Lemonade: Why The Juice Is Worth The Squeeze

Summary

• Lemonade is attempting to disrupt the insurance industry. It offers insurance products using AI to set policies and facilitate the customer experience.
• The company's operating metrics are improving, and the company has a massive TAM ahead of it.
• The stock is expensive and Lemonade is incurring losses. However, the upside is tremendous if the business can scale to profitability.

Photo by Seibertfilm/iStock via Getty Images

Lemonade, Inc. (NYSE:LMND) is an insurance technology company or "InsurTech" company that offers insurance products to consumers via automated bots run by artificial intelligence. The insurance industry is enormous, with a global market size of roughly $6.3 trillion and is very antiquated. This presents an enormous opportunity for the type of disruption that a company such as Lemonade is trying to accomplish.

There are risks in an investment in Lemonade as the model is not yet profitable (and is a long way from becoming profitable). However, as a long term investment, Lemonade offers compelling upside in a huge TAM should the model reach its inflection point. We will dive into Lemonade below and outline our investment thesis.

About Lemonade

Lemonade is an insurance technology company built on a digital footprint and utilizes artificial intelligence to slim operations and improve the customer experience. The AI system handles the customer experience from start to finish, which results in faster policy decisions, and payments on claims.

Lemonade operates on a smartphone app, which gives the business a convenient and simple interface. Customers can both sign up for insurance and file claims through the app via its AI powered chat bots "Maya" for customer service, and "Jim" for claims. This video demonstrates the customer experience.

Lemonade is a very young business for a public company, founded in 2015. The business generates just over $94 million in annual revenues.

source: Lemonade Inc.

Lemonade currently offers four types of insurance products in Renters, Homeowners, Term Life, and Pet insurances. The company plans to continue offering new types of insurance over time.

How Lemonade's Business Works

Lemonade has built its business model to improve the consumer's impression of the insurance industry compared to traditional insurance companies. Before we outline this, we need to review the core fundamentals of how insurance works.

Insurance companies sell policies to consumers, and price them by analyzing various risk factors that quantify the probability and extent that a customer may file a claim against the policy. Therefore an insurance company has incoming funds (premiums paid by customers), and outgoing funds (claims paid to customers).

There are a couple of important truths to this "balancing act" that insurance companies work with. First, insurance companies have to maximize the ratio between premiums and claims. The profitability of an insurance company depends on the company collecting as many premiums as it can while paying out as little claims as possible. This creates an inherent conflict of interest because there is financial incentive for an insurance company to not pay a claim.

Second, the insurance industry is extremely competitive. Consumers view insurance as a commodity, with pricing being the primary deciding factor in choosing an insurer. Therefore, a company needs to price its policies competitively while still making money in the end. This makes the insurance business a game of efficiency.

With this context, let's explore Lemonade's business strategy.

source: Lemonade Inc.

The company gets a flat take rate on the premiums that customers pay. Anything beyond this take is then donated to charities, often of the customer's choosing. In 2020, Lemonade donated more than $1.1 million. In fact, the company is a B-Corp, which is a designation that signifies the highest level of social and environmental standing. The fixed take rate also helps negate the financial incentive that an insurance company has to avoid paying out claims.

As part of this business strategy, Lemonade utilizes reinsurers to remove risk and capital intensity out of its business. Reinsurance is best thought of as "insurance for insurance". Lemonade surrenders 75% of its earned premium in exchange for a 25% commission.

In other words, $1 of gross earned premium is allocated as:

1. $0.25 to Lemonade, and $0.75 to the reinsurer
2. Reinsurer pays a 25% commission to Lemonade ($0.75 x 0.25)
3. Lemonade receives total of $0.435, and reinsurer receives $0.5625

This fixed model stabilizes profit margins for Lemonade, putting more emphasis on the company's gross loss ratio to drive unit economics. The gross loss ratio is the ratio of claims paid to earned premiums. We will talk more about this next.

Artificial Intelligence Drives Operating Metrics & Customer Experience

As we will discuss next, Lemonade utilizes artificial intelligence and machine learning to drive its business model and customer experience. Let's start with the company's loss ratio.

An insurance company's loss ratio is essentially the metric that determines how efficient the business is. It is expressed as a percentage, and the lower the figure is the better. If the metric is 100%, it means that outgoing claims are as high as earned premiums. Therefore the lower the percentage, the wider the gap between claims paid and premiums earned (a good thing). The average for the insurance industry as a whole averages between 65%-70%.

source: Lemonade Inc.

We can see in the graphic above that Lemonade's loss ratios have been terrible, but have steadily improved over the past eight quarters. This is because as the company's AI is fed more data, the better the system functions. Lemonade's system was able to go from terrible to "average" between Q2-Q3 in 2020.

A critical part of an investment thesis is that Lemonade is able to continue lowering and maintaining a satisfactory loss ratio. The long term viability of the business model (profitability) is dependent on this metric's strength. Failure of this is the largest risk to investors.

In addition to driving the back-end of operations, the company utilizes AI and its digital user interface to provide a strong customer experience. Users can sign up for insurance in as little as 90 seconds, and can get paid on claims in as little as three minutes. The AI bots remove layers of costs, labor, and customer inconvenience by removing the deep network of agents that are intertwined into the model of traditional insurance companies. This is why Lemonade has a net promoter score of 70, which is very high for the industry.

Long Growth Runway Ahead

One of the attractive qualities of an investment in Lemonade is the enormous and growing space that it plays in. With IFP (in force premium) of just over $200 million, Lemonade is a microscopic player in a global industry worth more than $6 trillion. The scale of the insurance industry means that Lemonade doesn't even need to become the largest player in the field to be an exceptional long term investment. Even more, the industry is growing. Over the coming years, premium volume will grow significantly as emerging markets with growing economies begin seeking insurance.

source: Munich Re

Lemonade will benefit from these tailwinds over time, but the most impactful growth will come from product and geographic expansion. The company has been steadily stretching its legs. Lemonade recently added term life insurance, and has discussed entering automotive insurance in the future.

And while the company is still growing rapidly in the US, Lemonade has begun to penetrate international markets. Lemonade is currently in Europe, having entered Germany, the Netherlands, and France most recently. These levers will combine to drive strong top line growth for the foreseeable future.

The Long Path To Profitability Is A Risk

While top line growth is exciting for investors, Lemonade's largest risk to investors comes from its lack of bottom line production. Lemonade is currently an unprofitable business and faces a long path to turning a profit.

source: Seeking Alpha

Even if we look ahead to 2023, analysts are expecting the company to lose almost $3 per share that year. The structure of Lemonade's fixed take rate and current costs require a large ramp up of volume to generate the scale needed to lower customer acquisition costs (will also be helped by entering premium insurance categories) and reach the inflection point that turns Lemonade profitable. An investment in Lemonade is a bet that the company will succeed in executing this. Because of the company's current long path to profitability, Lemonade is an admittedly risky stock.

Looking At Valuation

Lemonade has been a highly volatile stock. Over the past year, the stock has traded between a wide range of $44-$188 per share. The stock has pulled back from highs and currently trades at $81.

source: Ycharts

Based on its current enterprise value, Lemonade is trading at an EV to sales of 39.5X based on estimated sales for this year. When you consider the fact that traditional insurance companies such as Progressive (PGR) and Allstate (ALL) trade at an EV to sales multiple of 1X or less, Lemonade is clearly valued differently by the market. Whether you agree that Lemonade is a tech company would determine your view on the stock's valuation.

While I don't consider Lemonade to be "cheap" at these levels, the stock has pulled back a bit and the company's revenue growth will burn down the multiple over the coming years. If we use 2023 analyst estimates of $267 billion, the stock trades at an EV to sales of 17X. The company's long term runway makes the valuation palatable if you are bullish on the company's unit economics.

Wrapping Up

Great long term investments are born from innovation within large and stagnant industries. Insurance certainly fits that bill, and Lemonade has shown results (improving loss ratio) that signal the merits of Lemonade's model. The stock commands a premium and there are questions around profitability, but Lemonade's large TAM and long runway bring enticing upside. We are bullish over the long term.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[johnny inca]

@Wealth Insights What are your thoughts now?

[advisor4]

Your numbers and analysis are wrong q1 21 in force premium was $252 mln gross earned premium was $56 mln or around .$.25 for each dollar collected.And that doesn't guarantee stable income" they still bear 25% of the risk that's why the Texas storms created losses of 120% of the premiums collected.There is nothing "stable income" about their model...and they bear all the marketing and administrative for $1 of revenue but keep only $.25. A good deal for the reinsurers and if the reinsurers don't like underwriting disasters like Texas they can raise their rates or cut back and eliminate their business with lemonade.

[Terribly Mediocre]

@Wealth Insights wrote
"In other words, $1 of gross earned premium is allocated as:
.....
Lemonade receives total of $0.435, and reinsurer receives $0.5625"

@advisor4 wrote
"Your numbers and analysis are wrong q1 21 in force premium was $252 mln gross earned premium was $56 mln or around .$.25 for each dollar collected."

$LMND 10Q 2021Q1
Gross earned premium 56.2
Ceded Earned Premium -42.4
---------------
Net Earned Premium 13.8
Ceded Commission Income 9.0

---------------
Total received $22.8 million ~ 40.5c for $1 gross earned premium. Similarly, it was 40.4c for $1 gross earned premium in 2020Q4.

@advisor4
you may wanna understand the definition of in force premium. it's roughly the sum of last four quarters gross written premium (GWP). quarterly gross earned premium (GEP) would be somewhat the average of quarterly GWPs in the past. quarterly GEP looks always ~ 25% of in force. but that's not the 25% that $LMND talks about.

[Andy Bodrog]

It doesnt matter how you slice it, and what metrics you use. I worked at the company and in insurtech in general and the tidal shift is well underway. We are very early in destructing insurance is it is, and Lemonade is one of the only international players. Noone took Spotfiy seriously and now you are a subscriber. This is a platform business that globally everyone will carry on their phones for protection in a few years. Until then, analyze numbers and compare etc, doesnt matter.

[jguy2]

@Andy Bodrog spotify has a business and subscribers and takes in all its revenue and its a very straightforward business. Lemonade has already conceded that it is not capable of doing life insurance...it is just an agent. In homeowners insurance they are not comfortable giving insurance...they send $.75 of every dollar paid for premium to have someone else do the insurance. What does i mean to "carry" my life or homeowners on my phone. When the wildfires come to California or the storm to texas human beings from the companies come to the scene and pay claims on the spot .

[jguy2]

@Andy Bodrog there are many companies up and running either within existing dinosaurs or selling the services to insurance companies lemonade doesnt add anything new and their growth is dependent on availability and cost of reinsurance Just one example from 2018 www.forbes.com/...

[ejung2]

LMND’s AI is overrated in my opinion, but I think their biggest edge is their NPS score being triple the industry average. People hate insurance companies, but Lemonade customers are more likely to recommend the product than Apple users are.

Over the near to medium term, losses will pile up, and the company will struggle, but over the long term I believe that the company has a legitimate shot to be the largest insurance company by market share. As they introduce new services and expand into new markets, they should see rapid growth. Network effects are hugely important in growth stocks, and with a NPS score of 70, each customer will become a salesman.

Flywheel effects are cool.

[John Alford]

@ejung2 Conversely, they are new and small, so the NPS score is based on a small sample size. After having "a year's worth of claims" in one quarter, and a larger customer base, I'd expect it to come down some if not to industry average. But that's my opinion.

[advisor4]

@ejung2 people who have minimal coverage (avg premium $256) and get claims settled quickly via the "bot" people may be very happy. Those who bought major insurance on their home and encounter something like the Texas storm with $100000+of damage won't be able to settle a claim with a bot and a cellphone picture.They will be quite happy if they have insurance with a "dinosaur" that sends adjusters immediately to the scene and writes checks on the spot. John the bot with AI won't look so great.

[Britton Bush]

Why can’t the other insurance companies adopt AI?

LMND’s AI is not a long term discriminatory in my mind. I believe broad adoption of AI in the insurance industry will catch on.

[Jeremy Blum]

@Britton Bush They already have, decades ago. Insurance companies invented AI. You see there is this profession called actuaries. They create algorithms. That's what AI is.

[advisor4]

@Britton Bush if their ai was great the they wouldn't have paid out claims of 120% of premium collected ..far more than any other company . Their ai performed 3x worse than the dinosaurs the first time it was tested...the Texas storms

[Britton Bush]

@advisor4 Good point. Conceivably the algorithms should learn and get better. It will be interesting to see how the technology plays out in the insurance domain.

My point is that I'm not quite sure I understand what makes LMND unique, other than good user experience and ability to execute insurance transactions quickly.

[Mikew59]

This quarter shows how staggeringly inferior LMND's business model is. Ignore all their jargon and spin and look at the numbers. They state that it proved things worked that they had 50pts of CAT losses in the quarter. Excuse me, what? For what is basically renters insurance. The TX issues were not an earthquake or hurricane.

By comparison, Allstate had 6pts of CAT in the quarter (vs. 2.4pts in Q1 2020) and still made nearly $1.7bn of underwriting income on their P/C business, or 16.7% or earned premium. One of the largest personal lines insurers in the US, they grew premium by 11.4% to almost $10bn.

Chubb, a very different business mix due all the commercial lines had 9pts of CAT losses in the quarter

Oh, wait I forgot ALL doesn't have an app like LMND. So I am happy that their customers had a first class experience. The kind of experience that will drive LMND out of business if results like this continue.

[jguy2]

@Mikew59 you can go to allstates esurance app and file a claim, from your phone. Nothing disrupting about lemonade.

[John Alford]

@jguy2 USAA (Auto claims 2x in the past three years) and Liberty Mutual (homeowners due to windstorm/tree falling on roof) both used a great combination of app and real people. Settled quickly, fairly and for more than I expected in all three cases. So I agree, nothing disruptive. While I'm licensed for life, I know everyone in the insurance industry is heavily investing in big data, AI, and automation. We routinely get auto-approval for life insurance from $100,000 to $1M coverage by the time we are done with the online application. ZERO human underwriting other than the field agent asking standardized questions and a needs analysis.

[jguy2]

@John Alford I used to write some term insurance in addition to my investment advisory service and that was 20 years ago. I could run 10 competitive quotes for a prospect with the same rates as the internet and they would get some advice on proper amount of coverage (lemonade doesnt even have a basic calculator for that) and I would arrange the medical checkup which was a 10 minute visit arranged at the customer s convenience I have no idea what they offer in term life insurance that is consumer friendly ...unless you want to buy 20 or 30 year term life insurance without checking competing prices.but with a "splendid experience" with a bot that doesnt even have an 800 number or any other way to speak to a human being.

[ashleynevins]

LOL! Down 17%...and did you see the reasons why???
Keep making predictions before it reports new stock first quarter earnings.
Duh!

[ValueVector]

I fail to see how this company will ever make a profit AND grow revenue. LMND is spending all (100%) of its net premium revenue on advertising. It's dominant competitors spend 2%-3% and already saturate TV and internet with ads.

The company is wildly unprofitable and is projected to remain that way for at least 3+ years yet it still trades at 4x book value, above PGR at 3.5x despite PGR's dominant share in direct to consumer auto and home, immense scale advantage and consistent 20%+ ROE. Book value at LMND goes down every day as it continues to burn cash, and will do so for the next few years, it is a melting ice cube.

They just guided to $50M of stock comp paid to management despite projecting to lose -$223M to -$213M this year in EBITDA when correctly modeling stock comp as an expense (because it is). How is that shareholder friendly?

Management top-ticked their follow-on and share sale for insiders at $165 just four months ago. The stock will open 60% lower this morning. Great timing, for them!

[Wall Street Centauri]

Here's the thing. Lemonade has an app it takes you two minutes to buy insurance, two minutes to also make a claim. Which other insurance companies have similar apps?

[Jeremy Blum]

@Wall Street47 That 2 minutes works only part of the time for buying insurance and much less for claims. They usually need more info. Most of the other insurance companies have similar apps.

[Wall Street Centauri]

@Jeremy Blum just speaking from experience. At least for renters insurance it worked quicky for both buying and claiming. It was a medival process for a purchase through States Farm. There was an agent, emails and phones. No app.

[RisknReward]

@Wall Street47 I have been a lemonade customer for over 2 years and it beats State Farm by 50% on renters insurance. I totally agree with your take on State Farm's medieval process - (adds cost to the supply chain but I doubt if it adds value). I am looking forward to the car insurance product rollout by Lemonade. As much as I like the app and the insurance convenience, I can't say the same for valuation. Perhaps there will be a good entry point in the very near future.

[Jeremy Blum]

Ugly earnings. Losses are growing faster than revenues. The secret sauce here is not AI or a friendly bot, its spending 150% of revenues on marketing. Anyone can grow revenues at a loss if they do that.

[etrade2000]

@Jeremy Blum They're losing money on every sale, but they'll make it up in volume! You just don't understand man, they have the secret AI that NOBODY else in the world has. First mover advantage yo!

[Jeremy Blum]

@etrade2000 They do rule when it comes to buzz words.

[Corey123]

I see my other post got taken down. My point is that I don't believe Lemonade is my grandpa's insurance company. Some of those 1X stocks are dinosaurs. The younger people are switching to Lemonade in droves and they are telling their friends about it and it is only a matter of time before this becomes big. A knock out winner this stock will be. There is also pent up demand from people who want additional and/or other products that aren't even offered yet in certain areas. The key word is yet. Rome wasn't built in a day. And there is a clear path to profitability if you know what you are talking about. Copy and pasting the same thing over and over on different articles, and trolling people who post on them, is very childish in my opinion and even worse for someone who appears much older.

To the author of the article, nice job, I enjoyed the read.

[ValueGrowth Investing]

@Corey123 Just curious, how do you see them getting to profitability over time? Is it by scaling revenue; geographical expansion; reducing expenses or anything else?

And where do you see the best risk reward to get into or start a position in LMND in your opinion?

I'm bullish on the business model, just cannot fully wrap my head around the real path to profitability the company has + whether they can sustain the required customer growth (since they had a slowdown QoQ last quarter).. I think in the $60s and below is a good start, but as it gets lower risk is obviously less long-term

[Corey123]

@ValueGrowth Investing First of all, they already have gross margins with primarily renter's and term-life which are low margin. The gross margins should theoretically get better as they roll out new products like car insurance, and also the homeowners insurance isn't even offered in all 50 states yet. I think the goal is to get to a place where customers can bundle home and auto. So I believe the gross margins will get better as these products roll out and as more renter's customers start buying homes.

The combination of revenue growth and gross margin increasing with the additional products being offered should be positive to the gross profits.

On the other side of the formula, I think the AI is getting better at reducing the loss ratios. Right now, they use data from traditional insurance models, but the AI is learning and the ratios are trending in the right direction (Note: This Q you may see an uptick there because they got hit with a Texas freeze, but that was a unlikely event).

In order to scale, with new products and geographical growth, these things all cost money (investment). So they will have to invest some money on R&D and Marketing to build out the business. That will put pressure on operating margins for a while. As the products roll out, they will need less money for R&D and Marketing. In fact, I believe in the end that their cost to acquire a customer will be lower than for other insurance companies because of the seamlessness of the process and the fact that claims are not based on cooperate profits. There is no conflict of interest for them to not pay a claim. I don't think Lemonade will have the need of running commercials all day long like some of these other insurance companies. They are going to make the customer happy and when that happens one customer tells another customer and they starts buying other products, etc. I already see this happening today.

With all that said: Yes, it will take some time to get there, but Rome wasn't built in a day. Right now they seem to have a nice cash position to get them through. I bought a few shares at $87 and a few at $81 and a few more yesterday at $72. Full disclaimer: I don't know how to time the market, the Nasdaq sold off big yesterday and I look at those days like buying opportunities, but you have to have a long-term view of the company. If it drops into the $60's I will just buy more. Long-term, I think it goes well over $300 per share.

[johnny inca]

@Corey123 Not 300, just 30.

[Mikew59]

There almost seems to be a truism that throw around some tech jargon in a potentially large market and you have the makings of a business. This always leads to the word disruptive, for which there isn't a formal definition I'm aware of.

So, some things we know are true and how they apply to LMND.

1) The laws of economics have not been repealed. LMND can only keep destroying capital (losing money) to the degree the market will keep giving them cash.

2) P/C insurance is all about combined ratio -- the sum of loss ratio and expense ratio. The general rule has been for decades trade lower expense ratio for a higher loss ratio. This to a large degree has been the GEICO or Progressive approach. Direct selling has existed for decades, well before the internet. How much of a higher loss ratio will LMND accept. To date they have not put forth an equation that works.

3) This is a very data intensive business and the large underwriters are proficient data miners. LMND is at a massive data disadvantage.

4) Size -- large markets -- do not confer success.

5) Adverse selection is a major concern. LMND, right now, is likely getting business the large incumbents are indifferent about. These are very small niche markets.

6) Claims management matters. Most claims are fractional, there are few total losses. To manage this right you need a lot of data and knowledge and experience as to how to use it.

7) This is a very complex business requiring a lot of expertise, including underwriters and actuaries. So their Chief of Insurance is a former actuary. Oy!

8) Insurance, notably personal lines, is hyper competitive. If there is a lower price to be had you would already see it. LMND needs to raise their prices.

This company is a capital destruction machine. The magnitude of the losses are not sustainable. If I were I shareholder I would be very concerned.

[Jeremy Blum]

@Mikew59 Can I add these to my 24 reasons to avoid LMND above?

[Mikew59]

@Jeremy Blum Of course.

[Corey123]

@Jeremy Blum So is that what I should do? Go grab all the bullish reasons to buy the stock and copy and paste it to every LMND article?

[johnny inca]

the problem this and other LMND bulls have is that they don't address the elephant in the room -- you are valuing an insurance start up with tech valuations. Very stupid move. The larger LMND gets, the lower the share price will go, because once it reaches steady state, it's going to be valued 100% as an insurer.

[etrade2000]

Lemonade reports earnings tomorrow after the close. I'm positioned with put options. It's already plunging before earnings again today. If all goes well and the stock continues to plunge, I will make 6 figures by the end of the month.

"I have a 10 year investment horizon" is NOT an investment strategy. It's wishful thinking. You should re-evaluate your investment thesis if the stock drops below your risk tolerance threshold. Some people it's 10%. Others it's 20-30%. If you don't have a threshold and wants to blindly hold a stock, you should not be buying stocks. You are better off buying SPY.

[Edelhart]

@etrade2000 "If all goes well and the stock continues to plunge, I will make 6 figures by the end of the month."
THIS is wishful thinking!
Short-term, the market is a voting machine, long-term, it's a weighing machine!

[etrade2000]

@Edelhart My put options that I bought a few weeks ago are up 200% total (80% just today). How much money are you losing?

I'm not covering. It will plunge further. Look at the March 1, 2021 earnings report. The stock kept dropping for 5 straight days from $132 to $86. It will plunge more this time.

[Edelhart]

@etrade2000 Im not losing anything as im not selling. Congrats on your success though.

[ValueGrowth Investing]

@Wealth Insights Great summary on LMND business. Given the current sustained weakness in the stock, are you looking at ay particular entry point as a long-term investment? Given the lack of profitability with the business, do you think comparing their current MC with their huge international TAM is a way to get an idea of their future long-term upside potential?

I'm bullish on LMND and planning to start a position as it nears the $70 mark and below - been waiting for the stock since its ATHs

[Risk Professor]

Lemonade is the MoviePass, Inc. of the insurance industry.

[Kip Largo]

The “AI” is not real disruptor to the industry for two big reasons:
1. I worked at medium sized insurance company, it created and AI system in less than a year that handled roughly 50% of claims. Which means any of the big boys can if they want to. It’s not hard.
2. The AI is only as good as the proprietary data you already have to refine the algo. Lemonade being a new company has little valuable data from past claims to do this. Which also means it has the potential for big setbacks if they aren’t careful.

Lemonade’s only real disruption is how it is more marketed more around the 35 and younger crowd and how little friction it is to sign up. That’s it. Wait a couple of years when their customers really start having claims, and see what happens before jumping in.

[Jeremy Blum]

@Kip Largo Exactly!

[jguy2]

they are simply brokerimng someone else s term life insurance. I can go to selectquote.com and get multiple quotes in a minutr

[Jeremy Blum]

Wealth Insights, you have been drinking the Koolaid instead of the Lemonade. You need to dig deeper, past management's hype. Here's 24 reasons why.

1. Losses are massive - Losses have actually exceed revenues in every time period to date. This is unusually high for a growth company of this size. In the most recent quarter, revenues totaled $17.8 million and losses totaled $30.5 million. Losses increased from the prior quarter primarily due to the decision to cede insurance risk to reinsurers. The company is a long way from earnings.

2. There is no clear pathway to earnings - It is unclear how the company will become profitable based on the current business model. The company is currently paying more in sales and marketing expense than it is receiving in revenues. In the most recent quarter, sales and marketing was $22.2 million which exceeded revenues of $17.8 million. If this expense is reduced, growth is likely to be reduced significantly or even reversed. Every dollar spent on sales and marketing is currently resulting in more than $1 of losses.

3. Growth is slowing fast– Growth of the customer base was 46% in the first nine months of 2020 down from 108% in 2019. In the fourth quarter, growth slowed to only 6% from the linked quarter.

4. Not much bundling option - Lemonade is at a competitive disadvantage to its larger competitors who can bundle car and other insurance types Lemonade doesn’t have.

5. Very high stock price - Lemonade is in fact a traditional insurance company trading at an astronomical level. Most insurers trade at 1 to 2x book value and 1 to 2x revenues. Lemonade is currently trading at 69x last quarter’s revenues annualized.

6. Ceding to reinsurers significantly reduces earnings - By ceding most insurance risk to reinsurers Lemonade significantly reduces potential profit. If you remember only one thing on this list let be this. Most insurance companies derive the vast majority of their profits from insurance underwriting in the form of premiums. Investment income is a distant second and becoming even less so due to low interest rates. Lemonade has effectively ceded 75% of its premiums to reinsurers. That means it has given away the industry’s traditional profit center. It has little to replace that with. The 25% they keep needs to cover costs. Currently sales and marketing alone are well above the 25% of premiums they are getting.

7. The ESG claim has not proven accurate yet - The company’s claim to be ESG has so far hasn’t been accurate. The company did set up a charitable foundation. The company contributed 500,000 shares of its shares to the foundation in the first quarter of 2020. It claims that up to 40% of excess premiums each year will be donated to the charity of choice of the policy holder. So far it donated $1.1 million in the first nine months of 2020 and $631,540 in 2019. Both of those numbers are well under 1% of premiums. The foundation meanwhile has no website or defined vision. Increased contributions going forward will directly increase losses. Not good for investors.

8. Larger competitors offer online applications too - The three largest competitors for rental insurance are Allstate, State Farm and Liberty Mutual. All are much larger. All have internet applications for renters and homeowners insurance. All, unlike Lemonade, can also bundle with other insurance products. The lower price from bundling may offset any advantage Lemonade may have with its automated underwriting.

9. Automated underwriting is also done by their peers – Most of their peers have automated underwriting augmented by human interaction when needed. It is less effective overall than using a human component in reducing claims losses. Even Lemonade brings in a human for more complex applications. The move to more complex insurance like homeowners will require more human touch.

10. Limited underwriting data versus competitors - The company states the following on page 96 of its S-1 “ our extensive use of data and technology enables us to be increasingly precise at risk selection, risk pricing, and claims handling”. The reality is most competitors have decades of data to plug their algorithms into for underwriting insurance. Lemonade has barely two years worth of its own usable data. Lemonade does appear to pay for third party data to add to their own. That adds cost. Their competitors with much larger underwriting budgets almost certainly have better algorithms developed over decades. This is more of a disadvantage than advantage for Lemonade.

11. Reinsurers will call the shots - If you believe that underwriting doesn’t matter because the reinsurers are taking most of the risk think again. The reinsurers will eventually call the shots once the claims data is sufficient to model. If there are too many claims, they will increase their take from Lemonade. This will force Lemonade to either lose more money or increase the premiums.

12. Hurricane risk - Texas and Florida are two of three largest markets for Lemonade. Both are hurricane-prone. In fact, homeowners and renters insurers in those states suffered heavy losses in 2020 and 2019.

13. Insider selling has been massive since the IPO.

14. The AI bot can be duplicated - The only apparent secret sauce Lemonade appears to have is its Al Maya online bot. However, that can be easily knocked off by its larger competitors if they see it as a threat.

15. More costs are coming - The large operating losses are before all the new claims adjusters the company will need to hire to handle the increasing insurance. Lemonade not the reinsurers handles the claims.

16. Competition coming from tech companies - The S-1 on page 26 states “There are various technology companies that have recently started operating in adjacent insurance categories that may in the future offer renters and homeowners insurance products.”

17. Regulatory risk - Lemonade has not been examined by its regulator (the New York Department of Insurance) since 2018, a year when it wasn’t very active. A regulatory exam is due and its large losses will need to be considered. As a former bank regulator my experience is new financial companies trying new things often leads to errors and omissions that need to be cleaned up.

18. AI will likely have limited help with claims processing - The company claims that AI is being used for claims processing in addition to underwriting. I personally have an experience going through a large real estate insurance claim. The process took 9 months, with constant back and forth, and the eventual claim was three times the original estimate. The point is claims are much more complex than underwriting an individual customer. There are literally hundreds of potential variables. No program is going to able to handle all of them, at least yet. In the S-1 the company claims its bot, AI Jim, can handle a claim start to finish about 1/3 the time.

19. California law on bots - From the S-1 “A California law, effective as of July 2019, makes it unlawful for any person to use a bot to communicate with a person in California online with the intent to mislead the other person about its artificial identity for the purpose of knowingly deceiving the person about the content of the communication in order to incentivize a purchase of goods or services in a commercial transaction. Although we have taken steps to mitigate our liability for violations of this and other laws restricting the use of electronic communication tools, no assurance can be given that we will not be exposed to civil litigation or regulatory enforcement”

20. Human touch - The power of human interaction cannot be brushed aside. Humans can have empathy which is something robots or bots are nowhere close to. Humans can tell much by your tone or changes in your voice that bots cannot. The bot experience may be interesting or fun. But once things get serious it can and often will be annoying and frustrating.

21. No insider insurance background - BIG ONE. None of the directors or officers of Lemonade have an insurance background as shown by their backgrounds mentioned on the S-1. This one is very concerning. Lemonade is a technology company entering a financial segment. It doesn’t have the experience underwriting the incumbents have.

22. Little investment income - Lemonade’s competitors get a significant portion of their earnings from investment income. Lemonade currently has few investments held as assets. The two largest sources of income for insurance companies (premiums and investments) provide little for Lemonade.

23. Little traction in homeowners insurance - Based on its average premium size, Lemonade does not appear to be getting much traction in homeowners insurance. It does not provide a breakout between the two. The average annual premium per customer was $201 as of September 30, 2020 which is much closer to a renters premium than a homeowners.

24. The loss ratio is way understated due to LMND's rapid growth.

[etrade2000]

@Jeremy Blum The biggest problem I have with LMND is that I think management is actively misleading investors. In their earnings reports, they ALWAYS lead with how "gross premiums" are growing very fast and they downplay that fact that revenue is hardly growing.

That I think is a lie and the SEC should make them stop. Revenue - costs = earnings. Low revenue and high cost equals big losses. They acquire a customer and then turns around to sell that customer to a reinsurance company. What kind of business model is that?

The customer's premiums is the revenue coming in and they're handing it off to another company. Why don't they just turn themselves into Policy Genius and really call themselves a broker, a middle man comparison shopping web site. Margins are low in this market. For Lemonade, they lose money so they have no margins.

[Corey123]

@Jeremy Blum You’re just out of touch.

[Jeremy Blum]

@Corey123 So I list 24 reasons LMND is way over valued and that's all you can come up with?

[RisknReward]

I generally believe this is a solid company and a competitive insurance business model. My question is with Lemonade planning an expansion into car insurance - what do you think of the need for capital raise and valuation?

[jguy2]

@RisknReward You can read their description of their "breakthrough" car insurance (which they dont include in forecasts for the rest of 2021). Pure fantasy as the CEO talks about the power of cellphones to give data to use for insurance. Im not sure how that would work in underwriting new clients or how much better it is than the drivers record, the make and model of the car and the area. And many are aleady offering insurance per mile which can easily be done with the "black box" in many cars or in an inexpensive device companies can provide. And you cant evaluate and pay out large auto claims from a bot.