Item 1. Financial Statements.
LEMONADE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
($ in millions, except share and per share amounts)
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| As of |
| September 30, | | December 31, |
| 2022 | | 2021 |
| (Unaudited) | | |
Assets | | | |
Investments | | | |
Fixed maturities available-for-sale, at fair value (amortized cost: $722.2 million and $696.8 million as of September 30, 2022 and December 31, 2021, respectively) | $ | 693.1 | | | $ | 691.4 | |
Short-term investments (cost: $143.1 million and $110.4 million as of September 30, 2022 and December 31, 2021, respectively) | 142.8 | | | 110.4 | |
Total investments | 835.9 | | | 801.8 | |
Cash, cash equivalents and restricted cash | 225.0 | | | 270.6 | |
Premium receivable, net of allowance for credit losses of $2.7 million and $1.6 million as of September 30, 2022 and December 31, 2021, respectively | 187.7 | | | 127.0 | |
Reinsurance recoverable | 136.3 | | | 89.8 | |
Prepaid reinsurance premium | 181.6 | | | 149.6 | |
Deferred acquisition costs | 7.6 | | | 6.2 | |
Property and equipment, net | 19.1 | | | 11.7 | |
Intangible assets | 35.7 | | | 0.6 | |
Goodwill | 10.9 | | | — | |
Other assets | 73.1 | | | 53.2 | |
Total assets | $ | 1,712.9 | | | $ | 1,510.5 | |
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Liabilities and Stockholders' Equity | | | |
Unpaid loss and loss adjustment expense | $ | 220.6 | | | $ | 97.9 | |
Unearned premium | 294.1 | | | 207.7 | |
Trade payables | 1.5 | | | 1.0 | |
Funds held for reinsurance treaties | 131.7 | | | 103.1 | |
Deferred ceding commission | 43.0 | | | 36.5 | |
Ceded premium payable | 24.9 | | | 18.7 | |
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Other liabilities and accrued expenses | 90.3 | | | 57.4 | |
Total liabilities | 806.1 | | | 522.3 | |
Contingencies (Note 15) | | | |
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Stockholders' equity | | | |
Common stock, $0.00001 par value, 200,000,000 shares authorized; 69,120,346 and 61,660,996 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively | — | | | — | |
Additional paid-in capital | 1,738.1 | | | 1,553.5 | |
Accumulated deficit | (796.0) | | | (561.9) | |
Accumulated other comprehensive loss | (35.3) | | | (3.4) | |
Total stockholders' equity | 906.8 | | | 988.2 | |
Total liabilities and stockholders' equity | $ | 1,712.9 | | | $ | 1,510.5 | |
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
5
LEMONADE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
($ in millions, except share and per share amounts)
(Unaudited)
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| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
Revenue | | | | | | | | |
Net earned premium | | $ | 50.6 | | | $ | 21.5 | | | $ | 109.2 | | | $ | 51.6 | |
Ceding commission income | | 16.9 | | | 12.3 | | | 46.4 | | | 31.9 | |
Net investment income | | 2.6 | | | 0.6 | | | 4.7 | | | 1.0 | |
Commission and other income | | 3.9 | | | 1.3 | | | 8.0 | | | 2.9 | |
Total revenue | | 74.0 | | | 35.7 | | | 168.3 | | | 87.4 | |
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Expense | | | | | | | | |
Loss and loss adjustment expense, net | | 53.3 | | | 17.5 | | | 105.8 | | | 47.0 | |
Other insurance expense | | 12.1 | | | 6.3 | | | 30.9 | | | 16.3 | |
Sales and marketing | | 35.8 | | | 42.2 | | | 111.1 | | | 104.4 | |
Technology development | | 21.4 | | | 14.3 | | | 56.1 | | | 35.4 | |
General and administrative | | 40.5 | | | 19.6 | | | 91.1 | | | 49.5 | |
Total expense | | 163.1 | | | 99.9 | | | 395.0 | | | 252.6 | |
Loss before income taxes | | (89.1) | | | (64.2) | | | (226.7) | | | (165.2) | |
Income tax expense | | 2.3 | | | 2.2 | | | 7.4 | | | 5.8 | |
Net loss | | $ | (91.4) | | | $ | (66.4) | | | $ | (234.1) | | | $ | (171.0) | |
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Other comprehensive loss, net of tax | | | | | | | | |
Unrealized loss on investments in fixed maturities | | (5.0) | | | (0.8) | | | (23.8) | | | (1.2) | |
Foreign currency translation adjustment | | (1.5) | | | — | | | (8.1) | | | (0.5) | |
Comprehensive loss | | $ | (97.9) | | | $ | (67.2) | | | $ | (266.0) | | | $ | (172.7) | |
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Per share data: | | | | | | | | |
Net loss per share attributable to common stockholders—basic and diluted | | $ | (1.37) | | | $ | (1.08) | | | $ | (3.69) | | | $ | (2.80) | |
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Weighted average common shares outstanding—basic and diluted | | 66,877,100 | | | 61,580,145 | | | 63,482,945 | | | 61,086,238 | |
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The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
6
LEMONADE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
($ in millions, except share amounts)
(Unaudited)
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| | | | | Common Stock | | Additional Paid-In Capital | | Accumulated Deficit | | Accumulated Other Comprehensive (Loss) Income | | Total Stockholders' Equity |
| | | | | | | Shares | | Amount | | | | |
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Balance as of December 31, 2021 | | | | | | | 61,660,996 | | | $ | — | | | $ | 1,553.5 | | | $ | (561.9) | | | $ | (3.4) | | | $ | 988.2 | |
Exercise of stock options and distribution of restricted stock units | | | | | | | 97,743 | | | — | | | 0.6 | | | — | | | — | | | 0.6 | |
Stock-based compensation | | | | | | | — | | | — | | | 14.1 | | | — | | | — | | | 14.1 | |
Net loss | | | | | | | — | | | — | | | — | | | (74.8) | | | — | | | (74.8) | |
Other comprehensive loss | | | | | | | — | | | — | | | — | | | — | | | (15.4) | | | (15.4) | |
Balance as of March 31, 2022 | | | | | | | 61,758,739 | | | $ | — | | | $ | 1,568.2 | | | $ | (636.7) | | | $ | (18.8) | | | $ | 912.7 | |
Exercise of stock options and distribution of restricted stock units | | | | | | | 108,838 | | | — | | | 0.4 | | | — | | | — | | | 0.4 | |
Stock-based compensation | | | | | | | — | | | — | | | 13.9 | | | — | | | — | | | 13.9 | |
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Net loss | | | | | | | — | | | — | | | — | | | (67.9) | | | — | | | (67.9) | |
Other comprehensive loss | | | | | | | — | | | — | | | — | | | — | | | (10.0) | | | (10.0) | |
Balance as of June 30, 2022 | | | | | | | 61,867,577 | | | $ | — | | | $ | 1,582.5 | | | $ | (704.6) | | | $ | (28.8) | | | $ | 849.1 | |
Issuance of common stock from acquisition of Metromile (Note 5) | | | | | | | 6,901,934 | | | — | | | 137.7 | | | — | | | — | | | 137.7 | |
Exercise of stock options and distribution of restricted stock units | | | | | | | 350,835 | | | — | | | 2.3 | | | — | | | — | | | 2.3 | |
Stock-based compensation | | | | | | | — | | | — | | | 15.6 | | | — | | | — | | | 15.6 | |
Net loss | | | | | | | — | | | — | | | — | | | (91.4) | | | — | | | (91.4) | |
Other comprehensive loss | | | | | | | — | | | — | | | — | | | — | | | (6.5) | | | (6.5) | |
Balance as of September 30, 2022 | | | | | | | 69,120,346 | | | $ | — | | | $ | 1,738.1 | | | $ | (796.0) | | | $ | (35.3) | | | $ | 906.8 | |
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Balance as of December 31, 2020 | | | | | | | 56,774,294 | | | $ | — | | | $ | 859.8 | | | $ | (320.6) | | | $ | 1.8 | | | $ | 541.0 | |
Issuance of common stock upon closing of Follow-on Offering, net of underwriting discounts and commissions and offering costs of $22.8 million | | | | | | | 4,018,647 | | | — | | | 640.3 | | | — | | | — | | | 640.3 | |
Exercise of stock options | | | | | | | 577,162 | | | — | | | 6.1 | | | — | | | — | | | 6.1 | |
Stock-based compensation | | | | | | | — | | | — | | | 6.1 | | | — | | | — | | | 6.1 | |
Net loss | | | | | | | — | | | — | | | — | | | (49.0) | | | — | | | (49.0) | |
Other comprehensive loss | | | | | | | — | | | — | | | — | | | — | | | (0.8) | | | (0.8) | |
Balance as of March 31, 2021 | | | | | | | 61,370,103 | | | $ | — | | | $ | 1,512.3 | | | $ | (369.6) | | | $ | 1.0 | | | $ | 1,143.7 | |
Exercise of stock options | | | | | | | 162,024 | | | — | | | 1.7 | | | — | | | — | | | 1.7 | |
Stock-based compensation | | | | | | | — | | | — | | | 11.9 | | | — | | | — | | | 11.9 | |
Net loss | | | | | | | — | | | — | | | — | | | (55.6) | | | — | | | (55.6) | |
Other comprehensive loss | | | | | | | — | | | — | | | — | | | — | | | (0.1) | | | (0.1) | |
Balance as of June 30, 2021 | | | | | | | 61,532,127 | | | $ | — | | | $ | 1,525.9 | | | $ | (425.2) | | | $ | 0.9 | | | $ | 1,101.6 | |
Exercise of stock options and distribution of restricted stock units | | | | | | | 83,497 | | | — | | | 0.9 | | | — | | | — | | | 0.9 | |
Stock-based compensation | | | | | | | — | | | — | | | 12.7 | | | — | | | — | | | 12.7 | |
Net loss | | | | | | | — | | | — | | | — | | | (66.4) | | | — | | | (66.4) | |
Other comprehensive income | | | | | | | — | | | — | | | — | | | — | | | (0.8) | | | (0.8) | |
Balance as of September 30, 2021 | | | | | | | 61,615,624 | | | $ | — | | | $ | 1,539.5 | | | $ | (491.6) | | | $ | 0.1 | | | $ | 1,048.0 | |
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The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
7
LEMONADE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in millions)
(Unaudited)
| | | | | | | | | | | | | | |
| | Nine Months Ended September 30, |
| | 2022 | | 2021 |
Cash flows from operating activities: | | | | |
Net loss | | $ | (234.1) | | | $ | (171.0) | |
Adjustments to reconcile net loss to net cash used in operating activities: | | | | |
Depreciation | | 6.8 | | | 2.5 | |
Stock-based compensation | | 43.6 | | | 30.7 | |
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Amortization of discount on bonds | | 5.9 | | | (1.5) | |
Provision for bad debt | | 6.4 | | | 3.8 | |
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Changes in operating assets and liabilities: | | | | |
Premium receivable | | (49.8) | | | (46.9) | |
Reinsurance recoverable | | (32.2) | | | (21.8) | |
Prepaid reinsurance premium | | (32.1) | | | (58.9) | |
Deferred acquisition costs | | (1.4) | | | (2.5) | |
Other assets | | (5.1) | | | (15.0) | |
Unpaid loss and loss adjustment expense | | 46.5 | | | 27.7 | |
Unearned premium | | 71.5 | | | 79.4 | |
Trade payables | | (0.3) | | | 1.6 | |
Funds held for reinsurance treaties | | 28.6 | | | 35.0 | |
Deferred ceding commissions | | 6.5 | | | 13.7 | |
Ceded premium payable | | (5.8) | | | 11.8 | |
Other liabilities and accrued expenses | | 10.6 | | | 16.7 | |
Net cash used in operating activities | | (134.4) | | | (94.7) | |
Cash flows from investing activities: | | | | |
Acquisition of business, net of cash acquired | | 98.8 | | | — | |
Proceeds from short-term investments sold or matured | | 150.0 | | | — | |
Proceeds from bonds sold or matured | | 90.0 | | | 7.9 | |
Cost of short-term investments acquired | | (118.3) | | | (107.5) | |
Cost of bonds acquired | | (119.4) | | | (700.1) | |
Purchases of property and equipment | | (7.5) | | | (7.4) | |
Net cash provided by (used in) investing activities | | 93.6 | | | (807.1) | |
Cash flows from financing activities: | | | | |
Proceeds from Follow-on Offering, net of underwriting discounts and commissions and offering costs | | — | | | 640.3 | |
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Proceeds from stock exercises | | 3.3 | | | 8.7 | |
Net cash provided by financing activities | | 3.3 | | | 649.0 | |
Effect of exchange rate changes on cash, cash equivalents and restricted cash | | (8.1) | | | 1.0 | |
Net decrease in cash, cash equivalents and restricted cash | | (45.6) | | | (251.8) | |
Cash, cash equivalents and restricted cash at beginning of period | | 270.6 | | | 571.4 | |
Cash, cash equivalents and restricted cash at end of period | | $ | 225.0 | | | $ | 319.6 | |
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Supplemental disclosure of cash flow information: | | | | |
Cash paid for income taxes | | $ | 3.4 | | | $ | 2.1 | |
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Non-cash transactions: | | | | |
Warrants assumed from acquisition of Metromile | | $ | 0.8 | | | $ | — | |
The accompanying notes are an integral part of the unaudited condensed consolidated financial statements.
8
LEMONADE, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1.Nature of the Business
Lemonade, Inc. is a public benefit corporation organized under Delaware law on June 17, 2015. It provides certain personnel, facilities and services to each of its subsidiaries (together with Lemonade, Inc., the “Company”), all of which are 100% owned, directly or indirectly, by Lemonade, Inc. For the list of the Company's US and EU subsidiaries, see Note 1 - Nature of the Business, of the audited consolidated financial statements and related notes thereto for the year ended December 31, 2021 as included in the Company's Annual Report on Form 10-K for the year ending December 31, 2021 (the "Annual Report on Form 10-K") for more complete descriptions and discussions.
2.Basis of Presentation
The accompanying interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and include the accounts of the Company and its wholly-owned subsidiaries. All material intercompany transactions and balances have been eliminated upon consolidation. All foreign currency amounts in the condensed consolidated statement of operations and comprehensive loss have been translated using an average rate for the reporting period. All foreign currency balances in the balance sheet have been translated using the spot rate at the end of the reporting period. All figures expressed, except share amounts, are in U.S. dollars in millions.
Risk and Uncertainties
The COVID-19 pandemic has caused national and global economic and financial market disruptions and may adversely impact the Company. Although the Company did not see a material impact on its results of operations for the three and nine months ended September 30, 2022 and year ended December 31, 2021 due to the COVID-19 pandemic, the Company cannot predict the duration or magnitude of the pandemic or the full impact that it may have on the Company’s financial condition and results of operations, business operations, and workforce.
Unaudited interim financial information
In the opinion of the Company, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of only normal recurring adjustments, necessary for the fair presentation of its financial position and its results of operations, changes in stockholders’ equity and cash flows. The condensed consolidated balance sheet at December 31, 2021 was derived from audited annual financial statements but does not contain all of the footnote disclosures from the annual financial statements. The accompanying unaudited condensed consolidated financial statements and related financial information should be read in conjunction with the audited consolidated financial statements and the related notes thereto for the fiscal year ended December 31, 2021 as included in the Company’s Annual Report on Form 10-K.
3.Use of Estimates
The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. On an ongoing basis, the Company’s management evaluates estimates, including those related to contingent assets and liabilities as of the date of the financial statements as well as the reported amounts of revenue and expense during the reporting period. Such estimates are based on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities at the dates of the condensed consolidated financial statements, and the reported amounts of expenses during the reporting period. Actual results could differ from those estimates. Significant estimates reflected in the Company’s condensed consolidated financial statements include, but are not limited to, reserves for loss and loss adjustment expense, reinsurance recoverables on unpaid losses and valuation allowance on deferred tax assets.
4.Summary of Significant Accounting Policies
Cash, cash equivalents and restricted cash
The following represents the Company’s cash, cash equivalents and restricted cash as of September 30, 2022 and December 31, 2021:
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| | September 30, | | December 31, |
| | 2022 | | 2021 |
Cash and cash equivalents | | $ | 222.0 | | | $ | 270.6 | |
Restricted cash | | 3.0 | | | — | |
Total cash, cash equivalents and restricted cash | | $ | 225.0 | | | $ | 270.6 | |
Cash and cash equivalents consist primarily of bank deposits and money market accounts with maturities of three months or less at the date of acquisition and are stated at cost, which approximates fair value. The Company’s restricted cash relates to security deposits for an office lease in Tempe, Arizona and San Francisco, California. The carrying value of restricted cash approximates fair value.
Deferred offering costs
The Company capitalized certain legal, accounting and other third-party fees that are directly associated with in-process equity financings as deferred offering costs until such financings are consummated. After consummation of the equity financing, these costs were recorded as a reduction to the carrying value of stockholders' equity, as a reduction of additional paid-in capital generated as a result of such offering. On January 14, 2021, the Company completed a Follow-on Offering of common stock, as defined and discussed in detail in Note 10, which generated net proceeds of $525.7 million, after deducting underwriting discounts and offering costs. On February 1, 2021, the underwriters exercised their option to purchase additional shares, and generated additional net proceeds to the Company of $114.6 million. Deferred offering costs from the Follow-on Offering amounted to $0.4 million.
Recently adopted accounting pronouncements
Leases
In February 2016, the FASB issued Leases (Topic 842) ("ASU 2016-02"), as subsequently amended, which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors), and replaces the existing guidance in ASC 840, Leases. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine the recognition pattern of lease expense over the term of the lease. In addition, a lessee is required to record (i) a right-of-use asset and a lease liability the balance sheet for all leases with accounting lease terms of more than 12 months regardless of whether it is an operating or financing lease, and (ii) lease expense for operating leases and amortization and interest expense for financing leases, in the statement of operations. Leases with a term of 12 months or less may be accounted for similar to existing guidance for operating leases under ASC 840. In July 2018, the FASB issued ASU 2018-11, Leases ("Topic 842"), which added an optional transition method that allows companies to adopt the standard as of the beginning of the year of adoption as opposed to the earliest comparative period presented.
The Company adopted the new standard effective January 1, 2021, using the modified retrospective transition approach which uses the effective date as the date of initial application with no adjustment to prior periods presented. There was no adjustment to the opening balance of retained earnings, as a result of the adoption.
At adoption date, the new standard resulted in the recognition of an operating lease Right-of-Use ("ROU") asset of $16.9 million included under Other Assets, and a corresponding operating lease liabilities of $17.2 million included in Other Liabilities on the consolidated balance sheets. The difference of $0.3 million between the operating lease ROU assets and operating lease liabilities represents reclassification of deferred rent liability (the difference between the straight-line rent expenses and paid rent amounts under the leases) to operating lease ROU assets from other liabilities at the adoption date. The adoption of the standard did not have a material impact on the Company’s consolidated statements of operations and comprehensive loss, or consolidated statements of cash flows. The adoption impact relates to the Company’s existing operating leases for office spaces in the US, Netherlands and Israel.
The Company has elected to apply the package of practical expedients requiring no reassessment of whether any expired or existing contracts are or contain leases, the lease classification of any expired or existing leases, or the capitalization of initial direct costs for any existing leases. Additionally, the Company elected the practical expedients that permit the exclusions of leases considered to be short-term.
Current Expected Credit Losses
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses ("Topic 326"): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"). ASU 2016-13 introduced a current expected credit loss ("CECL") model for measuring expected credit losses for certain types of financial instruments held at the reporting date requiring significant judgment in application based on historical experience, current conditions and reasonable supportable forecasts, but is not prescriptive about certain aspects of estimating expected losses. The guidance replaced the current incurred loss model for measuring expected credit losses and provided for additional disclosure requirements. Subsequently, the FASB issued additional ASUs on Topic 326 that did not change the core principle of the guidance in ASU 2016-13, but provided clarification and implementation guidance on certain aspects of ASU 2016-13, and have the same effective date and transition requirements as ASU 2016-13. The Company adopted the guidance using a modified retrospective approach as of January 1, 2021 which resulted in no cumulative-effect adjustment to retained earnings.
The updated guidance in ASU 2016-13 also amended the previous other-than-temporary impairment (“OTTI”) model for available-for-sale fixed income securities by requiring the recognition of impairments relating to credit losses through an allowance account and limits the amount of credit loss to the difference between a security’s amortized cost basis and its fair value. In addition, the length of time a security has been in an unrealized loss position will no longer impact the determination of whether a credit loss exists. The Company adopted the guidance related to available-for-sale fixed income securities on January 1, 2021 using a prospective transition approach for available-for-sale fixed income securities that were purchased with credit deterioration or had recognized an OTTI write-down prior to the effective date. The effect of the prospective transition approach was to maintain the same amortized cost basis before and after the effective date.
Reclassification
Certain accounts in the prior period financial statements were reclassified to conform with the current period presentation.
5. Acquisition of Metromile
On July 28, 2022 (the "Acquisition Date"), the Company completed its acquisition of Metromile, Inc. (“Metromile"), a leading digital insurance platform in the United States that offers real-time, personalized auto insurance policies by the mile (the "Metromile Acquisition"). The Company acquired 100% of Metromile's equity through an all-stock transaction based upon the exchange ratio of 0.05263 shares of Lemonade for each outstanding share of Metromile. As a result of the acquisition, Metromile stockholders received 6,901,934 shares of Lemonade's common stock, with minimal cash paid in lieu of fractional shares. In addition, upon closing of the Metromile Acquisition, the Company assumed all outstanding and unexercised options, and outstanding restricted stock units (collectively referred to as "replacement awards") as of the Acquisition Date, which were converted into corresponding awards using the same exchange ratio of 0.05263 and with substantially identical terms and conditions prior to the close of the Metromile Acquisition.
Fair value of consideration transferred for the Metromile Acquisition is as follows ($ in millions):
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Metromile issued and outstanding stock exchanged for Lemonade common stock (1) | | $ | 136.9 | |
Contingent consideration (2) | | — | |
Metromile vested awards exchanged for Lemonade awards (3) | | 0.8 | |
Total Purchase Consideration | | $ | 137.7 | |
(1) The fair value of 6,901,934 shares issued and exchanged for Lemonade common stock was determined based on the closing price at acquisition date of $19.84, and includes a minimal amount of cash paid in lieu of fractional shares.
(2) Contingent consideration represents Metromile's contingently issuable shares that are convertible into Lemonade common stock in accordance with the exchange ratio as set forth in the merger agreement. In accordance with ASC 805-30-25-5, contingent consideration shall be recognized and measured at fair value as of the Acquisition Date. Given that the contingencies are not probable of being met within the contingency period, no fair value was assessed for these Metromile shares.
(3) Fair value of replacement awards related to services rendered prior to the acquisition are included as part of purchase consideration. The unvested portion of fair value attributable to these replacement awards of $4.3 million comprised of $0.1 million for assumed options and $4.2 million for assumed restricted stock units ("RSUs"), and associated with future service will be recognized as expense over the future service period.
This Metromile Acquisition increased the Company's geographic footprint as a tech-enabled insurance provider and is expected to accelerate growth of the Lemonade car product, including other product offerings.
The Metromile Acquisition was accounted for as a business combination using the acquisition method of accounting in accordance with ASC 805, Business Combinations (“ASC 805”). The purchase price was allocated to assets acquired and liabilities assumed based on the estimated fair values at the Acquisition Date. The excess of the purchase price over the fair value of the net assets acquired was allocated to goodwill, and will not be deductible for tax purposes. Goodwill from this business combination is primarily attributable to synergies from future expected economic benefits, enhanced revenue growth from expanded capabilities and geographic presence, including cost savings from streamlined operations and enhanced operational efficiencies.
The following table presents the preliminary allocation of purchase consideration recorded on the condensed consolidated balance sheet as of the Acquisition Date ($ in millions):
| | | | | | | | |
Assets acquired | | |
Fixed maturities, available for sale, at fair value | | $ | 1.8 | |
Short-term investments | | 64.2 | |
Cash, cash equivalents and restricted cash | | 98.8 | |
Premiums receivable | | 17.4 | |
Reinsurance recoverable | | 14.5 | |
Property and equipment | | 4.6 | |
Value of business acquired ("VOBA") | | 1.7 | |
Intangible assets - technology | | 28.0 | |
Intangible assets - insurance licenses | | 7.5 | |
Other assets | | 14.7 | |
Total assets acquired | | $ | 253.2 | |
Liabilities assumed | | |
Unpaid loss and loss adjustment expenses | | $ | 76.3 | |
Unearned premium | | 15.1 | |
Trade payables | | 0.8 | |
Ceded premium payable | | 12.0 | |
Other liabilities and accrued expenses | | 22.2 | |
Total liabilities assumed | | $ | 126.4 | |
Total identifiable net assets acquired | | $ | 126.8 | |
Total purchase consideration | | $ | 137.7 | |
Goodwill | | $ | 10.9 | |
Estimated fair values of assets acquired and liabilities assumed from Metromile are subject to change as we obtain additional information, and will be updated and finalized within the measurement period that will not extend beyond 12 months from the Acquisition Date.
The amounts, based on preliminary valuations and subject to final adjustment, allocated to intangible assets are as follows ($ in millions):
| | | | | | | | | | | | | | |
| | Fair Value | | Weighted-Average Useful Life |
Technology | | $ | 28.0 | | | 3 to 5 years |
Insurance licenses | | 7.5 | | | N/A |
Total | | $ | 35.5 | | | |
The results of operations for Metromile of $15.1 million of revenue and $20.7 million of net loss from the date of the acquisition to the period ended September 30, 2022, have been included within the accompanying consolidated statements of operations and comprehensive loss.
The Company incurred transaction expenses of approximately $7.4 million and $8.4 million for the three and nine months ended September 30, 2022, respectively. These expenses were included in General and administrative expenses within the Company’s consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2022, respectively.
The following unaudited supplemental pro forma combined financial information presents the Company’s results of operations for the three and nine months ended September 30, 2022 and 2021 as if the Metromile Acquisition had occurred on January 1, 2021. The pro forma financial information is presented for comparative purposes only and is not necessarily indicative of the Company’s operating results that may have actually occurred had the Metromile Acquisition been completed on January 1, 2021. In addition, the unaudited pro forma financial information does not give effect to any anticipated cost savings, operating efficiencies or other synergies that may be associated with the acquisition, or any estimated costs that have been or will be incurred by the Company to integrate the assets and operations of Metromile.
Unaudited Pro Forma:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, 2022 | | Nine Months Ended September 30, 2022 |
| | 2022 | | 2021 | | 2022 | | 2021 |
Total Revenue | | $ | 85.1 | | | $ | 64.2 | | | $ | 221.1 | | | $ | 159.1 | |
Net loss | | $ | (112.2) | | | $ | (90.6) | | | $ | (316.8) | | | $ | (344.7) | |
The unaudited pro forma financial information reflects pro forma adjustments to present the combined pro forma results of operations as if the acquisition had occurred on January 1, 2021 to give effect to certain events the Company believes to be directly attributable to the acquisition. These pro forma adjustments primarily include:
•a net decrease in amortization expense that would have been recognized due to acquired intangible assets;
•an increase in the nine months ended September 30, 2022 for acquisition-related transaction costs;
•a decrease in operating revenues due to the elimination of deferred revenues and assigned no value at the Acquisition Date;
•a decrease to amortization expense due to the elimination of unamortized deferred acquisition costs;
•an increase to income due to the adjustment of the loss and loss adjustment expense reserves at fair value; and
•an increase in income due to the depreciation of ROU assets and lease expense upon adoption of ASC 842.
6. Investments
Unrealized gains and losses
The following tables present cost or amortized cost and fair values of investment in fixed maturities as of September 30, 2022 and December 31, 2021 ($ in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Cost or Amortized Cost | | Gross Unrealized | | Fair Value |
| | | Gains | | Losses | |
September 30, 2022 | | | | | | | | |
Corporate debt securities | | $ | 597.3 | | | $ | — | | | $ | (24.5) | | | $ | 572.8 | |
U.S. Government obligations | | 120.9 | | | — | | | (4.6) | | | 116.3 | |
Municipal securities | | 1.2 | | | — | | | — | | | 1.2 | |
Asset-backed securities | | 2.8 | | | — | | | — | | | 2.8 | |
Total | | $ | 722.2 | | | $ | — | | | $ | (29.1) | | | $ | 693.1 | |
| | | | | | | | |
December 31, 2021 | | | | | | | | |
Corporate debt securities | | $ | 593.4 | | | $ | — | | | $ | (4.7) | | | $ | 588.7 | |
U.S. Government obligations | | 102.2 | | | 0.1 | | | (0.8) | | | 101.5 | |
Municipal securities | | 1.2 | | | — | | | — | | | 1.2 | |
Asset-backed securities | | — | | | — | | | — | | | — | |
| | | | | | | | |
Total | | $ | 696.8 | | | $ | 0.1 | | | $ | (5.5) | | | $ | 691.4 | |
Gross unrealized losses for fixed maturities was $29.1 million as of September 30, 2022 and $5.5 million as of December 31, 2021. Gross unrealized gains and losses were recorded as a component of accumulated other comprehensive loss.
Contractual maturities of bonds
The following table presents the cost or amortized cost and estimated fair value of investments in fixed maturities as of September 30, 2022 by contractual maturity ($ in millions). Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| | | | | | | | | | | | | | |
| | September 30, 2022 |
| | Cost or Amortized Cost | | Fair Value |
Due in one year or less | | $ | 251.4 | | | $ | 246.1 | |
Due after one year through five years | | 470.8 | | | 447.0 | |
Due after five years through ten years | | — | | | — | |
Due after ten years | | — | | | — | |
Total | | $ | 722.2 | | | $ | 693.1 | |
Net investment income
An analysis of net investment income follows ($ in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, 2022 | | Nine Months Ended September 30, 2022 |
| | 2022 | | 2021 | | 2022 | | 2021 |
Interest on cash and cash equivalents | | $ | 0.3 | | | $ | 0.1 | | | $ | 0.4 | | | $ | 0.4 | |
Fixed maturities | | 1.7 | | | 0.6 | | | 3.7 | | | 0.7 | |
Short-term investments | | 0.7 | | | — | | | 0.9 | | | — | |
| | | | | | | | |
Total | | 2.7 | | | 0.7 | | | 5.0 | | | 1.1 | |
Investment expense | | 0.1 | | | 0.1 | | | 0.3 | | | 0.1 | |
Net investment income | | $ | 2.6 | | | $ | 0.6 | | | $ | 4.7 | | | $ | 1.0 | |
Investment gains and losses
The Company had pre-tax net realized capital losses of $0.4 million for the nine months ended September 30, 2022. There were no pre-tax net realized capital gains or losses for the three months ended September 30, 2022, and for the three and nine months ended September 30, 2021.
Aging of gross unrealized losses
The following table presents the gross unrealized losses and related fair values for the Company’s investment in fixed maturities, grouped by duration of time in a continuous unrealized loss position as of September 30, 2022 and December 31, 2021 ($ in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less than 12 Months | | 12 Months or More | | Total |
| | Fair Value | | Gross Unrealized Losses | | Fair Value | | Gross Unrealized Losses | | Fair Value | | Gross Unrealized Losses |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
September 30, 2022 | | | | | | | | | | | | |
Corporate debt securities | | $ | 198.4 | | | $ | (7.0) | | | $ | 362.6 | | | $ | (17.5) | | | $ | 561.0 | | | $ | (24.5) | |
U.S. Government obligations | | 36.8 | | | (0.8) | | | 79.3 | | | (3.8) | | | 116.1 | | | (4.6) | |
Municipal securities | | 0.6 | | | — | | | — | | | — | | | 0.6 | | | — | |
Asset-backed securities | | 2.8 | | | — | | | — | | | — | | | 2.8 | | | — | |
Total | | $ | 238.6 | | | $ | (7.8) | | | $ | 441.9 | | | $ | (21.3) | | | $ | 680.5 | | | $ | (29.1) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Less than 12 Months | | 12 Months or More | | Total |
| | Fair Value | | Gross Unrealized Losses | | Fair Value | | Gross Unrealized Losses | | Fair Value | | Gross Unrealized Losses |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
| | | | | | | | | | | | |
December 31, 2021 | | | | | | | | | | | | |
Corporate debt securities | | $ | 581.9 | | | $ | (4.7) | | | $ | — | | | $ | — | | | $ | 581.9 | | | $ | (4.7) | |
U.S. Government obligations | | 95.0 | | | (0.8) | | | 0.5 | | | — | | | 95.5 | | | (0.8) | |
Municipal securities | | 1.2 | | | — | | | — | | | — | | | 1.2 | | | — | |
Asset-backed securities | | — | | | — | | | — | | | — | | | — | | | — | |
| | | | | | | | | | | | |
Total | | $ | 678.1 | | | $ | (5.5) | | | $ | 0.5 | | | $ | — | | | $ | 678.6 | | | $ | (5.5) | |
Investments in fixed maturities with gross unrealized losses for twelve months or more was $21.3 million and less than $0.1 million for September 30, 2022 and December 31, 2021, respectively.
As of September 30, 2022, 294 of the securities held were in an unrealized loss position. The Company determined that unrealized losses on fixed maturities were primarily due to the interest rate environment, and not credit risk related to the issuers of these securities. The Company does not intend to sell these investment in fixed maturities, and it is not more likely than not that that the Company will be required to sell these investment in fixed maturities before recovery of the amortized cost basis. No allowance for credit losses related to any of these securities was recorded for the three and nine months ended September 30, 2022. The Company does not measure an allowance for credit losses on accrued interest receivable and would instead write off accrued interest receivable at the time an issuer defaults or is expected to default on payments.
7. Fair Value Measurements
The following tables present the Company’s fair value hierarchy for financial assets and liabilities measured as of September 30, 2022 and December 31, 2021 ($ in millions):
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | September 30, 2022 |
| | Level 1 | | Level 2 | | Level 3 | | Total |
Financial Assets: | | | | | | | | |
Corporate debt securities | | $ | — | | | $ | 572.8 | | | $ | — | | | $ | 572.8 | |
U.S. Government obligations | | — | | | 116.3 | | | — | | | 116.3 | |
Municipal securities | | — | | | 1.2 | | | — | | | 1.2 | |
Asset-backed securities | | — | | | 2.8 | | | — | | | 2.8 | |
Fixed maturities | | $ | — | | | $ | 693.1 | | | $ | — | | | $ | 693.1 | |
Short term investments | | — | | | 142.8 | | | — | | | 142.8 | |
Total | | $ | — | | | $ | 835.9 | | | $ | — | | | $ | 835.9 | |
| | | | | | | | |
Financial Liabilities: | | | | | | | | |
Warrant Liability | | $ | — | | | $ | — | | | $ | 0.8 | | | $ | 0.8 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 31, 2021 |
| | Level 1 | | Level 2 | | Level 3 | | Total |
Financial Assets: | | | | | | | | |
Corporate debt securities | | $ | — | | | $ | 588.7 | | | $ | — | | | $ | 588.7 | |
U.S. Government obligations | | — | | | 101.5 | | | — | | | 101.5 | |
Municipal securities | | — | | | 1.2 | | | — | | | 1.2 | |
Asset-backed securities | | — | | | — | | | — | | | — | |
Fixed maturities | | $ | — | | | $ | 691.4 | | | $ | — | | | 691.4 | |
Short term investments | | — | | | 110.4 | | | — | | | 110.4 | |
Total | | $ | — | | | $ | 801.8 | | | $ | — | | | $ | 801.8 | |
| | | | | | | | |
Financial Liabilities: | | | | | | | | |
Warrant Liability | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
The fair value of all different classes of Level 2 fixed maturities and short-term investments are estimated by using quoted prices from a third-party valuation service provider to gather, analyze and interpret market information and derive fair values based upon relevant methodologies and assumptions for individual instruments.
There were no transfers between Level 1, Level 2, or Level 3 during the three and nine months ended September 30, 2022 and during the year ended December 31, 2021.
Warrant liability
As part of the Metromile Acquisition as discussed in Note 5, public and private warrants were assumed and are measured at fair value on a recurring basis at the end of the reporting period, and classified as level 3 for fair value hierarchy disclosure purposes. These warrants do not meet the criteria for equity treatment and are recorded as a liability and presented under "Other Liabilities and Accrued Expenses" on the consolidated balance sheet at fair value, with changes in fair value recognized and presented under "General and Administrative expenses" in the consolidated statement of operations and comprehensive loss. The Company utilized the binomial Monte-Carlo simulation to estimate the fair value of these warrants which are currently not actively traded as of reporting date, and are determined based on the following assumptions:
| | | | | | | | |
| | September 30, 2022 |
Weighted average expected term (years) | | 3.36 |
Risk-free interest rate | | 4.2% |
Volatility | | 80% |
Expected dividend yield | | — |
The following table below presents the change in fair value of the warrant liability ($ in millions):
| | | | | | | | |
| | September 30, 2022 |
Balance as of January 1 | | $ | — | |
Initial measurement of warrants liability as of July 31, 2022 | | 0.5 | |
Change in fair value | | 0.3 | |
Balance as of September 30 | | $ | 0.8 | |
8. Unpaid Loss and Loss Adjustment Expense
The following table presents the activity in the liability for unpaid loss and loss adjustment expense ("LAE") for the nine months ended September 30, 2022 and 2021 ($ in millions):
| | | | | | | | | | | | | | |
| | Nine Months Ended September 30, |
| | 2022 | | 2021 |
Unpaid loss and LAE at beginning of period | | $ | 97.9 | | | $ | 46.3 | |
Less: Reinsurance recoverable at beginning of period (1) | | 72.7 | | | 36.3 | |
Net unpaid loss and LAE at beginning of period | | 25.2 | | | 10.0 | |
Add: Incurred loss and LAE, net of reinsurance, related to: | | | | |
Current year | | 106.9 | | | 47.3 | |
Prior years | | (1.1) | | | (0.3) | |
Total incurred | | 105.8 | | | 47.0 | |
Deduct: Paid loss and LAE, net of reinsurance, related to: | | | | |
Current year | | 65.9 | | | 32.3 | |
Prior years | | 21.9 | | | 6.3 | |
Total paid | | 87.8 | | | 38.6 | |
Unpaid loss and LAE, net of reinsurance recoverable acquired from Metromile | | 68.1 | | | — | |
Unpaid loss and LAE, net of reinsurance recoverable, at end of period | | 111.3 | | | 18.4 | |
Reinsurance recoverable at end of period (1) | | 109.3 | | | 55.6 | |
Unpaid loss and LAE, gross of reinsurance recoverable, at end of period | | $ | 220.6 | | | $ | 74.0 | |
(1) Reinsurance recoverable in this table includes only ceded unpaid loss and LAE
Unpaid loss and LAE includes anticipated salvage and subrogation recoverable.
Considerable variability is inherent in the estimate of the reserve for losses and LAE. Although management believes the liability recorded for losses and LAE is adequate, the variability inherent in this estimate could result in changes to the ultimate liability, which may be material to stockholders' equity. Additional variability exists due to accident year allocations of ceded amounts in accordance with reinsurance agreements, which is not expected to result in any changes to the ultimate liability. Other factors that can impact loss reserve development may also include trends in general economic conditions, including the effects of inflation. The Company had favorable development on net loss and LAE reserves of $1.1 million for the nine months ended September 30, 2022, and favorable development on net loss and LAE reserves of $0.3 million for the nine months ended September 30, 2021. No additional premiums or returned premiums have been accrued as a result of prior year effects.
For the nine months ended September 30, 2022, current accident year incurred loss and LAE included $2.2 million of net incurred loss and LAE from Hurricane Ian. The net incurred loss and LAE from Hurricane Ian as of September 30, 2022 represents the Company's best estimates based upon information currently available.
For the nine months ended September 30, 2021, current accident year incurred loss and LAE included $6.2 million of net incurred loss and LAE from the severe winter storm that affected the Company's customers in the states of Texas and Oklahoma. The net incurred loss and LAE from Winter Storm Uri as of September 30, 2021 represents the Company's best estimates based upon information currently available.
In the ordinary course of business, the Company cedes losses and LAE to other reinsurance companies. These arrangements reduce the net loss potentially arising from large or catastrophic risks. Certain of these arrangements consist of excess of loss and catastrophe contracts, which protect against losses exceeding stipulated amounts. The ceding of risk through reinsurance does not relieve the Company from its obligations to policyholders. The Company remains liable with respect to losses and LAE ceded in the event that any reinsurer does not meet obligations assumed under the reinsurance agreements. The Company does not have any significant unsecured aggregate recoverable for losses, paid and unpaid including Incurred But Not Reported ("IBNR"), loss adjustment expenses, and unearned premium with any individual reinsurer.
Through June 30, 2021, the Company had proportional reinsurance contracts which cover all of the Company's products and geographies, and transferred, or “ceded,” 75% of the premium to reinsurers ("Proportional Reinsurance Contracts"). In exchange, these reinsurers paid a ceding commission of 25% for every dollar ceded, in addition to funding all of the corresponding claims, or 75% of all claims. The Company opted to manage the remaining 25% of the business with alternative forms of reinsurance through non-proportional reinsurance contracts ("Non-Proportional Reinsurance Contracts").
A portion of the Company’s proportional reinsurance program expired on June 30, 2021 and on June 30, 2022. As the business continues to grow and diversify, and with stability in the Company's insurance results, the Company decreased the overall share of proportional reinsurance from 75% of premium to 55% effective July 1, 2022. In addition, the Company purchased a reinsurance program to protect against catastrophe risk in the U.S that exceed $80 million in losses effective July 1, 2022. Other non-proportional reinsurance contracts were renewed with terms similar to the expired contracts.
Metromile entered into a Quota Share reinsurance agreement effective January 1, 2022 through June 30, 2023. Under the terms of the agreement, the Company cedes 30% of premiums and losses to reinsurers.
9. Other Liabilities and Accrued Expenses
Other liabilities and accrued expenses as of September 30, 2022 and December 31, 2021 consist of the following ($ in millions):
| | | | | | | | | | | | | | |
| | September 30, | | December 31, |
| | 2022 | | 2021 |
| | | | |
| | | | |
Lease liabilities | | $ | 36.6 | | | $ | 22.3 | |
Employee compensation | | 11.7 | | | 5.4 | |
Accrued advertising costs | | 8.6 | | | 11.2 | |
Accrued professional fees | | 6.2 | | | 4.6 | |
Premium taxes payable | | 5.0 | | | 5.4 | |
Advance premium | | 2.7 | | | 2.0 | |
Accrued hosting and software | | 1.7 | | | 0.6 | |
Income tax payable | | 1.5 | | | 4.7 | |
Accrued devices | | 1.0 | | | — | |
Warrant liability | | 0.8 | | | — | |
Other payables | | 14.5 | | | 1.2 | |
Total | | $ | 90.3 | | | $ | 57.4 | |
10. Stockholders’ Equity
Common stock
Upon closing of the initial public offering ("IPO") in 2020, the Company filed an amended and restated certificate of incorporation on July 7, 2020 with the Secretary of State of the State of Delaware to authorize the issuance of up to 200,000,000 shares of common stock, par value $0.00001 per share, and 10,000,000 shares of undesignated preferred stock, par value $0.00001 per share.
On January 14, 2021, the Company completed a Follow-on Offering of common stock (the "Follow-on Offering"), which resulted in the issuance and sale of 3,300,000 shares of common stock of the Company, and 1,524,314 shares of common stock by certain selling shareholders, and generated net proceeds to the Company of $525.7 million after deducting underwriting discounts and commissions and other offering costs. On February 1, 2021, the underwriters exercised their option to purchase additional shares, which resulted in the issuance and sale of an additional 718,647 shares of common stock of the Company, and generated additional net proceeds of $114.6 million to the Company after deducting underwriting discounts.
On July 28, 2022, the Company completed its acquisition of Metromile in which 6,901,934 shares of Lemonade's common stock were issued to Metromile stockholders (see Note 5).
As of September 30, 2022 and December 31, 2021, the Company was authorized to issue 200,000,000 shares of par value $0.00001 per share common stock. The voting, dividend and liquidation rights of the holders of the Company’s common stock is subject to and qualified by the rights, powers and preferences of the holders of the preferred stock.
The Company in 2020 made a contribution of 500,000 newly issued shares of common stock to a related party, the Lemonade Foundation (see Note 14). In connection with the Follow-on Offering noted above, Lemonade Foundation sold 100,000 of the contributed shares of the Company.
Undesignated Preferred Stock
As of both September 30, 2022 and December 31, 2021, the Company's certificate of incorporation, as amended and restated, authorized the Company to issue up to 10,000,000 shares of undesignated preferred stock, par value $0.00001 per share. As of both September 30, 2022 and December 31, 2021, there were no shares of undesignated preferred stock issued or outstanding.
11. Stock-based Compensation
Share option plans
2020 Incentive Compensation Plan
On July 2, 2020, the Company’s board of directors adopted and the Company’s stockholders approved the 2020 Incentive Compensation Plan (the “2020 Plan”), which became effective immediately prior to the effectiveness of the registration statement for the Company’s IPO on July 2, 2020. The 2020 Plan provides for the issuance of incentive stock options, non-qualified stock options, stock awards, stock units, stock appreciation rights and other stock-based awards.
The number of shares initially reserved for issuance under the 2020 Plan is 5,503,678 shares, inclusive of available shares previously reserved for issuance under the 2015 Incentive Share Option Plan, as amended and restated on September 4, 2019 (the “2015 Plan”). In addition, the number of shares reserved for issuance under the 2020 Plan is subject to increase for awards previously issued under the 2015 Plan which are forfeited or lapse unexercised. Annually, on the first day of each calendar year beginning on January 1, 2021 and ending on and including January 1, 2030, the reserve will be increased by an amount equal to the lesser of (A) 5% of the shares outstanding (on an as-converted basis) on the last day of the immediately preceding fiscal year and (B) such smaller number of shares as determined by the Company’s board of directors, provided that no more than 3,650,000 shares may be issued upon the exercise of incentive stock options. On January 1, 2022, the 2020 Plan share pool was increased by 3,083,050 shares, equal to 5% of the aggregate number of outstanding common stock as of December 31, 2021. As of September 30, 2022, there were 3,109,188 shares of common stock available for future grants.
2020 Employee Stock Purchase Plan
On July 2, 2020, the Company's board of directors adopted and the Company's stockholders approved the 2020 Employee Stock Purchase Plan (the "2020 ESPP"), which became effective immediately prior to the effectiveness of the registration statement for the Company's IPO on July 2, 2020. The total shares of common stock initially reserved for issuance under the 2020 ESPP is limited to 1,000,000 shares. In addition, the number of shares available for issuance under the 2020 ESPP will be increased on January 1 of each calendar year beginning in 2021 and ending in and including 2030, by an amount equal to the lesser of (A) 1,000,000 shares, (B) 1% of the shares outstanding on the final day of the immediately preceding calendar year and (C) such smaller number of shares as is determined by the board of directors. The board of directors or a committee of the board of directors will administer and will have authority to interpret the terms of the 2020 ESPP and determine eligibility of participants. On January 1, 2022, there was no increase in the 2020 ESPP share pool. As of September 30, 2022, there were no shares of common stock issued under the 2020 ESPP.
2015 Incentive Share Option Plan
In July 2015, the Company adopted the 2015 Incentive Share Option Plan ("2015 Plan"). The 2015 Plan has been amended and restated from time to time to increase the number of shares reserved for grant and to enable the grant of options to employees of the Company’s subsidiaries. Under the 2015 Plan, options to purchase common stock of the Company may be granted to employees, officers, directors and consultants of the Company. Each option granted can be exercised for one share of common stock of the Company. Options granted to employees generally vest over a period of no more than four years. The options expire ten years from the date of grant.
Pursuant to the 2015 Plan, the Company had reserved 7,312,590 shares of common stock for issuance. Effective immediately upon the approval of the 2020 plan, the remaining shares of common stock available for future grant under the 2015 Plan were transferred to the 2020 Plan. As of September 30, 2022, there were no shares of common stock available for future grant under the 2015 Plan. Subsequent to the approval of the 2020 Plan, no additional grants will be made under the 2015 Plan and any outstanding awards under the 2015 Plan will continue with their original terms.
Assumed Share Option Plans
As part of the Metromile Acquisition, the Company assumed the Metromile 2011 Incentive Stock Plan ("2011 Plan") and Metromile 2021 Incentive Stock Plan ("2021 Plan") (collectively referred to as "Assumed Plans"). The equity awards assumed of 404,207 were granted from the respective Assumed Plans but will be settled in the Company's common stock (see Note 5). The remaining unallocated shares reserved under both 2011 Plan and 2021 Plan were cancelled and no new awards will be granted under these Assumed Plans.
Options granted to employees and non-employees
The fair value of each option granted for the nine months ended September 30, 2022 and 2021 is estimated on the date of grant using the Black-Scholes model based on the following assumptions:
| | | | | | | | | | | | | | |
| | Nine Months Ended September 30, |
| | 2022 | | 2021 |
Weighted average expected term (years) | | 6.1 | | 6.1 |
Risk-free interest rate | | 2.7% | | 1.3% |
Volatility | | 47% | | 49% |
Expected dividend yield | | 0% | | 0% |
Expected volatility is calculated based on implied volatility from market comparisons of certain publicly traded companies and other factors. The expected term of options granted is based on the simplified method, which uses the midpoint between the vesting date and the contractual term in accordance with ASC Topic 718, “Compensation — Stock Compensation.” The risk-free interest rate is based on observed interest rates appropriate for the term of the Company’s stock options. The dividend yield assumption is based on the Company’s historical and expected future dividend payouts and may be subject to substantial change in the future.
The following tables summarize activity of stock options and restricted stock units ("RSUs") ($ in millions, except for number of options and weighted average amounts):
Stock options
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| | Number of Options | | Weighted- Average Exercise Price | | Weighted-Average Remaining Contractual Term (Years) | | Aggregate Intrinsic Value |
Outstanding as of December 31, 2021 | | 6,573,744 | | $ | 46.03 | | | 8.29 | | $ | 85.86 | |
Granted (1) | | 4,351,371 | | | 27.47 | | | | | |
| | | | | | | | |
Exercised | | (404,133) | | | 8.16 | | | | | |
Cancelled | | (584,411) | | | 50.66 | | | | | |
Outstanding as of September 30, 2022 | | 9,936,571 | | $ | 39.39 | | | 8.44 | | $ | 17.05 | |
Options exercisable as of September 30, 2022 | | 2,969,722 | | $ | 27.51 | | | 6.88 | | $ | 15.47 | |
Options unvested as of September 30, 2022 | | 6,966,849 | | $ | 44.45 | | | 9.10 | | $ | 1.58 | |
(1) includes assumed options of 72,410 from the Metromile Acquisition (see Note 5)
Restricted Stock Units
| | | | | | | | | | | | | | |
| | Number of Shares | | Grant Date Fair Value |
Outstanding as of December 31, 2021 | | 335,814 | | | $ | 66.94 | |
Granted (1) | | 1,743,224 | | | 22.59 | |
| | | | |
Vested | | (153,283) | | | 41.17 | |
Cancelled | | (190,104) | | | 27.88 | |
Outstanding as of September 30, 2022 | | 1,735,651 | | | $ | 28.38 | |
(1) includes assumed restricted stock units of 331,797 from the Metromile Acquisition (see Note 5)
Stock-based compensation expense
Stock-based compensation expense from stock options and RSUs granted are included and classified in the condensed consolidated statements of operations for the three and nine months ended September 30, 2022 and 2021, including assumed awards from the Metromile Acquisition for the three and nine months ended September 30, 2022, as follows ($ in millions):
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| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
Loss and loss adjustment expense, net | | $ | 0.7 | | | $ | 0.3 | | | $ | 1.9 | | | $ | 1.0 | |
Other insurance expense | | 0.4 | | | 0.4 | | | 1.2 | | | 0.8 | |
Sales and marketing | | 1.8 | | | 1.4 | | | 5.0 | | | 3.8 | |
Technology development | | 6.4 | | | 5.3 | | | 17.6 | | | 12.8 | |
General and administrative | | 6.3 | | | 5.3 | | | 17.9 | | | 12.3 | |
Total stock-based compensation expense | | $ | 15.6 | | | $ | 12.7 | | | $ | 43.6 | | | $ | 30.7 | |
Stock-based compensation expense classified by award type as included in the condensed consolidated statements of operations is as follows ($ in millions):
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| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
Stock options | | $ | 11.9 | | | $ | 12.0 | | | $ | 35.9 | | | $ | 28.0 | |
RSUs | | 3.7 | | | 0.7 | | | 7.7 | | | 2.7 | |
Total stock-based compensation expense | | $ | 15.6 | | | $ | 12.7 | | | $ | 43.6 | | | $ | 30.7 | |
The total unrecognized expense granted to employees and non-employees outstanding at September 30, 2022 was $109.9 million for the stock options and $46.2 million for the RSUs, with a remaining weighted-average vesting period of 1.5 years for the stock options and 1.7 years for the RSUs.
12. Income Taxes
The consolidated effective tax rate was (3.2)% and (3.5)% for the nine months ended September 30, 2022 and 2021, respectively. The change in effective tax rate over the two periods was predominantly reflective of the change in profit before tax of the Company's Israel subsidiary and uncertain tax positions.
Our unrecognized tax benefits related to tax positions, excluding penalty and interest amounted to $6.8 million as of September 30, 2022, and there was none as of September 30, 2021. The increase was primarily driven by the ongoing implementation of transfer pricing policies. Interest and penalties related to unrecognized tax expense (benefits) are recognized in income tax expense, when applicable. There was no accrual for interest and penalties as of September 30, 2022 and 2021. We believe it is reasonably possible that our unrecognized tax benefits could decrease within the next 12 months upon completion of implementation of transfer pricing policies.
13. Net Loss per Share
Basic and diluted net loss per share attributable to common stockholders was calculated as follows :
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| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2022 | | 2021 | | 2022 | | 2021 |
Numerator: | | | | | | | | |
Net loss attributable to common stockholders ($ in millions) | | $ | (91.4) | | | $ | (66.4) | | | $ | (234.1) | | | $ | (171.0) | |
Denominator: | | | | | | | | |
Weighted average common shares outstanding — basic and diluted | | 66,877,100 | | 61,580,145 | | 63,482,945 | | 61,086,238 |
Net loss per share attributable to common stockholders — basic and diluted | | $ | (1.37) | | | $ | (1.08) | | | $ | (3.69) | | | $ | (2.80) | |
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The Company’s potentially dilutive securities, which include stock options and unvested RSUs, have been excluded from the computation of diluted net loss per share as the effect would be anti-dilutive. Therefore, the weighted average number of common shares outstanding used to calculate both basic and diluted net loss per share attributable to common stockholders is the same. The Company excluded the following potential common shares, presented based on amounts outstanding at each period end, from the computation of diluted net loss per share attributable to common stockholders for the periods indicated because including them would have had an anti-dilutive effect.
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| | | | Nine Months Ended September 30, |
| | | | | | 2022 | | 2021 |
Options to purchase common stock | | | | | | 9,936,571 | | | 6,032,798 | |
Unvested restricted stock | | | | | | 1,735,651 | | | 130,241 | |
Warrants for common stock (1) | | | | | | 412,969 | | | — | |
Total | | | | | | 12,085,191 | | | 6,163,039 | |
(1) Each outstanding warrant of Metromile assumed by the Company are converted automatically into warrants denominated in the Company's common stock with the number of warrants and exercise price adjusted based on the exchange ratio of 0.05263
14. Related Party Transactions
The Company uses the services of a travel agency owned by a relative of one of the Company’s key stockholders. The Company incurred travel expenses in the amount of approximately less than $0.1 million for the three months ended September 30, 2022 and $0.1 million for the nine months ended September 30, 2022. Travel expenses were approximately less than $0.1 million for the three and nine months ended September 30, 2021.
The Company has historically leased office spaces in the United States and The Netherlands from an affiliate. Rental expense in connection with the leased space was approximately less than $0.1 million for the three and nine months ended September 30, 2022 and September 30, 2021. There were no outstanding amounts due from or to related parties as of September 30, 2022 and December 31, 2021.
The Company’s Co-Chief Executive Officers, both of whom are also members of the Company’s board of directors, are the two sole members of the board of directors of the Lemonade Foundation. The Company contributed 500,000 shares of common stock with a fair market value of $24.36 per share (see Note 10). In connection with the Follow-on Offering as discussed in Note 10, Lemonade Foundation sold 100,000 shares of the contributed shares of the Company. As of September 30, 2022, there were no outstanding amounts due to or from the Lemonade Foundation.
15. Contingencies
The Company is occasionally a party to routine claims or litigation incidental to its business. The Company records accruals for loss contingencies with these legal matters when it is probable that a liability will be incurred, and the amount of the loss can be reasonably estimated. The Company has been made a party to a class action litigation alleging that certain of our business practices were improper. The Company has accrued a liability for this matter in accordance with ASC 450, Contingencies ("ASC 450"), and was settled in October 2022.
Metromile Shareholder Litigation Matter
Following the announcement of Metromile's acquisition by the Company, multiple complaints were filed against Metromile and certain former officers and directors alleging that Metromile’s disclosures concerning the transaction were incomplete. Metromile also received demands to inspect its books and records under Delaware General Corporation Law Section 220, and one stockholder commenced litigation to enforce inspection rights. All of the foregoing complaints have been voluntarily dismissed with the plaintiffs reserving their rights to seek a fee in connection with each respective litigation. The Company will continue to monitor all legal issues and assess whether to accrue liability in accordance with ASC 450 based on new information and as further developments arise.
16. Geographical Breakdown of Gross Written Premium
The Company has a single reportable segment and offers insurance coverage under the homeowners multi-peril, inland marine, general liability and private passenger auto lines of business. Gross written premium by jurisdiction are as follows ($ in millions):
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| | Three Months Ended September 30, | | Nine Months Ended September 30, | | | | |
| | 2022 | | 2021 | | 2022 | | 2021 | | | | | | |
Jurisdiction | | Amount | | % of GWP | | Amount | | % of GWP | | Amount | | % of GWP | | Amount | | % of GWP | | | | | | | | | | |
California | | $ | 45.9 | | | 26.4 | % | | $ | 29.0 | | | 24.8 | % | | $ | 101.3 | | | 24.7 | % | | $ | 70.4 | | | 25.0 | % | | | | | | | | | | |
Texas | | 26.6 | | | 15.3 | % | | 21.7 | | | 18.6 | % | | 70.9 | | | 17.3 | % | | 55.4 | | | 19.6 | % | | | | | | | | | | |
New York | | 19.1 | | | 11.0 | % | | 14.3 | | | 12.2 | % | | 49.8 | | | 12.1 | % | | 35.2 | | | 12.5 | % | | | | | | | | | | |
New Jersey | | 8.9 | | | 5.1 | % | | 5.3 | | | 4.5 | % | | 20.1 | | | 4.9 | % | | 12.1 | | | 4.3 | % | | | | | | | | | | |
Illinois | | 8.8 | | | 5.1 | % | | 5.0 | | | 4.3 | % | | 19.8 | | | 4.8 | % | | 12.1 | | | 4.3 | % | | | | | | | | | | |
Georgia | | 6.1 | | | 3.5 | % | | 4.9 | | | 4.2 | % | | 15.5 | | | 3.8 | % | | 12.9 | | | 4.6 | % | | | | | | | | | | |
Colorado | | 4.9 | | | 2.8 | % | | 3.1 | | | 2.7 | % | | 11.8 | | | 2.9 | % | | 6.5 | | | 2.3 | % | | | | | | | | | | |
Pennsylvania | | 4.8 | | | 2.8 | % | | 3.3 | | | 2.8 | % | | 10.7 | | | 2.6 | % | | 7.4 | | | 2.6 | % | | | | | | | | | | |
Washington | | 5.6 | | | 3.2 | % | | 1.8 | | | 1.5 | % | | 10.0 | | | 2.4 | % | | 3.9 | | | 1.4 | % | | | | | | | | | | |
Virginia | | 4.4 | | | 2.5 | % | | 2.6 | | | 2.2 | % | | 9.5 | | | 2.3 | % | | 6.0 | | | 2.1 | % | | | | | | | | | | |
All other | | 38.9 | | | 22.3 | % | | 25.8 | | | 22.2 | % | | 91.3 | | | 22.2 | % | | 60.2 | | | 21.3 | % | | | | | | | | | | |
| | $ | 174.0 | | | 100.0 | % | | $ | 116.8 | | | 100.0 | % | | $ | 410.7 | | | 100.0 | % | | $ | 282.1 | | | 100.0 | % | | | | | | | | | | |
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17. Subsequent Event
On October 14, 2022, the Company entered into an omnibus agreement (the “Omnibus Agreement”) and a warrant agreement (the “Warrant Agreement” and, together with the Omnibus Agreement, the “Agreements”) with Chewy Insurance Services, LLC (the “Warrantholder”) in connection with the execution of an agency agreement on the same date between the Company, Lemonade Insurance Agency, LLC, Lemonade Insurance Company and the Warrantholder. In connection with the Agreements, the Company issued to the Warrantholder a warrant to purchase up to 3,352,025 shares of the Company’s common stock with an exercise price of $0.01 per share, which will vest in installments on a yearly basis for a period of five years, subject to certain performance requirements. Vesting events and thresholds as specified in the Warrant Agreement.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes and other information included elsewhere in this Quarterly Report, Annual Report on Form 10-K, and in our other filings with the Securities and Exchange Commission ("SEC"). The discussion and analysis below includes forward-looking statements that are subject to risks, uncertainties and other factors described in the "Risk Factors" section of our Annual Report on Form 10-K that could cause actual results to differ materially from such forward-looking statements. Additionally, our historical results are not necessarily indicative of the results that may be expected for any period in the future.
In this Quarterly Report, unless we indicate otherwise or the context requires, "Lemonade, Inc.," "Lemonade," "the company," "our company," "the registrant," "we," "our," "ours" and "us" refer to Lemonade, Inc. and its consolidated subsidiaries, including Lemonade Insurance Company, Lemonade Insurance Agency, LLC and Metromile Insurance Company and Metromile Insurance Services.
Our Business
Lemonade is rebuilding insurance from the ground up on a digital substrate and an innovative business model. By leveraging technology, data, artificial intelligence, contemporary design, and behavioral economics, we believe we are making insurance more delightful, more affordable, more precise, and more socially impactful. To that end, we have built a vertically-integrated company with wholly-owned insurance carriers in the United States, Europe, including the United Kingdom, and the full technology stack to power them.
A brief chat with our bot, AI Maya, is all it takes to get covered with renters, homeowners, pet, car or life insurance, and we expect to offer a similar experience for other insurance products over time. Claims are filed by chatting with another bot, AI Jim, who pays claims in as little as three seconds. This breezy experience belies the extraordinary technology that enables it: a state-of-the-art platform that spans marketing to underwriting, customer care to claims processing, finance to regulation. Our architecture melds artificial intelligence with the human kind, and learns from the prodigious data it generates to become ever better at delighting customers and quantifying risk.
In addition to digitizing insurance end-to-end, we also reimagined the underlying business model to minimize volatility while maximizing trust and social impact. In a departure from the traditional insurance model, where profits can literally depend on the weather, we typically retain a fixed fee, currently 25% of premiums, and our gross margin is expected to change little in good years and in bad. At Lemonade, excess claims are generally offloaded to reinsurers, while excess premiums are usually donated to nonprofits selected by our customers as part of our annual “Giveback.” These two ballasts, reinsurance and Giveback, reduce volatility, while creating an aligned, trustful, and values-rich relationship with our customers.
Lemonade’s cocktail of delightful experience, aligned values, and great prices enjoys broad appeal, while over indexing on younger and first time buyers of insurance. As these customers progress through predictable lifecycle events, their insurance needs typically grow to encompass more and higher-value products: renters regularly acquire more property and frequently upgrade to successively larger homes; home buying often coincides with a growing household and a corresponding need for life or pet insurance, and so forth. These progressions can trigger orders-of-magnitude increases in insurance premiums.
The result is a business with highly-recurring and naturally-growing revenue streams; a level of automation that we believe delights consumers while collapsing costs; and an architecture that generates and employs data to price and underwrite risk with ever-greater precision to the benefit of our company, our customers and their chosen nonprofits.
Acquisition of Metromile
On July 28, 2022 (the "Acquisition Date"), the Company completed the acquisition of Metromile, Inc. (“Metromile"), a leading digital insurance platform in the United States that offers real-time, personalized auto insurance policies by the mile (the "Metromile Acquisition"). The Company acquired 100% of Metromile's equity through an all-stock transaction based upon the exchange ratio of 0.05263 shares of Lemonade for each outstanding share of Metromile. Our results of operations include those of Metromile from the Acquisition Date through September 30, 2022.
Metromile is a leading digital insurance platform in the United States. With data science at its foundation, Metromile offers real-time, personalized auto insurance policies by the mile instead of the industry’s reliance on approximations that have historically made prices unfair. Metromile’s digitally native offering is built around the modern driver’s needs, featuring automated claims and complementary smart driving features.
Key Factors and Trends Affecting our Operating Results
Our financial condition and results of operations have been, and will continue to be, affected by a number of factors, including the following:
Seasonality
Seasonal patterns can impact both our rate of customer acquisition and the incurrence of claims and losses.
Based on historical experience, existing and potential customers move more frequently in the third quarter, compared to the rest of the calendar year. As a result, we may see greater demand for new or expanded insurance coverage, and increased online engagement resulting in proportionately more growth during the third quarter. We expect that as we grow our customers, expand geographically, and launch new products, the impact of seasonal variability on our rate of growth may decrease.
Additionally, seasonal weather patterns impact the level and amount of claims we receive. These patterns include hurricanes, wildfires, and coastal storms in the fall, cold weather patterns, and changing home heating needs in the winter, and tornados and hailstorms in the spring and summer. The mix of geographic exposure and products within our customer base impacts our exposure to these weather patterns.
COVID-19 Impact
The COVID-19 pandemic has severely impacted businesses worldwide, including many in the insurance sector. Insurers of travel, events or business interruption may be directly and adversely affected by claims from COVID-19 or the lock-down it engendered. Other insurers, in lines of business that are not directly impacted by COVID-19, may nevertheless be dependent on office-based brokers, in-person inspections, or teams that are poorly equipped to work from home — all of which can translate into value erosion. Finally, the broader financial crisis may hurt insurers in other ways, too.
Against this backdrop it is noteworthy that our business has continued to grow, and the key drivers of our business have continued their positive progress, despite the pandemic.
•Lemonade writes insurance in lines that have so far been largely unaffected by COVID-19, or indeed, historically, by recession.
•Our systems are entirely cloud based and accessible to our teams from any browser anywhere in the world. Customers’ phone calls are routed to our team’s laptops, and answered and logged from wherever they happen to be. Internal communication has been via Slack and Zoom since our founding. The upshot is that while we all enjoy each other’s company, our teams are able to access systems, support customers and collaborate with each other from anywhere, much as they did before the pandemic.
•Our customers’ experience with Lemonade is likewise largely unaffected by the turmoil, as AI Maya and AI Jim chat with customers, wherever they may be, without triggering concerns about social distancing.
While the global economy began to reopen in the first quarter of 2021, and continues to show positive economic growth in the U.S. as the vaccination roll-out has reduced the spread and severity of COVID-19 and variants of the virus, there remains to be an uncertainty about the duration and ultimate impact of COVID-19 and variants of the virus, including the length of time needed to vaccinate a significant segment of the global population and effectiveness of the vaccines with respect to the new variants of the virus. Management continues to monitor and cannot definitively determine the ultimate financial impact of COVID-19 and variants of the virus, and the related economic conditions at this time.
With respect to our investment portfolio which showed a diversified mix of securities beginning in the third quarter of 2021, and given the conservative nature of our portfolio and investment in high-quality securities, we do not expect a material adverse impact in the value of our investment portfolio, or long-term negative impact on our financial condition, results of operations or cash flows as it relates to COVID-19 and variants of the virus.
See “Risk Factors — Risks Relating to our Industry — Severe weather events and other catastrophes, including the effects of climate change and global pandemics, are inherently unpredictable and may have a material adverse effect on our financial results and financial condition.” in our Annual Report on Form 10-K.
Reinsurance
We obtain reinsurance to help manage our exposure to property and casualty insurance risks. Although our reinsurance counterparties are liable to us according to the terms of the reinsurance policies, we remain primarily liable to our policyholders as the direct insurers on all risks reinsured, see "Risk Factors - Risks Relating to Our Business" and "Risks relating to our Industry" in our Annual Report on Form 10-K.
As a result, reinsurance does not eliminate the obligation of our insurance subsidiaries to pay all claims, and we are subject to the risk that one or more of our reinsurers will be unable or unwilling to honor its obligations, that the reinsurers will not pay in a timely fashion, or that our losses are so large that they exceed the limits inherent in our reinsurance contracts, each of which could have a material effect on our results of operations and financial condition. Furthermore, reinsurance may be unavailable at current levels and prices, which may limit our ability to write new business.
Through June 30, 2021, we had proportional reinsurance covering 75% of our business. Under the proportional reinsurance contracts, which cover all of our products and geographies, we transferred, or “ceded,” 75% of our premium to our reinsurers ("Proportional Reinsurance Contracts"). In exchange, these reinsurers paid us a ceding commission of 25% for every dollar ceded, in addition to funding all of the corresponding claims, or 75% of all our claims. This arrangement mirrors our fixed fee, and hence shields our gross profit margin, from the volatility of claims, while boosting our capital efficiency dramatically. We opted to manage the remaining 25% of our business with alternative forms of reinsurance.
A portion of Lemonade’s proportional reinsurance program expired on June 30, 2021 and on June 30, 2022. As the business continued to grow and diversify, and with stability in our insurance results, we decreased the overall share of proportional reinsurance from 75% of premium to 55% effective July 1, 2022. In addition, we purchased a reinsurance program to protect us against natural catastrophe risk in the U.S. that exceeds $80 million in losses effective July 1, 2022. Other non-proportional reinsurance contracts were renewed with terms similar to the expiring contracts.
Metromile entered into a Quota Share reinsurance agreement effective January 1, 2022 through June 30, 2023. Under the terms of the agreement, the Company cedes 30% of premiums and losses to reinsurers.
Components of our Results of Operations
Revenue
Gross Written Premium
Gross written premium is the amount received, or to be received, for insurance policies written by us during a specific period of time without reduction for premiums ceded to reinsurance. Following the Metromile Acquisition on July 28, 2022, we also include gross written premium from the sale of pay-per-mile auto insurance policies within the United States. The volume of our gross written premium in any given period is generally influenced by new business submissions, binding of new business submissions into policies, renewals of existing policies, and average size and premium rate of bound policies.
Ceded Written Premium
Ceded written premium is the amount of gross written premium ceded to reinsurers. We enter into reinsurance contracts to limit our exposure to potential losses as well as to provide additional capacity for growth. Ceded written premium is earned over the reinsurance contract period in proportion to the period of risk covered. The volume of our ceded written premium is impacted by the level of our gross written premium and any decision we make to increase or decrease in reinsurance limits, retention levels, and co-participation. Our ceded written premium can also be impacted significantly in certain periods due to changes in reinsurance agreements. In periods where we start or stop ceding a large volume of our premium, ceded written premium may increase or decrease significantly compared to prior periods and these fluctuations may not be indicative of future trends.
Gross Earned Premium
Gross earned premium represents the earned portion of our gross written premium. Our insurance policies generally have a term of one year and premium is earned pro rata over the term of the policy. In addition, following the Metromile Acquisition, we also include earned premiums from the pay-per-mile auto insurance policies which is written for six-month terms. Premium for the policy provides a base rate per month for the entire policy term upon binding of the policy plus a per-mile rate multiplied by the miles driven each day (based on data from the telematics device, subject to a daily maximum).
Ceded Earned Premium
Ceded earned premium is the amount of gross earned premium ceded to reinsurers.
Net Earned Premium
Net earned premium represents the earned portion of our gross written premium, less the earned portion that is ceded to third-party reinsurers under our reinsurance agreements. Premium is earned pro rata over the term of the policy, which is generally one year. Net earned premiums from the pay-per-mile auto insurance policies is earned over the term of the policy which is written for six-month terms
Ceding Commission Income
Ceding commission income is commission we receive based on the premium ceded to third-party reinsurers to reimburse us for acquisition and underwriting expenses. We earn commissions on reinsurance premium ceded in a manner consistent with the recognition of the earned premium on the underlying insurance policies, on a pro-rata basis over the terms of the policies reinsured. The portion of ceding commission income which represents reimbursement of successful acquisition costs related to the underlying policies is recorded as an offset to other insurance expense.
Net Investment Income
Net investment income represents interest earned from fixed maturity securities, short term securities, and other investments, and the gains or losses from the sale of investments, net of investment fees paid to the Company's investment manager. Our cash and invested assets are primarily comprised of fixed maturity securities, and may also include cash and cash equivalents, equity securities, and short-term investments. The principal factors that influence net investment income are the size of our investment portfolio and the yield on that portfolio. As measured by amortized cost (which excludes changes in fair value, such as changes in interest rates), the size of our investment portfolio is mainly a function of our invested equity capital along with premium we receive from our customers less payments on customer claims. Over time, we expect that net investment income will represent a more meaningful component of our results of operations.
Commission and Other Income
Commission income consists of commissions earned for policies placed with third-party insurance companies where we have no exposure to the insured risk. Such commission is recognized on the effective date of the associated policy. Other income consists of fees collected from policyholders relating to installment premiums. These fees are recognized at the time each policy installment is billed.
Expense
Loss and Loss Adjustment Expense, Net
Loss and loss adjustment expense ("LAE"), net represent the costs incurred for losses net of amounts ceded to reinsurers. We enter into reinsurance contracts to limit our exposure to potential losses as well as to provide additional capacity for growth. These expenses are a function of the size and term of the insurance policies we write and the loss experience associated with the underlying risks. Loss and LAE are based on an actuarial analysis of the estimated losses, including losses incurred during the period and changes in estimates from prior periods. Loss and LAE may be paid out over a period of years. Certain policies we write are subject to catastrophe losses. Catastrophe losses are losses resulting from events involving claims and policyholders, including earthquakes, hurricanes, floods, storms, terrorist acts or other aggregating events that are designated by internationally recognized organizations, such as Property Claims Services, that track and report on insured losses resulting from catastrophic events.
Other Insurance Expense
Other insurance expense consists primarily of amortization of commissions costs and premium taxes incurred on the successful acquisition of business written on a direct basis, and credit card processing fees not charged to our customers. Other insurance expense also includes employee compensation, including stock-based compensation and benefits, of our underwriting teams as well as allocated occupancy costs and related overhead based on headcount. Other insurance expense is offset by the portion of ceding commission income which represents reimbursement of successful acquisition costs related to the underlying policies.
Sales and Marketing
Sales and marketing includes third-party marketing, advertising, branding, public relations and sales expenses. Sales and marketing also includes associated employee compensation, including stock-based compensation and benefits, as well as allocated occupancy costs and related overhead based on headcount. Sales and marketing costs are expensed as incurred.
We plan to continue to invest in sales and marketing to attract and acquire new customers and increase our brand awareness. We expect that sales and marketing costs will increase in absolute dollars in future periods and vary from period-to-period as a percentage of revenue in the near-term. We expect that, in the long-term, our sales and marketing costs will decrease as a percentage of revenue as we continue to drive customer acquisition efficiencies and as the proportion of renewals to our total business increases.
Technology Development
Technology development consists of employee compensation, including stock-based compensation and benefits, and expenses related to vendors engaged in product management, design, development and testing of our websites and products. Technology development also includes allocated occupancy costs and related overhead based on headcount. We expense technology development costs as incurred, except for costs that are capitalized related to internal-use software development projects and subsequently depreciated over the expected useful life of the developed software.
We expect product technology development costs, a portion of which will be capitalized, to continue to grow in the foreseeable future as we identify opportunities to invest in the development of new products and internal tools and enhancement of our existing products and technologies that we believe will drive the long-term profitability of the business.
General and Administrative
General and administrative includes employee compensation, including stock-based compensation and benefits for executive, finance, accounting, legal, business operations, and other administrative personnel. In addition, general and administrative includes outside professional services, non-income based taxes, insurance, charitable donations, bad debt expense and allocated occupancy costs and related overhead based on headcount. Depreciation and amortization expense is also recorded as a component of general and administrative.
We expect to incur incremental general and administrative costs to support our global operational growth and enhancements to support our reporting and planning functions.
We have incurred and expect to continue to incur significant additional general and administrative expense as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC and the listing standards of the New York Stock Exchange, additional corporate, director and officer insurance expenses, greater investor relations expenses and increased legal, audit and consulting fees. We also expect to increase the size of our general and administrative function to support our increased compliance requirements and the growth of our business. As a result, we expect that our general and administrative expense will increase in absolute dollars in future periods and vary from period-to-period as a percentage of revenue.
Income Tax Expense
Our provision for income taxes consists primarily of foreign income taxes related to income generated by our subsidiaries organized under the laws of the Netherlands and Israel. As we expand the scale of our international business activities, any changes in the U.S. and foreign taxation of such activities may increase our overall provision for income taxes in the future.
We have a valuation allowance for our U.S. deferred tax assets, including federal and state net operating losses. We expect to maintain this valuation allowance until it becomes more likely than not, that the benefit of our federal and state deferred tax assets will be realized through expected future taxable income in the United States.
Key Operating and Financial Metrics
We regularly review a number of metrics, including the following key operating and financial metrics, to evaluate our business, measure our performance, identify trends in our business, prepare financial projections and make strategic decisions. We believe these non-GAAP and operational measures are useful in evaluating our performance, in addition to our financial results prepared in accordance with GAAP. See “—Non-GAAP Financial Measures” for additional information on non-GAAP financial measures. and a reconciliation to the most directly comparable financial measures prepared in accordance with U.S. generally accepted accounting principles ("GAAP").
The following table sets forth these metrics as of and for the periods presented:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| ($ in millions, except Premium per customer) | | ($ in millions, except Premium per customer) |
Customers (end of period) | 1,775,824 | | | 1,363,754 | | | 1,775,824 | | | 1,363,754 | |
In force premium (end of period) | $ | 609.2 | | | $ | 346.7 | | | $ | 609.2 | | | $ | 346.7 | |
Premium per customer (end of period) | $ | 343 | | | $ | 254 | | | $ | 343 | | | $ | 254 | |
Annual dollar retention (end of period) | 84 | % | | 82 | % | | 84 | % | | 82 | % |
Total revenue | $ | 74.0 | | | $ | 35.7 | | | $ | 168.3 | | | $ | 87.4 | |
Gross earned premium | $ | 136.4 | | | $ | 79.6 | | | $ | 339.2 | | | $ | 202.7 | |
Gross profit | $ | 8.1 | | | $ | 11.7 | | | $ | 29.6 | | | $ | 23.4 | |
Adjusted gross profit | $ | 13.2 | | | $ | 15.2 | | | $ | 47.0 | | | $ | 33.0 | |
Net loss | $ | (91.4) | | | $ | (66.4) | | | $ | (234.1) | | | $ | (171.0) | |
Adjusted EBITDA | $ | (65.7) | | | $ | (51.3) | | | $ | (173.4) | | | $ | (133.0) | |
Gross profit margin | 11 | % | | 33 | % | | 18 | % | | 27 | % |
Adjusted gross profit margin | 18 | % | | 43 | % | | 28 | % | | 38 | % |
Ratio of Adjusted Gross Profit to Gross Earned Premium | 10 | % | | 19 | % | | 14 | % | | 16 | % |
Gross loss ratio | 94 | % | | 77 | % | | 90 | % | | 88 | % |
Net loss ratio | 105 | % | | 81 | % | | 97 | % | | 91 | % |
Customers
We define customers as the number of current policyholders underwritten by us or placed by us with third-party insurance partners (who pay us recurring commissions) as of the period end date. A customer that has more than one policy counts as a single customer for the purposes of this metric. We view customers as an important metric to assess our financial performance because customer growth drives our revenue, expands brand awareness, deepens our market penetration, creates additional upsell and cross-sell opportunities, and generates additional data to continue to improve the functioning of our platform.
In Force Premium
We define in force premium ("IFP"), as the aggregate annualized premium for customers as of the period end date. At each period end date, we calculate IFP as the sum of:
i)In force written premium — the annualized premium of in force policies underwritten by us; and
ii)In force placed premium — the annualized premium of in force policies placed with third party insurance companies for which we earn a recurring commission payment. In force placed premium currently reflects approximately 2% of IFP.
The annualized value of premiums is a legal and contractual determination made by assessing the contractual terms with our customers. The annualized value of contracts is not determined by reference to historical revenues, deferred revenues or any other GAAP financial measure over any period. IFP is not a forecast of future revenues nor is it a reliable indicator of revenue expected to be earned in any given period. We believe that our calculation of IFP is useful to analysts and investors because it captures the impact of growth in customers and premium per customer at the end of each reported period, without adjusting for known or projected policy updates, cancellations, rescissions, and non-renewals. We use IFP because we believe it gives our management useful insight into the total reach of our platform by showing all in force policies underwritten and placed by us. Other companies, including companies in our industry, may calculate IFP differently or not at all, which reduces the usefulness of IFP as a tool for comparison.
Premium per customer
We define premium per customer as the average annualized premium customers pay for products underwritten by us or placed by us with third-party insurance partners. We calculate premium per customer by dividing IFP by customers. We view premium per customer as an important metric to assess our financial performance because premium per customer reflects the average amount of money our customers spend on our products, which helps drive strategic initiatives.
Annual Dollar Retention
We define Annual Dollar Retention ("ADR"), as the percentage of IFP retained over a twelve month period, inclusive of changes in policy value, changes in number of policies, changes in policy type, and churn. To calculate ADR we first aggregate the IFP from all active customers at the beginning of the period and then aggregate the IFP from those same customers at the end of the period. ADR is then equal to the ratio of ending IFP to beginning IFP. We believe that our calculation of ADR is useful to analysts and investors because it captures our ability to retain customers and sell additional products and coverage to them over time. We view ADR as an important metric to measure our ability to provide a delightful end-to-end customer experience, satisfy our customers’ evolving insurance needs and maintain our customers’ trust in our products. Our customers become more valuable to us every year they continue to subscribe to our products. Other companies, including companies in our industry, may calculate ADR differently or not at all, which reduces the usefulness of ADR as a tool for comparison.
Gross Earned Premium
Gross earned premium is the earned portion of our gross written premium.
We use this operating metric as we believe it gives our management and other users of our financial information useful insight into the gross economic benefit generated by our business operations and allows us to evaluate our underwriting performance without regard to changes in our underlying reinsurance structure. See “— Components of Our Results of Operations — Revenue — Gross Earned Premium.”
Unlike net earned premium, gross earned premium excludes the impact of premiums ceded to reinsurers, and therefore should not be used as a substitute for net earned premium, total revenue, or any other measure presented in accordance with GAAP.
Gross Profit
Gross profit is calculated in accordance with GAAP as total revenue less loss and loss adjustment expense, net, other insurance expense, and depreciation and amortization (allocated to cost of revenue).
Adjusted Gross Profit
We define adjusted gross profit, a non-GAAP financial measure, as:
•Gross profit, excluding net investment income and interest income, plus
•Employee-related costs, plus
•Professional fees and other, plus
•Depreciation and amortization (allocated to cost of revenue).
•See “— Non-GAAP Financial Measures” for a reconciliation of total revenue to adjusted gross profit.
Adjusted EBITDA
We define adjusted EBITDA, a non-GAAP financial measure, as net loss excluding the impact of income tax expense, depreciation, amortization, stock-based compensation, interest income (expense), net investment income, change in fair value of warrants liability, and other non-cash fair value adjustment on warrants and other transactions that we consider to be unique in nature. See “— Non-GAAP Financial Measures” for a reconciliation of net loss to adjusted EBITDA in accordance with GAAP.
Gross Profit Margin
We define gross profit margin, expressed as a percentage, as the ratio of gross profit to total revenue.
Adjusted Gross Profit Margin
We define adjusted gross profit margin, a non-GAAP financial measure, expressed as a percentage, as the ratio of adjusted gross profit to total revenue. See “— Non-GAAP Financial Measures.”
Ratio of Adjusted Gross Profit to Gross Earned Premium
We define Ratio of Adjusted Gross Profit to Gross Earned Premium, a non-GAAP financial measure, expressed as a percentage, as the ratio of adjusted gross profit to gross earned premium. Our Ratio of Adjusted Gross Profit to Gross Earned Premium provides management with useful insight into our operating performance. See “— Non-GAAP Financial Measures.”
Gross Loss Ratio
We define gross loss ratio, expressed as a percentage, as the ratio of losses and loss adjustment expense to gross earned premium.
Net Loss Ratio
We define net loss ratio, expressed as a percentage, as the ratio of losses and loss adjustment expense, less amounts ceded to reinsurers, to net earned premium.
Results of Operations
Comparison of the Three Months Ended September 30, 2022 and 2021
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | | | |
| 2022 | | 2021 | | Change | | % Change |
| ($ in millions) | | |
Revenue | | | | | | | |
Net earned premium | $ | 50.6 | | | $ | 21.5 | | | $ | 29.1 | | | 135 | % |
Ceding commission income | 16.9 | | | 12.3 | | | 4.6 | | | 37 | % |
Net investment income | 2.6 | | | 0.6 | | | 2.0 | | | 333 | % |
Commission and other income | 3.9 | | | 1.3 | | | 2.6 | | | 200 | % |
Total revenue | 74.0 | | | 35.7 | | | 38.3 | | | 107 | % |
Expense | | | | | | | |
Loss and loss adjustment expense, net | 53.3 | | | 17.5 | | | 35.8 | | | 205 | % |
Other insurance expense | 12.1 | | | 6.3 | | | 5.8 | | | 92 | % |
Sales and marketing | 35.8 | | | 42.2 | | | (6.4) | | | (15 | %) |
Technology development | 21.4 | | | 14.3 | | | 7.1 | | | 50 | % |
General and administrative | 40.5 | | | 19.6 | | | 20.9 | | | 107 | % |
Total expense | 163.1 | | | 99.9 | | | 63.2 | | | 63 | % |
Loss before income taxes | (89.1) | | | (64.2) | | | (24.9) | | | 39 | % |
Income tax expense | 2.3 | | | 2.2 | | | 0.1 | | | 5 | % |
Net loss | $ | (91.4) | | | $ | (66.4) | | | $ | (25.0) | | | 38 | % |
Net Earned Premium
Net earned premium increased $29.1 million, or 135%, to $50.6 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021, primarily due to the earning of increased gross written premium and increased retention of ceded written premium under our Proportional Reinsurance Contracts as discussed above under "Reinsurance."
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | | | |
| 2022 | | 2021 | | Change | | % Change |
| ($ in millions) | | |
Gross written premium | $ | 174.0 | | | $ | 116.8 | | | $ | 57.2 | | | 49 | % |
Ceded written premium | (98.5) | | | (88.0) | | | (10.5) | | | 12 | % |
Net written premium | $ | 75.5 | | | $ | 28.8 | | | $ | 46.7 | | | 162 | % |
Gross written premium increased $57.2 million, or 49%, to $174.0 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. The increase was primarily due to a 30% increase in net added customers year over year driven by the success of our digital advertising campaigns and partnerships. We also continued to expand our geographic footprint and product offerings. We also saw a 35% increase in premium per customer year over year primarily due to an increasing prevalence of multiple policies per customer, growth in the overall average policy value, and continued shift in the mix of underlying products toward higher value policies.
Ceded written premium increased $10.5 million, or 12%, to $98.5 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021, primarily due to the impact of the change in reinsurance arrangements. The Company renewed a portion of the proportional reinsurance program expired on June 30, 2021 and on June 30, 2022, which decreased the overall share of proportional reinsurance from 75% of premium to 55% effective July 1, 2022. The Company also purchased a reinsurance program to protect against catastrophe risk in the U.S that exceed
$80 million in losses effective July 1, 2022. Other non-proportional reinsurance contracts were renewed with terms similar to the expired contracts.
Net written premium increased $46.7 million, or 162%, to $75.5 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. The increase was primarily due to the $57.2 million, or 49%, increase in gross written premium offset by the increase in ceded written premium of $10.5 million, or 12%, for the three months ended September 30, 2022, as compared to the three months ended September 30, 2021.
The table below shows the amount of premium we earned on a gross and net basis. Ceded earned premium as a percentage of gross earned premium decreased to approximately 63% for the three months ended September 30, 2022, as compared to approximately 73% for the three months ended September 30, 2021 primarily due to the change in proportional reinsurance contracts.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | | | |
| 2022 | | 2021 | | Change | | % Change |
| ($ in millions) | | |
Gross earned premium | $ | 136.4 | | | $ | 79.6 | | | $ | 56.8 | | | 71 | % |
Ceded earned premium | (85.8) | | | (58.1) | | | (27.7) | | | 48 | % |
Net earned premium | $ | 50.6 | | | $ | 21.5 | | | $ | 29.1 | | | 135 | % |
Ceding Commission Income
Ceding commission income increased $4.6 million, or 37%, to $16.9 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021, consistent with the increase in ceded earned premium related to the proportional reinsurance contracts with third-party reinsurers during the period.
Net Investment Income
Net investment income amounted to $2.6 million for the three months ended September 30, 2022 and $0.6 million for the three months ended September 30, 2021. We mainly invest in cash, money market funds, U.S. Treasury bills, corporate debt securities, asset-backed securities, notes and other obligations issued or guaranteed by the U.S. Government. Net investment income for the period was primarily driven by interest rates on investment balances, and offset by investment expenses of $0.1 million.
Commission and Other Income
Commission and other income increased $2.6 million, or 200%, to $3.9 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021, due to growth in premiums placed with third-party insurance companies during the period and an increase in installment fees billed.
Loss and Loss Adjustment Expense, Net
Loss and LAE, net increased $35.8 million, or 205%, to $53.3 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. The increase was primarily in line with growth in premium, increase in net retained losses due to change in proportional reinsurance contract and increased claims costs due to impact of inflation. During third quarter of 2022, net incurred losses of $2.2 million was recorded due to Hurricane Ian, which affected our customers primarily in Florida. These increases were partially offset by favorable prior period development.
Other Insurance Expense
Other insurance expense increased $5.8 million, or 92%, to $12.1 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. Professional fees and other increased $2.0 million, or 133%, primarily in support of growth and expansion initiatives for new products. Employee-related expense, including stock-based compensation, also increased by $1.5 million, or 63%, as compared to the three months ended September 30, 2021, driven by an increase in underwriting staff to support our continued growth. Amortization of deferred acquisition costs, net of ceding commissions increased $1.2 million, or 200%. Credit card processing fees increased $1.0 million, or 56%, as a result of the increase in customers and associated premium.
Sales and Marketing
Sales and marketing expense decreased $6.4 million, or 15%, to $35.8 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. Expense related to brand and performance advertising also decreased by $9.0 million, or 28%, for the three months ended September 30, 2022 as compared to the three months ended September 30, 2021, as a result of reduced spending on search advertising and other customer acquisition channels. Employee-related expense, including stock-based compensation, increased by $2.6 million, or 36%, as compared to the prior year period, driven by an increase in sales and marketing headcount to support our continued growth and expansion.
Technology Development
Technology development expense increased $7.1 million, or 50%, to $21.4 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. Employee-related expense, including stock-based compensation, and net of capitalized costs for the development of internal-use software, increased $4.8 million, or 40%, as compared to the three months ended September 30, 2021, driven by an increase in payroll expense for product, engineering, design and quality assurance personnel to support our continued growth and product development initiatives, including automation, improvement in machine learning and geographic expansion. Technology tools and software expense increased by $2.1 million, or 233%.
General and Administrative
General and administrative expense increased $20.9 million, or 107%, to $40.5 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021. Non-recurring transaction and integration costs of $7.4 million were incurred related to the Metromile Acquisition. Employee-related expense, including stock-based compensation, increased by $3.8 million, or 40%, as we increased finance, legal, business operations and administrative personnel. Depreciation expense increased $3.0 million, or 375%. Legal, accounting and other professional fees increased $1.6 million, or 107%, to support the compliance requirements necessary to operate as a growing global, multi-product line of business and regulated companies. Bad debt expense increased by $1.3 million, or 87%. Software costs increased $0.9 million, or 150%. Lemonade Giveback expense increased by $0.7 million, or 30%, as compared to the prior year period due to accrual during the quarter offset by the decrease in annual donations.
Income Tax Expense
Income tax expense increased $0.1 million, or 5%, to $2.3 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021 due to increased tax liability is primarily related to change in profit before tax of our subsidiary in Israel, and uncertain tax positions.
Net Loss
Net loss increased $25.0 million, or 38%, to $91.4 million for the three months ended September 30, 2022 compared to the three months ended September 30, 2021 due to the factors described above.
Comparison of the Nine Months Ended September 30, 2022 and 2021
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | | | |
| 2022 | | 2021 | | Change | | % Change |
| ($ in millions) | | |
Revenue | | | | | | | |
Net earned premium | $ | 109.2 | | | $ | 51.6 | | | $ | 57.6 | | | 112 | % |
Ceding commission income | 46.4 | | | 31.9 | | | 14.5 | | | 45 | % |
Net investment income | 4.7 | | | 1.0 | | | 3.7 | | | 370 | % |
Commission and other income | 8.0 | | | 2.9 | | | 5.1 | | | 176 | % |
Total revenue | 168.3 | | | 87.4 | | | 80.9 | | | 93 | % |
Expense | | | | | | | |
Loss and loss adjustment expense, net | 105.8 | | | 47.0 | | | 58.8 | | | 125 | % |
Other insurance expense | 30.9 | | | 16.3 | | | 14.6 | | | 90 | % |
Sales and marketing | 111.1 | | | 104.4 | | | 6.7 | | | 6 | % |
Technology development | 56.1 | | | 35.4 | | | 20.7 | | | 58 | % |
General and administrative | 91.1 | | | 49.5 | | | 41.6 | | | 84 | % |
Total expense | 395.0 | | | 252.6 | | | 142.4 | | | 56 | % |
Loss before income taxes | (226.7) | | | (165.2) | | | (61.5) | | | 37 | % |
Income tax expense | 7.4 | | | 5.8 | | | 1.6 | | | 28 | % |
Net loss | $ | (234.1) | | | $ | (171.0) | | | $ | (63.1) | | | 37 | % |
Net Earned Premium
Net earned premium increased $57.6 million, or 112%, to $109.2 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021 primarily due to the earning of increased gross written premium and increased retention of ceded written premium under our Proportional Reinsurance Contracts as discussed above under "Reinsurance."
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | | | |
| 2022 | | 2021 | | Change | | % Change |
| ($ in millions) | | |
Gross written premium | $ | 410.7 | | | $ | 282.1 | | | $ | 128.6 | | | 46 | % |
Ceded written premium | (262.0) | | | (210.1) | | | (51.9) | | | 25 | % |
Net written premium | $ | 148.7 | | | $ | 72.0 | | | $ | 76.7 | | | 107 | % |
Gross written premium increased $128.6 million, or 46%, to $410.7 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. The increase was primarily due to a 30% increase in net added customers year over year driven by the success of our digital advertising campaigns and partnerships. We also continued to expand our geographic footprint and product offerings. We also saw a 35% increase in premium per customer year over year primarily due to an increasing prevalence of multiple policies per customer, growth in the overall average policy value, and continued shift in the mix of underlying products toward higher value policies.
Ceded written premium increased $51.9 million, or 25%, to $262.0 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. A portion of the Company’s proportional reinsurance program expired on September 30, 2021. The Company renewed a portion of the proportional reinsurance program expired on June 30, 2021 and on June 30, 2022, which decreased the overall share of proportional reinsurance from 75% of premium to 55% effective July 1, 2022. The Company also purchased a reinsurance program to protect against catastrophe risk in the U.S that exceed $80 million in losses effective July 1, 2022. Other non-proportional reinsurance contracts were renewed with terms similar to the expired contracts.
Net written premium increased $76.7 million, or 107%, to $148.7 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. The increase was primarily due to the $128.6 million, or 46%, increase in gross written premium offset by the increase in ceded written premium of $51.9 million, or 25% for the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021.
The table below shows the amount of premium we earned on a gross and net basis. Ceded earned premium as a percentage of gross earned premium decreased to 68% for the nine months ended September 30, 2022, as compared to 75% for the nine months ended September 30, 2021 primarily due to the change in proportional reinsurance contracts.
| | | | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, | | | | |
| 2022 | | 2021 | | Change | | % Change |
| ($ in millions) | | |
Gross earned premium | $ | 339.2 | | | $ | 202.7 | | | $ | 136.5 | | | 67 | % |
Ceded earned premium | (230.0) | | | (151.1) | | | (78.9) | | | 52 | % |
Net earned premium | $ | 109.2 | | | $ | 51.6 | | | $ | 57.6 | | | 112 | % |
Ceding Commission Income
Ceding commission income increased $14.5 million, or 45%, to $46.4 million for the nine months ended September 30, 2022 compared to nine months ended September 30, 2021, consistent with the increase in ceded earned premium related to the proportional reinsurance contracts with third-party reinsurers during the period.
Net Investment Income
Net investment income increased $3.7 million, or 370%, to $4.7 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. We mainly invest in cash, money market funds, U.S. Treasury bills, corporate debt securities, asset-backed securities, notes and other obligations issued or guaranteed by the U.S. Government. Net investment income for the period was primarily driven by interest rates on investment balances, and offset by investment expenses of $0.3 million.
Commission and Other Income
Commission and other income increased $5.1 million, or 176%, to $8.0 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021, due to growth on premium placed with third-party insurance companies during the period and increase in installment fees billed.
Loss and Loss Adjustment Expense, Net
Loss and LAE, net increased $58.8 million, or 125%, to $105.8 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. The increase was primarily in line with growth in premium, increase in net retained losses due to change in proportional reinsurance contract and increased claims costs due to impact of inflation. During the third quarter of 2022, $2.2 million was recorded due to net incurred losses from Hurricane Ian which affected our customers primarily in Florida. These increases were partially offset by favorable prior period development.
Other Insurance Expense
Other insurance expense increased $14.6 million, or 90%, to $30.9 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. Employee-related expense, including stock-based compensation increased by $6.3 million, or 109%, as compared to the nine months ended September 30, 2021, driven by an increase in underwriting staff to support our continued growth. Professional fees and other also increased $4.2 million, or 102%, primarily in support of growth and expansion initiatives. Credit card fees also increased $2.2 million, or 46% as a result of the increase in customers and associated premium. Amortization of deferred acquisition costs, net of ceding commissions increased $1.9 million, or 119%.
Sales and Marketing
Sales and marketing expense increased $6.7 million, or 6%, to $111.1 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. Employee-related expense, including stock-based compensation, increased by $7.9 million, or 40%, as compared to the prior year period, driven by an increase in sales and marketing headcount to support our continued growth and expansion. Expense related to brand and performance advertising, the largest component of our sales and marketing expenses, decreased by $3.2 million, or 4%, for the nine months ended September 30, 2022 as compared to the nine months ended September 30, 2021, as a result of reduced spending on search advertising and other customer acquisition channels in response to new product offerings. Software expense increased by $0.8 million, or 80%.
Technology Development
Technology development expense increased $20.7 million, or 58%, to $56.1 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. Employee-related expense, including stock-based compensation, net of capitalized costs for the development of internal-use software, increased $15.6 million, or 50%, as compared to the nine months ended September 30, 2021, driven by an increase in payroll expense for product, engineering, design and quality assurance personnel to support our continued growth and product development initiatives, including automation, improvement in machine learning and geographic expansion. Technology tools and software expense increased by $3.3 million, or 127%.
General and Administrative
General and administrative expense increased $41.6 million, or 84%, to $91.1 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021. Employee-related expense, including stock-based compensation, increased by $13.3 million, or 55%, as we increased finance, legal, business operations and administrative personnel. Nonrecurring transaction costs and integration costs of $8.4 million were incurred related to the Metromile Acquisition. Legal, accounting and other professional fees increased $6.9 million, or 150%, to support the compliance requirements necessary to operate as a growing global, multi-product line of business and regulated companies. Depreciation expense increased $4.4 million, or 176%. Bad debt expense increased by $2.6 million, or 68%. Software cost increased $2.4 million, or 141%. Lemonade Giveback expense increased by $0.7 million, or 30%, as compared to the prior year period due to accrual during the period offset by the decrease in annual donations.
Income Tax Expense
Income tax expense increased $1.6 million, or 28%, to $7.4 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021 due to increased tax liability is primarily related to change in profit before tax of our subsidiary in Israel, and uncertain tax positions.
Net Loss
Net loss increased $63.1 million, or 37%, to $234.1 million for the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021 due to the factors described above.
Non-GAAP Financial Measures
The non-GAAP financial measures below have not been calculated in accordance with GAAP and should be considered in addition to results prepared in accordance with GAAP and should not be considered as a substitute for, or superior to, GAAP results. In addition, adjusted gross profit and adjusted gross profit margin, ratio of adjusted gross profit to gross earned premium, and adjusted EBITDA should not be construed as indicators of our operating performance, liquidity or cash flows generated by operating, investing and financing activities, as there may be significant factors or trends that they fail to address. We caution investors that non-GAAP financial information, by its nature, departs from traditional accounting conventions. Therefore, its use can make it difficult to compare our current results with our results from other reporting periods and with the results of other companies.
Our management uses these non-GAAP financial measures, in conjunction with GAAP financial measures, as an integral part of managing our business and to, among other things: (i) monitor and evaluate the performance of our business operations and financial performance; (ii) facilitate internal comparisons of the historical operating performance of our business operations; (iii) facilitate external comparisons of the results of our overall business to the historical operating performance of other companies that may have different capital structures and debt levels; (iv) review and assess the operating performance of our management team; (v) analyze and evaluate financial and strategic planning decisions regarding future operating investments; and (vi) plan for and prepare future annual operating budgets and determine appropriate levels of operating investments.
Adjusted Gross Profit and Adjusted Gross Profit Margin
We define adjusted gross profit, a non-GAAP financial measure, as gross profit excluding net investment income and interest income, plus fixed cost and overhead associated with our underwriting operations including employee-related expense and professional fees and other, and depreciation and amortization allocated to cost of revenue. After these adjustments, the resulting calculation is inclusive of only those variable costs of revenue incurred on the successful acquisition of business and without the volatility of investment income. We use adjusted gross profit as a key measure of our progress towards profitability and to consistently evaluate the variable contribution to our business from underwriting operations from period to period.
We define adjusted gross profit margin, a non-GAAP financial measure, expressed as a percentage, as the ratio of adjusted gross profit to total revenue.
The following table provides a reconciliation of total revenue and gross profit margin to adjusted gross profit and the related adjusted gross profit margin, respectively for the periods presented:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| ($ in millions) |
Total revenue | $ | 74.0 | | | $ | 35.7 | | | $ | 168.3 | | | $ | 87.4 | |
Adjustments: | | | | | | | |
Loss and loss adjustment expense, net | $ | (53.3) | | | $ | (17.5) | | | $ | (105.8) | | | $ | (47.0) | |
Other insurance expense | (12.1) | | | (6.3) | | | (30.9) | | | (16.3) | |
Depreciation and amortization | (0.5) | | | (0.2) | | | (2.0) | | | (0.7) | |
Gross profit | $ | 8.1 | | | $ | 11.7 | | | $ | 29.6 | | | $ | 23.4 | |
Gross profit margin (% of total revenue) | 11 | % | | 33 | % | | 18 | % | | 27 | % |
Adjustments: | | | | | | | |
Net investment income and interest income | $ | (2.9) | | | $ | (0.6) | | | $ | (5.0) | | | $ | (1.0) | |
Employee-related expense | 3.9 | | | 2.4 | | | 12.1 | | | 5.8 | |
Professional fees and other | 3.6 | | | 1.5 | | | 8.3 | | | 4.1 | |
Depreciation and amortization | 0.5 | | | 0.2 | | | 2.0 | | | 0.7 | |
Adjusted gross profit | $ | 13.2 | | | $ | 15.2 | | | $ | 47.0 | | | $ | 33.0 | |
Adjusted gross profit margin (% of total revenue) | 18 | % | | 43 | % | | 28 | % | | 38 | % |
Ratio of Adjusted Gross Profit to Gross Earned Premium
The Ratio of Adjusted Gross Profit to Gross Earned Premium measures the relationship between the underlying business volume and gross economic benefit generated by our underwriting operations, on the one hand, and our underlying profitability trends, on the other. We rely on this measure, which supplements our gross profit ratio as calculated in accordance with GAAP, because it provides management with insight into our underlying profitability trends over time.
We use gross earned premium as the denominator in calculating this ratio, which excludes the impact of premiums ceded to reinsurers, because we believe that it reflects the business volume and the gross economic benefit generated by our underlying underwriting operations, which in turn are the key drivers of our future profit opportunities. We exclude the impact of ceded premiums from the denominator because ceded premiums can change rapidly and significantly based on the type and mix of reinsurance structures we use and, therefore, add volatility that is not indicative of our underlying profitability. For example, a shift to a proportional reinsurance arrangement would result in an increase in ceded premium, with offsetting benefits to gross profit from ceded losses and ceding commissions earned, resulting in a nominal overall economic impact. This shift would result in a steep decline in total revenue with a corresponding spike in gross margin, whereas we expect that the Ratio of Adjusted Gross Profit to Gross Earned Premium would remain relatively unchanged. We expect our reinsurance structure to evolve along with our costs and capital requirements, and we believe that our reinsurance structure at a given time does not reflect the performance of our underlying underwriting operations, which we expect to be the key driver of our costs of reinsurance over time.
On the other hand, the numerator, which is adjusted gross profit, includes the net impact of all reinsurance, including ceded premiums and the benefits of ceded losses and ceding commissions earned. Because our reinsurance structure is a key component of our risk management and a key driver of our profitability or loss in a given period, we believe this is meaningful.
Therefore, by providing this Ratio of Adjusted Gross Profit to Gross Earned Premium for a given period, we are able to assess the relationship between business volume and profitability, while eliminating the volatility from the cost of our then-current reinsurance structure, which is driven primarily by the performance of our insurance underwriting platform rather than our business volume.
The following table sets forth our calculation of the Ratio of Adjusted Gross Profit to Gross Earned Premium for the periods presented:
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| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| ($ in millions) |
Numerator: Adjusted gross profit | $ | 13.2 | | | $ | 15.2 | | | $ | 47.0 | | | $ | 33.0 | |
Denominator: Gross earned premium | $ | 136.4 | | | $ | 79.6 | | | $ | 339.2 | | | $ | 202.7 | |
Ratio of Adjusted Gross Profit to Gross Earned Premium | 10 | % | | 19 | % | | 14 | % | | 16 | % |
Adjusted EBITDA
We define adjusted EBITDA, a non-GAAP financial measure, as net loss excluding income tax expense, depreciation, amortization, stock-based compensation, interest income (expense), net investment income, change in fair value of warrants liability, and other transactions that we would consider to be unique in nature. We exclude these items from adjusted EBITDA because we do not consider them to be directly attributable to our underlying operating performance. We use adjusted EBITDA as an internal performance measure in the management of our operations because we believe it gives our management and other customers of our financial information useful insight into our results of operations and our underlying business performance. Adjusted EBITDA should not be viewed as a substitute for net loss calculated in accordance with GAAP, and other companies may define adjusted EBITDA differently.
The following table provides a reconciliation of adjusted EBITDA to net loss for the periods presented:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2022 | | 2021 | | 2022 | | 2021 |
| ($ in millions) |
Net loss | $ | (91.4) | | | $ | (66.4) | | | $ | (234.1) | | | $ | (171.0) | |
Adjustments: | | | | | | | |
Income tax expense | $ | 2.3 | | | $ | 2.2 | | | 7.4 | | | $ | 5.8 | |
Depreciation and amortization | 3.8 | | | 0.8 | | | 6.8 | | | 2.5 | |
Stock-based compensation | 14.8 | | | 12.7 | | | 42.8 | | | 30.7 | |
Transaction and integration costs (1) | 7.4 | | | — | | | 8.4 | | | — | |
Interest income (expense), net | (0.3) | | | — | | | (0.3) | | | — | |
Net investment income | (2.6) | | | (0.6) | | | (4.7) | | | (1.0) | |
Change in fair value of warrants liability | 0.3 | | | — | | | 0.3 | | | — | |
Adjusted EBITDA | $ | (65.7) | | | $ | (51.3) | | | $ | (173.4) | | | $ | (133.0) | |
(1) Includes $6.6 million of retention and severance costs, including $0.8 million of stock-based compensation, related to the Metromile Acquisition.
Liquidity and Capital Resources
As of September 30, 2022, we had $225.0 million in cash, cash equivalents and restricted cash and $835.9 million in investments. From the date we commenced operations, we have generated negative cash flows from operations, and we have financed our operations primarily through private and public sales of equity securities. On January 14, 2021, we issued and sold 3,300,000 shares of common stock, and generated net proceeds to us of $525.7 million after deducting underwriting discounts and other offering costs. On February 1, 2021, the underwriters exercised their option to purchase additional shares, which resulted in the issuance and sale of an additional 718,647 shares of common stock by us, and generated additional net proceeds of $114.6 million. Excluding capital raises, our principal sources of funds are insurance premiums, investment income, reinsurance recoveries and proceeds from the maturity and sale of invested assets. These funds are primarily used to pay claims, operating expenses and taxes. We believe our existing cash and cash equivalents as of September 30, 2022 will be sufficient to meet our working capital and capital expenditures needs over at least the next 12 months.
Our cash flows used in operations may differ substantially from our net loss due to non-cash charges or due to changes in balance sheet accounts.
The timing of our cash flows from operating activities can also vary among periods due to the timing of payments made or received. Some of our payments and receipts, including loss settlements and subsequent reinsurance receipts, can be significant. Therefore, their timing can influence cash flows from operating activities in any given period. The potential for a large claim under an insurance or reinsurance contract means that our insurance subsidiaries may need to make substantial payments within relatively short periods of time, which would have a negative impact on our operating cash flows.
We are a holding company that transacts a majority of our business through operating subsidiaries. Consequently, our ability to pay dividends to stockholders, meet debt payment obligations and pay taxes and operating expenses is largely dependent on dividends or other distributions from our subsidiaries and affiliates, whose ability to pay us is highly regulated.
Our U.S. and Dutch insurance company subsidiaries, and our Dutch insurance holding company, are restricted by statute as to the amount of dividends that they may pay without the prior approval of their respective competent regulatory authorities. As of September 30, 2022, cash and short-term investments held by these companies was $306.5 million.
Insurance companies in the United States are also required by state law to maintain a minimum level of policyholder’s surplus. Insurance regulators in the states in which we operate have a risk-based capital standard designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of the insurer’s assets and liabilities and its mix of net written premium. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. As of September 30, 2022, the total adjusted capital of our U.S. insurance subsidiaries was in excess of its respective prescribed risk-based capital requirements.
The following table summarizes our cash flow data for the periods presented:
| | | | | | | | | | | |
| Nine Months Ended September 30, |
| 2022 | | 2021 |
| ($ in millions) |
Net cash used in operating activities | $ | (134.4) | | | $ | (94.7) | |
Net cash provided by (used in) by investing activities | $ | 93.6 | | | $ | (807.1) | |
Net cash provided by financing activities | $ | 3.3 | | | $ | 649.0 | |
Operating Activities
Cash used in operating activities was $134.4 million for the nine months ended September 30, 2022, an increase of $39.7 million from $94.7 million for the nine months ended September 30, 2021. This reflected the $63.1 million increase in our net loss, primarily offset by increases in unearned premium, unpaid loss and loss adjustment expense and funds held that exceeded the increases in premiums receivable and amounts expected to be recovered from our reinsurance partners and prepaid reinsurance premium. The increase in cash used in operating activities from the nine months ended September 30, 2022 compared to the nine months ended September 30, 2021 was primarily due to claim payments, settlements with our reinsurance partners, and increased spend related to growth and expansion.
Cash used in operating activities was $94.7 million for nine months ended September 30, 2021. This resulted from our net loss of $171.0 million, partially offset by non-cash charges and net cash provided by changes in our operating assets and liabilities. Non-cash charges primarily consisted of non-cash stock-based compensation. Net cash provided by changes in operating assets and liabilities primarily consisted of increases in unearned premiums, unpaid loss and loss adjustment expense, funds held and accrued and other liabilities partially offset by increases in prepaid reinsurance, premiums receivables and amounts expected to be recovered from our reinsurance partners.
Investing Activities
Cash provided by investing activities was $93.6 million for the nine months ended September 30, 2022 primarily due to proceeds from sales and maturities and offset by purchases of U.S. government obligations, corporate debt securities, asset-backed securities, short term investments, cash from the Metromile Acquisition, and property and equipment purchased during the period.
Cash used in investing activities was $807.1 million for the nine months ended September 30, 2021 primarily due to purchases of fixed maturities and property and equipment.
Financing Activities
Cash provided by financing activities was $3.3 million for the nine months ended September 30, 2022 primarily due to proceeds from stock option exercises.
Cash provided by financing activities was $649.0 million for the nine months ended September 30, 2021 primarily due to proceeds received from our Follow-on Offering (as defined in Note 10 - Stockholders' Equity to the unaudited interim condensed financial statements included elsewhere in this Quarterly Report) and proceeds from stock option exercises.
We do not have any current plans for material capital expenditures other than current operating requirements. We believe that we will generate sufficient cash flows from operations to satisfy our liquidity requirements for at least the next 12 months and for the foreseeable future. There have been no material changes as of September 30, 2022 to our contractual obligations from those described in our Annual Report on Form 10-K. To the extent our future operating cash flows are insufficient to cover our net losses from catastrophic events, we had $1,060.9 million in cash and investments available at September 30, 2022. We may also seek to raise additional capital through pursuing third-party borrowings, sales of our equity, issuance of debt securities or entrance into new reinsurance arrangements. There can be no assurance that we will be able to raise additional capital on favorable terms or at all.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with GAAP in the United States. The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires our management to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the period. We evaluate our significant estimates on an ongoing basis, including, but not limited to, estimates related to unpaid loss and loss adjustment expense, reinsurance assets, stock-based compensation prior to the Company's initial public offering ("IPO"), income tax assets and liabilities, including recoverability of our net deferred tax asset, income tax provisions and certain non-income tax accruals. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.
Our critical accounting policies are described under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates” in our Annual Report on Form 10-K and the notes to the unaudited interim condensed consolidated financial statements appearing elsewhere in this Quarterly Report. During the nine months ended September 30, 2022, there were no material changes to our critical accounting policies from those discussed in our Annual Report on Form 10-K.
Recently Issued and Adopted Accounting Pronouncements
See “Note 4 — Summary of Significant Accounting Policies” in the notes to the unaudited condensed consolidated financial statements included elsewhere in this Quarterly Report for a discussion of accounting pronouncements recently adopted and their impact to our unaudited condensed consolidated financial statements.