Shares of artificial intelligence-powered insurance expert Lemonade (LMND +4.19%) have not been treated nicely in 2021. The stock has fallen more than 65%, year to date. This came after a combination of blows to the business, especially in the first quarter.
Some of the drop is justified, but I do believe that the stock market overreacted. Mainly, the low share price doesn't appear to account for a recent acquisition and the launch of a big product: Lemonade Car. If the company can focus on gathering more data for its AI and use its recent buyout of MetroMile to mature its newest product, I think Lemonade investors could see a generous bounce back in 2022.
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Lemonade offers insurance in a unique way. The company's decision process, both for applications and claims, is determined primarily by artificial intelligence and computerized bots. The benefit to this is that applicants can get approved for insurance or claims in seconds, and this customer-friendly approach has allowed the company to see rapid adoption. Lemonade was the fastest-ever insurance company to reach 1 million customers, and it currently has over 1.3 million customers. As a result of this rapid scaling, the company has also been adding products at a brisk clip, including two in 2021 alone. The primary and most exciting addition, of course, is Lemonade's car insurance product.
Why it fell
This quick scaling of the product offering is the first reason shares have fallen. Because of Lemonade's major focus on AI, when the company expands into new products, its AI needs to take time to gather data and learn from it. This process allows Lemonade's systems to become more accurate in their decision-making.
However, there's a downside to this important step.
While Lemonade's AI is not completely useless when a product is first launched, it is less accurate than it would be in the future when it has more data on the product industry. With two new products this year and its pet insurance and homeowners insurance also being relatively young, Lemonade has been less efficient than it aims to be.
The company targets a loss ratio -- the percentage of Lemonade's premium it pays out in claims during the period -- of 75% for the long term. For the first nine months of 2021, the company's loss ratio has been 88%, much higher than the 75% goal. This has been driven by the company's additional product launches -- which have high but improving loss ratios -- and a rough first quarter.
In the first quarter of 2021, Lemonade was hit hard by the Texas Freeze, where much of Texas has hit by a severe winter storm. This caused lots of power outages and home damage for its customers, resulting in almost a year's worth of claims in a few days for Lemonade. Clearly, these claims were warranted, but this event still hurt Lemonade, resulting in a loss ratio of 121% in Q1. Investors, understandably, were not happy about that.
Lastly, after the company came public in the middle of 2020, the stock was bid up because of Lemonade's appealing use of AI along with the strong interest in newly public companies at the time. However, as this IPO hype wore off, many investors fled, which sent shares sinking for the next six months.
Could it recover?
In its third quarter, the lack of game-changing disasters within Lemonade's coverage areas brought down the company's loss ratio substantially from the 121% ratio it had posted in Q1, so clear progress is being made to bounce back from that extreme cold snap. It still trades at 23 times sales, which is far lower than the egregious 100 times sales it once saw. This provides investors with a much more bearable starting price.
Therefore, Lemonade's focus should be on improving its loss ratio. If it can do this and get it below the 75% goal management set for itself, the company could see a recovery. The company's main way to do this is simply by giving its AI more data, allowing it to mature and make more accurate decisions. With some of its products, the loss ratios have already started to improve. Lemonade's loss ratio for pet insurance improved 4% sequentially while its homeowners' loss ratio improved 52% year over year.
With Lemonade Car, the company has taken a slightly different approach. Instead of waiting for its AI to learn organically, Lemonade decided to acquire a business that already has data on over 400 million trips and billions of miles driven. The buyout of MetroMile in Q3 carried Lemonade's hopes to mature its car insurance segment rapidly with MetroMile's data. With this massive influx of training data, I think this endeavor could be successful, and it could be producing more accurate decisions, resulting in a top-notch loss ratio right from the start.
A big bet
The accelerated AI training idea is not a sure thing for the company, and this process could take a couple of quarters to see improvements if customer growth slows. However, if it can continue the 45% year-over-year customer growth it saw in Q3 and the 26% year-over-year growth in premium per customer, this shouldn't be a problem.
Here's the bottom line: Lemonade has been punched in the gut as a few negative factors came together, all of which the company has improved on. Its new acquisition is fueling an exciting opportunity for Lemonade, and the new auto insurance product could become a driving force for the company's future loss-ratio success. With this new acquisition and constant improvements in its existing products, I think Lemonade could recover vigorously in 2022.
