Insurance disruptor Lemonade (LMND 7.35%) hasn't exactly been a great performer recently, with shares down about 45% year to date. However, in this Fool Live video clip, recorded on Sept. 23, Fool.com contributor Trevor Jennewine discusses why he's still bullish on the company's long-term growth potential.
Trevor Jennewine: I'm going to start with Lemonade. For anybody that's not familiar with the company, Lemonade is a tech company that sells insurance. That sounds a little bit strange. Before I jump into what makes Lemonade different, I want to point out a few things about traditional insurance companies. Most of the big players in the industry were founded about 100 years ago or longer, and of course, they've made updates over time, but they still weren't built to capture the volume and variety of data that modern technology can produce.
For that reason, their businesses that are highly dependent on human workforces. For instance, agents and brokers help consumers buy insurance, actuaries set premium prices, and adjusters handle claims. Lemonade does things a little bit differently. Its digital platform was built for those types of data, and it relies on artificial intelligence to make its business more efficient in a number of different ways.
For instance, when you buy insurance or file claims, you interact with AI-powered chatbots, and this accomplishes two things. It removes friction from the onboarding process, or it creates what management calls the delightful digital experience. It also allows Lemonade to capture a lot of data. In fact, management believes its platform captures 100 times more data per customer than legacy systems. That includes all of the data points that you would capture with the traditional homeowners insurance application.
There are other types of data in there, too, for instance, how long do you spend looking at each individual question or do you answer them all very quickly? Do you linger on any particular one? Are you buying insurance in the middle of the night, or is it during the day? Are you buying insurance from a desktop or mobile device? Those data points may seem unrelated, but when you put them all together, Lemonade estimates the collect about 1,700 data points per person.
So when you put all those data points together, the idea is that a pattern will emerge over time and so Lemonade can correlate its datasets with the risk of a claims payment. Over time as Lemonade collects more of that data, its AI models become more intelligent, and the idea is that helps Lemonade quantify risks more precisely. That translates into better underwriting and fraud detection, ultimately meaning that Lemonade should pay out less on claims. The company should have a cost advantage.
To measure this, investors should pay attention to a metric called gross loss ratio. This is just the percentage of premiums that are paid out in claims. As it turns out, Lemonade's loss ratio has improved over time. Three years ago, in the second quarter of 2018, it was 132%. Lemonade was actually paying out more in losses than it was taking in in premiums. That number has ticked down to 74% in the most recent quarter. To put that in context, management has said the property- and casualty-insurance industry average is about 82% in recent years. Or if you just look at the top 20 in shares, the average is about 72%. Lemonade is still a little bit above the market leaders, but things are moving in the right direction. Ultimately, this cost advantage should translate into lower prices. That's the goal here. You have that flywheel effect where more consumers or more customers means more data, more data means more precise underwriting, and more precise underwriting means lower prices. And then that should bring more consumers to the platform. Lemonade is still a very young company, and so there's still a lot to prove. But so far, it looks like this is playing out.
Lemonade's entry-level renters policy that's typically 50% cheaper than equivalent coverage from the legacy insurance company. There's also another element to this cost advantage. Remember I said traditional insurance providers are highly dependent on a human workforce. Well, Lemonade uses AI that is less dependent on human workers. In fact, the company has just one employee per 1,700 customers, whereas a typical insurance company has one employee for 150-450 customers. That helps Lemonade keep payroll expenses low. Like I said, Lemonade is a very small company, orders of magnitude smaller, and premiums written in the most recent quarter over last year were over $200 million. But a company like Allstate (NYSE: ALL) is writing $35 billion in premiums per year. So much smaller than a lot of these incumbents out there and still a lot to prove, but things are headed in the right direction.
During the second quarter of 2021, the company reached 1.2 million customers. That was up 48%. It's started reporting retention rate, too, which I like. The retention rate came in at 82%. I'd like to see that number come up higher, but 82% in the most recent quarter was an improvement from 73% last year.
