Lemonade is a quality insurance business that has figured out how to acquire customers who have previously never engaged with an insurance company for their renters insurance needs at reasonable payback economics (~2 years). This low-touch customer base / insurance product allows Lemonade to service the insurance policies with minimal human oversight, thus providing reasonable economics on an otherwise razor thin insurance product. Their renters insurance product is magical and is a step-up from any other insurance transaction I've experienced.
For Lemonade to achieve its true potential (and recent multi-billion dollar valuation) it will have to successfully move into other lines of insurance (homeowners, life, auto, or commercial). Unfortunately, the prospectus does not touch on Lemonades ability to sell beyond the initial renters insurance market, even branching into the homeowners insurance space with HO-3/HO-5 policies, which requires a higher amount of engagement for underwriting and claims servicing. Based on the self-reported $183 of premium per customer, it's hard to imaging they're doing much business outside of renters. In order to turn into a Lemonade bull, I'd want to understand loss ratio + gross margin profile (underwriting, servicing, etc) of lines outside the renters category or at least better appreciate the depth of technology built today to price and service the renters insurance.
In its current state, operating at an estimated EOY 2020 GWP of $265M and net revenue (not GAAP) of $80M and -$100M+ in loss, I find it hard to believe Lemonade will price north of their latest funding round of $2B (25x net revenue), or at least I find it hard to believe that it's worth north of this price, public markets sentiment is not a great indicator of value.
Lemonade runs on a fixed fee model: 25% of premium. They're a lot less like an insurance carrier than previously imagined. They're offloading risk to reinsurance partners, therefore act more like an MGA than a traditional carrier. Smart.
- Lemonade cedes $0.75 of every $1 in gross written premium (GWP) to reinsurer for a fee of $0.25. That reinsurer then covers 75% of the losses.
- "Net Revenue" improves from ~30% to 35% if they can materially improve loss ratio. We don't see as much fluctuation in the net margin figure due to shielding from reinsurance contracts.
- Reinsurance also improves capital efficiency. $0.50 has to be kept in reserves for $1 in written premium. Reinsurance leverages that to $0.14 per $1 of written premium
- Note that this net revenue is a different calculation than described in the prospectus and is comparable to other recurring revenue businesses within the technology category (namely software)
$116M GWP in 2019, at a 30% net margin, $35M in net revenue
$183 in premium per customer, these are SMALL policies, majority renters... can they break into homeowners and effectively service those policies?
"90% of our customers said they were not switching from another carrier." Lemonade is capturing first time buyers of renters insurance who previously haven't engaged with the product likely due to the difficulty in procuring insurance. Can they convince customers who work with an existing player to switch? That's the majority of the market unless they want to grow at the rate the population ages.
- I wonder how real the underwriting advantage is from Lemonade? Average homeowners loss ratio is 74%, but they're primarily selling renters policies which likely have a different loss profile. Can Lemonade defend a low loss ratio at its current premium pricing? In other insurance markets, loss ratio is not a particularly defensible economic barrier since other parties will come in and underprice on premium until loss ratio equilibrates to a market figure.
- At a 79% loss ratio and 25% fee, reinsurance partners are breakeven on the insurance policy, making money on the float. Lemonade is a risky partner if the only benefit is cheap capital, they've gotta expect either a) better loss performance, or b) massive growth in written premium.
Growth + 2020 Numbers
- Spent $42M in S&M in 2018, $89M in 2019
- Grew from $47M to $116M (GWP 2018 to 2019 (on spend of $42M).
- 75% retention of the original $47M =$35M in premium retained
- $82M in acquired premium on $42M in spend. Checks out with the prospectus guidance that they spend $1 to acquire $2 in premium.
- 2020 Projects (Nitin's Estimates)
- 75% retention of the $116M = $87M
- $89M in S&M spend to acquire $178M in new premium (assuming acquisition economics stay the same)
- EOY 2020 GWP of $265M
- Net revenue EOY2020 of $80M, not bad.
- (I'm not giving credit for cohort revenue growth, I am cutting that out in favor of company-initiated cancellations, and deterioration in acquisition economics as they scale S&M)
Margin + Payback
- I'm very disappointed not to see a broken out G&A line that covers customer service, customer onboarding, underwriting, claims administration, etc.
- 643,118 customers EOY 2019 up from 308,835. At $21M in G&A costs (up from $9.1M). Thats ~$33 in G&A per customer that seems to have scaled linearly with the number of customers they serviced, $33 in G&A for an average of $183 in premium is almost 20% which would tank customer payback.
- Bright side is that much of this could be one-time (if related to underwriting) or not relevant entirely (office space, etc). Payback is incredibly sensitive to this spend though and I'd be interested in how this changes as they move into higher touch insurance products
- The prospectus quotes a "20% gross margin", which would imply 10% additional cost 50% of G&A spend) on top of the revenue margin math done above.
- 1/3 of claims do not require human intervention (I wonder how this number has changed over time) and what the cost of human intervention is for the other 2/3. Similarly 1/3 of customer support inquiries were handled by the bot, but the prospectus clearly states thats up from 6% 2 years ago. These numbers will likely perform better over time within the renter segment, but it's unclear how they will perform w/ new products.
- Acquisition cost. $1 in marketing for $2 in-force premium, or $0.50 for every $1. At 30.25% net margin (from above) and 10% margin from G&A (allocating 33% of G&A spend conservatively), you get 2 year payback on marketing spend. For a very low value consumer product, not sure how good that is