Lemonade files to go public and reveals Nephila as reinsurer

Lemonade, Inc., one of the highest profile insurtech start-ups that had been funded by Softbank among others, has filed an initial public offering (IPO) registration statement in which it has also revealed that one of its reinsurers is the largest ILS fund manager in the world Nephila Capital.

Lemonade is targeting a listing on the New York Stock Exchange under the ticker symbol “LMND” with the IPO targeting a minimum $100 million, but commentators have suggested the insurtech could target up to $300 million.

Already backed by some $480 million of funding raised across seven rounds of capital raising, Lemonade’s filing makes clear that for an insurtech start-up targeting high-growth, access to reinsurance capital is one of the key levers it has at its disposal.

With the capital raised from this IPO, Lemonade is expected to continue to drive forward its European expansion and seek greater market share in the U.S. as well.

Lemonade has entered into a new multi-year quota share reinsurance arrangement that incepts at July 1st 2020.

Reinsurance is one of two “ballasts” that Lemonade has at its disposal, the company explains in its S1 filing, allowing the insurtech to offload excess claims to reinsurers, rather than retaining them at the balance-sheet level.

Reinsurance helps to “largely eliminates the bottom-line volatility inherent in traditional insurance companies” Lemonade says.

The insurtech highlights that wild swings with losses can make insurance companies more capital intensive, while using reinsurance can help to buffer against that and make revenue and profitability more predictable.

The quota share has been entered into with seven reinsurers, with three-quarters of these contracts set to run over a three-year term.

This new proportional reinsurance arrangement will see Lemonade ceding 75% of its premiums to the panel of seven quota share reinsurers, in exchange for which they will pay a 25% ceding commission.

“This arrangement mirrors our fixed fee, and hence shields our gross margin, from the volatility of claims, while boosting our capital efficiency dramatically,” Lemonade explained.

Thanks to the quota share, Lemonade will have roughly 55% of its portfolio reinsured on a three-year term, the rest on an annual basis.

The company highlighted that, “We believe that staggering the terms this way provides the appropriate balance between maximizing predictability, and enabling us to capture more margin over time.”

In addition, Lemonade has non-proportional reinsurance contracts in place with eight reinsurers, in a combination of per risk reinsurance and facultative reinsurance arrangements.

This will minimise the size of losses for Lemonade, meaning no single loss can ever cost it more than $125,000.

“We believe our reinsurance structure achieves important goals: making us capital-light, buffering our gross margins from the vicissitudes of claims, and leaving room for our gross margins to grow,” the insurtech said.

The aim is to maximise results and minimise the downside, using the quota share to ensure claims are buffered significantly and provide capital efficiency, while the non-proportional reinsurance covers avoid large losses and optimises margins.

Given Lemonade is looking at reinsurance capital as a key operational lever for its business, it’s no surprise to find that the insurtech is already sourcing some of this from a capital markets source.

Lemonade lists insurance-linked securities (ILS) fund manager Nephila Capital as a reinsurer, through the companies Lloyd’s of London syndicate 2357.

Lemonade has an unsecured reinsurance recoverable balance of $1.7 million from Nephila’s syndicate 2357 as of the end of 2019. Others listed with a balance include Hannover Re, Munich Re, Hiscox, and MS Amlin.

Of course, Nephila Capital has provided reinsurance capital to support a number of insurtech start-ups in recent years, as well as made some investments in others.

Given Lemonade is operating a business model that will rely on reinsurance capital to support its profits, while acquiring risk through a high-performance marketing strategy that aims to bring in roughly double the premium to the dollars it spends, access to flexible reinsurance capital is going to be key, to provide the levers it needs to support expansion and growth.

Lemonade’s loss ratio has improved significantly since its launch and its margins have too, but still raising profitability remains reliant on spending much more in terms of marketing to source premiums, and as those premiums grow it will have to spend more on reinsurance too. With the margin seemingly squeezed by the pair at this stage in the companies growth.

Without the huge amount of capital raised Lemonade would struggle it seems and the test coming from this insurtech will be in finding a sustainable level of growth, margin and profit that allows it to sustain the business model without having to repeatedly raise new sums of capital.

All of which makes reinsurance capital efficiency absolutely key to high-growth insurtech’s like Lemonade, as it is going to need to explore the various ways it can bring reinsurance capital more efficiently into its business model over time.

Signing up a reinsurance partner like Nephila Capital from the off will certainly help and that opens up the options of the ILS market to Lemonade, which it might find very useful as it navigates a public listed phase in its growth cycle.