In 2016, Lemonade (LMND -0.46%) embarked on a journey to transform the insurance industry. It placed technology at the center of its mission, developing artificial intelligence (AI) algorithms to interact with consumers, pay claims, and calculate more accurate premiums.
It seemed crazy at the time, especially in an insurance industry that was entrenched in its traditional processes. But with the current surge in companies using AI, Lemonade's strategy now seems incredibly obvious in hindsight.
The company just reported its 2023 first-quarter earnings and its stock soared 27% on the day. As it turns out, the positive impact of AI on its business is rapidly becoming apparent. Lemonade stock is still down 91% from its all-time high, but here's why that's a big opportunity to buy right now.
Here's how Lemonade is using AI to reshape insurance
OpenAI's ChatGPT online chatbot has taken the tech world by storm this year for its ability to instantly answer complex questions and even write computer code. But Lemonade has been using a chatbot for years; it's called Maya, and it can prepare a quote for pet insurance, renters insurance, homeowners insurance, life insurance, or car insurance in less than 90 seconds.
Then there's AI-Jim, which is another bot designed to pay claims. In 2016, Jim broke a world record by autonomously paying a claim in under three seconds, and today, over half of Lemonade's customers are paid out this way with no need for human intervention.
Few people enjoy interacting with their insurance company because it can be frustrating with long, convoluted claims processes. But by using the above AI-powered assistants, Lemonade has transformed that experience for its 1.85 million customers.
That's not all. Insurers succeed in their ability to price premiums accurately. If they're too cheap, the company risks losing money. If they're too expensive, customers will simply jump to a competitor. Last year, Lemonade released its lifetime value 6 (LTV6) AI model, which had the ability to predict which customers were most likely to switch insurance providers, and those most likely to make claims. It also unlocked new cross-selling opportunities by identifying customers who were likely to purchase multiple Lemonade products.
LTV6 also assisted with business operations; it could recognize underperforming and overperforming products in certain geographic areas, so the company could pivot its marketing spend to maximize revenue. Lemonade has since upgraded to a new LTV7 model and it's transitioning to LTV8 in the second (and current) quarter of 2023.
Lemonade delivered stellar first-quarter financial results
Lemonade's Q1 revenue came in at $95 million, up a whopping 115% year over year and well beyond the $89 million forecasted. It prompted the company to increase its full-year revenue estimate to $396 million from $379 million previously, much to the delight of investors.
The positive result was underpinned by strong growth in the company's in-force premium, which is the cumulative value of all premiums payable for active policies. The figure came in at $653 million, an increase of 56% year over year.
A higher in-force premium has the ability to smooth out the volatility in Lemonade's gross loss ratio, which is calculated by deducting the value of claims paid out from the value of premiums taken in. Lemonade typically experiences wild swings in this metric because it continues to expand into new markets like car insurance, which it entered last year.
If the company only has a small number of customers in a new market, a few claims can trigger large swings in its gross loss ratio. Pricing premiums accurately is the other piece of the puzzle, which is why AI is so important to Lemonade's strategy. As the below chart shows, the company managed to shrink its gross loss ratio to 87% in Q1 from 90% at the same time last year. It's working toward a target rate of 75%.
Image source: Lemonade.
Why Lemonade stock is a buy right now
Despite the 27% jump in Lemonade's stock price the day following its Q1 earnings release, it's still down 91% from its all-time high. The company continues to lose money while it scales up, and investors have expressed doubts about its ability to penetrate the entrenched insurance industry.
But the good news is Lemonade expects to achieve profitability with the cash it has on hand, which is a positive because it's incredibly hard to find fresh capital in this tough economic environment. And given the company's growth rates right now, it's certainly finding traction with customers.
On that note, Lemonade's strong revenue result drove a 12% reduction in its Q1 net loss to $66 million. Plus, it significantly lifted its guidance for the full year, shrinking its expected earnings before interest, tax, depreciation, and amortization (EBITDA) loss to $200 million from $245 million.
In its Q1 commentary, Lemonade told investors to expect meaningful cost savings in the coming 18 months thanks to AI. The company has identified over 100 business processes that can be automated using generative AI, which will speed up business processes and likely require a lighter workforce.
Overall, Lemonade is certainly moving in the right direction and its stock presents a great way for investors to play the AI revolution. It has successfully operated and monetized its models since 2016, while many other players in the AI space are still in a very early stage. In the long run, investors might be glad they took this opportunity to buy Lemonade stock on the dip.
