Insurance is an old industry, dating back to before the United States was a country in the 1700s. Today's global insurance industry is worth more than $5 trillion.
Lemonade (LMND -3.07%) is trying to use artificial intelligence and a digital experience to carve out its share of this massive market opportunity. The stock's also been among the most volatile, swinging between $16 and $180 since its IPO less than two years ago.
After a multi-month slide among growth stocks, Lemonade shares are sitting near their lows. So is Lemonade an innovative company trading at a discount? Or has the market sniffed out a flawed business and an overvalued stock? Here is what investors need to consider before deciding for themselves.
A bold start-up effort
Traditional insurance companies that rule the industry -- companies like Allstate, GEICO, and Progressive, which often dominate your TV with their commercials -- have been around for many decades. An army of more than 1.1 million insurance agents in the U.S. supports them; they wake up each day to sell policies to consumers.
Lemonade has its work cut out as a new challenger in a crowded field. The company is doing things differently, and this is helping it establish itself. Lemonade uses artificial intelligence-powered chatbots to do most of its business through a smartphone app; it has a bot that handles claims and one that handles customer service.
The company claims that customers can sign up for a policy in 90 seconds and get paid for filing a claim in three minutes. The smartphone app apparently provides a great customer experience; it boasts 4.9 out of 5 stars on the App Store and has more than 55,000 reviews. Lemonade doesn't use sales agents and only minimal staff for claims, which reduces costs and helps Lemonade price its policies for less.
Can Lemonade stop burning so much money?
Lemonade seems to be executing on the sales end of its business; its customer count grew 42% in 2021 to 1.4 million, up from roughly 1.0 million at the end of 2020. Management states that its converting members from many of the traditional competitors, so this at least implies that the product itself is attractive to consumers.
However, Lemonade's tiny size compared to the competition could be holding it back. The company is very unprofitable, losing $241 million over the past year against just $128 million in revenue. This wide gap suggests that Lemonade will need years of growth to help it become profitable.
Aggressive sales and marketing are partly to blame; Lemonade spent $142 million on just sales and marketing in 2021, more than its revenue. As the following chart shows, losses have gotten larger as revenue grows. It's not sustainable for these two lines to trend in opposite directions; a business needs losses to shrink as revenue rises, or it'll never make money.
Aside from having to spend heavily, Lemonade's a smaller insurance company, so a natural disaster like the Texas Freeze that causes more people to file claims can create losses for Lemonade. Its gross loss ratio, which tells how much in claims an insurance company pays out against the premiums it collects, was 90% in 2021. In other words, Lemonade paid out $0.90 in claims for every $1 in premiums it collected.
This situation is partially due to a launch of new products such as home and pet insurance, and those are seeing more losses from claims while Lemonade collects data and improves at analyzing risk. While management expects to see a ratio closer to 75% over the long term, the higher percentage will make it harder to generate a profit in the short term. Competitor Allstate's gross loss ratio was 72 for automotive policies in 2021 and 71 for liability and property policies. Lemonade will need to improve significantly to match how effective traditional competitors are.
Is Lemonade a technology or insurance stock?
The stock market has valued Lemonade as a technology company since it went public. The stock traded at a price-to-sales ratio of more than 90 before its slide down to 11. The following chart shows that Lemonade remains significantly more expensive than competitors Allstate and Progressive.
Lemonade's technology should help it be more profitable than traditional insurance companies, or I don't know how the stock could justify a tech company's valuation. Right now, Lemonade's loss ratio is inferior to the competition, so it needs to show that it can do insurance better than the "old" companies can.
Investors will need to be patient; launching new products is likely to require time to roll them out as the company learns to better analyze risk and price its policies. Lemonade's tiny $1 billion market cap gives it a ton of potential upside if the company can succeed over the long term.
However, there could be more room for the stock to slide if Lemonade can't financially differentiate itself from other insurance companies.