Lemonade (NYSE:LMND) looked as refreshing as the drink after its debut as a public company in July 2020. But after an initial surge that sent it shares to a high of $163, this next-generation insurance company may have left a sour taste in the mouths of some investors, as the stock has plummeted.

Lemonade is down about 45% this year, trading at around $67 per share. Is this a stock worth holding onto or should you dump it? Here are three things to know about Lemonade that may help you decide.

A woman reading something on her phone, holding a glass of lemonade.

Image source: Getty Images.

1. Lemonade has a different business model

Lemonade sees itself as a disruptor in the insurance business. The company is really a technology firm that offers insurance, and everything is done through its app -- bill payment, customer service, account management, filing claims, and collecting benefits. Lemonade offers renters, homeowners, term life, and pet insurance, although it plans to branch out. 

Lemonade does things a little differently from traditional insurers. With most insurance, the customer pays a monthly premium, and that premium is used to pay claims, if necessary. The insurer keeps whatever is left over as profit or reinvests it.

Lemonade also charges a monthly fee or premium, which is split into two buckets. One bucket, about 25%, covers administrative and operating fees, with any money left over serving as profit. The other bucket, about 75%, goes to cover claims. If that money isn't fully used at the end of the year, the excess goes to the charity of the customer's choosing. As of the end of this year's second quarter, Lemonade had already given $2.3 million, which is twice what it gave last year.

This helps create a high degree of trust and loyalty, as Lemonade's Net Promoter Score (NPS) is 47, which is off the charts for the insurance industry, where the average is in the low single digits.

2. Lemonade uses AI to gather data and write policies

Another way that Lemonade differs from the average insurer is that it uses artificial intelligence to gather data and more efficiently price policies. An AI-powered chatbot asks only about a dozen questions of new customers, but that interaction allows Lemonade's AI to gather about 1,700 data points on the average customer. This is much more than for most insurance companies.

The more data Lemonade gathers, the better its algorithms become, allowing the company to better quantify and price risk in underwriting. The better the underwriting, the lower the loss ratio, which is the percentage of premiums paid out in claims. That, in turn, leads to lower premiums, as the risk is more accurately assessed. 

In the second quarter, Lemonade had a gross loss ratio of 74%, which is close to the average of the market leaders -- about 72%. Apart from the first quarter of 2021, when it spiked because of the Texas freeze, Lemonade's ratio has steadily decreased over the years. 

 

Another advantage of Lemonade's AI is that it doesn't take customers long to buy insurance or file claims. Using the chatbots, it takes about 90 seconds to get insured and about three minutes to file a claim and get paid, in most cases. This lowers the need for staff and reduces overhead, although more complicated claims may be referred to employees and take a little longer.

3. Lemonade is branching out into car insurance

The car insurance market is highly competitive, but it's also huge: at $300 billion, it dwarfs the market for pet, renters and homeowners insurance. 

Lemonade is in the process of diving into this market with Lemonade Car, which it expects to launch next year pending approval from regulators. 

It will collect data on how customers drive through the Lemonade app on their phone

, measuring speed, braking patterns, fuel usage, accidents, and a host of other data points. This will help the company customize policies based on driving performance. This type of data collection is called telematics, and while other companies use telematics, Lemonade believes its technology and processes stand out, allowing it to gather more data -- which leads to better underwriting. 

Another key part of adding car insurance is that it will allow Lemonade to bundle services in the same way as its competitors. Chief Executive Officer Daniel Schreiber, speaking on the company's second-quarter earnings call, said bundling will aid client retention, which now is about 82%: 

We are quite optimistic that the car-home bundling will be a significant driver of value. It's very common for...customers to bundle home and car, something that our competitors are able to offer and that to date we've not been able to. So adding car products should...enable us to improve homeowners and renters conversion rates and retention rates and accelerate the business growth.

So what does this mean for this beaten-down stock? Lemonade has a long way to go before it's profitable, which isn't uncommon for a start-up. But the gains it has made in attracting customers and improving its gross loss ratio, along with its customer loyalty, indicate that its model is working. And car insurance could be a real game changer for Lemonade. Expect volatility, particularly as it starts to ramp up its car insurance business, but the long view on this stock is pretty good. 

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.