Insurance technology company Lemonade (LMND -0.46%) has left a sour taste in the mouths of investors, with its stock falling 80% over the past year to around $32 at recent prices. The stock's nosebleed valuation at its high, plus a marketwide sell-off of growth stocks, has contributed to its fall.
Investors probably shouldn't expect the stock to revisit its highs around $183 anytime soon, but could it rebound to $50 sometime this year? Nobody can know for sure; of course, Mr. Market tends to be unpredictable. However, there are several reasons to be optimistic that Lemonade will one day be sweet for investors again.
1. Making insurance cool for young people
Insurance companies are heavy advertisers; you probably see at least one insurance commercial every time your favorite show goes to a break. They rely on beating you over the head with ads to grab mindshare because the overall consumer experience typically doesn't win customers over. The net promoter score (NPS) indicates how likely a consumer is to recommend a brand to a friend or family; the average NPS for insurance companies ranges between 35 and 41 out of 100.
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Lemonade is a newcomer to insurance, founded in 2015. But its late arrival allowed it to adopt a business model that resolves a lot of typical insurance pain points among customers.
If you want to sign up for a policy or file a claim with traditional insurance, you often have to go through an insurance agent. Lemonade doesn't use agents; it uses two artificial-intelligence-driven chatbots called Jim and Maya, which handle claims and customer service. Users can use Lemonade's smartphone app to sign up for a policy within 90 seconds or file a claim within three minutes, often without having to talk to anyone.
Traditional insurance companies have a financial incentive to deny your claims to increase their profits. But Lemonade takes a flat charge from unclaimed premiums and donates what's left to charity; it donated $2.3 million in 2021. This model helps remove the friction between the customer and the insurance company.
Lemonade claims that roughly 70% of its customers are under 35 and 90% are not switching over from another carrier (meaning they're new policyholders). It also claims an NPS score above 70, higher than the industry average. Its digital model seemingly attracts young users, and increased satisfaction could keep them from leaving.
2. Years of growth ahead
Retaining these customers could help drive Lemonade's growth over the long term. Its premium per customer grew 26% year over year to $254 in the third quarter of 2021, resulting from customers graduating into more expensive insurance categories as they mature.
However, Lemonade's natural growth potential is in product and market expansion. The company started in renter's insurance but has quickly grown its offerings to include homeowners, car, pet, and life products. It's also a multinational company, with a presence in the United States, France, Germany, and the Netherlands and plans to expand into more markets over time.
Lemonade has 1.3 million customers and $347 million in in-force premium (IFP) money paid toward policies. The global insurance industry is worth an estimated $5.5 trillion, according to Statista. If Lemonade's addressable market were a baseball game, the company wouldn't even be in the first inning yet. Lemonade's growth is truly an ocean of opportunity, even if the insurance industry is highly competitive.
It grew its customer count 45% year over year in the 2021 third quarter, showing that Lemonade is succeeding at bringing customers on board. With car insurance just getting off of the ground, we could see customer growth accelerate from here.
3. Efficiency is improving
Lemonade's disadvantage as a young insurance company is its inexperience in analyzing risk and underwriting policies. Insurance is a game of pricing policies low enough to be competitive with other insurers but high enough to cover your claims.
The company cedes 70% of its premiums to reinsurance to reduce its book of business risk. This makes Lemonade's financials less volatile because it's not as large as many competitors. The company used to cede 75% but adjusted it down as its business grew, showing that Lemonade's confidence in its underwriting is improving.
The company's loss ratio shows how good the insurance company is at analyzing risk. For example, if an insurance company takes in $100 in premiums and pays out $60 in claims, the loss ratio is 60%. A lower loss ratio is better. Allstate posted a loss ratio of almost 67% for its auto insurance segment in its 2021 Q2.
Lemonade's overall loss ratio was 77% in its most recent quarter, so it has some work to do in getting that ratio down. But management expects this to improve as its algorithms get more data over time. Its long-term expectation is a loss ratio of less than 75% across all insurance products.
Financial red flags to watch
Lemonade seems to be moving in the right direction, but things are far from perfect. The business is currently losing a ton of money; in its 2021 third quarter, its sales and marketing expenses alone exceeded revenue, and total net losses were $66 million, nearly double its $36 million in revenue. This obviously needs to change, but the company is investing to take market share and introduce new insurance products at the same time. And don't forget that Lemonade caps its profits per policy as part of its business model. That might please customers, but it might take longer for the company to become profitable. It makes customer growth very important, so investors will want to watch for this moving forward.
Lemonade is a risky investment today, but if its customer growth continues while its loss ratios improve, the stock could have a lot of long-term potential.
