In its fourth-quarter and full-year 2021 shareholder letter, Lemonade’s CEO wrote that 2022 is expected to be a year of peak losses. This follows unfavorable development and product mix changes that plummeted 2021 loss ratios into the 90s, 20 points higher over comparable 2020 periods. The projection is that 2022 will see highest losses, with EBITDA improving in subsequent years.
In future, Lemonade expects to start leveraging machine learning capabilities to lower loss ratio and automation to lower expense ratio. 2022 is expected to launch the company into the next phase of growth, piggybacking on a diversified product suite, that now spans renters, home, pet, life and auto. The game-plan is to grow with existing customers through cross-selling and bundling.
During the last year, higher-premium products and expanded portfolio had the effect of growing premium per customer almost 50%. In-force premium increased by 78% to $380 million compared to a year earlier, due to increase in number of customers and premium per customer.
Their overarching strategy has been to win with technology and grow with customers. Winning with technology has meant to leverage technology to lower expense and loss ratios, while growing LTV/CAC. With Lemonade car, they have demonstrated strong bundling, as 3/4th of customers have bundled it with other Lemonade policies.
The shareholder letter attributed the bottom-line net loss of $70.3 million to a higher loss ratio (98 vs 75.6 in Q4’20), greater sales of newer products, increased hiring for Lemonade Car, and greater marketing-spend growth.
In their earnings call, company executives waxed eloquent about Lemonade’s advantages over incumbents, highlighting its technological foundation that lets it move from proxy-based pricing to precision pricing. The reason for the fourth-quarter 2021 loss ratio creeping to 98, compared to 75.6 a year earlier, was attributed to a handful of older large losses which were under-reserved. These losses were mainly in the homeowners line, where few losses of $1 million homes can impact the loss ratio significantly. Half of the increase was from adverse developments and the rest due to the mix shift.
Lemonade announced there were several projects across newer product lines to address underwriting profitability which were yielding steady improvements in loss ratios. In time, loss ratios across lines are targeted to drop to 75 in due course. Lemonade reiterated they reserve conservatively, with prior-period development typically moving in the favorable direction. They have several more quarters of positive development than adverse development but due to a relatively small book, a few homes can swing things one way or another, especially during cat season.
The earnings call witnessed scrutiny of Lemonade’s technology edge and probing on when it would start showing up on the bottom line. Lemonade started at a data disadvantage but built formidable strengths, collecting information at every customer interaction and forming risk scores that accurately predict future loss ratios. A couple of years back, senior executives had asserted that reserving was critical, and they were getting it right. The latest debacle proves this is an area they will need to continue bolstering.
Inaccurate placement of risks not only causes an immediate mispricing but erodes the reliability of underlying data used to set future rates and reserving. Mispriced insurance risk just in auto insurance causes nearly $29 billion of premium leakages annually. Incumbents such as Assurant excel here, with direct loss ratios of 51.72. Allstate, founded in 1931, with 16 million insured households, has a ratio of 55.30. The first mover advantage of Lemonade with customer experience, digital technology and analytics adroitness might be diminishing as it scales and moves into newer business lines. In several respects, its playbook is starting to resemble that of incumbents launching major improvement initiatives, while learning from past experiences. To amplify its disruptive impact, Lemonade needs to rev up its innovation engine and trailblaze with hard-to-replicate differentiators.
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