Lemonade Insurance Stock Analysis: Deep Dive

Lemonade, Inc. [NYSE: LMND] operates as an insurance company. It offers digital and artificial intelligence-based platform for various insurances, and for claims settlements and paying premiums. The company is powered by a unique combination of artificial intelligence and behavioral economics, and uses bots and machine learning to disrupt the centuries-old insurance industry.

The company offers renters’ insurance, home owners’ insurance, pet insurance and term life insurance in the United States, contents and liability insurance in Germany and the Netherlands, and renters’ insurance in France.

The peer-to-peer property and casualty insurance company seeks to replace brokers and bureaucracy with AI and machine learning, using bots to deliver insurance to consumers through its chatbot-driven Lemonade application.

It keeps a flat 25% fee of a customer’s premium while setting aside the remaining 75% to pay claims and purchase reinsurance (it obtains reinsurance from Lloyds of London), meaning it’s much less incentivized than most insurers to deny claims.

Lemonade donates leftover premiums to charities selected by its community during its annual Giveback. The New York City-based company was founded by Daniel Schreiber (former president of Powermat Technologies), Shai Wininger (co-founder of Fiverr) and Ty Sagalow in April, 2015, and went public in July, 2020.

Lemonade Insurance Stock Analysis: Bull Thesis

Lemonade is still a small company, but an extremely fast-growing one with an unusually high user base, and big dreams of disrupting the long-standing insurance industry.

Its emphasis on big data and artificial intelligence to quickly and efficiently process claims, and its B-Corp status has quickly made it popular with customers, especially the younger ones, who haven’t had insurance before. 

Lemonade uses AI-powered chatbots to help consumers buy insurance and file claims. This, apart from helping it trim operations and improve customer experience, gives the company the luxury of saving on manpower, the benefits of which it can pass on to customers.

Lemonade also takes a different approach to monetizing its business. It charges a flat premium, and the money saved after covering claims and expenses are donated to charities selected by its customers. In 2020, Lemonade donated more than $1.1 million to charities.

Gross written premiums (GWP) grew 84% in 2020, 147% in 2019, and 422% in 2018, which attests to the efficiency of its business and the fact that its customer-centric business model is gaining traction.

Also, Lemonade boasts a very high user satisfaction rating.  It has a 4.9-star rating on the App Store and a very high net promoter score.

Plus, Lemonade was co-founded by Shai Wininger, who also founded Fiverr [NYSE: FVRR]. Fiverr is a very successful growth story which, in turn, inspires confidence about the future success of Lemonade.

Lemonade’s Loss Ratio Is Worrisome

An insurance company’s loss ratio is a determinant of a business’s efficiency. The long-term viability of the business model (profitability) is dependent on this metric’s strength.

Loss ratio is calculated by dividing the total claims processed by total collected premiums. The lower the figure, the better it is for the company. For example, if a company pays $80 in claims for every $160 in collected premiums, the loss ratio would be 50%.

Lemonade’s loss ratios have been worrisome, but the company has steadily managed to lower it over the past eight quarters. This is because as the company collects more data, the better the system functions.

Big Growth Opportunities In Emerging Markets

The global insurance industry is worth $6 trillion, and still growing.

The scale of the insurance industry automatically favors Lemonade to be an exceptional long-term investment. Moreover, over the years, premium volume is expected to grow significantly in emerging markets.

And while the company is still growing rapidly in the US, Lemonade has begun to spread its wings internationally, with presence in Germany, the Netherlands, and France. These levers will combine to drive strong top line growth for the foreseeable future.

Lemonade recently launched pet insurance and life insurance over the past 12 months and is getting ready to roll out auto insurance which, according to Lemonade, is a $300 billion market.

Why Be A Bull: The Bottom Line

Lemonade’s valuation is a bit extreme right now, and there are questions around profitability, but Lemonade’s operating metrics are improving, and the company has a massive TAM (total addressable market) ahead of it.  

The upside is tremendous if the business can scale to profitability, which means it’s a good stock for growth-oriented investors with a long-term time horizon.

The Bear Case for Lemonade

Lemonade’s IPO was a runaway success. A new age tech-based insurance company, Lemonade has been trying to redefine the insurance business, by working hard towards eliminating the general sense of distrust usually found between insurers and their customers.

However, despite all the hype and hoopla, it is one of the many Softbank’s investments that is still running in the red. The company reported ($0.81) EPS for the quarter. The company had a revenue of $23.50 million for the quarter, down 10.3% compared to the same quarter last year.

Lemonade’s radical approach to insurance has generated a fair amount of both, plaudits and brickbats for the company. There are critics who believe that the company is all rhetoric and little substance.

To better understand the risk-reward scenario, it is imperative to first understand how the company actually functions. Some detractors of the company claim that Lemonade is actually two companies consisting of a risk-bearing insurance company AND a brokerage firm.

It should be known that when consumers buy a policy from Lemonade, the company keeps a flat 25% fee of a customer’s premium while setting aside the remaining 75% to pay claims and purchase reinsurance. Let’s delve into the details a bit further.

How Lemonade Makes Money

Lemonade asserts that it pays about a third of its claims in a few seconds, something of a rare phenomenon with most traditional insurance companies.

And it’s true.

However, this setup carries a significant amount of risk with it. The less rigorous the verification process, the more the probability of paying off spurious claims. And while Lemonade believes that it can ward off such risk through the use of AI and behavioral economics where aligned interests is expected to breed honesty, it certainly is not a foolproof method to shield the company from taking a bath.

The company believes its unique business model can help it avoid the probability of such a doomsday scenario turning into reality.

The company operates on two layers.

At the first level, it charges a flat fee from customers buying insurance. At the second level, it operates as a ‘not-for-profit’ silo that settles claims.

Here’s how it works.

It takes a certain percentage as a fee and treats the remaining amount as that of the policyholders. The money so pooled is used to pay claims as and when they’re due. At the end of the year, whatever money is left is given to charities chosen by the policyholders.

In simple terms, leftover premiums are given to the charities, which means the company has nothing to gain by denying claims.

Also, the company contends that customers are unlikely to exaggerate their claims since they are not hurting a nameless, faceless behemoth with whom they have a conflicted relationship—but a charitable cause that’s near and dear to their heart.

So, technically, they are trying to make money by building a system that brings out the best in people.  However, what looks so good on paper may turn out to be practically unfeasible. There are lots of ifs and buts involved in the equation such as:

  • What if the premiums paid by customers is less than the total payouts the company needs to make?
  • What if the company has no money to donate to charities?
  • What if this whole scheme turns out to be a dud in the long run?

Lemonade Insurance Stock Analysis: Skeptics View

Well, for starters, Lemonade, to protect itself from such a gloomy scenario, reinsures most of its policies. It means Lemonade buys insurance from other insurance companies which, in turn, bear most of the risk.

The reinsurance companies are tagging along for now hoping that they will eventually start making a profit from the whole transaction a few years down the line.  However, things can quickly turn sour if they keep making losses, having to pay more in claims than premium earned.

Also, in order to buy reinsurance, Lemonade may have to charge higher premiums. More importantly, a situation could arise when the company does not have a lot left for charity.

There’s also a very real and present danger of the whole thing turning out to be a marketing gimmick. This could be totally ruinous for its investors.

In order to survive, it is therefore almost critical for the company to improve upon its loss ratio. In simple terms, a loss ratio is the claims you pay divided by the premium you earn. For example, if an insurer collects $100 million in premiums and pays out $70 million for claims, the insurer has a loss ratio of 70%.

But improving upon the loss ratio for a company like Lemonade is easier said than done. If you are not charging enough premium your loss ratio is high, and if you increase your premium, you lose your goodwill with your customers. Walking this tightrope can be extremely hard, which means it is imperative to strike the right balance to stay in the business.

Technology: Pro Or Con for LMND Share Price?

And the company can sometimes land in a soup owing to its emphasis on the use of certain modern technology which allows it to do business in a better manner compared to legacy insurance companies.

For instance, Lemonade recently faced a lot of backlash with a proud declaration that its AI analyzes videos of customers when determining if their claims are fraudulent.

Lemonade provided an example of how its AI “carefully analyzes” videos that it asks customers making claims to send in “for signs of fraud,” including “non-verbal cues,” crediting its AI for helping it improve its loss ratios.

Lemonade had to face a lot of brickbats, as furious customers questioned if their claims would be denied because of the color of their skin, gender, economic class, or if Lemonade’s claims bot, “AI Jim,” decided that they looked like they were lying. Lemonade eventually had to backtrack on its claims.

Overall, only time can tell if Lemonade will be able to leverage data, cut costs and build a profitable business, more so given the fact that many of the things Lemonade is currently doing are unproven and, in some cases, controversial.

Anyone that invests in Lemonade has to realize that for all its sophistication and a different business model, Lemonade is an unprofitable company operating in a highly competitive market. Hopefully, Lemonade can fix its problems going forward and give investors something to cheer about.

Lemonade Stock Price Forecast

Analysts’ 12-month price forecasts for Lemonade Inc. have a median target of $88.00, with a high estimate of $134.00 and a low estimate of $27.00.

This suggests that the stock has a possible downside of 19% from its current price.

Is Lemonade Stock a Buy?

It hasn’t been smooth sailing for shareholders of Lemonade since the stock debuted on the market last July.  After hitting an all-time high in January, the stock has been on a long decline.

Much of it could be attributed to investors rotating out of highly priced growth stocks for fear that burgeoning inflation may prompt central banks to dial back the lavish support that has lifted the market to an astral plane after the bedlam witnessed during the pandemic.

Also, some reasons for Lemonade’s slide could also be attributed to the havoc wrecked in Texas by the winter storm Uri.

Add to that the fact that Lemonade is still unprofitable, and you will find very few investors having the stomach to digest this kind of a wild ride. But then, high growth stocks often carry the maximum amount of risk with them.

Let’s find out if Lemonade is the right stock for you.

Lemonade is a relatively new company, but growing at a rapid rate. The company’s products (at least one) are available in all 50 states.

What is more impressive is that the company is rapidly expanding its portfolio, having launched pet insurance and life insurance over the past 12 months.  The term life insurance is fully digital, and the entire process is fairly easy to complete.

A unique thing about this offering is that Lemonade just acts as an insurance agent here charging a commission, while the product is actually issued by North American Company that is actually taking risk on the term life policies. 

More importantly, recently in April, Lemonade began to open up early registration for Lemonade car insurance. This is major news for Lemonade as car insurance is a huge market.

According to Lemonade, the auto insurance market is a $300 billion market in the U.S. alone. That’s 70 times larger than the renters’ insurance market (Lemonade’s main market), 80 times larger than the pet insurance market and three times larger than all of the homeowner’s insurance market. 

Product portfolio expansion not only immensely increases its addressable market, but also augments its up-sell and cross-sell opportunities across its happy customer base.

However, the competition in the auto insurance market is fierce with Lemonade expected to face some formidable foes in very old companies like  GEICO, and Progressive, and newer ones like Root, which is a digital auto insurance company that is in many ways similar to Lemonade.

Lemonade Q1 Earnings Report

Lemonade’s customer count in Q1 jumped 50% to 1,096,618 as compared to the first quarter of 2020.

The company’s first quarter total revenue was $23.5 million compared to the consensus estimate of $21.88 million. Its quarterly revenue was down 10.3% compared to the same quarter last year.

Total operating expense in Q1 increased 25% to $55.1 million as compared to the $44.2 million in the first quarter of 2020, driven primarily by increases in other insurance expense, technology development, sales and marketing expense, and general and administrative expense, to name a few.

Lemonade’s net loss in Q1 came in at $49.0 million, or -$0.81 per share.  Total net loss was $36.5 million, or -$3.16 per share in the same quarter a year earlier.  The loss could be attributed to increased operating expenses.

Moving forward, analysts expect Lemonade to grow around 26% YoY annually in 2021 and around 58% YoY in 2022.

The optimism stems from the belief that the life insurance product and the car insurance product will start making greater impact on the overall growth of the company in coming years.

Lemonade Stock Analysis: Bear Case Conclusion

Lemonade is not profitable, and on top of that, its revenue for its latest quarter declined over 10% as compared to the same quarter a year ago. However, it is not unlikely for a young growth company in its early stages to rake in losses.

The company, having already proved its tech and AI advantage, is launching new products at a quick pace which, in turn, is expected to expand its addressable market and enhance its up-selling and cross-selling opportunities.

The firm’s Net Promoter Score (NPS), which is an indicator of customers’ satisfaction, is a whopping 70, which attests to its popularity amongst its target audience. 

The company has attracted more than 1 million customers in its four years of operations and its auto insurance product has a huge potential.

On the flip side, Lemonade has taken shareholders on a roller-coaster ride since its stock debuted last July, and the stock is down about 20 % year to date.

This makes Lemonade a good stock to buy at the current price, but only for investors willing to speculate in what is almost certain to be a very volatile stock.

Lemonade Investment Thesis: Buy or Sell

Critics of Lemonade are quick to dismiss it is an overhyped and overvalued insurance company. However, despite all the volatility and unprofitability, we should not forget that Lemonade is a rapidly growing insurance company with an unusually high user base and NPS rating.

The firm’s business model is also different from traditional insurance companies as the extensive use of AI, data, and behavioral economics puts it somewhere between an insurance and a tech company (insurtech company). 

In fact, the company describes itself as “rebuilding insurance from the ground up on a digital substrate and an innovative business model”.

Lemonade has tremendous growth prospects, but then the firm’s high-risk profile means it’s, to an extent, suitable only for very risk-tolerant investors with a long-time horizon.

The company is growing at a rapid pace (YoY growth of 84%), courtesy a strong brand, efficient marketing strategy and very high customer satisfaction rating.

Lemonade is a certified B-Corporation. Certified B Corporations are a new kind of business that balance purpose and profit by meeting the highest standards of verified social and environmental performance, public transparency, and legal accountability to balance profit and purpose.

The firm’s heavy use of reinsurance along with its B-Corp status is expected to be its prime growth driver.

Future Profitability In Jeopardy?

A young and fast-growing company, Lemonade is currently running into losses, as it is making heavy investment in growth. The insurance firm spent $80 million on sales and marketing in 2020, whereas its total revenue was $94.4 million in revenue).

This is a very high ratio, but should not be a cause of great concern given the firm’s efficient marketing campaigns. Also, sales and marketing budget is expected to come down once the company grows older and settles down. 

The company is also making some progress on its gross loss ratio (the percentage of an insurer’s premiums paid out as claims). It currently stands at 71%, down from 79% in 2019, which is not bad for a young company. Moreover, the loss ratio is expected to decline over time. 

Lemonade’s high-tech platform means that, over time, it is expected that the gap between its general and administrative expenses and its revenue should continue to widen.

A cause of concern for investors, though, could be Lemonade’s share dilution, as it can reduce the value of existing investors’ shares and their ownership proportion. Lemonade did an offering of 5.5M shares in 2021, compared to their issuing of 12.7M shares at IPO. The company, however, has asserted that it does not plan further offerings in 2021.

Huge Market = Huge Growth Prospects for Lemonade?

Lemonade notes that “property, casualty, and life insurance premiums amount to approximately $5 trillion globally, and account for 11% of gross domestic product in the United States.”

It offers all these three types of insurance to customers, and in such a scenario, a few people can be forgiven for getting carried away, believing that Lemonade can gobble up a major chunk of this luscious pie to become one of the most valuable company on the planet.

However, before we start fantasizing about such a fairytale possibility for Lemonade, it is important to note that the insurance industry is very competitive and fragmented, and regulated by strong laws and guidelines.

Lemonade relies a lot on technology and AI, but it would be grossly wrong to assume that technology alone can help Lemonade steal a march over deeply entrenched traditional insurance giants.

For reference, Lemonade is currently worth $6 billion, whereas Anthem (ANTM) is worth $92 billion and Progressive is worth $54 billion. To put it in perspective, at 30% growth rate, it would take around 17 years for Lemonade to catch up with Anthem’s gross written premiums (GWP).

The B-Corp Business Model: A Branding Victory

Lemonade is a certified B-Corp which means they are a business “that meets the highest standards of verified social and environmental performance, public transparency, and legal accountability to balance profit and purpose.”

The company believes that being a B-Corp will help it win public trust and minimize volatility. Apart from minimizing volatility (good and bad years making little impact on gross margin), being a B-Corp also makes for an excellent marketing/branding tool.

This could also help Lemonade protect itself from fraudulent insurance claims, as most people would not like to take money from charity.

This concept, however, is not new as there are insurance companies such as Assurity and G2 that are B-Corp, and then there are other insurance companies, including Kinsale Capital [NASDAQ: KNSL] which use reinsurance, but Lemonade is the first publicly traded insurance company that’s a B-Corp.

And this is where Lemonade has to take a very precarious course to prevent conflict of interest between its social cause and its investors. Jettisoning its status as a B-Corp will be extremely detrimental to its branding and marketing efforts, whereas becoming a successful investment would attract criticism of prioritizing shareholders’ interest over charitable causes. 

To sum it up, Lemonade is a very young company, which means it could take years before it manages to establish a convincing record of being both profitable and charitable. Also, despite the use of reinsurance, Lemonade cannot expect to be completely shielded from catastrophes, as the reinsurance rates, too, will go up during such times.

Young Customer Base = Sustainable Revenue

Lemonade is most popular with younger users, with approximately 70% of its current customers being under the age of 35, who haven’t had insurance before.

This is extremely good news for the company because as they will grow older, their value to the company will increase as well.

The key is to retain them for longer periods of time, and Lemonade scores here as well.

It has an exceptional 4.9-star rating on the App Store, and a net promoter score (“NPS”) of above 70 in an industry that typically scores much lower. The NPS is a rough measure of user satisfaction.

Better Cost Advantages: Maybe Not?

Lemonade claims that, by eliminating human-driven parts of a traditional insurance company, it has obtained cost advantages and better efficiency, which they pass onto their customers. However, this looks better on paper than in reality.

First and foremost, when it comes to services like insurance it has been found that customers are willing to pay extra for a friendly and supportive human-based customer service. 

Also, Lemonade’s claim that it holds cost advantage fails to pass muster under closer scrutiny.

There are a lot of insurers that are price competitive with Lemonade, while some like State Farm actually have a lower rate.

Moreover, until Lemonade turns profitable, having any cost advantages (real or imaginary) could be of little value to investors.

Sky-high Valuation Poses High Risk

At over 60x price-to-sales, Lemonade is valued more richly than most high-growth tech companies, some of which are growing at the same rate as Lemonade, and some of which are even profitable.

However, current valuation should be of lesser concern for investors, if the company has the potential to grow at a quick pace in coming years.

If Lemonade’s business model indeed works, and the company continues to grow rapidly for the next decade or so, then it will see itself in the same league as some of the larger insurers are now.

On the other end of the spectrum, if Lemonade’s business model turns out to be a dud, or gets wiped out by some black swan event (an extremely negative event or occurrence that is impossibly difficult to predict), or continues with share dilution, the business will eventually fail and the stocks will not be worth the paper it is printed on. 

Lemonade Insurnace Stock Analysis: Conclusion

Lemonade has been a major success when it comes to top line growth. In fact, Lemonade surpassed 1 million customers in 2020, less than five years after it was founded.

On the other hand, however, Lemonade is unprofitable, trades at a pricey 62 times sales, and more ambitious parts of its business like blending digital-first business model with big data and artificial intelligence (AI), and B-Corp are yet to be proven. 

Also, Lemonade faces stiff competition from titans of the industry like State Farm and Berkshire Hathaway’s GEICO.  As a result, it is still unknown whether this company can be very profitable for shareholders.

To sum it up, given the risks and current valuation, you can buy Lemonade, keeping its long-term prospects in mind, and not for short-term quick returns.

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