Insurance industry upstart Lemonade (LMND 2.19%) doesn't just provide more efficient ways to buy policies and process claims. The company's general business model is very different from those of most traditional insurance companies. In this Fool Live video clip, recorded on Nov. 29, Lemonade's co-CEO and co-founder Daniel Schreiber explains how the business works to Fool.com contributor Matt Frankel.
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Matt Frankel: You just mentioned that excess underwriting profits are donated to charity. At the end of the day, this is a business for investors, this is a show for investors. You're in business to make money, obviously. Where do Lemonade's profits come from? Can you walk us through the split on where -- if, say, I pay my renter's insurance premium, where does the money go?
Daniel Schreiber: Absolutely. While we do give money to charity -- in our last giveback, it's an annual event, we gave about $2 million to charity -- I never apologize to my investors for the fact that we give money to charity because I think it's accretive to the shareholder value. I'd see very little that is noble about taking shareholders' money and giving it charity. Being generous with other people's money is not generosity at all. What we're really doing is using the giveback, using charity, in order to solve the business problems of distrust and consumers not wanting to buy insurance from you, not staying loyal to you. All of these things get solved by changing the nature of the game, and giveback is part of that.
But in answer to your question, you give us $100, 75 cents on those dollars are going to come back to you in one form or fashion, either because you make claims -- and collectively, a million people give us $100 -- either because you make a claim and then we will give back the money to you as part of the claim payout, or if there's money left over, up to that 75%, we will then give it to a charity of your designation. One way or another, we consider it your money -- with a capital "Your," a plural "Your" -- but 75% is going back to our customers one way or the other; 25% is retained by us.
And that 25% has to cover our expenses and allow us to eke out a profit as well. Now, traditional insurance companies have what's known as an expense ratio of about 30%, give or take, which means that for every dollar, about 30% goes on their expenses. If we were going to be as inefficient as everybody else, we would never make a dime. But already today among the incumbents, the most efficient have a 14%, 15% expense ratio. Companies like GEICO, Progressive (PGR 0.91%), USAA, who are really the best of the bunch. If you assume that we even don't do any better than them, we just go toe-to-toe with the best of the incumbents, I think we'd be able to do better than them or best them, you'd still see a 10% net profit, and that's before you have all the things that insurance lives on like investment income and other products that you can layer on top of their core product. That gives you a sense of where the money goes.
Frankel: That answered a really important question for me, the investment income question, because that's something I don't really hear about too much when it comes to Lemonade. I've heard the 75%/25% before. But so you are planning on building up a portfolio and generating investment income, and having that be a significant source of future revenue, correct?
Schreiber: It's interesting, because if you speak to a traditional insurance company, that is the source of the income. That combined ratio, which is the loss ratio plus the expense ratio, tends to hover at around 100%, so there's nothing left, there's very thin margins. But for us, we expect to be making much healthier margins. Our gross margins today tend to be in the low 20s, we do see ourselves as operating with a healthy margin before you come to investment income, and in our thinking, investment income is on top of our core business model. It's not a substitute for it. We think of ourselves as more as a tech company, as a platform that takes a margin for transactions rather than simply an investment-income-based insurance company.