Lemonade (LMND 1.64%) reported its results for the second quarter not too long ago. Revenue totaled $105 million, up 109% year over year. And the business now has 1.9 million customers. Those figures look good on their own, but the stock has dropped 42% since the announcement.
There might be a reason for the heightened investor pessimism. The artificial intelligence (AI)-enabled insurance provider had one specific metric that stood out in its Q2 report. Here's why the gross loss ratio of 94% was the biggest number from Lemonade's latest financial update.
Getting losses under control
While it can seem complex at first glance, a typical insurance company operates by taking in premiums from its policyholders and paying out claims when these customers incur an insured loss. A business that can better manage risk pays out less in claims, while one that might not have the same level of proficiency pays out a higher amount. The figure that measures the amount of premiums that go out as claims is called the gross loss ratio. It's the key to understanding any insurance company's success (or lack thereof).
During the most recent quarter, Lemonade's gross loss ratio came in at 94%. This was higher than the 86% figure in the year-ago period, while also being worse than what it reported for the first three months of 2023. Besides trending in the wrong direction, which is something no shareholder wants to see, it's alarming that Lemonade is so far from management's long-term goal of getting to a 70% gross loss ratio. At that point, executives think the company can be solidly profitable.
The leadership team blames unusual weather events -- like hail, straight-line winds, and tornadoes -- as the primary reason for the higher claims that were paid out. I'm not so sure I'm giving executives the benefit of the doubt here. Lemonade's entire business model relies on AI and data running its risk models and analyzing various customers in different geographies across the country. What good is all that technology if it can't show any signs of positive performance when it had the perfect opportunity to do so?
Not only was the gross loss ratio the most important metric in the latest quarter, but it should also be the key data point that investors watch.
Growth can help
The bright spot is that Lemonade continues to post strong growth, with its customer base and revenue rising at stunning rates in Q2. These gains are more impressive given the uncertain macroeconomic environment. This bodes well for the company once the economy is back on solid footing.
By adopting a digital-first strategy, Lemonade avoids the costly brick-and-mortar locations and sales agents used by industry incumbents. This allows the business to bring on new customers and approve and pay out claims in minutes. The expectation is that this user-friendly model will one day lead to sizable net income potential.
Lemonade's tech-based platform naturally brings in younger consumers. Management hopes to benefit from this by finding ways to cross-sell them other products over time, like auto, pet, and life insurance. Only 4% of Lemonade's policyholders use multiple products, while legacy providers see 60% of customers adopting multiple products. Insurance is a truly huge industry, so there appears to be a ton of opportunity to further penetrate the market and gain customers who can be loyal.
But despite its growth potential, I'm staying away from Lemonade shares. I think the company's AI models still have a lot to prove, plus the path to profitability remains uncertain. I can understand why growth-minded investors would be attracted to the stock, though.
