In the Freshfields insurtech team, we noted with interest the announcement by Lemonade last week that it is preparing to launch an IPO on NYSE. At a time when insurers across the industry are looking to raise capital, we thought we should take a closer look at Lemonade and the drivers behind its plans.
Lemonade's business model
Lemonade sells renters and homeowners insurance in the US, Germany and the Netherlands and has grown to become one of the best-known insurtech businesses in recent years. Unlike many other tech driven insurance start-ups, Lemonade is not solely an intermediary or tech provider but also a traditional insurer which backs the policies it sells with its own balance sheet (or, at least, the balance sheet of its reinsurance partners – Lemonade retains only a small percentage of the risk it underwrites). A key distinguishing feature of Lemonade is that it takes a fixed fee out of premiums and uses the rest of the premium to buy reinsurance, pay claims and return any surplus profit through its annual “Giveback” programme (where virtual groups of peers select a common cause to which the money is donated – this is the “peer” element of the business model, rather than the insurance itself). This approach, Lemonade say, reverses the traditional insurance model, as the interests of the policyholder and insurer are aligned (by denying a claim, Lemonade are not themselves profiting beyond the fixed fee as any surplus amounts not used to pay claims are donated to charity at the end of the year, a key element of its designation as a “public benefit” corporation, making it legally required to consider the social impact of its operations on its wider stakeholders).
Its heavy use of reinsurance achieves the capital-light approach Lemonade desires but at the cost of premiums going to reinsurers, rather than Lemonade (or charities of policyholders’ choosing under the “Giveback” concept). With hardening reinsurance rates (property cat renewals are predicted to be up by 5-15%), Lemonade may see the IPO as a good opportunity to obtain more negotiating ballast for future reinsurance renewals by being able to retain more risk on its own balance sheet. Indeed, in its prospectus Lemonade say the principal purpose of the IPO is to increase capitalisation and financial flexibility. The IPO also provides Lemonade with the opportunity to use proceeds to expand into new geographies (they have plans to open across Europe), launch new products (like their Policy 2.0 which was launched at the same time as Lemonade opened in Germany) and grow with their policyholder base (as they transform from millennial renters to homeowners).
The current market for fund raising
Lemonade is not alone in seeking capital in the insurance sector. So far insurers have raised over $4billion in equity in the last few weeks and over $10billion is expected to be raised by insurers before the end of the year. The recent capital raises are primarily to build cash buffers against potential COVID-19 losses and to take advantage of the improved pricing environment triggered as a result of the pandemic. While Lemonade’s drivers are not as closely linked to COVID-19, it may consider this to be right moment to strike with its IPO given the pandemic has accelerated the rate of disruption of traditional insurance models and resulted in a flight to tech-based products.
Lemonade’s entry into the IPO market in the US is something of an outlier in the current cycle, which has largely been limited to companies in the life sciences and special purpose acquisition sectors, each of which is more obviously poised for opportunities in the COVID-19 environment. Lemonade’s subscription-based model with recurring revenues, however, distinguishes it from tech companies pursuing a pure user-growth investment case, which fell out of favour even before the pandemic, with several high-profile flops.
Whatever the drivers, with its combination of traditional-insurer-model dressed in a user-friendly tech wrapper and social-good ethos, we’re sure investors will drink up Lemonade’s plans to fizz up the insurance space.