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Lemonade Insurance Company is making noise in the homeowners and renters insurance markets as a pioneer in the Insurtech space.
Lemonade opened its doors in 2016, supercharged with venture capital horsepower, strategic partnerships with global reinsurance giants, and an idea. Management aimed to take a fresh perspective on homeowners insurance by leveraging high-tech and behavioral economics. Customers obtain coverage through Lemonade’s app and are assisted by the proprietary bot “Maya,” as opposed to dealing with an agent either in person or over the phone. Not only is the front end of the insurance process automated, but so is the claims handling process. Utilizing artificial intelligence (AI) and blockchain-backed anti-fraud algorithms, Lemonade is able to pay out 25% of claims in three seconds of receiving first notice of claim. The remaining claims are handled by Lemonade’s claim department staffed by human beings.
More than just trying to gain efficiency with technology, Lemonade sought to change the claims handling practice of insurance companies. It’s a common perception that insurance companies want to avoid paying as many claims as possible in order to add to the bottom line. With a unique corporate structure, Lemonade mitigates this impulse, whether it is actual or perceived, by being a certified B corp. Lemonade donates any underwriting profit in a “Giveback” to a nonprofit of their customers’ choice ($162,135 total in 2018). This behavioral economics feature of Insurtech is the cornerstone of its allure.
On the app, the prospective insured designates a nonprofit for which they care. At the end of the year, Lemonade distributes any underwriting profit to those causes. This process attempts to cluster insureds into similar groups with a shared affinity (their giveback nonprofit). The idea is that pooling loss experience with “Giveback,” peers will reduce moral hazard and curb fraudulent behavior. The “Giveback” instills a sense of empowerment, goodwill, and community for the insured.
Lemonade still intends on making profit. They do so by giving a 25% (recently changed from 20% in 2018) flat fee to their for profit parent company in return for various services. The remaining premiums are used to buy reinsurance, pay claims, and for the “Giveback.” CEO Daniel Schreiber said that the company’s bottom line isn’t impacted by the loss ratio, that only the giveback and the reinsurers are affected by the loss experience.
Taking a look at Lemonade’s 2018 Annual Statement filing with state regulators, we can see they are gaining market share, evidenced by their 2018 direct written premium of $46.8 million, which is up from $9 million in 2017. Premium writings are concentrated in the states of Texas and California. When an insurance company grows rapidly, a primary concern is the quality of risks being written. Time will tell as loss experience matures for their relatively young book of business.
Lemonade buys reinsurance for their higher layers of exposure. In 2018, the company ceded $4.1 million of earned premium (16.4% of gross). Estimates for accident year 2018 net ultimate loss and loss adjustment expense total $15.2 million, indicating a 72% net loss and LAE ratio. Booked loss ratios on a direct basis did not fare as well, running at 171% and 111% for accident years 2017 and 2018 respectively. The implied loss ratios for the ceded business are 529% and 317% in the latest two years. In the near future, relationships with Lemonade’s reinsurance partners will certainly be tested if loss ratios do not improve.
Net income for Lemonade was -$6.6 million in 2018. The $6.2 million advertising expense contributed to this deficit, but undoubtedly is a driver for the premium growth. While this may be traditionally alarming in the insurance industry, the tech industry is no stranger to running a net income loss at the cost of revenue growth. This appetite is evidenced by an additional $13 million of paid in capital during 2018.
Will Lemonade be able to compete in the hyper competitive market for homeowners and renters going forward? Lemonade’s edge is predicated on the advantages of their AI models’ ability to outperform traditional industry professionals. Feeding these models more and more information will give Lemonade and their AI-backed systems its best shot.
James Wencil is an Actuarial Analyst II with Pinnacle Actuarial Resources, Inc. in the San Francisco, California office. He holds Bachelor of Science degrees in Actuarial Science and Finance from Florida State University in Tallahassee, Florida. James has experience in assignments involving Loss Reserve Analysis, Rate Filings, and Loss Cost Projections. He is an Associate of the Casualty Actuarial Society and a Member of the American Academy of Actuaries.
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