Lemonade, Inc., perhaps the highest profile insurtech company so far, has been the subject of a lot of discussion over its quota share reinsurance arrangements in recent quarters.
Analysts and observers have clashed over Lemonade’s use of reinsurance, with some saying that the insurtech’s approach of using a significant amount of quota share cover means it is giving away margin unnecessarily.
While others recognise and appreciate the capital-light approach of leaning on reinsurers while it builds-out a business.
Whichever side you sit of this discussion, Lemonade’s reinsurance arrangements have always come under scrutiny, especially as the company has also struggled to keep its underwriting profitable at the same time.
At the July 1st reinsurance renewal, Lemonade renewed the majority of its reinsurance contracts at expiring terms.
At the same time, Lemonade has opted to dial back its quota share reinsurance, from a 75% share to a 70% share.
The company explained, “We are pleased to share that despite meaningful noise and volatility in the reinsurance market, which has anecdotally been a point of concern for some of our shareholders, we were able to secure similar financial terms on the portion of the quota share that we renewed.”
Lemonade had always been planning to reduce this quota share percentage, to retain more of the business as its underwriting reached scale and achieved greater profitability.
However, in the last quarter its loss ratio was elevated, which the company largely puts down to its expansion into new lines of business.
But after a first-quarter when the loss ratio was elevated due to the US winter storm catastrophe, Lemonade has perhaps made a decision to add a different kind of protection to its reinsurance program.
One thing the analysts and observers have largely missed when discussing the adjustment to the quota share, is that Lemonade also added a new catastrophe reinsurance treaty at the July renewal.
The company said that it has purchased a new reinsurance program to protect it specifically against natural catastrophe risk in the U.S.
This may be a reaction to the impact of the winter storms, or it could be part of a strategic plan to add more excess-of-loss catastrophe reinsurance as the quota share gets dialled back.
Either way, it makes sense for a growing insurtech like Lemonade to be adding more catastrophe reinsurance protection, especially after the loss ratio impact it experienced in Q1.
Lemonade clearly wants to be a sophisticated user of reinsurance, which is why its always tried to impress on its shareholders the capital light nature of an insurer that uses a significant quota share.
But Lemonade can still be capital light using other forms of reinsurance, which may prove better buffers for its shareholders profits as its portfolios of risk expand, especially against catastrophe loss events.
Lemonade could make itself even capital lighter, if it opted to control its reinsurance more closely through launching a third-party capital structure, such as side car, or ventured into the catastrophe bond market.
But that’s likely a few years away, as the carrier needs to grow to a certain scale that will make those kinds of reinsurance options more accessible and also economical for it to enter into.
For now, a strategy of heavy use of quota share, alongside growing use of other forms of reinsurance (as the quota share reduces), seems like the most appropriate way forwards, with the pace of change likely to be both dependent on Lemonade’s rate of growth, but also its ability to control its loss ratios in quarters where catastrophe activity is lighter, like Q2 2021.
Lemonade’s strategy remains squeezed between marketing and reinsurance costs, it seems, which could serve to make partnerships and use of third-party reinsurance capital an attractive route, if it can help to reduce the costs of protection, while giving away some margin.
That’s effectively what the quota shares are designed to do, but perhaps by bringing reinsurance more under its own control, the costs could be kept down and efficiencies recognised by working closely with capital market investors.
Having raised more than $480 million in funding, Lemonade definitely has the coffers to experiment a little on the reinsurance side.
It would be very interesting to see insurtech’s, like this, exploring how innovative capital market solutions could perhaps make their reinsurance use more efficient over time.
We’ve spoken with a number of insurtech’s who already do that.
We’d be surprised if Lemonade wasn’t already either exploring the idea of how it could secure more efficient reinsurance risk capital and take greater ownership of the structures and relationships providing it, or actively experimenting.
Of course, even efficient use of reinsurance capital cannot make an insurtech profitable and that is where Lemonade’s time needs to currently be focused.
As, without demonstrating that its underwriting is worth backing, any insurtech, no matter how well-known or funded, may struggle to hold onto its reinsurance relationships over the longer-term, or at the least find its reinsurance terms and pricing become more punitive.