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On Monday, June 8, startup insurer Lemonade (New York) filed with the SEC to raise up to $100 million in an initial public offering. Few InsurTechs have been so visible in the press and the subject of so many of the discussions among industry observers. As the next great step in the story of Lemonade, the IPO can be seen as the firm’s greatest triumph to date, but questions remain about its long-term prospects.

Launched in 2016, Lemonade’s premium has grown from $9 million in 2017 to $116 million in 2019, while its gross loss ratio has fallen from 161 percent to 79 percent, according to Renaissance Capital. The company yielded $83 million in revenue for the 12 months ended March 31, 2020.

“Lemonade is now five years old and their unique financial model combined with their clever use of AI and data has helped them stand out in the marketplace,” comments Karlyn Carnahan, Head of Celent’s (Boston) Property Casualty practice in North America. “Of course, timing of an IPO is everything when it comes to getting the best valuation possible and market volatility caused by the pandemic has slowed the pace of IPOs. However, Lemonade has a top-notch executive team, a strong path to profitability, and a clear roadmap for growth. Using IPO proceeds to build out product lines puts them on a clear trajectory for achieving scale.”

Loss Ratio Improving Faster than Growth

Lemonade’s business model affirms a recent finding from a J.D. Power survey that found for the first time that consumers rank the digital experience as better than the agent experience, notes Carnahan. “Lemonade has the best UI around—in my opinion due to the behavioral science built in and the use of data/prefill,” she says. “They are growing rapidly, and their loss ratio is improving faster than their growth.”

Carnahan adds that Lemonade’s premium has grown from $22.5 million in 2018 to $67.3 million in 2019. The company’s losses rose from $52.9 million in 2018 to $108.5 million in 2019, meaning that premiums went up 199 percent but losses only rose by 105 percent—meaning a drop in loss ratio of 32 percent. “You expect first year loss ratios to be terrible,” she says. The whole industry acknowledges that. So, despite this rapid growth, loss ratios overall dropping is an excellent indicator.”

The key to Lemonade’s success is reinsurance, Carnahan adds. “Because their business model says they will take 25 percent for costs, 75 percent for losses—regardless of performance—the reinsurers continued willingness to take the difference between the actual loss ratio and 75 percent is the key to success.”

There is little question that Lemonade’s success is in part due to a consistent and comprehensive marketing and branding strategy, according to Mark Breading, a partner with Boston-based research and advisory firm SMA (Boston). “In 2019 they had $67 million in revenue but spent $89 million on sales and marketing,” he says. “They are obviously making the long play and may still be a few years away from profitability. This is why their expansion into new lines, new states, and new countries is essential for them to achieve the kind of scale they need to become a larger carrier and justify their valuation.”

Marketing and advertising play an important role in the success of leading insurers, and that’s especially the case with InsurTechs. Root insurance, a Columbus, Ohio-based auto insurance startup spent over 513 percent of net written premium on advertising, compared to Lemonade’s 43 percent, according to statutory data.

The Limits of Rental Insurance Profitability

Jeffery Williams, a Senior Analyst at Forrester notes that Lemonade’s S1 form acknowledges that its customer base is young and that, as a rental insurer, its business consists of smaller risks. “These may not be the customers that the larger, more established insurers are looking at anyway,” Williams says. “Lemonade has a great opportunity, but that market will reach its limits and, as its customers mature and build assets and wealth, it will have to go up against incumbents with really deep product portfolios and customer relationships.”

Lemonade has been able to grow within its market niche, and it has also enjoyed improvements in profitability, Williams acknowledges. “If there’s one bright spot it’s in the trend that Lemonade’s underwriting profits have been getting better,” he says. “Maybe its AI has become smart enough to sort through and select the right risk and pay out the right claims.”

The question, Williams adds, is whether Lemonade can replicate that success across other product lines. “Higher profitability comes with the more complex risk: homeowners, life, commercial property,” he comments. “The challenge for Lemonade is focusing on selling direct and cross-selling of more complex, but profitable products. Can they do that effectively? That’s the big question we’ll just have to wait and see.”

Reflecting on the IPO announcement in question, one might ask whether the Lemonade is sweet or tart, in the view of Kaenen Hertz, Managing Director of New York-based InsurTech Advisors. “If you are a technology analyst and believe that legacy financial services institutions are archaic and behind the times, then you would say that Lemonade is sweeter than anything out there,” he comments. “Lemonade is the cream of the crop because they have rethought the application process for direct-to-consumer, and they have a cute chatbot thing where you put in your address and get a quote.”

However, the view of industry analysts is probably more muted because Lemonade’s dominant product is low-value, Hertz adds. “One of the first thing an industry analyst notices is that Lemonade has never been profitable, and they’re spending a lot of money,” he says. “And though it’s obviously not unusual for a startup to spend heavily, I was surprised at how much they’re spending on marketing versus technology.”

Based on statutory filings, Lemonade generates $6.81 in premium for every dollar of advertising expense, as compared to USAA gaining about $63 and a typical regional carrier making nearly $138, Hertz notes.

Hertz sees “a very long road ahead” with regard to Lemonade’s lack of profitability. “Their entire future is predicated on the ability to transition customers from renters to homeowners, which is more expensive and it’s not clear what the direct market potential is there,” he says. “Homeowners is predominantly agent-sold by far in no small part because policyholders may need to call on them for advice.”

Too Complex for a Chatbot

The role of the agent is especially important in the case of a claim, Hertz adds. “Homeowners claims are typically not simple in the way renters claims are,” he says. “From personal experience of a fire in my house, I can verify that it’s far too complicated for a chatbot to handle it.”

Hertz notes that Lemonade’s operations have still gone untested by the rigors of a natural disaster. “They’re also ceding almost three-quarters of premium to their reinsurers,” he adds. “When Hippo’s reinsurers cooled to extending their reinsurance, Hippo had to do three things: create a captive, a new reinsurance panel and solidify their aim of owning an insurance carrier.”

Lemonade is already a carrier, but they’re also already ceding the vast majority of their premium to their reinsurers, Hertz elaborates. “The current impact to reinsurers is minimal,” he says. “But if the risk is a house worth $400,000, the risk will be much greater—and if insuring it turns out not to be profitable, they won’t allow the reinsurance contracts to continue the way they are.”

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