This AI-Driven Fintech Is Making Advances: Is It Time to Buy?

Lemonade (LMND -4.33%) was the talk of the town when it became public a couple of years ago. The AI-powered insurance fintech got off to a flying start in gaining market share, and its share price exploded after it went public in July 2020, gaining 551% a few months later.

The company has added more insurance products to expand its reach and has made great strides. However, there is one aspect of the company that needs significant work. But once management addresses this issue, Lemonade will shoot to the top of my list of stocks to buy.

An insurance company that wants to give back to society

Lemonade is on a mission to reimagine the insurance business. It leverages artificial intelligence (AI) to help people buy renters, homeowners, pet and auto insurance with just a few questions via its website or app. The company also uses AI to handle insurance claims quickly, and aims to appeal to younger customers.

The mission is noble in that the company donates profits to charitable purposes. Since its launch, Lemonade has given more than $6 million to charities chosen by customers — $1.8 million this year alone.

Expand the offer and the customer base

Lemonade has done a solid job of building the business and has achieved fantastic growth by expanding the product offering to customers.

Before 2021, two-thirds of Lemonade’s policies were for rental insurance. Since then, it has launched homeowners insurance and pet insurance, and it bought Metromile last year to accelerate its push into the $300 billion auto insurance market. Now rental insurance accounts for less than half of the insurances.

Gross earned premiums have grown from $75 million in 2019 to $411 million through the first nine months of this year. Total customer numbers in the third quarter increased 30% year-over-year to more than 1.7 million, and current premium increased 76%.

Lemonade’s growth has come at a cost

Lemonade has done a fantastic job of expanding its scope and taking a bigger bite out of the insurance market. However, this growth has not yet resulted in profitability for the insurance company. In fact, net losses have increased from $108 million in 2019 to more than $234 million through the first nine months of 2022.

Losses have increased due to its increased product offerings and higher claims costs as it evolves its pricing models. Net loss ratio is a crucial metric for any insurance company: It measures the ratio of losses and loss adjustment costs, minus the amount paid to reinsurers, to its total gross earned premium.

Image source: Lemonade.

Over the past three years, the insurance industry’s net loss percentage has averaged 71% (lower is better). Lemonade management has stated that the goal is to keep the ratio below 75%. And in 2020, the net loss ratio was right in line with the industry average of 71%. It was then that the tenant policy made up a majority of the business. However, after it expanded supply, the net loss rate jumped to 93% in 2021 and 97% this year.

What I want to see before I buy

Lemonade’s business is growing fast, but so are its losses. The stock has fallen nearly 90% since peaking at $188 per share in early 2021, and now trades at a price-to-sales ratio of 5.9 — near its lowest valuation as a public company.

LMND PS Ratio data by YCharts

At this discounted price, the stock may be appealing to some investors. However, I would like to see improvements in the business before I buy. Lemonade needs to improve its risk models and price policies more efficiently so it can make money. I would like to see loss rates improve over the next few quarters and get closer to management’s target of 75%. Until that happens, I will stay away from this stock.