If the last decade was all about the cloud and advances in high-end computing, then the next decade will see many new businesses emerge making use of these new technologies -- with the COVID-19 crisis acting as a catalyst to speed up adoption among consumers. On the insurance front, Lemonade (NYSE:LMND) aims to be just such a company.
Lemonade is a fast-growing AI-enhanced insurance company, founded in 2015 and newly public as of July. But the growth story isn't the question here. It's about whether the company can reach a profitable scale before it runs out of cash. My bet is that the upstart will be successful.
A technologist through and through
Lemonade insures renters, homeowners, and more recently, pets in most of the U.S., and sells similar "contents and liability" insurance products in Germany and the Netherlands. The company has been growing fast as it both expands both the number of households it can serve and the products it has available. There are long-term plans to offer health insurance as well, and coverage will expand to France by the end of 2020.
At the end of the second quarter, Lemonade had just 815,000 customers, but that was an 87% increase over the same period last year. The insurance upstart can attribute its fast rise to artificial intelligence (read: automation). Instead of relying on a large sales force of agents, the company uses online bots (in the form of its AI assistant "Maya"), thus nearly eliminating paperwork and making everything from new customer signups to loss claims a quick and painless process.
Through the first half of 2020, Lemonade's gross earned insurance premiums collected from insured parties and adjusted gross profit were $65.8 million and $12.4 million, respectively, up 131% and 202% from a year ago. However, adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) losses totaled $40.6 million, compared to losses of $44.6 million last year.
Many investors will be turned off by all the red on the bottom line -- even after the stock has been cut nearly in half from its peak pricing in the weeks following its initial public offering (IPO). However, the AI model isn't just about picking up new customers. It's also helping Lemonade run a lean operation that may put it on a profitable path sooner rather than later.
Automation doing more than boosting growth
Most insurance companies run a profit by trying to limit the amount paid out in claims. Lemonade simplifies the process, though, by simply keeping 25% of premiums for itself and making the rest available for payouts. Anything left over after paying claims doesn't go back into Lemonade's coffers, but is instead distributed to nonprofits.
This has unique implications. Thanks to its AI algorithms that collect data and learn from its community of insured households, Lemonade's bottom line is primarily tied to how many customers it has (and the amount in premium each is paying), rather than its ability to control claims payouts. No games here, both for the insured and for shareholders. The real question, then, is this: How many customers (and premiums per customer, which stood at $190 in Q2 2020) does Lemonade need to start breaking even on the bottom line?
It remains to be seen, and this is the primary metric I'll be watching at Lemonade going forward. But in the meantime, the steep losses are manageable. Management predicted full-year adjusted EBITDA losses would total as much as $109 million. But as of June 30, there was $184 million in cash, equivalents, and investments on the books (when excluding the $112 million in restricted cash to pay for claims), and the IPO raised more than $300 million more in cash not counted in the last report. Put another way, even if Lemonade continues to operate at a loss similar to the 2020 run rate (it won't if it keeps adding new customers), it has at least a few years' worth of reserves on hand.
How many customers and premiums per customer it needs to turn the red ink into black is the main question in my mind for Lemonade. But given its current momentum, it may reach break-even within a couple of years -- and it isn't at risk of depleting its war chest anytime soon, given the current information.