Could Lemonade’s Auto Insurance Business Finally Jump to the Next Level?

Insurance disruptor Lemonade (LMND 0.26%) has gained serious traction in its core businesses of renters, homeowners, and pet insurance. However, its initial rollout of Lemonade Car — its auto insurance product — has been rather slow, despite being the highest-potential insurance type offered by the company so far.

Last November, Lemonade announced its agreement to acquire auto insurance technology company Metromile in an all-stock deal in order to jump-start its auto insurance business. Nearly nine months later, the acquisition has been finalized, and Metromile is officially a part of Lemonade. Here’s why investors should pay attention and what it could mean for Lemonade over the long term.

Why it could be such a big deal

The Metromile acquisition adds $110 million in car insurance premiums to Lemonade’s business, and also adds $155 million in cash to the company’s already cash-rich balance sheet (the company had over $1 billion in cash and investments at the end of the first quarter). Lemonade paid for the acquisition with about $145 million worth of stock, so this already looks like a great deal.

However, there are two other key components that could end up being the most valuable parts of the acquisition:

  • Metromile has car insurance licenses in 49 states. Prior to the acquisition, Lemonade Car was licensed in just three (Illinois, Ohio, and Tennessee).
  • Metromile has an unmatched collection of driver data, built over a decade with its sensors monitoring billions of miles of driving. The idea is that this data-driven approach will allow Lemonade to offer the cheapest rates to drivers who deserve them, while still producing a profit.

It’s tough to overstate the potential of Lemonade’s auto insurance business. About a year ago, the company estimated that its current customers spend about $1 billion on their auto insurance premiums each year, and that was at a time when the customer count was about two-thirds of its current size. For context, even after the $110 million in premiums that came with the Metromile acquisition, Lemonade has about $530 million in in-force premium. In other words, it could triple its scale if its existing customers use Lemonade’s auto insurance.

Car insurance is a more expensive form of insurance than Lemonade’s core products today. The average car insurance premium paid by US drivers is more than 10 times the average rental insurance premium, which is Lemonade’s bread-and-butter today. With a total market size of more than $300 billion in the United States alone, it wouldn’t take too much of a market share to have a meaningful impact.

Is Lemonade a buy?

To be sure, there are still some big unanswered questions, which is why Lemonade trades for about 90% less than its all-time high. The main issue is that Lemonade is paying out far too much of its premiums to cover losses, and this cannot continue if Lemonade is to be a sustainable business. The company’s gross loss ratio was 90% of premiums in the first quarter, far above the 75% target. Quite frankly, it doesn’t matter if Lemonade gets $5 billion in auto premiums if it can’t get underwriting correct.

If the company can scale its auto insurance business, and can do so profitably, the current stock price could end up being a bargain. But that’s a big “if” for now, and we should start to get some clarity over the next few quarters as the auto insurance business ramps up.

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