Thank you, I have read through your analysis as well and think it has a lot of interesting points.
Regarding retention, I chose to not incorporate regulatory or underwriting risk driven cancellation to capture demand driven cancellations only. I expect as time goes on and Lemonade's capital increases & they fine tune the underwriting model / better price risk, these Company forced cancellations will decrease, as they have the past two years.
I'd be interested to know what % of customers transfer to a competitor vs. not needing the renters / homeowners product anymore.
I do agree with you, however, that this lowers their implied customer lifetime even further, and by extension unit economics.
Thanks! After drafting & reading S-1s for years, my superpower is skimming through quickly :)
On your first point, Lemonade's loss ratios are currently higher than industry average. This is likely tail weighted & driven by a few outlier claims, as their premiums underwritten are minuscule versus their large competitors. Lemonade has every incentive to continue pricing risk better, and ML is the perfect tool for this. Having spoken to CIOs (chief insurance officers) in the industry, the amount of data insurance companies generate is tremendous, and very quickly ML can spot correlations between price, claims payouts, frequency, etc. Harnessing the data as the largest insurcos are surprisingly manual & paper based, and asking the right questions to the machine is the hard part, but Lemonade has the advantage of being more nimble & not encumbered by the legacy tech stack.
Lemonade's original philosophy of taking a flat fee & donating the unpaid claims, was driven by disincentivzing fraud. They hired behavioral scientists, and this was big marketing push for their 1.0/1.5 platform. Insurance companies only have so many value levers to pull, and I think while not explicitly stated in the S-1, reading through publicly available posts & data show Lemonade is very much focused on pricing risk correctly and lower LR.
Regarding point 2, GAAP revenue (rarely use this term) is on the income statement throughout the S-1 (pg 18 is the first instance). Ceded premium to reinsurers is excluded from GAAP revenue (pg 103 has a table breakdown).
My thought is Lemonade is marketing GWP front and center on page 2, but shifting their biz to be heavily ceded to insurers, which lowers revenue. Yes, Lemonade is receiving a fee in exchange, and maybe lowering liabilities on their balance sheet. But, its not a great trade because 1) expensive CAC to cede it away, 2) they essentially become a broker, and brokers don't generate the multiples investors want, and 3) they don't take advantage of insurance float.
Yup, Lemonade is certainly has the advantage of being more flexible and nimble. I've spoken / worked with larger insurers and they are hampered by the amount of manual processes and bureaucracy that are typical for +50 year old corporations.
Lemonade's competitors also do most types of insurance, there aren't very many large private or public insurance companies that only focus on renters, homeowners, etc. The power is in the bundle and upselling a suite of insurance products to the customer you've already spent the CAC to acquire. With this comes more data to better underwrite deals, and the cycles goes on.
Lemonade has mentioned looking into niche products like pet, phone, etc. Sure, they can carve out a nice space for itself, but the reality of those products is its low premium, low addressable market stuff so its not the most efficient use of capital for large insurers.
One major piece Lemonade is also missing is the traditional float an insurance company has. Even if loss ratios + expenses are 100% of premiums, insurance companies can still generate returns on the massive amount of float these premiums generate every year.
The institutional investors whom Lemonade's exec team will be pitching to on the road show in a few weeks will be long-term focused. The bankers are likely pitching to insurance-focused and technology-focused funds. The investors will ask questions about normalized loss ratios, margins, etc. to determine the run-rate cash flow and ultimately the end-state profitability of Lemonade.
The problem is investors will certainly appreciate an emerging leader in a traditional space with a good product & brand presence. However, I think at the end of the day this feels eerily similar to some aspects of WeWork's story. The insurance (WeWork - real estate) investors will negatively view the near-term cash hemorrhage, and the tech investors will puke at the normalized, future margin profile.
You come from the SaaS world, so you appreciate the low marginal cost of distributing a SaaS product (Ben Thompson fan, anyone?). This means high gross margins and initially large Sales & Marketing spend to acquire customers, but then decreases as percentage of revenue as 1) customers are locked into your platform and their business processes rely on the product) and 2) cash generated from high margin business can fund future growth.
This is not the story at Lemonade. Much like WeWork, there is a ceiling on their gross margins. They are at ~17% right now gross margins, driven by a ~70% loss ratio. This loss ratio is near-industry historicals, and unlikely to materially change. This is similar to WeWork, Rent + Operating Expenses of buildings were ~70-80% of revenue. Compare both to a SaaS company gross margins of 80%. I just can't see investors being excited about this, even if they do inexpensively grow market share. Lemonade's loss profile is similar to competitors, but they have nowhere near the spending power on advertising & customer acquisition needed to make the insurance model work.
Regarding your thoughts on CAC, I think Lemonade is working hard on improving their S&M channel efficiency, and this is evident in Q1. However, my problem is insurance is inherently a high-need, low-value industry. The need for insurance is acute, but the general population places very little value in the activity of seeking out the best insurance experience. You purchase insurance and hope you never interact with the insurance company again. Does brand really matter past the initial, fervent adopters? Furthermore, the value proposition not only has to be clear, but also meaningful to capture people's attentions and make the switch.
I believe CAC will continue to increase if Lemonade intends to grow at their historical pace. For the past 3 years, Lemonade has attempted to market themselves as an anti-insurer, which is great, but the reality is the U.S. market is broker and traditional marketing channel dominated. Insurance lacks organic growth because its inherently a low value activity compared to Facebook, Uber, etc. If they don't spend to capture mindshare, its challenging to see people promoting their product naturally. To get investors excited, Lemonade needs to 1) capture market share inexpensively, 2) through ML/AI, decrease their loss ratio vs. industry average, and 3) allocate capital more efficiently as they are giving away 75% of their premiums under a new deal starting June 2020.
I'm not entirely sure what the answer to a higher-margin insurance product is for them. Lemonade mentions getting into pet, auto, etc. Sure, customer upsell seems easy, but still a very different product, and like I mentioned above, loss ratios are loss ratios. Shit breaks or things go wrong eventually and no amount of pricing risk correctly is going to make that decrease unless you reject higher-risk customers.
Traditional insurers trade on Price / Book, and also Price / Earnings. Allstate trades at ~10x price to earnings, and Progressive trades at ~13x.
Hi all, I think this thread has been full of great discussion, and there has been many questions surrounding Lemonade's financials and strategy.
I am a former investment banker, and enjoy analyzing companies in my spare (limited) time. I've been following Lemonade since 2018 so their S-1 filing piqued my interest.
Long story short, I think there are two major topics that pop out upon reviewing. 1) The unit economics are extremely concerning. 2) Cedeing 75% of gross written premiums starting June 2020 not only shifts business model towards a brokerage business, but also calls into question the true value add of their heavily marketed ML / AI platform for underwriting, and the ensuing loss decrease that can be generated from better data = more profits.
Happy to answer any questions, appreciate the look!
Unfortunately their LTV / Cac is terrible, I've provided a full teardown on what parts of the S-1 trouble me the most (unit economics and revenue growth).
Regarding retention, I chose to not incorporate regulatory or underwriting risk driven cancellation to capture demand driven cancellations only. I expect as time goes on and Lemonade's capital increases & they fine tune the underwriting model / better price risk, these Company forced cancellations will decrease, as they have the past two years.
I'd be interested to know what % of customers transfer to a competitor vs. not needing the renters / homeowners product anymore.
I do agree with you, however, that this lowers their implied customer lifetime even further, and by extension unit economics.