It sounds like you don't know what "loss ratio" means in the context of an insurance company. Loss ratio is the % of premiums collected that are paid back out in claims. If the number is below 100%, then your core insurance business is profitable

Of course, this doesn't mean your company is. Insurance companies have many expenses beyond paid claims. But loss ratio should never get to 0% and, by definition, can't be negative. 72% is pretty good for a relatively new insurance business.

Here to echo. I work in insurance and 72% is actually very good when you consider (1) their trajectory of how long it took them to get there (2) how strongly they're investing in growth, which is very expensive.

The 72% does not include overhead or sales and marketing, just losses and LAE. I wouldn't call that very good. Their combined ratio is more like 200%

Thanks. I was looking for their combined ratio. I suppose it’s not surprising that overhead is high for a fast-growing company. As with many startups, GAAP only reveals part of the story and more fine-grained metrics are needed to gauge potential future profitability.

For those unfamiliar with the combined ratio, taking a stab at an explanation by simplified analogy…

For most normal companies:

              Revenue
  −     Cost of goods
  ———————————————————
         Gross income
  −   Operating costs
  ———————————————————
     Operating income
  −  Interest expense
  ———————————————————
           Net income

For insurance companies:

             Premiums
  −            Losses
  ———————————————————
        “Gross income”
  −  “Operating costs”
  ———————————————————
    “Operating income”
  + Investment income
  ———————————————————
           Net income

Most normal companies use profitability metrics:

      Gross margin =     Gross income / Revenue
  Operating margin = Operating income / Revenue

Insurance companies use inverted expense ratios:

        Loss ratio =                       Losses / Premiums
    Combined ratio = (Losses + “Operating costs”) / Premiums

(The above is obviously simplified, for the sake of illustrating by analogy. For instance, insurance companies usually won’t have “Gross income” in their financial statements, and “Operating costs” and “Operating income” are typically called “Underwriting expense” and “Underwriting gain”.)

In their most recent quarter--

  Net earned premium 25.3
  Net investment income 0.9
  -------------------------------------   
  Total revenue 26.2
  
  Expense
  
  Loss and loss adjustment expense, net 18.2
  Other insurance expense 3.3
  Sales and marketing 19.2
  Technology development 3.5
  General and administrative 18.2
  -------------------------------------   
  Total expense 62.4
  
  Loss before income taxes (36.2)

18.2 / 25.3 ain’t bad. Sales and marketing at 19.2 seems a bit high, but I guess they’re doubling down on growth, and it implies they have a long runway. The administrative costs is the one that you’ll want to see grow logarithmically, as 25.3 goes up, and it’s not unbelievable that it will.

> 18.2 / 25.3 ain’t bad.

It's somewhat worse than average, but trending in the right direction. Will give a qualified "OK".

> Sales and marketing at 19.2 seems a bit high, but I guess they’re doubling down on growth, and it implies they have a long runway.

It's very high, relative to written premium. You can always buy market share in insurance by increasing commissions and/or increasing marketing, and it's okay to overspend in the beginning for branding/momentum purposes, but it's not sustainable. They raised $500 MM, and spent $200 MM (and much of the remaining $300 MM is needed for statutory surplus) so who knows how much longer they can sustain that.

Administrative and tech I'm somewhat sanguine about, as long as they keep moving upmarket to Homeowners' insurance. Renters' insurance is never going to have a great margin. Tech is at least decent, and hopefully the kernel for expanding easily into other markets.

Agreed on all points. The only caveat I’d add is that they might not need all of that 300mm if they have a decent reinsurance deal on the books or in the hand. My guess is that they plan on keeping all of the expense rows more or less the same, while growing into new markets to increase their volume.

> how strongly they're investing in growth

The combined LR isn't 72%. The combined LR includes marketing and sales.

I'd argue the pure LR should be evaluated without respect to growth. If you want to adjust for growth look at the combined LR which doesn't look too pretty. But if they can manage to get that LTV it will be a big success

How to get there:

1) Grow really big with VC money (You'll need this for step 3)

2) Stop paying out claims with made-up reasons

3) If someone sues you to get their payout, use your massive resources to bankrupt them with legal fees

That misses a 3 key points:

1) 72% pure loss ratio is ok, but normally for these lines I'd aim for mid 60s. Nothing special to see here..

2) It took them THREE YEARS to get there, and they were exceedingly poor at selecting and managing risk for 2 years. 161% loss ratio??!! That is flunky-level poor risk management. If they had a reinsurer, that reinsurer is probably very unhappy and unlikely to renew the treaty.

3) The combined ratio is really poor. They are hemorrhaging cash because of high G&A and high sales & marketing. Again, after 3 years of effort. This indicates they have not operated any more efficiently that other legacy insurers, AND that Lemonade is spending aggressively to acquire customers.

Lemonade's competitors have vastly more financial resources and market reach, can cross-sell more products, can equal or better its tech experience (USAA, Esurance), operate more efficiently (every major direct P&C writer), and acquire customers at scale at equivalent or better acquisition costs. For the Lemonade investment thesis to work, one must believe they will eventually address these weaknesses at scale, and that they will be given a software valuation multiple when they are really just another direct writer of insurance.

Why does LR even matter? They cede 75% of their risk so they operate more like a broker. I reckon the reason they don't cede more risk is because the re-insurers want them to have skin in the game. The re-insurers could get adversely selected if Lemonade can't price well

LR always matters, whether or not one cedes a portion of the risk. An insurance program has little value unless it is profitable over time. While some large P&C insurers historically ran their book of business at break-even, and made it up on investment income (reflected in their combined ratio), that is not a viable option given current interest rates.

Loss ratio is a specific measure in the insurance industry. You don't need to get to 0% loss ratio for the company to be profitable and ~70% loss ratio isn't bad for a relatively new company. Typical P&C insurance companies have loss ratios ~ 50%.

The relevant metric here is:

Do you gain more in expense reduction than you lose in loss increases?

By itself, the loss ratio tells you nothing because the pitch here is really that they can reduce expenses, not that they can reduce losses.

And I think the way they present this is slightly misleading. They only handle 1/3 of claims by computer in their entirety. The innovation is really on the front-end. And whilst this is probably a big part of costs, it isn't exactly huge. In addition, this is something that is fairly easy to replicate.

The specific claim made is: we have a "flywheel" (as ever, every company has one of these in 2020) whereby we use data to reduce costs and losses. This seems, from what I can see, false.

Whoa - if typical loss ratios are around 50%, surely there is a big opportunity for someone else to swoop in with cheaper insurance products?

You still have to support the policy, process claims, customer support, etc. The biggest expense on a unit-economics level, post claims paid, is marketing -- acquisition and retention costs.

If you look at the auto insurers, it's incredibly competitive and everyone is trying to balance those unit costs with the loss ratio. They are all moving targets but premium pricing is heavily regulated meaning your pricing will 100% come under scrutiny from some states (this must be done individually for every state in the U.S.) so any changes to pricing tends to be a complex process that could take months, if not a year+ (in some states) to take effect.

So when you get pricing wrong and are taking a big claims loss, it takes some time to dig out of that and you'll also piss off lots of customers who got in "cheap" and are now getting a rate increase. And when you get pricing wrong and you're loss ratio starts looking better, your competitors may be out-pricing you, making you uncompetitive until your adjustments are improved.

Losses + “Loss adjustment expense” are your costs. Loss adjustment expense is broken into Allocated Loss Adjustment expense - expenses tied to a particular claim (Typically lawyers); Unallocated Loss Adjustment Expense - overhead.

Theoretically two companies with the same policies will pay out the same losses but will differentiate themselves in expense ratios.

In some lines it’s not bad to have loss + expense ratios > 100% because the average time of premium is very far from the average date of loss, so while there is an underwriting loss it is offset by the investment gain.

I'm not so sure. Insurance companies exist based on probabilities. How much margin do you need to make a given profit worth the risk? What about that dollar you brought in where you ended up paying out $10?

Hence Lemonade.

Thanks the Fed's policy of Leave No Investor behind, the NASDAQ is +10% on the year. So many of the deals will get done, somewhat irrespective of L/T, M/T profitability. Investors have too much cash and no where good to put it.

> "the founders probably already did by selling to the VCs"

That is the opposite of how that works, FWIW. Unless the founders took VC money to pay themselves multi-million Dollar salaries or something?

It's fairly common, in a strong series C round and beyond for founders to take money off the table, especially when the VC appetite demands it. Typically, founders can sell as much as 10-20% of their vested shares, which can be worth 10s of millions of dollars or more.

I can confirm this goes beyond the founding team, I've sold shares as a part of raising capital at the last two places I've been employed. I was an early hire at both and held the CTO title. Series C in 2014 and most recently series B at the start of 2018. I also seek out opportunities to unload my equity in the secondary market, but I'm usually taking a haircut there vs the premium investors that are looking for a bigger share will pay during a capital event.

I'm a bird in hand guy when it comes to equity at the fast-growing private companies I tend to be attracted to. I'm almost certain I'd feel differently if I had a larger stake or founder-level attachment to what was being built.

Out of curiosity, how did you find investors to sell to for secondaries?

Founders often get the opportunity to cash out some of their stake in the company in mid and late VC rounds.

Sometimes VCs will purchase founder equity for cash.