Today’s sharing is by my friend – Harry, who is a Growth Investor. I invest in ETFs primarily as I adopt a hands-off approach in investing. A small portion of my funds are invested in a couple of individual stocks. Syfe REITS are part of my holdings as well.
Nevertheless, I am always open to learning about stock analysis and what makes each company ticks. It’s interesting to how companies differentiate their services and products, and their business model etc.
I came across Lemonade Insurance Company from Chicken Genius’ video!
Lemonade is an insurance company, founded in 2015, that is powered by artificial intelligence and behavioral economics. Its mission is to replace brokers and bureaucracy with bots and machine learning, aiming for zero paperwork and instant everything.
Insurance can be bought extremely quickly (90s median time), with easy interfaces that are very attractive to the millennials. When claiming from the insurance, there are also no brokers required; customers just have to speak to the bot to claim from the insurance. At the moment, about one-third of the claims are being done solely from the bot itself.
So how is Lemonade disruptive? Using AI, Lemonade collects as much as 100x more data from customers than a legacy insurance company. As we all know, the more data we have, the more accurate their risk models can be. Therefore, Lemonade will be able to offer premiums that are way more competitive than their less innovative competitors.
Lemonade currently offers 3 different types of insurance: renters insurance, homeowner’s insurance and pet insurance, and is looking to expand into other types of insurance such as auto insurance and life insurance.
According to CEO & Co-founder Daniel Schreiber, there is much distrust in the insurance companies not because they do not have a way to pay the claims, but because they do not have a will to pay the claims. In a typical insurance company, the company generates greater profits when there are denial of claims, which potentially can cause distrust. Because of this, part of Lemonade’s business fundamentals is based on building trusts with the customers. Lemonade takes a flat fee of the premiums paid, and the remaining will be used to pay off claims and purchase reinsurance. Any leftover money will then be donated to the charity of the customer’s choice. This way, it changes the incentives for both the company and customers. For Lemonade, there is no need for any denial of claims simply because there are no incentives to do so. For the customers, they are less likely to embellish a claim because they understand that any false claims made will be hurting the charity of their choice.
It is also important to note that the management plays a significant part of the company’s growth. It is important that the management consists of people who are technically trained as well. Take for example successful businesses such as Tesla, Facebook, Amazon, etc, not only are the CEOs great businessmen, they are also sound in their technical skills as well. A CEO who understands both the business and the technical sides of the company brings about more value to the company in my opinion.
COO & Co-Founder Shai Wininger is a 20 year veteran in the tech sector & CEO Daniel Schreiber is a law-trained veteran who could be involved in the regulations of the policies. They realised that there can be much disruption in the insurance industry; an industry that has not changed their business model in more than 100 years.
Based on the app store review, Lemonade currently scores at 4.6/5.0 in Google play store and 4.9/5.0 on Apple’s app store; generally with high level of satisfactions from the customers. This is important as we cannot underestimate the power of word of mouth from consumers. Take a look at Tesla, a company that spends $0 on advertising but have so many fans loving the product; people will get influenced easily through word of mouth.
Lemonade currently earns revenue based on:
- premiums charged to the consumers
- investment done using the premiums charged to consumers
- “ceding commission” of 25% for every dollar ceded for reinsurance. This ceded commission can be looked as sort of a “rebate” for purchasing reinsurance.
So what is Reinsurance? It’s the way insurance companies hedge the risks their policyholders pay them to assume. Think of it as insurance for insurance companies. Lemonade’s reinsurance program protects Lemonade against all kinds of losses, including large individual losses and accumulations of losses (such as would result from a hurricane). When they pay a claim under the customer’s policy, and that payment is reinsured, the reinsurance company reimburses Lemonade Insurance Company for all or part of that payment. This helps to protect Lemonade from a heavy downside in an event of an unexpected disaster.
The insurance industry is extremely huge; it is a 4.6 trillion dollar market globally. No one company has a market share greater than 4%. Global premiums were growing well in 2019, with a growth of ~4.4%. In 2020, due to the pandemic, global premium income is seen shrinking by 3.8%, with life insurance premiums shrinking about 4.4% and P&C (Property & Casualty) shrinking about 2.8%. However, once the world recovers from the pandemic and everything goes back to normal, we should see a steady growth of ~4.4% again over the next decade.
Lemonade’s plan is to grow alongside the customers (millennials mainly). As these millennials get wealthier, they may upgrade their plans. For example, from renter’s insurance to homeowners insurance when they purchase their own property. So there is massive potential for Lemonade to grow fast; from increasing customer base to customers upgrading plans as they remain satisfied with the company’s products.
Beginning July 1, 2020, Lemonade will have proportional reinsurance protecting 75% of their business. This means that Lemonade will transfer 75% of their premiums collected to their reinsurers and in exchange, receives a “ceding commission” of 25% for every dollar transferred, in addition to funding all of the corresponding claims, i.e. 75% of the claims.
This is very interesting because it helps to protect the company tremendously from the downside of big claims. To me, I see it as a double-edge sword. It might be beneficial for Lemonade as Lemonade can now take up a larger customer base as they limit their payout claims to only 25% (reinsurers protecting 75%). At the same time, it might limit the growth of the company since a large portion of the revenue generated is used for the purchase of the reinsurance. We can only know more in-depth how it affects Lemonade when Q3 & Q4 reports are out.
Also, the company might also run in regulation problems, potentially causing delay in the expansion of policies and growth. But in my personal opinion, this should not be a big hindrance.
All in all, in my personal opinion, how successful Lemonade becomes depends on a big factor; whether their competitors are able to innovate quickly to keep up with the technological change. That being said, these legacy insurance companies have been around for more than 100 years (median age of insurance companies is 125 years old) and it might be very difficult for them to adapt to changes, hence Lemonade might be able to take up greater market shares as the AI collects more and more data. Moreover, these insurance companies have assets in the form of agents which are extremely valuable to them. For them to adapt to the new innovations, they will have to cut down these agents which the CEOs might not be willing to take the risks.
For Q2 2020, Lemonade’s report is actually really impressive despite the global pandemic. Customer base grew 84% YoY from 443k to 814k. What is also worthy to note is that premiums per customer also grew 17% YoY from $163 per customer to $190. This is likely the result of home renters upgrading to homeowner insurances, which is a good sign of customer satisfaction. Overall, premiums collected increased 115% YoY, from $72 million to $155 million.
Loss ratio is also an important metric to take note of for insurance companies. Loss ratio refers to the ratio between what they give out in claims and what they have collected in premiums. A loss ratio of 80% will mean that they are currently paying out 80 cents out of every dollars collected in claims. The loss ratio for Lemonade has dropped tremendously from 368% in Q1 2017 to 72% in Q1 2020, which is a sign that the AI has collected good amounts of data to provide premiums that do not result in losses. In Q2 2020, the loss ratio continues to decrease to 67%, which is a good sign of continuous improvement. Once the AI has collected enough data on the different locations, I believe that the loss ratio can be improved to be comparable to the top insurance companies like Allstate insurance & AIG, with respective loss ratio sitting at 59.1% & 66.8%.
However, operating expenses continue to increase, from $27 million in Q2 2019 to $30 million in Q2 2020. This is driven mainly by insurance expenses & general administrative costs, which is likely to happen as the company grows. Sales and marketing costs decreased from $19 million to $16 million, which is a great sign that the company does not need to advertise as heavily to gain huge customer growth. View Lemonade’s performance highlight here.
Potential price points for entries ( personal opinion)
As this is a company that has just IPO-ed, the price movement can be extremely, extremely volatile. This is one of the stocks that you have to just buy and toss the trading app into a cabinet for 5-10 years. Prices may very well fall back to its IPO prices ($29) and even more, or might just double in the upcoming months. As long term investors, we rely on the company’s fundamentals to grow massively along with its stock price in the long term and not look for short term profits.
First entry: $49-$51
Second entry: ~$40
Third Entry: ~$29
Personally, I am still on the side line on this stock but observing carefully about news around them. There is a very high likelihood that I will invest in them. As with new IPO stocks, share prices can be hit massively with any bad news arising related to the stock due the nature of short-selling (traders and institutions borrowing shares to sell them and buying them back at a lower price to gain profits, resulting in a heavy downward pressure in the share prices). Also with the new reinsurance plan taking effect from July 2020, I would want to see how this change translates into their financials in Q3 and Q4.
Do note that the market is always forward looking, and with all disruptive companies, there is always a premium to be paid for its shares (due to its potential to take up huge market shares). Therefore, these kinds of companies always looked expensive. Take example 3 disruptive companies: Amazon, Tesla, Shopify; these companies were never “cheap” based on the typical financial metrics such as PE Ratio (Price-to-Earnings), PS Ratio (Price-to-Sales) and there is never a proper way of valuing these kinds of companies. What matters most is whether these companies are taking up huge market shares and how disruptive they are in the respective industries. If you believe in the technology and business model that Lemonade uses, then invest in them and hope that prices will fall even more so you can accumulate even more shares at a lower cost.
For more analysis, you can head here.