Lemonade Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 3, 2023

There are 12 speakers on the call.

Operator

I'll now hand it over to your host, Yael Wissner Levy from

Speaker 1

Good morning, and welcome to Lemonade's Q2 2023 Earnings Call. My name is Yael Wissner Levy, and I'm the VP Communications at Lemonade. Joining me today to discuss our results are Daniel Shriver, Co CEO and Co Founder Shay Winninger, Co CEO and Co Founder and Tim Bixby, our Chief Financial Officer. Letter to shareholders covering the company's Q2 2023 financial results is available on our Investor Relations website, investor. Lemonade.com.

Speaker 1

Before we begin, I would like to remind you that management's remarks on this call may contain forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward looking statements As a result of various important factors, including those discussed in the Risk Factors section of our Form 10 ks filed with the SEC on March 3, 2023, Our Form 10 Q filed with the SEC on May 5, 2023 and our other filings with the SEC. Any forward looking statements made on this call represent our views only as of today, and we undertake no obligation to update them. We will be referring to certain non GAAP financial measures on today's call such as adjusted EBITDA and adjusted gross profit, which we believe may be important to investors to Reconciliations of these non GAAP financial measures to the most directly comparable GAAP financial measures are included in our letter to shareholders. Our letter to shareholders also includes information about our key performance indicators, including customers, in force premium, premium per customer, annual dollar retention,

Speaker 2

Good morning and thank you for joining us to discuss Lemonade's Q2 results and our updated outlook for the year. The second quarter bested our expectations on both Tim will provide all the details shortly though. The headline is that our in force premium grew 50% year on year, while our operating expense grew only 9% And our net loss decreased. Premium is growing more than 5 times faster than expenses highlights the scalability of our business. As we continue to grow, we expect this dynamic to drive our progress towards profitability.

Speaker 2

The importance of achieving scale was the driving behind a major piece of news in Q2, the launch of our Synthetic Agents program with a long time investor General Catalyst. We believe this program is something of a game changer and I've written about it at length on our blog and we cover its mechanics in the back of the shareholder letter published yesterday. I do encourage you to study this program as it is not quite like anything we've seen before and we believe its impact on our business will be material in 2024 and beyond. Let me explain it briefly. To date, our direct to consumer business model has served us extremely well and with no plans to change it, But it does have one downside.

Speaker 2

Customer acquisition costs, known by the acronym CAG, are born upfront and it takes us about 24 months To be clear, our expenditure on CAC is money well spent because over their lifetime with us, our customers Typically, we pay their CAC three times over, even accounting for the time value of money. But because it takes Time to recoup the initial outlay, rapid growth is typically cash flow negative. If we spend $100,000,000 on CAC in year 1, for example, and $100,000,000 in year 2 $300,000,000 in year 3. We could expect that $600,000,000 of CAC investment to yield about $2,000,000,000 in gross profit over time, Which is a very compelling ROI. But before we saw that return, our bank account would see a dramatic dip in its balance, Not a sustainable approach at higher growth rates.

Speaker 2

Without the synthetic agents program, long term profitability comes at the expense This trade off limits our pace of growth, particularly while the cost of capital is elevated. Slowing growth preserves cash, which is good, but it also caps the amount of gross profit we can generate, slowing our path to profitability and lowering our terminal value. Now insurance companies that sell through independent agents don't have this issue. The agent finances the CAC And the insurance company can grow without depleting cash reserves. But while we do partner with agents to some extent, we prefer not to let this become our primary distribution model.

Speaker 2

For one, the agent mediated business replaces the magical lemonade experience with the agent's own interface, commoditizing our brand and watering down the data we collect. For another, the agent siphons offers matches half of the gross profit of the customer over the life of the customer, Greatly reducing the lifetime value or LTV. So while agents do solve the cash flow gap, their costs In terms of gross profit, brand, data and customer relationship are significant, which is where Synthetic Agents come in. Synthetic agents were designed to provide the cash flow benefits of independent agents without what we perceive to be their biggest downsides. How?

Speaker 2

Synthetic agents finance our cap or up to 80% of it to be precise and they get the equivalent of a 16% commission From those cohorts they helped finance. They have no other recourse whatsoever, just a right to a portion of the premiums that wouldn't have existed if it wasn't for their funding. That is broadly similar to independent agents. But unlike independent agents, payments to synthetic agents aren't for the lifetime of the customer. Far from it.

Speaker 2

They stop after 2 to 3 years And Lemonade owns 100 percent of the LTV thereafter. That's a huge difference. Secondly, synthetic agents are just financial partners and therefore They don't intermediate the relationship between us and our customers. Our model remains direct to consumer and we own the customer relationship, the customer experience and the customer data, Another huge difference. The upshot is that our Synthetic Agents program enables rapid growth without foregoing the customer relationship, Without foregoing much LTV, without depleting our cash reserves and without selling equity to finance our growth, Synthetic Agents has paved the way to a larger business and more profits sooner and with more cash in the bank.

Speaker 2

And hopefully, you see why we believe this program is something of a game Yes. Same with the theme of making the most of our capital, in addition to announcing our Synthetic Agents program, this quarter also saw the renewal of our reinsurance program, notwithstanding one of the hardest reinsurance markets in these many, many years. The REopt program is for the same 55% seed as we had previously to the same top tier reinsurers yielding similar capital efficiency. There are some changes to the renewed program, particularly around the treatment of cat events. Named hurricanes are excluded, for example, and there's a $5,000,000 per event cap.

Speaker 2

Yet these are risks we can comfortably bear in our newly formed captive structures while maintaining our target capital efficiency. Taken together, the impact of our reinsurance program and synthetic agents program is significant. In that elemental state, The capital burdens of insurance, both regulatory capital and working capital would weigh us down, slowing growth, idling cash and delaying profitability. That's why our Q2 agreements are so material. Our reinsurance partners relieve our regulatory capital burden through our quota share program Therefore, the agreements that came into effect July 1 mean that we're all set to grow and to go the distance, Which brings us to the next hurdle we need to clear before picking up our growth rates, most notably rate approvals and loss ratio more broadly.

Speaker 2

In my remarks last quarter, I said, and I quote, we expect our current trajectory to broadly continue, albeit with occasional hiccups I stand by those comments. Q2 indeed saw a reversal due to outsized cat events, But the underlying trend line continues to be in line with our expectations. Our rate filings have gained steam and approvals are also coming in faster now. Significantly, California approved a 30% rate increase for our homeowners product and 23% for our pet business. It will take some time for these rates to earn in and we still need to take more rates, but we have reason to believe things are moving as they ought to.

Speaker 2

Importantly, in parallel to our rate approvals picking up, inflation has been slowing down. This is really significant to us. And so long as These trends continue. As I said last quarter, we'll continue to expect the downward trajectory of our gross loss ratio to broadly continue, albeit with occasional hiccups And with that, let me hand over the call to Tim, who can provide more details on our Q2 results

Speaker 3

for the Q3 and the full year and then we'll take some questions. It was a strong quarter across the board with continued loss ratio progress despite cat Grew 50% in Q2 as compared to the prior year to $687,000,000 Absent the impact of the Metro Mile acquisition, organic annual growth was approximately 28%. Organic annual growth was approximately 28%. Our customer count increased by 21% to 1,900,000 as compared to the prior year. Premium per customer increased 24% versus the prior year to $3.60 This increase was driven primarily by both Volume growth and mix shift, including the impact of the addition of Metromile's pay per mile customers and to a lesser extent increased price and coverage.

Speaker 3

Annual dollar retention or ADR was flat as compared to the prior quarter and improved by 4 percentage points to 87% versus the prior year. We measure ADR on an annual cohort basis as a reminder and this includes the impact of changes in policy value, additional policy purchases and churn. It's worth noting that our ADR may decline somewhat in coming quarters as we recently passed the 1 year anniversary of the Metromile acquisition on July 28. This will add in a base of customers with slightly higher churn rates than the rest of our book. I expect this headwind to ADR driven by the change in product mix will dissipate Our gross earned premium in Q2 increased 53% as compared to the prior year to $164,000,000 Roughly in line with the increase in in force premium.

Speaker 3

Revenue in Q2 increased 109% from the prior year to 105,000,000 The growth in revenue was driven by the increase in gross earned premium as well as a reduction in the proportion of premium ceded to reinsurers to roughly 53% in the quarter as compared to approximately 71% in the prior year. Absent the change in the proportion ceded, revenue growth would be roughly in line with the growth in our gross earned premium. Our gross loss ratio was 94% for Q2 as compared to 86% in Q2, 2022 and 87% in Q1, 2023. The impact of cats in Q2 was roughly 21 percentage points within the gross loss ratio. Absent the impact of all cats in Q1 and Q2, the underlying non cat loss ratio showed solid improvement of roughly 8 percentage points Including loss and loss adjustment expense increased 9% to $95,000,000 in Q2 as compared to the prior year.

Speaker 3

This is primarily driven by increased personnel expense, stock based compensation expense and legal and professional fees, in large part due to the Metromile acquisition, Partially offset by lower sales and marketing expense. Other insurance expense grew 55% in Q2 versus the prior year, roughly in line with the growth of earned premium. While total sales and marketing expense Declined by $12,000,000 or about 33%, primarily due to lower growth acquisition spending to acquire new customers. Notably, our growth spend efficiency improved significantly in Q2 in large part due to this lower spend level. Each dollar spent on growth generated roughly 75% more IFP this quarter versus the prior year.

Speaker 3

We spent approximately $12,500,000 for growth advertising in the quarter or roughly 50% of our total sales and marketing spend. Technology development expense increased 35%, primarily due to the Metro Mile acquisition, while G and A expense increased 37% as compared to the prior year, but notably decreased 6% as compared to the prior quarter. Personnel expense and headcount continued to be quite stable despite continued growth in customers and premium. In fact, our headcount actually decreased 2% as compared to year end 2022 to 1333 and has been essentially flat for 3 quarters running. Headcount increased 17% as compared to the prior year, primarily due to the acquisition in Q3 last year.

Speaker 3

Net loss was $67,000,000 in Q2 or a loss of $0.97 per share As compared to the $68,000,000 loss we reported in the Q2 of 2022 or a loss of $1.10 per share, Well, our adjusted EBITDA loss was $53,000,000 in Q2 as compared to the $50,000,000 adjusted EBITDA loss in the Q2 of 2022. Our total cash, cash equivalents and investments ended the quarter at approximately $942,000,000 reflecting primarily a use of cash for operation of $97,000,000 since year end 2022. With these goals and metrics in mind, I'll outline our specific financial expectations for the Q3 and for the full year 2023. So for the Q3, we expect in force premium at September 30 of between $703,000,000 $706,000,000 Gross earned premium between $166,000,000 $168,000,000 revenue between $102,000,000 $104,000,000 And then adjusted EBITDA loss of between $51,000,000 $49,000,000 We also expect Stock based compensation expense of approximately $16,000,000 capital expenditures of approximately $3,000,000 And a weighted average share count of approximately 70,000,000 shares. And for the full year 2023, we expect in force Premium at December 31 between $710,000,000 $715,000,000 gross earned premium between 654 $658,000,000 revenue between $402,000,000 $408,000,000 And adjusted EBITDA loss between $199,000,000 $196,000,000 and stock based compensation expense of approximately $62,000,000 We also expect capital expenditures of approximately $12,000,000 and a weighted average share count of approximately 70,000,000 shares.

Speaker 3

And with that, I would like to hand things over to Shay.

Speaker 4

Thanks, Tim. We'll now turn to our shareholders' questions In the first question, Paperback asked about our plan to reach profitability between the years 20252027 As we laid out in last year's Investor Day, he asked for a time line update for when we think profitability would most likely occur. Well, Paperback, based on what we know today, we see little bit changes in our multi year breakeven timing. When we shared long term financial scenarios in November 2022, it was before our synthetic agents funding and before a notable improvement in our EBITDA. So we plan to work that into our long term planning and give a more updated view shortly.

Speaker 4

In the second question, Patrick K. Wanted to know about our giveback program, Citing that the Lemonade Twitter feed has demonstrated a left leaning bias for the company and noting that I tweeted back that this is unintentional. He asks how the company will show political neutrality going forward. Well, Patrick, this is a topic that has always been top of mind for us since we started the company. Levenidasino was founded as a public benefit corporation and integrated social impact into the core of its DNA.

Speaker 4

That means that we may be vocal about topics like gun control and climate change, which can be considered political, But we stay above the fray when it comes to party politics. Beyond doing the right thing, we believe that taking a stand is important for our business and brand, Even when it comes at the cost of not being everyone's cup of tea. As I once wrote as part of our branding strategy, We'd rather be loved by some than ignored by all. We believe that being bold and having an opinion helps our brand rather than hurts it. This is where I believe our giveback and the Lemonade Foundation coming to perfect alignment with our team and with our investors.

Speaker 4

As for our giveback causes, I think you will find that we offer quite a wide range of options from which most of our customers Patrick, to sum up this answer, we welcome yours and others' In the next question, Darren asks How many generative AI prototypes have made it into production? And what is the estimated impact on 23 and beyond? So just to give some context, last quarter we spoke about the potential positive impact of generative AI in our business And how this is the perfect moment in time for it to be added into our already highly advanced AI and machine learning platforms. Using generative AI, We plan to take our automation even further. And alongside other major tech developments now going into our platform, challenging and quite risky to implement generative AI in their systems.

Speaker 4

For 1, generative AI models are highly unpredictable by design, and it's often impossible to create a consistent and perfectly compliant result. Secondly, insurance companies who rely mostly on agents We'll see much less efficiency gains using this tech because more often than not, they don't communicate directly with their customers. Since we handle and control 100% of our customer communications, being able to automate a large portion of those Experimenting with generative AI, it was clear that we needed a way to tame these models. Regulators require predictability and auditability, This has been an area of focus of ours and one which I'm proud to say we've now solved. With our new generative AI compliance platform, we're able to combine the generative capabilities of large language models With our predictable, consistent and compliant chat platform, we're now able to deploy fully compliant generative AI capabilities at scale and in a very short period of time.

Speaker 4

We're still running in lab mode, but I'm happy to report that our new generative CX technology already handles hundreds of customer e mails And is capable of performing complex tasks with 0 intervention from our team. Our new system cancels policies, In parallel, we're also in advanced stages of development of features that utilize the vision capabilities of generative AI, allowing you to review documents such as VAT records, look at damaged photos and more. Mixed with our existing models, we're seeing extremely positive results. As I mentioned before, I believe that generative AI, when combined with Lemonade's tech, will help reduce our operating costs From building and maintaining software to how we service our customers, and I promise to share more about it soon. And with that, let me hand the call over to the operator so we can take some of the questions from our friends on the street.

Operator

Our first question for today comes from Yaron Kinar from Jefferies. Your line is now open. Please go ahead.

Speaker 5

Thank you. Good morning. My first question or a couple of questions are on the reinsurance program. Is there a loss corridor in the new reinsurance structure? And Also, maybe you can touch on the fact that you're now retaining the hurricane risk through the affiliate entity in Bermuda.

Speaker 5

How should we think about, let's say, losses, cat losses this quarter, net losses this quarter and net cat losses in

Speaker 6

Tim, a couple of comments on the new reinsurance structure. So in terms of a loss quarter, no, there's not A traditional that's traditionally defined last quarter. There is a sliding scale commission, so it's somewhat more nuanced than our prior structure, which was a fixed static commission rate with some potential upside. So it's somewhat different. But overall, I would sort of point out the quota share ceding proportion is the same, the players are So substantially unchanged.

Speaker 6

With the exception that you noted, we are retaining more of the cat risk. So hurricane, for example, named hurricanes, it's fully If you roll back historically, our losses have been not 0, but quite low For named hurricanes and that's more a result of how we underwrite and where we're present. So no real homeowners presence in Florida and then fairly conservative underwriting in other areas where we are active with homeowners. In terms of other storms, obviously, in the last 2 years, we've had fairly significant and quite unique Storms that were not named hurricanes, and so our existing or our previous reinsurance did exactly as designed, Which was protect us against the most unpredictable events and those kind of performance as they should have mitigated a significant amount of those losses. That's why we're able to hit achieve an EBITDA result, for example, in this quarter despite a fairly elevated And so we are taking on more risk.

Speaker 6

We'll use our new captive structures that we've put in place. Those are recent adds. That enables us to continue to be sort of capital light in our approach, but we will take on a bit more volatility risk than we would have had previously. But given the hurricane history and that exclusion, we're quite comfortable with that.

Speaker 5

Got it. Thank you. And then my second question, on the synthetic agent, given that it now lowers your Your term and longer term and maybe taking them up.

Speaker 2

Hey, Arun. Yes, I think we will. We now have the flexibility certainly from a financing point of view, from a capital structure point of view to do a lot more. Our degrees of freedom Have it significantly expanded? When we gave our last kind of in-depth analysis back in November during our Investor Day, We spoke about a 20% to 25% growth rate on a multiyear kind of CAGR basis as being optimal.

Speaker 2

You grow much slower And we don't get to scale, grow much faster and the capital that's required along the way would be too excessive. So there was a path to profitability with the money in the bank. That path remains available to us. But now actually we've got quite a wide corridor on one end of that. So At least from a financial point of view, from a capital requirements point of view, there are new degrees of freedom.

Speaker 2

As we mentioned Earlier, we will be constrained by other things. We still only want to grow profitably. So getting rates approved And being able to grow in places where we see the kind of LTV to CAC that we want is a precondition to accelerating our growth rates. But as those rates come online, as our products continue their downward March in terms of the underlying loss ratio, we do hope to be able to The one asterisk I will underline is our guidance for this year remains As we well, we upgraded it a bit, but it remains largely as we've spoken about in the past because we don't anticipate all those conditions coming true in the next two quarters. So we do think that the next two quarters will still be quarters where we slowed down our growth and focus on Implementing those rates earning into them.

Speaker 2

And we are hopeful that at some point in 2024, if things go to plan and early in the year and if they take a little bit longer, they'll Take a little bit longer, but during 2024, we will be able to reaccelerate growth.

Speaker 6

Thank you. I understand. And Yaron, if I might sorry, Yaron, if I might, I was Just checking my notes here. I skipped over one of your questions, which I think is worth clarifying, which was around the reinsurance. If you look at Q2, which was notable for its Combination of cats, a very large quantity of relatively small events that aggregated to a significant number For that kind of event, we would expect to continue to be covered under the new structure.

Speaker 6

So not exactly the same, but substantially unchanged given what we saw in Q2.

Speaker 5

But the sliding commission structure wouldn't have impacted the net results?

Speaker 6

It would have an isolation, but again, on a sort of a macro view over the course of the year, would not have a significant impact.

Speaker 5

Got it. And then a quick numbers question on PYD or Prior period development, did you have any in the quarter?

Speaker 6

Yes, but fairly modest. The vast majority of the impact was in period.

Speaker 5

Do you have the number by any chance?

Speaker 6

Let me double check that and I'll add that in a moment.

Speaker 5

Okay.

Speaker 6

Thank you. We can go on to the next question. Thanks.

Operator

Thank you. Our next question comes from Josh Shanker of Bank of America. Your line is now open. Please go ahead.

Speaker 7

Yes. Good morning. Following up a little about the conversation here with Yaron on You've spoken in the past about conserving cash until the capital markets are more willing to embrace Lemonade's ambitious plan. You materially exceeded the growth guidance in 2Q 2023 and this was before the capital light synthetic agents program was put in place. Did lemonade grow more quickly than desired?

Speaker 7

And how much control do you have for reining in the growth in the back half of the year Before the rate that you're really desiring pushes through.

Speaker 6

Yes. This has been a sort of a continuing Theme for a couple of quarters now when we're by choice choosing lower growth rates, lower spend rates to conserve capital. And what you see when you're in large and established growth Channels is that when you dial back spend, you're by definition reducing your less efficient or less productive Spend and what you're left with is the more efficient. And so sometimes it's difficult to predict how much more efficient you will become. And so some of the upside you've seen versus our own guidance, particularly in Q1 and Q2 has really been as a result of that.

Speaker 6

For Q1 or sorry, Q2, for example, if we just compare Q2 to the prior year, we saw something like a 75% increase in the efficiency dollar dollar versus a year ago. Now we can't take credit for all of that. We're spending fewer dollars. If we were to spend the exact same number of dollars as a year ago, I would expect that efficiency Difference would not be so significant. It would likely be favorable.

Speaker 6

We consistently get better over time in increments, but it would probably not be So dramatic as you saw. So going forward into the rest of the year, we have a guidance that lays out a sort of a mid teens Growth rate for the year in terms of IFP, because we're updating guidance quarter by quarter, we do try and capture some of that Overperformance or underperformance, which we haven't had, but the variance in what our guidance is. So I wouldn't expect we don't expect to sort of see that Dramatic an overperformance versus our guidance, but you could see some portion of that repeat. Coming back to Yaron's question real quickly on the prior period development, just over 1% or so, 1.3% or so was prior period development and the remainder was otherwise.

Speaker 7

I'd just help that you're on the 1.3% favorable or unfavorable?

Speaker 6

Unfavorable.

Speaker 7

Okay. And then so coming back to the growth question, I mean, if I subtract the 4Q guidance from the 3Q guidance, The guidance basically implies almost no growth in 4Q. You have the 30% rate coming through in homeowners and 23% in Petton, California. If I layer that, I mean, it does suggest that there's almost no policy count growth that your anticipation is that you can shut it down, I guess. Is that am I reading the numbers correctly when I think that way?

Speaker 2

Hey, Josh. Daniel here. Yes, yes. We'll what growth we're going to do in the next 6 months will be largely skewed on Q3. It is the moving season.

Speaker 2

It's when every dollar goes further. So we are taking our dollars spent and we're going to Skew them towards Q3. In general, we've spoken about this in prior years. Q4 gets busy for a couple of reasons. One of them is, as I say, the moving season tapers off, but also, just the shopping season, the holiday season means that AdWords become more costly.

Speaker 2

So We will definitely skew this towards a Q3 spend. Do we expect policy count growth in Q4? We do, but I think the broad strokes of your analysis holds.

Speaker 7

Thank you very much.

Operator

Thank you. Our next question comes from Bob Wang of Morgan Stanley. Your line is now open. Please go ahead.

Speaker 8

Hi, good morning. One quick question regarding just your commentary around AI, right? As maybe not generative AI, but AI broadly. I think in the past you talked about machine learning, which is a much lower form of AI, so to speak, if at all, Would get you to about a sub-seventy 5 percent loss ratio. Just as we see the continued development of AI and the continued More efficient data analytics, especially on the cloud, which is much more scalable.

Speaker 8

Can you maybe help us think about What would be the path to achieve that sub-seventy 5 percent loss ratio for you, just given the technological implementation going forward? And how do you

Speaker 2

Hey Bob. So I think our AIs are Pretty much where we need them to be. Our analysis was shared what LTV6 did back in November where 6 graduated to LTV8. It's worth just delineating. Shay's comments were about generative AI, which is we spoke about it in our Investor Day, but it certainly exploded over the course of the last few months.

Speaker 2

Our machine learning AIs are mature and they're much more focused in on risk assessment. So every customer that comes into Lemonade, We have about 50 different machine learning models making predictions about likelihood to claim, severity of a claim, likelihood to churn, likelihood to Aptal, etcetera, etcetera. So We have a pretty robust infrastructure now making fairly specific and detailed predictions. And as we audit them, we are finding them to be I'm holding true. So we are confident in relying on these models is growing with every turning of the cycle.

Speaker 2

The big Hurdle today for us in terms of loss ratio does not lie in the domain of machine learning or AI. It's about getting regulatory approvals. And once those have been received, implementing them. So particularly in an inflation heavy environment, Let's start with before you even get to regulatory hurdles. The fact that you price a policy today and you don't get to amend it for another year Other than in the car where you get one opportunity mid year, means that if inflation has been significant 10% As a year ago, we had, let alone the 15% or 20% that you saw in the field of car and home repairs, it means that you price today and then you're Fielding a claim 6 months from now, which may be 10% higher than the price when you set it, and you don't get another bite of that apple until renewal a year later.

Speaker 2

And that is if regulators approve every bit of your filing. More likely since regulatory processes take more time and sometimes have limitations on how much rate they'll approve and at what frequency. It may take longer than a year. And then once it's approved, You then have an earning in period because everybody who was priced at the older policy have to wait until their renewals come up and it will take you Pretty much a full year for those new rates to take effect, which is why if inflation remains high, you're in a constant Race to adapt rates. You don't have a knowledge gap.

Speaker 2

Our machines tell us exactly what rates we need to have for each risk. What we have is a time lag between when that knowledge comes in and when it actually hits our books. And that dissipates in 2 ways. One is inflation comes down as indeed it is. It's come down significantly and we're feeling that.

Speaker 2

And the second one is we pick up our rate of filing And approvals and we're seeing that as well. It will remain some of the inflation remains elevated, it will remain a cat and mouse game. I don't want to pretend that that It goes away and we've seen this across the industry. But in the event as we're seeing these two trend lines coming 1 on top of the other, which is Decreasing inflation and increasing rate, the 2 combined to give us optimism that we've broken the back of this thing and we're on a path towards getting to where we need to go.

Speaker 8

Okay. That's very helpful. But sorry if I can just like stay on that topic as my follow-up. Then in that case, is it kind of fair to imply from what you said so far that Essentially, the technological development so far is somewhat of a secondary to essentially The regulatory and the macro environment, whereas the underwriting efficiency from the tech driven Underwriting really is more of a secondary and then the macro environment such as Catastrophe losses that the current regulatory environment would essentially nullify a lot of the tech advantage you're having? Is that the wrong way to think about it?

Speaker 8

Or how should I think about it?

Speaker 2

It's a fair question. I'd draw your attention to a couple of things. One is, have a look at our the loss ratios by product and The high cat impact of this past quarter perhaps masks some of the dramatic improvements that we shared in our letter and just draw your attention, look what Happened to homeowners ex cat dropping from like 110 to 60s over the course of the last few months when you neutralize cat. As Tim said, we have to pay for cats. This isn't an effort to sidestep our responsibility for paying for cats, but it does demonstrate a fundamental improvement.

Speaker 2

And indeed, if you look at some of the best players in the industry and the loss ratios are some of the best known names, I won't name names, but everybody in this call knows who they are. And you look at what Their loss ratios were for this last quarter. You'll see that we came in significantly better than some of the best known names in the industry suggesting a competitive advantage. So no doubt, while we are in a high inflation environment, you will see the whole industry as well as us Suffer the brunt of that. That is true.

Speaker 2

But we can also see when you look kind of beneath the headline is that there is a competitive advantage emerging. And as the inflation recedes, I think the competitive advantage remains. It is already in evidence if you know where to look and as times normalize, It would become more and more pronounced. And in the long term, that is how this industry is 1 by being superior at selecting risks and pricing them. And I think that the technology and infrastructure that we're building affords us that advantage.

Speaker 2

The greed that when the storm howling outside, it's hard to see that. But as the storm passes us by, I think it will become increasingly obvious.

Speaker 8

Thank you. That's very helpful.

Operator

Thank you. Our next question comes from Jason Helfstein of Oppenheimer. Your line is now open. Please go ahead.

Speaker 9

Thank you. I want to go back when you originally kind of came up with the long term plan, Whether it's when you guys came public, etcetera. I mean, look, I think regardless of your views about climate change, it does seem that You know, storms are just it's more frequent, right, whether depending on how you categorize the weather in etcetera, etcetera. Do you feel that as a result of that, like if we're like we're starting again, you'd say we need to have a bigger business to kind of absorb The risk because it's all about kind of spreading it out. And then just how that again, That may have been some of the catalysts of some of the recent announcement.

Speaker 9

Just how you think about that now if you reflect back 5 or 7 years? Thank you.

Speaker 2

I'll take a back at that and then Tim come in with anything that I've omitted. Jason, that's a great question. I think that Rather than suggesting a different course of action, it reconfirms us in a multi product, multi geography strategy. So yes, we saw some pretty severe outcomes this quarter. Of course, we're not just a homeowners business.

Speaker 2

That's a sizable minority of our businesses. It's a fraction of our business, about a quarter of our business. And the rest of our business is performing very, very well. And we shared again our per product loss ratios. You see what's happening in our pet business, which is now Almost as large as a homeowners business.

Speaker 2

You see what's happening in our renters business, which is larger than a homeowners business. So our multiproduct And multi geography is already mitigating the worst of those risks. Indeed, the fact that we are able to report The EBITDA that we reported, a beat on the bottom line and a beat on the top line, notwithstanding a 94% growth loss ratio, I think Speaks volumes to the structures that we put in place, including reinsurance. It's I don't want to oversell this, but If we didn't tell you our loss ratio and we just told you our financials, our P and L, you wouldn't know that this was a particularly severe So there are structures in place that allow us to buffer ourselves from the last worst of these storms And to be able to deliver strong EBITDA and strong top line notwithstanding. So coming full circle, I agree with your underlying premise, which is that Major catastrophes are becoming more frequent, certainly that has been our experience.

Speaker 2

Ultimately, insurance gets a handle on that Pricing, once you understand risks, you can price for them. There is a time lag in doing that. We discussed the regulatory and other time lags That will allow us to course correct. In the meantime, I will tell you part of our slowing down and we laid this out in our earlier comments and in the letter It's to focus on the areas that are less cat exposed. So Tim already mentioned that we are having for these many years very cautious about Wildfire exposure and hurricane exposure.

Speaker 2

We understood those risks and we're pretty conservative. We have been able to write around those. As these other risks become more We are sidestepping them as well. We have written stuff prior that we are now paying for. But if you were to look at ourselves these many quarters, You'll see that our new sales in exposed areas are really de minimis.

Speaker 2

So we are taking course corrective actions. We are fighting for the price rates that we need. We are diversifying our portfolio geographically and by product. And I think all of that translates into a healthier business as time passes by. Anything I omitted there?

Speaker 6

I would just add one thought, which is, again, if you sort of look in broad brush at the Several years since going public, probably one of the larger surprises is in this period of more What feels like in the short term more frequent intensity of more volatile storms, we've weathered that test nicely. We've Seemed elevated results, but they have not been too far out of line from much larger incumbents. I think if we'd seen it would have been more reasonable, I think, in this period with newer products and a much smaller The consistent improvement in consistently declining losses relative to our premium line, Really solid improvement there too. So I think that's been a we didn't set out for the last 3 years to be a test of this rigor, But I think we've weathered that test very well.

Speaker 9

And then just like a technology question. So now that Large language models and machine learning is becoming more accessible to other companies without some of the hard work that Companies like yourself did as early kind of, we'll call it, pioneers. Do you think that is a competitive threat because So technologies technically were not available and are going to become more available if your competitors choose to use them for the next kind of upstart We're

Speaker 6

not too troubled by Large competitors access to technology. It's been something that's been true forever. Certainly, there are things that about Large language models in the transition of the past year or so that are new for all of us. But Having built our platform from day 1 in anticipation of just such data advantages, only I think amplifies the advantages

Speaker 2

Okay. I thought it's all finished. I was just going to say, if you look back at Something I commented on at the time, but when Berkshire Hathaway held AGM a few months ago, Ajijain, the Vice Chair of Berkshire Hathaway spoke about GEICO and he said that they have some 500 systems and then he corrected himself and he said it's actually over 600 systems that don't talk to each other. Those kinds of legacy challenges are I don't want to say insurmountable, but they certainly make it very, very difficult To overcome the kind of challenges that Shay referenced in his comments, which is these are novel and powerful technologies, but applying them seamlessly Integrating into the operations of the company is an entirely non trivial matter. So just reinforcing what Tim says, I think at a headline, it sounds like, oh, everybody would be To deploy these technologies, having now ensconced a thousand and put a lot of effort into these models and trained our own models, We rest easy that Tim's comments are exactly right.

Speaker 2

This is not a major threat to us.

Operator

Thank you. Thank you. Our next question comes from Mike Zaremski from BMO. Your line is now open. Please go ahead.

Speaker 5

First question is just a numbers question on the catastrophe losses on a gross basis. We're calculating it was Around 21 points. Is that similar on a net basis?

Speaker 6

Yes, it is.

Speaker 5

Okay. And my follow-up, you Tim mentioned that In the prepared remarks that Metro Miles churn rate is slightly higher than the rest of the portfolio. I was looking I think Metro Miles Annual customer retention rate, it said it was around 60% annually back when it disclosed it in 2020

Speaker 6

Yes. So we don't disclose that specifically. And a couple of things have changed, obviously, since we took over the book. Our how How we deal with customers renewals and marketing, of course, is more in the realm of eliminate approach than the metro mile approach. The retention rate is somewhat better under the period of time when they've been part of Lemonade since previously.

Speaker 6

And what's been interesting is the actual premium run rate has continued. Even though The customer base has declined. We've not been proactively increasing that customer base. And therefore, the churn has outpaced the growth and therefore, Customer count has declined. The premium level has been fairly steady.

Speaker 6

It has declined, but at a much more modest rate than we had originally assumed

Operator

Thank you. Our next question comes from Matt Smith of Halter Ferguson Financial. Your line is now open. Please go ahead.

Speaker 10

Yes. Hi. Thanks. I wanted to stick on the Metro Mile theme a

Speaker 5

little bit. One of the notes you made in

Speaker 10

the letter was that the auto loss ratio, you haven't really made a lot of progress on. And it would just strike me that you probably have more kind of textured and personalized data for those customers. So I'm wondering what's the plan

Speaker 2

Yes. We have a good amount of clarity there. The bulk of a whelming majority of our car business is the paper mile, metro mile business. And the overwhelming majority of their premiums are in California. So we've got a book there that is very geographically concentrated And there's a rate awaiting rate approval there, which I hope will be coming in the not too distant future.

Speaker 2

That would be a big unlock But with such a concentration, we're very dependent on a single approval cycle in order to get the rates back in line with the risks.

Speaker 10

So are you seeing I mean, it struck me that you're not trying to grow that piece of

Speaker 5

the business until you get The loss ratio is kind of

Speaker 10

in line. Are you just trying to prove that out in the California market first and then kind of expand and try to have more bundling in other geographies?

Speaker 2

We do have it in a number of states. So we are selling car in close to a dozen states. But in terms of just fixing the existing loss ratio, which is where the bulk of the results come from, you were referring earlier to the Comment that said we from our letter that said that KAR hasn't improved dramatically. I was just explaining why our historical book Hasn't improved dramatically. In terms of new sales, we are making those absolutely in the areas where we feel our rates are adequate.

Speaker 2

That just happens to account for a small part of the book.

Speaker 8

Okay. And then if I

Speaker 5

could just switch over to the synthetic agent. You mentioned again the LTV to

Speaker 10

CAC ratio over 3 in your opening comments Daniel. And I'm just curious given Kind of what's your modeling versus what your realized results have been? Is that what confidence do you have in that ratio kind of holding over time Given the increase in cat events that we've seen recently.

Speaker 2

It's been Surprisingly perhaps constant. So we've been through as a company, as an industry, as an economy some tumultuous years, but We've seen that overall being fairly stable, fairly constant, slightly improving over time. So I hesitate to say too much about the future, but the optimism we suggest that this is an area that we can continue to As our retention rates continue to improve, as our cross sell rates continue to improve, as our new rates come online, I think there is room For optimism on that regard, I'll put it in the inverse side. I see no headwinds that we're aware of.

Operator

Our next question comes from Yaron Kinar from Jefferies. Your line is now open. Please go ahead.

Speaker 5

Thanks for taking my follow-up. On the Homeowners front, so I appreciate you providing the discipline on Loss ratios by line. But for homeowners, you offered ex cats the total number with cats for the loss ratio?

Speaker 6

Yes. We chose that carefully. We haven't disclosed the home rate. It's somewhat more elevated, and you can probably back into it by the share of business, We've not disclosed every line item. Just wanted to show we're making good progress.

Speaker 6

And so we'll hopefully share more over time. And Yaron, I'm glad you came back in so I can correct my earlier Misstatement to you and to Josh on the prior period development. So I said it was Unfavorable is actually favorable by 1 percentage point. So I just wanted to correct that for the record and for the transcript. Hey, Yaron, your unfortunately your audio broke up a little bit for us.

Speaker 6

Can you just repeat that please?

Speaker 5

Yes. Can you maybe tell us where the favorability came from?

Speaker 6

Nothing notable. It was only one point. So I wouldn't highlight any specific categories. It was fairly material.

Speaker 5

Got it. Okay. And then maybe going back to the synthetic agent, Just want to make sure I'm thinking about the accounting correctly. Does the cost associated with the agency, star. Do they go above the line into sales and marketing or do they go below the line into essentially a coupon or a debt payment?

Speaker 6

So just to sort of think about the mechanics a little bit, the expense that We spend to actually acquire customers will be unchanged and that will continue to flow through the sales and marketing expense line As in the past, as current and that will not change. The incremental expense, which is the return earned by General Catalyst, the provider, The 16% IRR will show up as an interest expense. So that will be Excluded from EBITDA, but in the interest expense line on the P and L.

Speaker 5

Okay. Thank you.

Operator

Thank you. Our next question comes from Tommy McJoynt of Stifel.

Speaker 11

I wanted to go back a little bit to the new captives that you guys are introducing. I guess just do you see them As strictly a form of capital efficiency or is there an opportunity for true risk transfer where there's a third party capital behind it?

Speaker 6

I think we have optionality with the Came in captive, that's really wholly integrated and we will basically Attain all that risk on a consolidated basis. So that's really a capital driven structure. With the Bermuda transformer, there opportunities and structures that exist there that are not available to us otherwise, where over time there could be interaction with 3rd parties. That's not Something that we've instituted yet, but there are opportunities there where there could be 3rd party involvement. And so stay tuned as we roll those out over the coming quarters and we'll provide more clarity when that becomes more operational.

Speaker 11

Okay. Got it. And then other question just on the synthetic agent. Understanding that The cadence of deploying customer acquisition spend might be lumpy and potentially pushed out a couple of quarters. Is it fair to assume that the full Maximum of the $150,000,000 financing liability would be on the balance sheet by the end of next year, just Given your trajectory of marketing spend?

Speaker 6

So I think it's certainly possible, But I won't because we're not giving guidance beyond the current year, I won't say that that is our expectation. But it's certainly within the realm of reason. And again, Going back to our earlier comments, the driver of our decision there is primarily rates coming online, loss ratio Improvement in the underlying sort of LTV to CAC of each of the product lines. And so if we see that improvement continue Or perhaps accelerate and obviously we can move the growth up higher and that would make it more likely that we

Speaker 11

Okay. Got it. And then just my last question. This is obviously your first kind of form of leverage that you're putting on the balance sheet. Do you the rating agencies to treat this financing any differently than, I guess, what would be traditional debt on the balance sheet?

Speaker 6

Well, they I can't speak for rating agencies, the regulator. But yes, I would expect that they would take into account The true terms of the structure, there's essentially no recourse other than the cash flows that result from the acquired cohorts, Which is significantly different, is distinct from traditional debt. That said, it is a unique structure. We're not we're one of a fairly relatively small number of companies that are employing something like this It has these unique aspects. We're hopeful though that those distinctions will be recognized.

Operator

Thank you.

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Earnings Conference Call
Lemonade Q2 2023
00:00 / 00:00