Lemonade (LMND -2.82%) wowed investors earlier this month with a better-than-expected first-quarter earnings report that demonstrated solid growth along with progress toward profitability. Its artificial intelligence-based insurance model has attracted customers from inception, but its ability to competitively price policies more efficiently is finally beginning to show.
Just days later, at the Berkshire Hathaway (BRK.A +0.40%)(BRK.B +0.38%) annual meeting, Ajit Jain, Warren Buffett's hand-picked manager of Berkshire Hathaway's insurance subsidiaries, made some comments that shed some light on why Lemonade may become unstoppable.
How Lemonade is different
Lemonade was created to change what people think about insurance. It has B-corp status, which implies a positive social impact, and that was an integral part of creating a shift in the perception of insurance companies. Co-Chief Executive Officer and founder Daniel Schreiber thought that giving excess funds left over after paying claims to charity could reduce insurance fraud. As part of this overall shift, the company was developed on a digital model, with chatbots handling a large percentage of policy sales and claims payments. That results in cheaper policy pricing and faster processing.
NYSE: LMND
Key Data Points
Lemonade uses artificial intelligence (AI) and machine learning to predict catastrophes and claims and uses that data to price its policies effectively. It made substantial progress in lowering its loss ratio in the 2023 first quarter, which demonstrates that its model is working and is likely to improve over time.
In today's age of tech and AI, every insurance company is moving toward AI and digital processes. The work of an insurance company is data collection and prediction, so that's a natural shift. As people use digital for more and more functions, insurance companies need to get there as well to keep up.
What does it have to do with Warren Buffett?
Berkshire Hathaway, Warren Buffett's holding company, owns many companies in addition to a stock portfolio. One of its major industries is insurance, headlined by GEICO.
Ajit Jain heads up the insurance branch of Berkshire Hathaway and is a key player in the company's operations. In the past, he has admitted that GEICO was behind the curve in telematics, which are digital functions that track how someone drives and contribute to lowering the cost of a policy.
He explained how the insurer is changing that during Berkshire's annual meeting last weekend:
GEICO ... has made rapid strides in terms of trying to bridge the gap in terms of telematics and its competitors. They have now reached a point where on all new business, close to 90%, has a telematics input to the pricing decision. Unfortunately, less than half of that is being taken up by the policyholders.
However, there's a long way to go, as he continued:
Even though we have made improvements in terms of bridging the gap on telematics, we still haven't started to realize the true benefit. And the real culprit of the bottleneck is technology. GEICO's technology needs a lot more work than I thought it did. It has more than 500 -- actually, more than 600 legacy systems that don't really talk to each other. And we are trying to compress them to no more than 15, 16 systems that all talk to each other. That's a monumental challenge. And because of that, even though we have made improvements in telematics, we still have a long way to go because of technology.
For the naysayers who wonder whether Lemonade has a real edge and that legacy insurers can easily move their operations into the digital era, this might help them think again.
The insurance company of the future
Buffett himself took a jab at Lemonade's model during the annual meeting:
There have been a lot of public companies created in the last decade or thereabouts in insurance. And there's none of them that we would like to own. And they always started out in their prospectus saying, 'This is a tech company, not an insurance company.' Of course, they're a tech company. Everybody, whether they're an insurance or a lot of other places, are
using the facility, but you still have to properly match rate to risk. And they invariably have reported the huge losses. They've eaten up capital.
Buffett has never made a secret of the fact that he doesn't love unprofitable tech stocks. Lemonade made strides in its profitability in the first quarter, shrinking its net loss, but it's still a long way from net profits.
However, it's hyperfocused on lowering its loss ratio and matching rate to risk. The company told investors a few months ago that it would not need to borrow cash to continue operating, a plus now that the cost of capital has increased. It's well-capitalized and working to lower expenses at the same time that revenue is rising.
Could it be that Lemonade will prove Buffett wrong? His own people admit they're at a significant disadvantage. Insurance might finally be ready for a different look, and Lemonade may have the model to make that happen.
Lemonade stock is up almost 40% since its first-quarter report, and if you think its advantage is durable, now could be a great time to buy.
