Lemonade (LMND 1.44%) hit the scene big when it went public. The AI-powered insurance company looked to disrupt the insurance industry with its socially conscious business. The stock got off to a hot start in July 2020 and was trading up over 510% by January 2021.
However, Lemonade made some big moves to grow its business which ended up challenging its pricing models. Those moves got investors worried. Since its peak in January 2021, the insurer's stock has fallen 87.5%. If you're considering buying Lemonade stock, there is one key measure you should know before making the leap.
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An insurance company with a conscience
Lemonade wants to reinvent how people buy insurance by leveraging data and artificial intelligence to help customers buy renters, pet, homeowners, and car insurance.
The company leverages chatbots to help customers get policy quotes and handle insurance claims. Its chatbot, AI Maya, helps customers get policies with as little as 13 questions, which generate over 1,700 data points based on how the customer interacts with its website.
Lemonade targets millennials and Gen Zers as its customers and goes for a more mission-driven approach by donating excess underwriting profits to charity.
Investors, pay attention to this number
When investing in insurance companies, one key metric you want to watch is the net loss ratio. This ratio represents the total losses paid, net of reinsurance, divided by premiums earned. This ratio tells you how well an insurer is pricing its policies. The three-year industry average net loss ratio for property and casualty (P&C) insurers is around 71%.
When Lemonade wrote mostly renters insurance policies, its net loss ratio was in line with the industry average of 71%. However, it began expanding its policies to include homeowners insurance in 2021. It faced significant losses early that year from winter storms in Texas and Oklahoma which caused nearly $7 million in losses.
In the first quarter of 2021, its net loss ratio jumped to 120% and has come in above the industry average every quarter since then, averaging 93% in the last six quarters, showing that its property insurance models have plenty of room for improvement.
Data source: Lemonade regulatory filings. Industry data from the National Association of Insurance Commissioners. Chart by author.
Lemonade's aggressive expansion will come with growing pains
Lemonade is aggressively growing its business. In addition to homeowners insurance, it has added pet and auto insurance to its menu of products. The company hopes to cross-sell these policies to its existing customers who started with its renters insurance policies.
Last year, Lemonade acquired the car insurance company Metromile for $500 million in an all-stock deal. The deal was completed at the end of June, so Lemonade's results don't include any of the impacts from the acquisition yet. In 2021, Metromile's direct loss ratio, the ratio of direct losses to direct earned premiums, was 78%, and it went up to 86% in the first quarter of this year. Lemonade will also need to dial in the pricing on its newly acquired auto insurance business to bring down this loss ratio.
Is Lemonade stock a buy?
Lemonade will continue to face growing pains as it expands its product offerings. The insurance industry is tough to disrupt because competitors have built up decades of data to help price their policies. It will take some time for Lemonade to dial in its pricing model for property and auto insurance as it builds up its database.
The company is pursuing an aggressive growth strategy, which could reward risk-tolerant investors willing to buy and hold at its current prices. While I'm not an investor in Lemonade now, I'm keeping a watchful eye on its loss ratios and would like to see this come down over quarters and get more in line with the industry average. When that happens, I'll be a buyer of this innovative fintech stock.
