In this article, I’m going to give you a core overview of what this business is then objectively dive into whether this business is a good investment or not. To do this, we’re going to go over 3 key checkpoints so you can weigh the Pros and Cons before you think about investing.
Lemonade is a really radical approach in charging coverage and funding insurance claims. It leverages a peer-to-peer approach. This means they pool your monthly premiums into a collective pot. When one of you needs to make a claim, they take money out of the pot. They collect a 20% flat fee off the top and donates what is leftover. It’s also worth noting that as I understood it, they use a reinsurer which is essentially a 3rd party insurance for your insurance so that if anything goes wrong, like a natural disaster hits and everybody starts filing claims, the 3rd party will pays out, reducing Lemonade’s potential overhead. I’m not sure if the reinsurer kicks in for regular claims though, please leave a comment if you know. But ultimately, the value prop for its user segment is charitable people and who also looking to cut monthly overheads.
Another thing to note is that they went to Softbank and are throwing a shit ton of money at marketing to grow fast. They’ve clearly gained enough momentum to become a unicorn and go public, which can be interpreted as a good thing, because people are willing to adopt. The outstanding question might be whether they are building brand love or are they capturing users because they are spending a ton of marketing dollars, because one of these approaches is a lot more sustainable as a business practice.
Checkpoint #1 is it a disrupter.
Because if you’re going into a space /w tons of established billion dollar players, you better be. If you are, sky is the limit.
Lemonade seems to think that with a modern onboarding user experience, savings, and the donation play it’s enough to be a disrupter player. Well considering that the company says 90% of their user segment is first time buyers, they really aren’t disrupting. They are capturing the new generation of homeowners. This is probably because the amount saved for a guy like me to switch is not covering the hassle of me switching. We’ll test this hypothesis in a minute.
I also want to point out that this is not necessarily a bad thing, because there’s no better way to put it, old people die. If 90% of their demographic is 35 and under and they are capturing first time buyers FASTER than old institutions then there is absolutely an upside here.
Checkpoint #2 – Is there Explosive Growth Potential
They currently do only home and renters insurance with select markets. With this IPO they’ll have the money to scale up to tackle all the key outstanding markets and also go into Auto. According to my research, homeowner’s insurance market size is 105.7bn and and auto insurance market size is almost 300Bn. You accommodate that fact with the fact that they aren’t in all key markets yet, I definitely see an opportunity for them to at least triple their top line.
On the flipside, just instinctively, there should be a much higher claim rate for auto insurance than home, so they will probably need a much higher number of insurance buyers to reach critical mass so that they actually have a legit chance to make money. In other words, you need more people so you reduce the number of claims and the average cost per claims filed to make financial sense as an insurance business. Imagine you have 100 college kids who signed up paying 30 dollars a month. That’s 3000 dollars a month in liquidity. If 10% files a claim because they all ran into ferraris with their honda civics, suddenly lemonade needs to either use the reinsurer or use themselves to pay out hundreds of thousands of dollars. If you had One MILLION auto insurers and only 100 of them ran into ferraris though, you’re no longer losing money on the payout.
If they cannot get critical mass then either they will have to go out of business or they need to raise premiums. A perfect example is our obamacare. It would have been perfect if everyone played ball; but everybody didn’t.
Checkpoint #3 – Size of their Moat
With software companies, holding patents is most of the time meaningless. It’s very easy to copy technologies and applying good ideas to existing ecosystems can potentially be very easy. Just look at one of my favorite fin-tech startups, Motif. Motif offered a novel way to invest of which my friends LOVED using. Schwab like it, built their own, ate its pie and Motif had to close shop.
The bigger problem is Lemonade isn’t exactly a disrupter in the sense that it has better FEATURE. You’re still paying premiums. If you hit somebody, you’re still doing police and claims. They aren’t delivering you a comfort puppy after you rear-ended somebody here.
To an end user, in reality, all you care about is lower premiums and MAYBE a charitable company right. So let me pose you this. If Progressive tells you they have an internal donation program that donates in the 10s of millions already (lemonade donated 600k last year) and they will price match whatever lemonade offers you, would you still take your chances with a startup IPO? One that according to the internet has very questionable claim practices? (show screenshot)
So the final question is would I invest. That would be an unequivocal no and it’s not exactly why you think. Yes those checkpoints don’t sit well with me, but I will not and it’s primarily because of a pretty stupid almost superstitious reason that i’m almost embarrassed to say. I unequivocally think that whenever Softbank invests in a company I look at, it goes south. For the past half decade, every company that I was interested about got involved with Softbank and one way or another went south. RENREN, UBER, WEWORK, slack
There is a category of companies that I think are really good investments but usually incredibly coma-inducing. And that is companies that are trying to change the behemoths of the old world. Some examples are 401k businesses, stock trading platforms, HR tools (ie workday, servicenow), learning institutions (find public ones), and now insurance.
There’s a principal you’re taught in most business schools, which is that there is a lot of money in old established industries (obviously) and it is usually an uphill battle UNLESS your product is an industry disrupter. The easiest way to think about it is if you’re paying for auto insurance right now at let’s say 50 dollars a month. Would you switch if someone said you can get a difference insurance for 49? Probably not. 48? No, I’d be saving 2 big macs a year, For me it’s not worth the hassle. To people who are getting insurance for the first time, yes they absolutely will, provided all else is is the same if not better.
You’d have to lower the cost SIGNIFICANTLY in order to meet not only my willingness to pay but my willingness to switch. Thus, a lot of these startups like food delivery, uber, etc… They accomplish this by taking a loss to attract you. Once you are bought in, they employee the same strategy as the big companies, raise your fees to “normal” because the difference isn’t great enough for you to switch and BAM, successful business.
All in all, I do see why some people see an upside in this company’s endeavors. However, due to the checkpoints that I’ve outlined, I will personally stay away from this opportunity until I’ve seen better disrupting differentiators that have larger moats.