Lemonade (LMND 1.44%), the insurance company powered by artificial intelligence (AI), has lost favor with investors, and its stock has declined significantly since early 2021. The market is disappointed that the company's highly publicized AI has not provided the promised benefits. Moreover, in such a volatile market, you might wonder whether now is the time to invest in a risky company like Lemonade.
Here are three reasons things are looking up for Lemonade.
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1. Its loss ratio is trending down
Lemonade's original premise was that by collecting 100 times more data points per customer than traditional insurance companies, it could extract better insights to predict insurance losses. As a result, Lemonade could theoretically price risk at higher levels of precision than older insurance companies.
The primary way for investors to measure whether Lemonade has found a better way to underwrite insurance policies is to measure its loss ratio: claims paid divided by the premiums earned. The company aims to maintain a loss ratio below 75% (the lower this ratio, the better) for all its product lines.
Lemonade's second-quarter 2022 gross loss ratio was at 86%, a 10% improvement over two quarters. And leading indicators show the loss ratio moving under 75%. As a result, a continued decline in the loss ratio would put the company on the path to profitability.
2. Increasing ability to cross-sell products
Image source: Lemonade.
Lemonade has a powerful appeal among younger consumers. For instance, as of 2020, approximately 70% of its customers were under age 35, and about 90% were first-time insurance buyers.
From the beginning, Lemonade intended to become a multiple-policy company to fill its customers' need for additional insurance products as they age. One massive advantage of being a multiple-product company is that, unlike other insurance techs that sell only one product, Lemonade can cross-sell policies.
Cross-selling and bundling strategies lower customer acquisition costs while raising a customer's lifetime value. These benefits help solve an issue many investors have disliked about Lemonade for a long time: The cost of acquiring a customer exceeds what the customer will spend with the company over time. And until people pay more over their time as customers than it costs to gain their business, Lemonade will remain unprofitable. So naturally, you want to see the company increase its cross-selling numbers.
The good news is that Lemonade's recent second-quarter results show that 23% of the sales were from cross-selling, and that percentage is trending up, one sign that the company is on the way to profitability.
3. It's fast approaching the tipping point
Management has consistently made investors aware that the cost of launching new products, entering new markets, and acquiring new customers is heavily front-loaded. And that it would take time to see these investments pay off. Since analysts will quickly downgrade companies with long time horizons to profitability during inflationary times, it is little wonder that this stock has sharply declined recently.
The good news is that the company is fast approaching the point where the return on its earlier insurance investments like rental insurance will overtake the costs of new investments in areas like car insurance. And as more of its business lines turn profitable over time, investors should see the company's overall results turn positive. During the second-quarter 2022 earnings call, Chief Executive Officer Daniel Schreiber said that he expects the company's losses to peak in the third quarter, and to narrow after that.
Additionally, management plans on slowing its spending on growth and hiring, which should result in a more rapid improvement in financials and eliminate the need for further capital raises.
Lemonade is best judged over the longer term
Only patient long-term investors willing to withstand short-term market gyrations should invest in Lemonade because the market judges most companies quarterly. And over a short time horizon, inflation and substantial claims from unpredictable disasters could result in poor results, shaking investor confidence and resulting in the stock selling off.
So Lemonade should be judged over multiyear periods because it can take as long as two years before new customers start paying off. And 73% of Lemonade's premiums in the second quarter were from customers who have been with it for less than 24 months. Consequently, some quarterly reported numbers are lagging indicators that fail to fully reflect the significant upside ahead as the company's current customer base ages beyond two years.
