.
The appeal is clear. Lemonade is a great bolt-on acquisition for an insurance company looking to acquire 730,000 new millennials along with the tech platform to service them. Just be aware of the risks. For example, approximately 61% of Lemonade’s gross written premiums as of December 2019 originated from customers in California (25%), Texas (25%), and New York (14%). California has wildfires and earthquakes, Texas has hurricanes and tornados, New Yawk has people who think they’re living in the greatest city on earth, and pretty much everywhere in the USA there’s civil unrest right now. When disaster strikes, that’s when we’ll see how well Lemonade had built their business. (It’s worth noting that Lemonade has reinsurance protecting 75% of their business, but they’re still exposed with the remaining 25%.)
Lemonade talks about how their platform “continuously analyzes spectrometry imaging beamed from NASA’s satellites, identifying wildfires in real time and blocking ads and sales in the affected areas.” That’s great, but what happens when you’ve already sold policies in those areas? How long until the State of California says that you’re “discriminating” against whatever special class of people they’re purporting to represent? Location probably comes into play a lot when issuing renter’s insurance. So does income. How long until some armchair Twitter CEO decides to direct their moral outrage at Lemonade? There seems to plenty of uncertainty – in other words, risk – alongside the opportunity.
Conclusion
The basic idea of running a successful insurance company is that you collect premiums, invest that money in something that produces a profit without taking too much risk, and then pay out less in claims than what you collected in premiums. Accomplishing this in the short term is easy, in the longer term, harder.
It’s safe to assume that everyone who invested in Lemonade is now taking profits during this exit event. Retail investors eyeing Lemonade’s IPO need to decide if it makes sense to pick up the baton here. Lemonade is a new company that’s enjoyed success in building a list of youthful customers quickly, and now they need to show that they can do so profitably. We’re very risk-averse, so we’re sticking with companies like Chubb that have already shown they can.
Lemonade plans to raise $100 million in the proposed offering with shares to trade under the ticker LMND.
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