Recent media leaks suggest Lemonade is looking to go public. Surely, it will be seeking a valuation higher than it’s last private round at $2B. Many people know I have been critical of the Lemonade business model, but I will save that story for another day. Today, I will focus on the broader Insuretech group, namely the four most visible “disruptors” = the aforementioned Lemonade, Root, Metromile, and Next.
Summary for those with short attention spans:
1) None of these models are unique and anyone successful will be copied.
2) PGR grows every two weeks what these “hypergrowth” companies do in a year.
3) It is going to be extremely difficult for the companies to grow into their valuations.
Ian’s Insuretech Theorem: An insuretech worth caring about should be doing something nobody else is doing AND which can’t be easily copied. Otherwise, there really isn’t any value being created.
Let’s knock these out one at a time…
Next = direct small business insurance. There are some others trying this (namely Berkshire) but nobody has critical mass yet. It is not an original idea and can be easily copied. All the major commercial carriers have the ability to enter direct small commercial tomorrow if they wanted to (in fact, Travelers already has). Some will resists over social issues (aka channel conflict) but there are no barriers to entry.
Metromile = pay by the mile auto insurance. It’s a good idea and will attract certain parts of the market, most obviously city drivers who don’t use their car much. However, it’s very easy to copy and some of the established auto carriers have already started pilots. It’s hard to see how they end up as more than a niche carrier.
Root = usage based car insurance. Hmm, where have I heard about that before? Gee, Progressive has been doing it for over a decade. And they do a lot of it. Other auto carriers have copied it and even GEICO may finally get into the game. Why does the market need Root?
Lemonade = cheap (maybe too cheap???) renter’s insurance. Talk about a niche market! While I’m sure the idea is to expand into other markets over time, they’re starting in a pretty small pond. I will give them this: they are doing something nobody else is doing! Whether it works or not, remains to be seen. If their generous approach to claims does work, certainly competitors can replicate a policy form that provide less benefits in return for quicker payment.
OK, let’s say maybe I’m wrong about all of the above and I’m just too skeptical. Let’s take a look at the numbers. GPW was $106M last year for Root, $87M for Metromile, $47M for Lemonade, and $44M for Next. Combined, that is $284M of 2018 premium. In 2017, they wrote a combined $75M, so impressive growth, at least in percentage terms.
However, it is worth looking at the absolute values for more context. In total, they grew a little over $200M last year. In comparison, Progressive grew $5.5B!
In other words, PGR grew every two weeks what these four superstar growth companies did in a year! And they did it off a large base rather than from near zero.
Somebody wake me when one of these companies grows $1B in a year. Then, it’s a story. Right now, it is a curiosity and no more. None of these companies should be thinking about going public. They should be thinking about proving their viability.
What’s ironic given Lemonade’s “behavioral research” bent is that the only reason any of these companies have big valuations is because they were funded by Silicon Valley and not traditional insurers or private equity with a history in the space. There is a behavioral bias to give more credibility to these companies because of who funded them rather than evaluating the merits of their business plans.
Yes, I know, I know, these are tech companies! Can’t value them like insurers! Well, at maturity, whenever that day comes, they will look like insurance companies so we must value them as such.
Lemonade’s last private round was at $2B and the IPO will likely be higher. Root was at $1B and it appears Metromile and Next are in that ballpark. So, in total, the foursome have about $5B of market cap. Let’s compare that to a traditional insurer.
Hanover has a $5B market cap and writes $4.5B of gross premium (not the best valuation metric normally, but in this case it is probably the best proxy). So the question before the house is do we think these companies can get to about $1B of premium each? That would be the equivalent of say a RLI or PURE.
I think that’s reasonable but I doubt all four will. Maybe some will even make it to $2B but some will also flame out. Also, those who do succeed are not going to get there in a year. Let’s take PURE as an example. It took PURE nine years to get to $1B. That seems a reasonable path for a successful insuretech. Maybe because everything happens faster now, it can be five years?
That still doesn’t mean they will be profitable when they get there though. At some point, the valuation will transition from a multiple of premium to one on earnings.
So if it’s 10+ years to get to $5B of total premium and a normal profit margin on that, then, well, maybe these companies should be valued at $5B somewhere in the distant future. It shouldn’t be where they are valued today. In fact, when you put in a risk premium for the non-zero probability that some or all of the four never make money, you would have to haircut the valuation even further.
I don’t know what the right valuation is. It’s certainly something we can debate. I just know it’s lower. That doesn’t mean further funding rounds or IPOs won’t come in at even higher valuations. They probably will. I just don’t think long term investors will make money investing at those levels.