2020 has been a very active year for initial public offerings, or IPOs. Berkshire Hathaway (BRK.A -0.28%) (BRK.B -0.68%) even put some money to work in a new issue for the first time ever when Snowflake (NYSE: SNOW) went public a few months ago.
There's another recent IPO that could make a lot of sense in Berkshire's portfolio: insurance tech company Lemonade (LMND -0.46%). Here's why Warren Buffett and his team should take a closer look at this exciting and innovative company while it's still a relatively small business.
Image source: The Motley Fool.
Insurance 2.0
Lemonade aims to leverage artificial intelligence and other technologies to make selling insurance quicker, easier, and more affordable for the customer, while also making the process efficient and profitable for the company. Customers can get an insurance quote in just a few seconds. Early reviews indicate that the claims and application processes are both quick and easy.
Most insurance companies collect premiums, invest the money they collect in the meantime, and then use it to pay out claims. Anything left over is known as an underwriting profit. Lemonade has a different approach. It takes 75% of the premiums collected to purchase reinsurance policies that will cover claims, essentially taking the unpredictable nature of insurance out of the equation. Whatever isn't used toward reinsurance or claims is donated to charity ($1.13 million donated in 2020 -- an aspect of the business Buffett would likely love). Lemonade keeps the remaining 25% to pay expenses and hopefully generate a profit.
Lemonade currently focuses on homeowners, renters, and pet insurance, but these coverage types might just be the beginning. Most of Lemonade's customers are new to insurance, and 70% are under 35. Since nearly everyone needs either homeowners or renters insurance every year, the company is building a base of lifelong customers who could eventually be sold other types of insurance through the platform.
Growth has been very impressive so far. Lemonade's customer count increased by 84% year over year in the second quarter, and the company is now making 17% more on a per-customer basis than it was a year ago. The company's loss ratio has improved dramatically and should continue to do so as the business scales.
Why Lemonade could be a good fit for Buffett
We all know that Buffett loves the insurance business. Berkshire already owns GEICO and a massive reinsurance operation, so an investment (or even an acquisition of) Lemonade could fit nicely into the portfolio and potentially create some opportunities to share technology and for Lemonade to get favorable reinsurance policies.
Insurance is a $5 trillion industry that's just begging to be disrupted. The process of buying insurance hasn't changed much in decades. As the first and most successful tech-focused insurance company, Lemonade is developing technology that could turn into a durable competitive advantage.
Would Buffett actually consider Lemonade for Berkshire's portfolio?
To be perfectly clear, we have no reason to suspect that Berkshire Hathaway (or Warren Buffett himself) has been or is planning to buy shares of Lemonade. There are certainly some aspects of Lemonade's business that Buffett probably won't like. The company isn't yet profitable, it trades at a sky-high valuation, and its business is still in the very early stages of growth -- all qualities Buffett tends to avoid.
However, Berkshire and Buffett's stock-picking investment managers have started to take more of a tech-oriented focus, and Lemonade could be an excellent way to incorporate Buffett's favorite business into their strategy.
