Is the worst over for the lemonade?

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When insurance company Lemonade (NYSE: LMND) debuted on the New York Stock Exchange in July 2020, there was a lot of excitement. The share price more than doubled on the first day of listing to around $ 69 per share. Just over 14 months later, on September 20, Lemonade is trading at around $ 70 a share – but it’s been a mad rush to get there, as it soared to over $ 160 a share in January from this year and peaked at around $ 188 in February.

It has since plunged considerably and is currently down almost 43% since the start of the year. Is the worst over for Lemonade?

Image source: Getty Images.

How Lemonade Works and Why It Gets Investors’ Attention

There is a lot of enthusiasm for Lemonade as a business and for good reason. It seeks to disrupt the insurance industry with the way it offers insurance. Lemonade offers renters, homeowners and pets insurance through its app, through which customers can pay their bills, file claims, and do all of their insurance-related business. It uses machine learning and artificial intelligence to more efficiently price policies and review claims. About a third of complaints are resolved within seconds, while more complex complaints are passed on to staff members.

What is also different is its business model. From the premiums that customers pay, Lemonade takes a percentage, roughly 25%, to cover administrative costs and grow the business. The remaining 75% is used to cover claims and associated expenses. Lemonade treats this money as the customer’s, so any excess of the 75% set aside for claims goes to a charity of the customer’s choice. This year, he donated $ 2.3 million to charity, more than double the total from last year.

Because its interactions with customers are all done digitally, Lemonade benefits from reduced overhead and expense, and customers are happy because the process is much faster than working with traditional insurers. In addition, with the Lemonade platform, the more data it collects about its customers, the more robust its algorithms become and the more accurately it can quantify risk. This, theoretically, will lead to lower loss rates – which are the percentage of premiums paid in claims – and, in turn, lower premiums.

In any case, that’s the idea. Let’s take a look at how the company is doing and why it has struggled since its IPO.

Better days for Lemonade?

The company has been around since 2015 and has yet to make a profit. This is not unusual for start-ups, as it takes a lot of money and investment to grow. But Lemonade really took a hit in the first quarter as its gross claims rate soared to 121%, from 72% in the first quarter of 2020. That was almost entirely due to the unexpected freeze in Texas in mid-February, which caused power outages. for millions for an extended period. Company officials said they received about a year of claims within days. As a result, revenue and gross profit declined year over year and the company suffered a net loss of $ 49 million. The share price fell sharply around this time.

The second quarter was much better, as the gross loss ratio fell back to 74%, which is extremely low – anything below 100% means you are profitable for the claims paid versus the premiums received. This is the fork that Lemonade has always been in place, reflecting its excellent subscription. While gross profit was up, the company recorded a net loss of $ 55 million, up from $ 21 million a year ago. This is due to higher spending, which jumped 161% year over year, mainly due to technology investments.

Lemonade announced in the second quarter that it was launching Lemonade Car, an auto insurance company, so the spike in spending was likely related in part to that.

The best is yet to come for Lemonade

There is a lot to like about Lemonade, from its business model to its low loss ratio to its rapid growth. The company has more than 1.2 million customers after only six years of existence. That’s against 814,000 just a year ago. His entry into the car Assurance the company, although incredibly competitive, opens the company to a huge new market where it could establish itself, as it has done in its current activities, with its growing notoriety and ease of use.

He is a young and growing company, and as such it is not yet profitable, which is not unusual for a start-up as it takes a lot of capital and investment to scale up. It’s also in a very competitive field with a lot of established players as well as hungry newcomers.

There will certainly be more volatility in the short term, especially in the face of weather events such as the Texas freeze for example. It does not yet have the user base to fully and effectively absorb the heavy hits of outsized weather events like hurricanes and wildfires. However, management has learned a few things as they grow older. Last year he changed his approach to reinsurance, which reduced his exposure during the Texas freeze. It switched to a quota share reinsurance program, which, without being too technical, means that it paid its reinsurance partners a higher percentage of costs, but they also take more responsibility for losses. catastrophic, thus cushioning the blow. This should help with similar shocks in the future.

Whether the worst is over or not is an open question. There will certainly be more volatility in the short term, but over time Lemonade has great potential to be a major disruptive force in the industry.

While I really like his long term potential, I would not be buying his stock at this time. There is still a little too much uncertainty. While the price has come down I don’t think it will start to rise again anytime soon, so you have time to see where things are going. Keep an eye on this business and see how it performs over the next few quarters with its loss ratio and profitability. It will also be interesting to see what the initial market reaction is to the early days of auto insurance business.

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Dave kovaleski has no position in any of the stocks mentioned. The Motley Fool owns stock and recommends Lemonade, Inc. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


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