Lemonade, Inc. [LMND]

In my view, Lemonade has to be the potential to be the low cost provider of insurance for families. Home, Auto, Life, Pet, Renters and Umbrella.

Unlike other insurers they run their business through chat bots and apps. Despite their very small scale, LMND boasts that they have 2,500 policies per employee. According to data the next best competitor in their industry is State-farm at 1,200.

While as a small company this advantage is not be borne out in the numbers, as they scale I think it will be very clear.

For the time being, like many growth companies they are investing aggressively in growth initiatives and are likely not to have profits until sizable market share is achieved despite annual recurring revenue.

This year they are acquiring metro mile for their data, employees and auto insurance licenses. Once integrated, they will finally be able to fully compete with legacy insurance as they will have a bundle.

In addition LMND is wisely ceding their premiums to reinsurers. This means lemonade gets a customer in their system and they sell a large portion of the premium and associated claims risk to a larger insurance company. This enables them to not reserve as much capital and enables more investment in growth and their product.

It should be noted that the premiums ceded to reinsurers are not counted as revenue per GAAP accounting; even though they own the client and the money flows through the business. This is why LMND is likely to trade at outlandish multiples of sales.

The beauty of this model is that LMND needs to hold less cash in reserves because they are not responsible for most of the claims. In my view, this will eventually go away as they scale. For the time being LMND can invest more in growth initiatives and improve their chatbots. Around 1/3 of all claims on LMND are paid automatically (no LMND employees). This number will likely rise over time.

Here is the bottom line pitch. LMND’s emphasis on an AI run business gives them a cost advantage through a significantly higher customer per employee. This advantage is widened as they scale and enhance their AI.

Furthermore insurance is an industry that is extremely slow moving. If state farm wanted to hit the same metrics as LMND for customer per employee they would need to build a new business operation while simultaneously laying off about 50% of their staff. I think state farm and others will struggle to get to lemonade’s cost structure. I also believe that lemonade’s low cost advantage will stem from the lack of agents cut into the business.

While it is still early innings, their story reminded me of Buffett’s purchase of GEICO. In the 1950s Buffett realized GEICO operated a direct mail business where they did not use agents. This enabled them to undercut the market. Since insurance is a product that we all need but don’t want to pay for, the low cost provider gets an enormous benefit.

It’s clearly a different world now, but I like their chances as apps are the new direct mail.

Please do your own due diligence