When life gives you lemons, Silicon Valley may not have the best recipe to make lemonade.
Shares in New York-based insurer Lemonade are trading around $14 after it reported a second-quarter net loss of $67 million earlier this month. Two years ago, they were briefly above $180. The company went public at $29 in 2020.
Lemonade was founded by technology entrepreneurs Dan Schreiber and Shai Wininger as part of a new crop of “insurtech” startups seeking to upend traditional insurance through automation, data and artificial intelligence. It uses a smartphone app to replace agents, a chatbot to get rid of paperwork and AI algorithms to pay claims swiftly. Unclaimed premiums are channeled to charities selected by customers.
This sounds like the perfect nonalcoholic cocktail to attract Gen-Z. Lemonade’s idea is to start with renters’ insurance and cross-sell other product lines—homeowners, car, pets and term life—to its young customers as they get older and wealthier. This is meant to circumvent a big insurtech hurdle: Tech-style focus on growth attracts the least-desirable policyholders and, without the benefit of size, there isn’t enough data to price risks accurately.
Lemonade’s financial metrics are moving in the right direction, and it remains more loved by the market than peers Root and Hippo. Those two focus on cars and homeowners, respectively, where cutthroat players such as Geico, Progressive and Allstate dominate. By contrast, renters’ insurance is a small market with infrequent claims. Though “nobody wants insurance, they need insurance,” as the old dictum goes, this may be one segment where an easy-to-use platform can entice young renters to get cover.
In the second quarter, Lemonade’s loss ratio—claims relative to premiums—dropped to a creditable 47% in the renters segment. However, direct-to-consumer companies spend heavily on tech and, once these costs are added, a back-of-the-envelope calculation suggests the business still loses money. Also, it is hard to know how Lemonade’s ratio compares to peers: The market isn’t large enough for big insurers to report comparable numbers.
Meanwhile, the company’s loss ratio on homeowners’ insurance, excluding natural catastrophes, was 69%, far above the 47% reported by Allstate. Lemonade didn’t publish a loss ratio for autos, where it expanded last year by acquiring troubled insurtech firm Metromile, but Jefferies analyst Yaron Kinar thinks it is a deeply loss-making 137%.
This suggests Lemonade has no clear edge over peers in pricing insurance, and that its margins could get worse as it expands into more competitive lines. Even if it stuck to renters, a $5 billion niche market would hardly justify an enterprise value of almost twice expected sales. Many insurers trade below one times sales.
A key challenge in Lemonade’s model is that customer-acquisition costs are all upfront, rather than spread over time as agents’ commissions are. The firm said earlier this month that customers repay these expenses three times over in their lifetime—a ratio considered decent by the “software as a service” companies Lemonade is modeled on. Yet it still takes two years to recoup them.
In any case, Lemonade has adopted some unusual financing practices in an apparent effort to keep such costs under control.
In June, it introduced venture-capital firm General Catalyst as a “synthetic agent,” billing it as a “novel financial structure that unlocks growth without depleting cash.” Through this deal, Lemonade can finance up to 80% of its customer acquisition costs by paying commissions of up to 16% over time. One way to look at it is that Lemonade is burning too much cash and got a loan at a very high interest rate—albeit with advantageous terms, such as the lender only having recourse to the money generated by acquired clients.
Last November, Lemonade announced a partnership with Chewy, only to reveal in regulatory filings that, rather than a commission, it would pay the online pet-food retailer with equity, flattering earnings by diluting shareholders.
There are red flags in other cost lines too. Earlier this month, the company said it had renewed its contracts with reinsurers—insurtech ventures outsource a lot of risk to save on capital—using a “sliding scale” that will yield greater commissions if Lemonade’s performance gets better and smaller ones if it gets worse. Also, less weather-catastrophe risk will be reinsured, despite the big impact it had on second-quarter earnings: “Named hurricanes” will now be excluded, because unlike smaller storms and wildfires they haven’t yet caused big losses.
Lemonade has “no real presence in Florida” and is conservative elsewhere, Chief Financial Officer Tim Bixby told analysts. Yet Lemonade is very present in hurricane-prone Texas.
The overall impression is that Lemonade’s executives are gambling more in their quest to improve results. As cases like WeWork have shown, mixing Silicon Valley creativity with the kind of business your grandfather knew can mean investors end up sucking on a lemon.