How is Lemonade Different Than Mutual Insurance?

lemon_logoAfter my initial post about Lemonade insurance, there was a discussion in the comments about how Lemonade’s business model compares with existing mutual insurance companies. Lemonade reached out to me and wanted to clarify some things, and I suggested that they write a guest post about the topic. (By the way, they are now available in both New York and Illinois.) Lemonade agreed and below is their response:

A Deeper Dive Into the Lemonade Business Model

Not all insurance companies work the same way. Beyond the technology and AI, behind its slick app and website, Lemonade’s different because its business model is different.

As opposed to traditional insurers, Lemonade takes a fixed 20% fee out of your monthly payments, pays reinsurance and other unavoidable expenses, and uses the rest for paying claims. If there’s money leftover, Lemonade returns it in the annual Giveback. Giveback is a unique feature of Lemonade, where each year leftover money is donated to causes our policyholders care about. Policyholders who care about the same causes are virtual groups of ‘peers.’ Lemonade uses the premiums collected from each peer group to pay the group’s claims, giving back any leftover money to their common cause. And, if the group’s claims exceed what’s left in the pool, reinsurance covers it! (Reinsurance = insurance for insurance companies!)

That changes everything.

Insurers typically make money by investing your premiums (“float”) and by paying out less in claims and expenses than they took in premiums (“underwriting profit”).

Lemonade relies on neither. We collect premiums monthly, so the money earns interest in your bank account, not ours, and we return unclaimed money to the causes customers care about at year’s end.

So what does Lemonade do with the remaining 80%?

In a nutshell: pays claims.

Lemonade spends approximately 20% buying ‘reinsurance’ from folks such as Lloyd’s of London, to ensure there will be enough money for claims even in ‘bad’ years. This kind of reinsurance buys peace of mind, but it is costly.

So our data scientists have modeled an optimal mix of internal and external ‘reinsurance’, and set aside another ~20% as the ‘Lemonade Reinsurance’. Think of it as a ‘rainy day fund.’ The costs of reinsurance fluctuate over time, and there are other smaller expenses (transactional fees, premium taxes and others) that are also paid out from this combined 40%.

The final 40% goes towards the Giveback to the cause selected each year, if none of the people who selected that cause make a claim.

Most years, there will be some claims, so the amount available for Giveback will average less than 40%. But our number crunchers tell us there should be a nice amount left for most causes most years.

What about the ‘bad’ years? Fear not. That’s what the reinsurance is for, and Lemonade Reinsurance as well as the reinsurance partners have set aside funds for exactly such a situation.

In short, job #1 is to make sure your claim is paid, job #2 is to Giveback what’s left.

Wait, so how is that different from mutual insurance, you may ask?

Lemonade is the oldest new idea in insurance. And whether you view its tech and user experience as being radically new, or its business model as centuries-old infrastructure, Lemonade is using technology to reconstitute a business model which was once prevalent.

Look at Uber or AirBnB: Neither have created spanking new markets. It’s their technology packaged with a sharing economy-esque business model that is novel. Similarly, there’s nothing new about renters and homeowners insurance, but the technology, together with the behavioral economics and unique business model, differentiate Lemonade from the rest. Lemonade writes policies on your phone in seconds, pays claims in minutes, gives back money to nonprofits, all using AI and other tech that incumbents have not used.

The mutual companies started with the notion that pooling people into meaningful communities, instead of meaningless masses, is better for consumers. But the mutuals of today have wandered off into a different direction from that sense of community that started hundreds of years ago.

What made mutuals stray this way? Well, if you take any community and you enlarge it with millions of anonymous people, the social bonds between the people break down. Insurance companies have tried to cope with the challenge of pursuing growth, but it came at the expense of group affinity.

Yet with technology, you don’t have to trade off affinity for growth. Specifically, affinity in Lemonade has spurred growth, and has not been an obstacle of growth. Think of Lemonade as having thousands of mutuals under one company, rather than being one giant mutual.

Lemonade is a Public Benefit Corporation, a certified B-Corp and our team genuinely wants to do the right thing. Lemonade takes a flat 20% fee so as to never be in conflict with our customers, and never make money by denying claims. By placing ‘unclaimed money’ beyond reach, we removed temptation, and changed the game.

That’s a first for insurance.

Comments

  1. The first article was much more clearly written and to the point. Lemonade seems to be constructed to market based on the idea that you will be able to give to charities. When I buy insurance, I care about price, coverage, service and insurance rating. Lemonade has no record in these important areas, so they want you to focus on the charities aspect and that they are a whole new type of company with a team that “genuinely wants to do the right thing.” How about an article on their price, coverage, service and insurance rating.

    • This. And I think it funny that they mention Uber and AirBnB who are losing gobs of money. I do think the concept of Lemo is on track. Cut out what is unnecessary, the bloat of current insureres is comical, Prime X3 for profit, all left of is in reassurance, this allows lowers rates for next year.

  2. Interesting article and they have some experienced insurance people involved. It will be interesting to see how they do.

    But, the comment on monthly premiums (vs bi-annual or annual) is puzzling. Most carriers will allow customers to pay monthly premiums.

    Second, if the company cannot profit, how do they intend to build up their statutory surplus (necessary to grow the business)?

  3. I agree with abc and Brad. Also, although I am a charitable person and I give to my own charities each year, I would prefer a model that returns at least some of the “excess” money each year to the policyholders. Years ago I had a policy with New Jersey Manufacturers Insurance, and that is exactly what they did. Each year I received a check from them for some amount (generally $100-$300). It was a nice bonus and showed that the company was willing to honor its policyholders in addition to any charities it supported.

  4. “Lemonade takes a flat 20% fee so as to never be in conflict with our customers, and never make money by denying claims. By placing ‘unclaimed money’ beyond reach, we removed temptation, and changed the game. ”

    I don’t understand these Lemonade guys and their marketing hype – first they say they are P2P, then they backtrack. Now they say they are the first to take a flat fee, but several attorneys-in-fact today do this with the reciprocals they manage (see Erie, Farmers and PURE…PURE is actually paid more if they pay MORE claims).

    Here’s another false statement, “But the mutuals of today have wandered off into a different direction from that sense of community that started hundreds of years ago.” This may be true for the largest mutuals, but not for smaller ones that find affinity in regional exposures (FL property), common exposures (farm mutuals; medical E&O) and common beliefs (church mutuals).

    These guys have a great idea and I like their business model, but can they stop lying to us about what they aren’t? They have leveraged data and analytics to cut out inefficiencies in the underwriting and claims processes, that’s it. What’s next, they will claim to be the first insurance company that “cares”?

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