Lemonade Still Has a Lot To Prove in the Insurance Game

Lemonade (LMND -0.46%) posted some strong numbers in its recent fourth-quarter report. But, in this segment of "The Future of Fintech" on Motley Fool Live, recorded on Feb. 24, Fool.com contributors Matt Frankel and Jason Hall discuss some big areas where the insurance company fell short of expectations. 

Matt Frankel: We'll start with the good. I found some good. I told Jason I was having trouble finding good, but I found some good.

Jason Hall: How hard did you have to squint? [laughs]

Frankel: Well, the first few lines of the earnings report were good. In-force premium was up 78% year-over-year. That's a great growth figure. Gross earned premium was even better, up 79%. Revenue grew 100% year-over-year. That's really where the good news ends. The customer count was good news too. Remember around this time last year, Lemonade put out a press release saying they reached a million customers quicker than any of the big legacy insurers. They're ahead of 1.43 million customers now, so 43% customer growth year-over-year, which is pretty impressive.

The bad news and why the stock tanked this morning, 96% gross loss ratio. Lemonade wants to keep its losses under 75% and use the other 25% to cover expenses and hopefully turn a profit. If your loss ratio is 96%, you're not turning a profit in the insurance business, you're just not, and that's kind of what happened here.

Hall: That's essentially how much of its revenues have to go toward losses, that's what that number is.

Frankel: This wasn't just an unprofitable quarter for Lemonade. I could deal with unprofitable quarters from growth stocks. We do it all the time and it doesn't really concern us. This was a very unprofitable quarter.

Hall: It was a huge step backwards.

Frankel: Right. Lemonade's revenue in the quarter was $41 million. Their loss was $70 million. They lost more than their sales. That's a big loss. The good news is one, they had the money to lose. They did a very well-timed capital raise in early 2021. The stock was almost at an all-time high. I don't know if you remember this, Jason.

Hall: I'm actually going to do a screen-share while you're talking.

Frankel: I was getting ready to do that, but I'm happy to let you. Lemonade raised $640 million at a share price of $165 a share last January. The stock is at about $20 right now.

Hall: Purple line is the stock price, the orange line that goes up is when they did that secondary.

Frankel: Right. They couldn't have timed that better.

Hall: Yeah.

Frankel: That essentially subsidized their losses for the year. [laughs] If you can look at it that way, it was essentially free money for the losses.

Hall: They raised that capital with the stock, the price that was six times higher than it is today.

Frankel: Correct. That was fortunate timing. Another good thing, Lemonade has $1.1 billion of cash and investments on its balance sheet right now. Its entire market cap is $1.3 billion, and that's not including the Metromile acquisition, which is going to add over $200 million of additional cash and is trading for $139 million, so less than its net cash.

They're planning on burning through a good bit of that. In 2022, they see their adjusted loss. That's not including things like stock-based compensation and things like that. They see their adjusted loss at about $285 million for 2022. They are planning on burning through some of that cash to get some of this growth, and their guidance came in a little bit light, they're expecting in-force premium of about $535 million at the midpoint, which will be solid growth, but not really what the market was looking for.

The car insurance roll-out has been promising so far, but not great. It's only in Illinois so far, so I'd like to see them really take steps to expedite that roll-out once the Metromile acquisition closes. That can make all the difference. But all in all, this was a pretty disappointing quarter. Like Jason said, it was a step backwards with a lot of the numbers. Growth still looks good, but that's really it. Jason, what's your take on this?

Hall: You go back a year ago and I don't want it to sound like I'm a genius here because I want to put some context on this. You go back a year ago and the market cap was like $10 billion for the company, somewhere around there. I cautioned investors at that point I hadn't invested, I really liked the idea. I like what they were doing. Using the AI to improve the experience, speed up everything, but also follow the money, so change the incentives to make it a better relationship for everybody so you're not working against the company that you gave money to to ensure your losses, so you're working with them.

They've changed a lot of those things. What I said was we got to find out if they know how to actually underwrite insurance and what we're learning is they're not very good at it. That's the bottom line. There was that 96, 97% gross loss ratio. They're aiming for 75 and they said, well, part of it was not this period, it was losses from a prior period. That's not a good excuse. That's just saying that the 70-something percent gross loss ratio they gave us last quarter was wrong. [laughs] It wasn't reflective of where their underwriting quality really was.

The point is that that continues to me to be the big concern and I've bought along the way. Over the summer, I opened a position, in the past month or so, I've substantially increased that position before I feel like an idiot because the stock price has come down a lot. I don't feel like an idiot for buying and the stock falling, I feel like an idiot for not being more patient to get another data point in the form of this quarter that now tells me I need to give them a little more time to prove that what they're saying about their process and as they add these new products.

They went from a single line company a year-and-a-half ago to now they have four or five lines. They're going to really step into a major dog fight with auto once they're in more than one or two states against some real serious competitors. They have a massive share of that business that they have to execute well. If they just go in on price, the losses could be so much larger because that market is so much larger, so they have to figure out how to insure auto well.

I'm a little concerned, despite all the other stuff they're doing right now, Matt, you know how their machines learn how to underwrite? They eat money. [laughs] That's the thing. I want to see them figure this insurance part out, so I think investors should be very mindful about that really important aspect. All the other stuff is really cool, but it's window dressing if you can't underwrite well because all of your costs are going to go up.

You're not going to be able to rely on reinsurers because they're going to want a higher premium to reinsure which means you still have to charge customers higher to pay for reinsurance. I know that's a lot to say just to say, they need to be disciplined in underwriting and prove that they can do it.