Why Lemonade Stock Popped 12% in June

Shares of Lemonade (NYSE: LMND) stock jumped 12% in June, according to data provided by S&P Global Market Intelligence. The digital insurance start-up gave shareholders some good news about its reinsurance program.

A different kind of insurance company

Lemonade set out to disrupt insurance with artificial intelligence (AI) and machine learning long before they became today's catchphrases, and it's harnessing the technology to create a better insurance company.

Since it's just over a decade old, it's still building up its business. It's attracting new members at a rapid pace, cross-selling existing customers to bundles and new policies, and edging closer to profitability.

Image source: Getty Images.

Part of developing the business has been working with third-party reinsurers. Reinsurance programs work as "extra" insurance in the case of catastrophes, and in the past, Lemonade has ceded a high rate to its third-party partners to cover the extras. As its economics improve, it has been renegotiating the deals down so it keeps more of the good stuff while retaining the extra coverage.

This week, Lemonade said that its newest agreement cedes 18% of premiums, down from 20%, allowing it to keep more of the gross profit. The implications of that are clear: more of the premiums will flow to the bottom line without any other changes. At the same time, the new deal has even better coverage, plus a new partner, widening its reinsurance base. Altogether, management believes it's much better than its previous agreement, and it's easy to see why the market is giving this news a thumbs-up.

Profits on the horizon

Lemonade isn't profitable yet, but management has been guiding for positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) by the end of this year and positive net income next year.

In-force premium (IFP), the average total of premiums at a given time, and the top-line metric commonly used by insurance companies, has been increasing at an accelerated rate for 10 quarters already. Lemonade has a steady road to further growth as it rolls out new products in new regions and attracts new users. This has come at a price, though, in high rollout expenses.

However, accelerating IFP (and revenue) will start to cover more expenses, and AI is helping the company keep operating costs steady. As AI algorithms help reduce its loss ratio, it's also keeping more of each policy's premium. Adding the higher gross profit from its new agreements, it's likely to hit its goal of becoming profitable on an adjusted EBITDA basis, and the stock will reflect that.

Jennifer Saibil has positions in Lemonade. The Motley Fool has positions in and recommends Lemonade. The Motley Fool has a disclosure policy.