Insurance is a multitrillion-dollar business that consumers need in nearly every aspect of life. Insurance technology company Lemonade's (NYSE:LMND) artificial intelligence-driven user interface brings a fresh take to the industry, but this rapidly growing stock carries high risks and rewards alike. Here are two reasons to be excited and two reasons to be concerned about Lemonade's prospects moving forward.
1. Exciting: Lemonade is reinventing insurance
We need insurance companies, but nobody actually likes dealing with them. Traditional insurance companies drag their customers through call centers, sales agents, and a combative claims process, because paying you hurts their bottom lines. As a result, insurers typically have low-single-digit net promoter scores, which measure how likely consumers are to recommend the brand to a friend or colleague.
Lemonade's direct-to-consumer model uses artificial intelligence-powered chatbots to handle consumer-facing tasks such as sales (chatbot Maya) and claims (chatbot Jim). Using Lemonade's mobile app, customers can buy a policy in as little as 90 seconds and file a claim in three minutes.
Lemonade takes a flat 25% fee from each premium, and after it pays out claims, it donates any leftover money to charity. In 2020 alone, Lemonade donated more than $1.1 million. Operating on a flat fee negates the company's incentive to deny claims, putting Lemonade and consumers on the same team. Lemonade's 47 net promoter score exceeds industry averages, and its mobile app has a 4.9-out-of-5 rating in the Apple app store, with more than 46,000 reviews.
2. Exciting: Rapid growth with room to run
Lemonade is expanding beyond renters and homeowners insurance to offer term life, pet, and automotive. Lemonade markets to young consumers, hoping to develop a relationship that blossoms as consumers age and need additional, more expensive insurances. Lemonade estimates that 70% of its customers are under 35, and its 2021 Q1 premium per customer grew 25% year over year to $229.
In-force premiums, which measure the gross value of premiums paid by Lemonade's customers, grew 89% year over year to $252 million in 2021 Q1. Lemonade now has 1.09 million customers, up 50% from Q1 of 2020.
The United States accounts for more than 80% of Lemonade's business, but the company has acquired the licensing to sell insurance in 31 countries across Europe. Lemonade currently operates in the US, Germany, the Netherlands, and France. According to the Global Insurance Industry Almanac report, Lemonade's in-force premiums represent a tiny piece of the nearly $6 trillion global insurance market.
3. Concerning: Financials are being squeezed
Lemonade spends 75% of its premiums on reinsurance, which is "insurance for the insurance company" that acts as a safety net to limit losses from claims. This creates a lower financial risk/reward for each policy that Lemonade rights, making profitability dependent on writing more policies (volume). Lemonade also spends a lot on marketing to acquire users, causing adjusted EBITDA losses of $97.9 million in 2020, more than its $94.4 million in total revenue.
Lemonade has a concentrated customer base, with 22.3% of its gross premiums written in Texas. In early 2021, the "Texas Freeze" winter storm caused Lemonade to pay out 121% of its 2021 Q1 premiums as claims, netting Q1 losses of $49 million. Lemonade could reduce the risk of these disasters by expanding in new markets.
Lemonade is still early in its efforts to grow its product offerings, and penetrate new markets, so investors might be waiting a while for Lemonade to reach profitability. Management is guiding 2021 revenues to grow 27% to $120 million, but expected EBITDA losses of $173 million to $163 million would again exceed revenues.
4. Concerning: Valuation is counting on everything "going right"
Lemonade's $6 billion market cap equates to a 50x price to sales ratio against management's 2021 guided revenue. While the company has the growth opportunities to justify this valuation over time, it still has yet to show a profit.
Lemonade currently has $1.1 billion in cash on hand, more than enough for the company's near-term needs. But if it continues to lose money as management has guided this year, investors could be looking at share offerings down the road.
Investors currently value Lemonade as an insurance disruptor, compared to traditional insurance companies like Allstate and Progressive that trade at roughly 1x price to sales. If the market deems Lemonade's business unsustainable, it could send the stock a lot lower.
A sweet or sour investment?
Lemonade's new approach to insurance is a great story with a lot of potential upside. Investors will want to keep an eye on Lemonade's premiums per customer, an indicator of how well customers are progressing to more lucrative insurance products.
Lemonade needs to show losses beginning to stabilize (and improve) while revenue and customer count continue to grow, which would all signify that Lemonade's business is sustainable. Progress here could make Lemonade a truly refreshing investment.