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John Engle
John Engle
Articles (529) 

Why Lemonade's Tech Disruptor Story Does Not Add Up

Though billed as an insurtech disruptor, Lemonade looks more like a high-risk insurance business

July 09, 2020 | About:

Lemonade Inc. (LMND) has promised to disrupt the vast traditional insurance industry, yet the company remains far from profitability, as I discussed in a previous article for GuruFocus. Even so, Lemonade’s big promises and lofty ambitions have fired up market attention and enthusiasm. Failure to deliver could prove disastrous for investors.

Insurance meets SaaS

According to its S-1 filing, Lemonade is a on a mission to single-handedly transform the insurance sector:

“Lemonade is rebuilding insurance from the ground up on a digital substrate and an innovative business model. By leveraging technology, data, artificial intelligence, contemporary design, and behavioral economics, we believe we are making insurance more delightful, more affordable, more precise, and more socially impactful.”

That is quite a mouthful, but what does it mean? Essentially, Lemonade offers streamlined digital insurance services, principally to renters. However, its real differentiator is its claimed ability to leverage its machine learning algorithm to better understand customers and develop more accurate risk-pricing models.

The company’s various tech-focused bells and whistles, such as its AI virtual assistant Maya, have helped it stand out from the crowded pack of incumbent insurance providers, which has allowed it to differentiate its brand.

But insurance is a boring industry known for high competition and low margins. It is hard to turn a new entrant into such a market into a compelling growth investment story. Hence, Lemonade has tried to position itself as a tech disruptor, which can allow it to claim a valuation multiple more akin to that of a software company than an insurer.

As Nima Wedlake of Thomvest Ventures observed on June 15, Lemonade’s S-1 uses the term “digital platform” more frequently than “insurance carrier” to describe the business. According to Wedlake, this is a clear effort by Lemonade to “steer investors towards SaaS-like multiples.”

The reinsurance conundrum

Lemonade continues to be heavily involved with reinsurers; according to its S-1, Lemonade cedes 75% of its premiums to insurers. This is not strange in and of itself, as many insurers transfer policies to reinsurers to varying extents.

It is strange, however, in light of Lemonade’s claim that it can evaluate and price risk more accurately than its competitors through the power of its machine learning and AI algorithms, as financial blogger "A Balanced View" observed on June 9:

“Lemonade may still be in the data-gathering stage to inform correlations for their algorithms, but if Lemonade believes they can truly more efficiently price risk and identify high-risk policyholders, I wouldn’t think ceding or handing over the majority of their premiums to reinsurers would be the correct strategy, as Lemonade should, in theory, participate in the upside from their technology platform. Lemonade states this is a capital efficiency decision, but I think it’s coming from a capital preservation position.”

If Lemonade really had an analytical “secret sauce” that could give it a tangible, persistent edge over other insurance providers, one would think that this would show up in the form of reduced reinsurance. Thus, Lemonade’s stated intention to continue relying heavily on reinsurance suggests that it may not have quite as much confidence in the power of its machine learning capabilities to generate profits as it claims publicly.

My verdict

It remains unclear whether Lemonade’s various digital, machine learning and AI-related tools add much value beyond first-order convenience for customers. Even less clear is whether these tools can expand Lemonade’s performance metrics beyond industry averages, let alone surpass those of the very best insurers.

The economics of the insurance business are well understood. Technology will undoubtedly disrupt the industry over time. However, Lemonade’s offerings are have yet to prove sufficiently differentiated from or demonstrably better than those of traditional insurance providers. Hence, I am skeptical of the company’s ability to maintain its insurtech disruptor image, and its SaaS-like valuation multiple, over the long run.

Still, given its eye-watering IPO and bulging valuation multiple, Lemonade’s gambit to brand itself as a tech company has apparently paid off - for now, at least.

Disclosure: No positions.

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About the author:

John Engle
John Engle is president of Almington Capital Merchant Bankers and chief investment officer of the Cannabis Capital Group. John specializes in value and special situation strategies. He holds a bachelor's degree in economics from Trinity College Dublin, a diploma in finance from the London School of Economics and an MBA from the University of Oxford.

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