Lemonade, Inc. ($LMND)

Well, thank you, everybody. I'm Paul Newsome. I cover the insurtechs, among other things for Piper Sandler. Very happy to have the CEO of Lemonade, Daniel Schreiber here to chat about Lemonade and technology and all the fun things that we have there. I apologize in advance, I have -- getting over a cold. So I'm going to rely on you to [indiscernible] also speaking. But maybe we could talk -- begin some of the conversation with a fairly broad question.

We're here at a fintech exchange conference. How do you see insurance fitting into the fintech ecosphere? And how do you see the opportunities just a big picture perspective as it fits in broadly...

Good morning. And I wish you a speedy recovery.

Thank you very much. I'm on my way I just had...

Speed recovery. Good morning, everyone. Great to be with you. I think insurance is the most disruptible industry on the planet, but I'll use your question as a way to kind of highlight that. So you've got kind of banking and lending and those kind of more traditional financial services, and you've got insurance as somewhat distinct -- but actually, they're pretty similar in size. If you look at the contribution to GDP, they both hover a few decimal points of the side of 3%. If you look at the Fortune 100, you'll find that there are actually twice as many insurance companies as there are banks on the Fortune 100. But they're sizable, huge kind of industries. And yet, one has seen so much more innovation than the other. So I'll give you a few measures of that. But last year, something like $115 billion was invested in fintech, about $5 billion in insurance. So you're talking about an over 20-fold, 20x outspending by one sector over the other. If you look at the market caps of fintech companies on public traded exchanges versus insurtechs, you're talking again at an over 20x if you look at penetration rates, new bank and Stripe and Revolut and you're talking about hundreds of millions of customers, you're talking about single-digit million customers of insurance, all of which is to say you've got these 2 behemoth sectors, one of which has seen tremendous amount of innovation, one of which has seen rounds down to 0. And you see this in the incumbent responses as well. So banks and major financial institutions outspend insurance companies about 3:1 on IT. There's a competition going on, and they've had to invest, and we see major innovations, open banking for traditional banks, over 50% of their interactions are now app-based. And you can transfer it with insurance, where it's still broker-based going into your local State Farm agent and on the high street, it's really kind of remarkable how distinct they are. So I think when -- if you look at all the amazing value that's been created in banking and you contrast it with the value that's waiting to be made on insurance, that should give you a cause for pause and ask yourself whether the alpha isn't really on the other side of the fence there.

So if it continues to evolve in the way we think it's going to, does that imply a larger role for insurance than as technology becomes improving or is it becomes a smaller? Well, you hear insurance folks talk about how different types of technology will sort of eliminate risks. But I'm curious as to whether or not you think that what's happening from a technology perspective will make the biggest industry bigger or smaller, current looks of it?

I hope it makes it smaller. And the reason I say that is insurance premiums are a direct correlator of risk and exposure. So to the extent that technology can help us mitigate risk, we should be paying less premiums. We see that today with our car insurance, our auto insurance, where we use telemetry. All of our customers do that. We even have amazingly high connections to Tesla. And if you're driving with FSD, which is safer than any member of your household, we will give you like 50% discount per mile driven. So assuming we've get to much safer technologies and in the case of auto, it's lives are at stake, not just dollars, it is true that the cost of repair goes up a bit because these are computers on wheels rather than just mechanical machines, but the frequency drops pretty precipitously. So I would like to see it's contract. It doesn't matter. We're talking about multitrillion dollar sector. These are 11% of GDP is insurance today. So you've really got such a huge sector. And at the same time, you see -- I'm wishful thinking saying it would be great if it went down, but cyber exposure and other things like that keep going up. So there's an offsetting going on there.

Yes. I'm a long time said that the size of the insurance is equal to the size of the claims. As long as there are lawyers and inflation, we're all going to be in business for a long time.

You're right. Yes.

One of the things that I've struggled with as an outsider looking into the industry is sort of the competitive moat of technology. And I think part of that has to do with the fact that as an outsider, it's just very difficult to tell if company A has come with better technology than thee company B. Obviously, your company has been sort of a leader in trying to use artificial intelligence and other technology. Can you talk a little bit about just sort of how as an outsider, we can see that competition other than obviously the results over time?

Sure. It's a challenge. We founded the company in 2015, and our first -- my first slide deck to my Board was about artificial intelligence. Playfully said kind of artificial intelligence, not artificial delays, and that was kind of the founding deck. So we didn't discover AI in November 2023. This is -- or '22. This is what we've been doing since the founding of the company. And suddenly, everybody, of course, is talking about AI. It's like pixie dust that you sprinkle on your earnings and there's loads of press releases coming out, and it makes it genuinely difficult. Is it AI or is it DS?

I have some theories.

Yes. I think there are lane to pierce through and have a look, and I'll try and unwrap it for you a little bit. Insurance accounting is convoluted and it makes it difficult, and they do not offer the kind of metrics that we use to track automation rates. But there are 2 or 3 things that it's very hard to obfuscate. One is what we call the scaling quotient. And what I mean by that is the following. And since ChatGPT came out as -- take that as a kind of good point of 3.5 years, our business has grown considerably. We're talking about almost threefold the revenue now than we had then. We've added not quite, but close to 1.5 million customers. Our gross profit has more than tenfold increased over the course of 3 and a bit years. And yet, our headcount today is smaller than it was then. To be able to scale your business like that, see almost 3x the revenue and add millions of customers and shrink your headcount, that's an incredible Telltale sign, and it has not been replicated by any of the incumbents. They're not growing at the rates that we're growing. We've now had since GPT 10 consecutive quarters of accelerating growth, not just growth, but accelerating growth. So we're growing very rapidly. But no change to our operating expenses net of marketing, no change to our headcount over 3 years. That is mind-blowing. It's very rare outside of the insurance space. It's nonexistent in insurance. So that would be one measure that I think is helpful. Another one which is usually disclosed by incumbents and allows maybe the only true apples-to-apples metric is something known in the industry as LAE, stands for loss adjustment expense. And that is basically a measure of every dollar premium I take in, how much do I spend or waste on the bureaucracy of managing claims, not on paying your claim, but in the overhead, which is why it's such a helpful measure of efficiency. The more I have to spend on bureaucracy, the less efficient I am. Now [ obviously ], there's an advantage to scale. We're at $1.5 billion roughly to round it there for a second. GEICO Progressive, State Farm, you're talking about anywhere between $50 billion and closer to $100 billion. So they loom over us 50-fold bigger than we are. And yet their LAE ratio stands hovers at around 10% 1 point below, 1 point above. That seems to be kind of best-in-class. They're spending something like $0.11 on the dollar on the bureaucracy of handling claims. We're at [ $0.6 ]. And that halved over those same 3 years. We have almost threefold more claims today with a smaller claims team than we had 3 years ago. So we're just seeing this explosion of business with no explosion -- correlating explosion of costs. And we've already guided that we think as we double our business again, that might drop from 6 down to 3 or 4. So we've just got this new reality where our variable costs have become fixed costs. And as we continue to scale our business, the profitability just grows as a direct result of that. And that gives you a clear snapshot of us versus incumbents who are 50x bigger and yet twice as inefficient, if you like. There are other places that are harder to measure, for example, the precision with which you underwrite claims. Loss ratio is not a helpful measure, although we've seen 10 consecutive quarters of improving loss ratios, but I don't actually point to that. You can get there just by raising prices. So I don't think that tells you that you're using AI. But here's a nice snippet. We have about $0.5 billion book of pet insurance. And in the last year, the sector, the industry took a lot of rate. They kept raising prices. So you saw something like 27% increase in prices across the industry. Our rate increases were less than half of that. We were at 12%. So we took much less rate. We outgrew the industry 3:1. We grew -- they were growing at like 17%, we grew at 50-something percent, 55% if memory serves. So we took less rate. We grew 3x faster and our loss ratios were better. That does tell you about the precision of the pricing. That's not just lazy raising rates. That is modest raising rates in precise places so that the loss ratio doesn't move and yet your growth means that you're being priced very, very competitively. So I think there are -- if you look for Telltale signs and you don't just look at the press release, you try to pierce through, you think there are numbers to be found all over the place. I'll say one other thing that it's -- we are a young and fast-growing insurance company. We are outspent clearly on IT or technology by the incumbency. And that is a very poor indicator of anything at all. State Farm, which is the largest P&C insurance company in the U.S., spend something like $3 billion a year on their IT. Gartner estimates that this year, the whole sector will spend something like $0.25 trillion. Just in the U.S., I think since we were founded in 2015, our competitors have spent something like $1 trillion on IT. We spent less than $0.5 billion. So we have, call it, $500 million. We're being outspent pretty dramatically at 2,000 fold or whatever it is. And yet, our technology is better than any incumbent technology by a mile. This isn't something that you can just throw dollars at. If your business model is one where you have human beings selling and being an agent and a broker on the high street, your data collection is appalling, your ability to harness data is appalling. I saw an interesting study from 2019 that the #1 cause of loss for some of the incumbents was other garbage in, garbage out, that kind of problem doesn't get solved by just throwing dollars at it.

Yes. The kind of related to that, one thing I -- everyone notice is that the industry is large and there's an enormous range of performance, particularly in personal lines. Could you talk a little bit about how broadly you might compare to some of these companies that are spending a ton of money that are doing much better, right? I mean it's one thing to compare yourself to State Farm or generic regional insurer, which clearly has green screens and programming that I probably did when I was a young guy, and we can tell the stories of that versus like a Progressive or GEICO, which managed to have very low expense ratios overall. As an outsider, why should we think, hey, Lemonade has really gotten ahead of even some of the better ones as well? Is there something we could point to? Or maybe that's just going to be the subset will be those handful of folks who really won't be just Lemonade at the end of the conversation.

Progressive from an outsider's perspective as well, but my sense is that they are leading the pack. I'm not sure I'd put GEICO in the same breath. At last year's AGM, Berkshire Hathaway, who owns GEICO, spoke about this. Ajit Jain, the Vice Chairman, who runs Insurance, said that GEICO is doing very poorly on technology. They've got this wonderful honesty kind of policy at Berkshire, so it's easy to get a visibility. And he said, GEICO has 500 and then he paused and corrected himself and he said, actually over 600 disparate systems that don't talk to one another. Lemonade has one. And it wasn't bought. It was built. We're an engineering -- culture engineering team. We built it in-house. We control everything. It's the same system that will allocate the marketing dollars and acquire the customers, and we'll use 50 different machine learning models to make predictions about every single person hitting our website, what is the likelihood to claim to convert to churn, to cross-sell. We're going to amalgamate all of that and produce a lifetime value prediction on every single person hitting our website in real time, the likes of which doesn't exist by any of these systems. We'll then allocate dollars based on a kind of an algo trading system of which campaign is generating the best return on marginal dollars spent. Then an AI will sell you the insurance once you click on that link and you come through, we've got an AI Maya, and she will use all of that information in real time to make the best offering to you to give you the right defaults to offer you the right add-ons, when you have a support question before or post purchase, that will be handled by AI. And finally, when you make a claim, the majority of our claims are handled without a single human being in the loop at any point, millions of claims. And some people blown the lack of the human contact, not our customers. If I can pay a claim in 2 or 3 seconds, which we do all day long, you're not building the lack of the human -- please wait for your call is important to us and it will be answered and all of that. So I think these things speak for themselves. You look at NPS as one metric, and you'll see that notwithstanding the fact that we are a cost leader, we are a service leader as well. Technology lets you do that. You can -- with a 3-second claim, you're happy and my cost just crush, which is why the LAV is where it is. And honestly, when you start thinking about the incumbency in general, and I'm not picking on names, GEICO happens to speak about these things kind of...

Please do.

There are structural reasons why it's very difficult to get rid of those green screens or to transform your business. And they start with -- I know quite a lot of the CEOs of the largest insurance companies, it starts with them having the wrong investor base. Their investor base wants a 5% dividend and total stability and what's needed is massive transformation. They have the wrong management team. They were groomed for business preservation, not for business transformation. Their systems date back to the '80s and instead of having a black box, they have a black hole, and they just throw billions of dollars into it. They have a distribution network that means they don't -- they'd love to move to an app-based distribution, but it would sacrifice all of their current channel conflict would be unmanageable. So they are deeply encumbered. And the reason we founded Lemonade is because we don't know of a solution to their innovative dilemma. If I thought I could just sell them, shovel them pick axis and tell them, hey, just bolt this on top of what you have, we would have done that. I think their job is much harder than ours. Starting from scratch as a tech company is very helpful. And remember that insurance is the most disruptive, I said earlier for financial reasons, but think about it from an AI perspective, it is an ephemeral product that is all about statistics. That's what insurance is. I am monetizing probability theory. Everything else is distribution. It's at its core, it's about ingesting data, having high-quality data being a data leader using machine learning to find the multivariate correlates and being able to price accordingly and then serve customers at the lowest cost to serve. One of those maps on to loss ratio, one maps on to expense ratio.

It has long-term issue.

Of course. So I think that the fact that everybody else is so encumbered with these old systems and these other issues that we've discussed makes it very, very difficult to drag themselves into the 21st century.

Your thoughts on distribution. Obviously, a hot topic with the brokers [indiscernible] and maybe you could talk about what you see as the technology changes, especially recently in distribution. And obviously, you have a direct channel, but I'll let you talk to.

Yeah, I'll be fine, okay. From our point of view, actually, distribution surprising me very little in terms of the AI ramifications. I was just kind of saying that the 2 core metrics in insurance are loss ratio and expense ratio, loss ratio is about precision of pricing, expense ratio is about cost to serve. You combine the 2 and it's called rather unimaginatively the combined ratio, and that's what that's about. And LLM and Agentic AI maps onto one and machine learning and deep learning maps onto the other, which is why it's so disruptible. The distribution piece, as consumers move more and more to LLMs in order to recommend their insurance or even send their agents to buy the policy for them, we're just fine with that. If you now ask your LLM of choice about pet insurance or renters insurance or clients, Lemonade will be over-indexed quite significantly. And the reason for that is that consumers going back to things we said earlier, we tend to be a cost leader because we use technology to get to the best cost. We tend to have the highest NPS because of that same reason, technology is the common denominator to both of those. LLMs scour all the sources out there, ingest that and then we'll play it back to you when you ask them who's good at insurance. So we're actually finding that we are punching considerably above our weight on LLMs. And to the extent that distribution becomes increasingly headless, where it's your agent talking to my agents, we're fine with that as well. We're not relying on human agents or what we call agents. We're very comfortable with the machine to machine. Everything that we do is MCP or API-based. In some places like in the U.K., which tends to be price comparison website-based distribution rather than anything else, we have the equivalent of algo trading going on there, where we can bid for every lead that comes in very effectively. So being a cost leader has got to be an advantage in the current scheme, but even more so when all of the Geckos and cockney accents get displaced by just agents talking to each other and looking at the core facts. That's an advantage to us rather than a disadvantage.

So the key issue is to be essentially distribution neutral.

Carriers that. I think the key issue is to be a cost leader and to offer the best product and the best service because -- not because you're living on thinner margins, but because your underlying cost structure is automated through AI and that costs less than humans, and that will then flow through in all the distribution methods.

Makes sense. Getting towards the end, I should ask at least a few numbers questions. Fourth quarter positive EBITDA, very focused. Any thoughts about mechanically how that's going to emerge over the course of the year and the sustainability of that over time? And is it just more of the same? Or is there something else that we should be thinking about in the next year or two?

I think the simplest way to think about our business model is to kind of think about something that's [ Yay-shaped, ] where the top is tracking gross profit growth. Gross profit is much more helpful than revenue or premium because it incorporates the quality of the revenue. If you've got a bad loss ratio, then you don't get much gross profit. But track gross profit dollars, not margins because oftentimes higher loss ratios will yield more dollars given the price elasticity of demand. So track gross profit dollars. This last quarter, we announced results, which reflected 159% growth year-on-year of our gross profit dollars. So this is just a rocket ship. And then track our underlying expenses. Because if that continues, where we have underlying expenses net of marketing spend, but all of our OpEx basically stand still and gross profit keeps surging, you just know that, that translates into profitability. And if you look at our EBITDA margin over the last several years, it's a straight up into the right line. We announced about 4 years ago that we're going to be profitable -- EBITDA profitable in Q4 of this year. That's still what we're saying because the machine is operating in a highly predictable way. We just can calculate the rate of growth and how many gross profit dollars are needed to drop through to the bottom line. And this is our third year of cash flow positive. It's not like we've been burning cash along the way, but the GAAP accounting follows for whatever reason, we'll get to EBITDA profitable, and that will keep -- as far as we can tell, that will continue forever in a day. So we're not expecting any near-term reversals on that.

Is there a terminal value to what point you get to true scale and...

Is the one of the exciting things. Insurance, the prize at the end of the rainbow is stunning, right? The dominant insurance companies around the world today date back the young ones to the 18th century. You've got the Lloyds and the AXA. AXA is over 200 years old. Lloyd's is 300 years old. Aviva in the U.K., 330 years old, and they grow to be $100 billion, $150 billion a year. So that is where our sights are set. We're not planning to slow down anytime soon. We're going to, as best we can, continue to compound. We are in all 50 states. Rather unusually, we also operate in Europe and in the U.K. for some reason, the Atlantic seems to be a barrier for most insurance companies, but we're operating all over the place. And we see tremendous opportunity, which we hope will compound for many years to come. We could 10x our business, and we would still barely be noticeable to our competitors. We'd have to 10x again before they really start paying attention. That's a nice position to be in.

It's a big business.

Yes.

Well, I want to thank you guys for. Thank you, Dan, for being here. Appreciate it very much.

Thanks.