Artificial intelligence (AI) has taken the world by storm and captured people's attention with its transformative potential. The debut of Open AI's ChatGPT showed the world what is possible, and more businesses are looking for ways to incorporate AI to streamline and make their businesses more efficient.
Lemonade (LMND -4.70%) is at the forefront of AI-driven disruption in the insurance industry. The company streamlines the entire customer experience by employing AI chatbots, from obtaining quotes and purchasing policies to efficiently and quickly settling claims.
Lemonade has increased its areas of coverage and has expanded rapidly, which has fueled significant growth in its policies in force in recent years. However, it has struggled with profitability, resulting in considerable volatility in earnings and its stock price.
The company continues to refine its AI models and has made notable progress in recent quarters. Here's what investors will want to pay close attention to moving forward.
How Lemonade plans to upend insurance
Lemonade is taking on a huge industry with numerous big players that have decades of experience underwriting policies. The company has an ambitious goal of upending the legacy insurers by using AI and machine learning to streamline and expedite the insurance process, making it more efficient and customer-friendly.
One of its top features is its AI-powered claims processing system, led by its chatbot, AI Jim. The system assesses claims, checks policy conditions, and uses anti-fraud policies to evaluate and settle claims quickly and efficiently. It also has another chatbot, AI Maya, which handles customer inquiries. Lemonade hopes to significantly reduce overhead and operational costs by leveraging AI.
Lemonade looks to disrupt the industry, but it's no easy task. Several factors make it difficult for newer entrants, including capital, regulatory hurdles, and competitors with decades of built-up data and technological investments. It also takes companies time to accurately access and price risks and dial in risk models to ensure they price policies and manage risks effectively.
Lemonade's top-line growth has come at a cost
Early on, Lemonade focused on renters' insurance as it targeted young adults, hoping to turn them into lifelong customers. Since then, it has rolled out homeowners' insurance along with pet, life, and automotive coverage. Over the past two years, the company's in-force premium, or the amount of active policies, has grown from $609 million to $889 million, or 45%, and it now has 2.3 million customers.
While growth has been solid, it has come at the cost of higher losses on those policies it underwrites. One key measure investors can watch to see how effectively Lemonade is pricing its policies is its net loss ratio. For Lemonade, this ratio is calculated as the ratio of losses plus loss adjustment expenses minus amounts paid to reinsurers divided by net premiums collected.
Two years ago, Lemonade's net loss ratio stood at 105%. In other words, for every $100 in policies written, Lemonade paid out $105 in claims losses. To put this in perspective, Lemonade's long-term goal is to achieve a loss ratio of around 75% consistently. This means that its losses would equal roughly three-quarters of its total premiums.
In the most recent third quarter, the company's net loss ratio was 81%, slightly higher than in previous quarters but down from previous years' higher readings.
While it's encouraging to see the loss ratio improve, it's worth noting that this trend could be more reflective of broader industry movements rather than specific enhancements on Lemonade's part.
Last year was tough for property and casualty (P&C) insurers, which lost $24 billion collectively. Things have improved industrywide; in the first half of 2024, P&C insurers have made a $3.8 billion underwriting gain, which has undoubtedly been a tailwind for insurers like Lemonade.
Is it a buy?
Lemonade hasn't quite hit management's target of 75%, but it is significantly closer than it has been over the last two years. However, it continues to lose money as its sales and marketing expenses rise. In the third quarter, Lemonade lost $67.7 million compared to the $61.5 million loss from the previous year. Through the first three quarters of 2024, Lemonade's net loss of $172 million is an improvement from its $194 million loss one year earlier.
This trend shows that the company is improving its AI models to assess risks better. Aggressive investors may consider the improvement in the loss ratio a positive sign of things to come and may find its recent 36% pullback an appealing entry point.
That said, the overall insurance landscape has improved, with many companies reporting lower loss ratios. Given this backdrop, I'm taking a more cautious approach. I want to see sustainable progress in its net loss ratio that aligns more with its 75% target. I also want to see those AI efficiencies realized with an improving bottom line before buying the stock.
