Lemonade - Q2 2024

Transcript

Operator (participant)

Hello and welcome everyone to the Lemonade Q2 2024 earnings call. My name is Maxine, and I'll be coordinating the call today. If you would like to ask a question, you may do so by pressing star followed by one on your telephone keypad. I will now hand you over to Yael Wissner-Levy, VP Communications at Lemonade, to begin. Yael, please go ahead when you are ready.

Yael Wissner-Levy (VP Communications)

Good morning and welcome to Lemonade's second quarter 2024 earnings call. My name is Yael Wissner-Levy, and I'm the VP Communications at Lemonade. Joining me today to discuss our results are Daniel Schreiber, CEO and Co-founder, Shai Wininger, President and Co-founder, and Tim Bixby, our Chief Financial Officer. A letter to shareholders covering the company's second quarter 2024 financial results is available on our investor relations website, investor.lemonade.com. Before we begin, I would like to remind you that management's remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the risk factors section of our 2023 Form 10-Q filed with the SEC on May 1st, 2024, and our other filings with the SEC.

Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligation to update them. We will be referring to certain non-GAAP financial measures on today's call, such as Adjusted EBITDA and Adjusted Gross Profit, which we believe may be important to investors to assess our operating performance. Reconciliations of these non-GAAP financial measures to the most direct comparable GAAP financial measures are included in our letter to shareholders. Our letter to shareholders also includes information about our key performance indicators, including customers, In-Force Premium, premium per customer, Annual Dollar Retention, Gross Earned Premium, Gross Loss Ratio, Gross Loss Ratio ex-CAT, and Net Loss Ratio, and a definition of each metric, why each is useful to investors, and how we use each to monitor and manage our business.

I'd also like to bring your attention to our upcoming Investor Day to be held on November 19th, 2024, in New York City. We will be providing detailed updates on our strategic expansion plans, operating efficiencies, and growth trajectory. Hope to see you there. With that, I'll turn the call over to Daniel for some opening remarks. Daniel.

Daniel Schreiber (CEO and Co-founder)

Good morning, and thank you for joining us to discuss Lemonade's results for Q2 2024. I'm happy to report continued, consistent, and strong progress across the board. Year-over-year, our top line grew 22%, our Adjusted EBITDA loss improved by 18%, and our gross profit grew by a remarkable 155%. Despite a quarter that saw elevated CAT losses across the industry, our loss ratio came in at 79%, improving 15 points year-over-year. This is no accident. We have been laser-focused on reducing CAT volatility by growing products with lower CAT exposure, notably pet and renters, geographic diversification of growth, including via Europe, where we recently launched homeowners insurance in the U.K. and France, continuing to sell Lemonade homeowners insurance in the U.S. only where our AI predicts attractive LTVs, and simultaneously placing some home premiums with third parties in select geographies.

Tellingly, our trailing 12-month gross loss ratio continued its decline for the fourth consecutive quarter, also hitting 79%. We think this number, in preference to the quarterly results, neutralizes some of the volatility and provides a more bankable indication of our ongoing performance. But whatever your preferred metric is, the picture that emerges is the same: great progress that enables us to deliver notably expanded gross margins. I'm also pleased to share that Q2 was net cash flow positive. We expect cash flow to be positive consistently from here on out, excepting only Q4 this year, where various timing issues will make that quarter a one-off exception. In any event, we don't expect our cash balances to decline by more than 1% or maybe 2% before climbing consistently. With these updates, we feel exceedingly well-positioned to continue investing in robust and profitable growth.

I also wanted to put a spotlight on our Giveback program for a moment. A couple of weeks ago, we announced our contribution of more than $2 million to 43 nonprofits around the globe, our eighth consecutive year of giving back to dozens of local and global charities chosen by our customers. Social impact is a core pillar of who we are at Lemonade. Our contribution since inception now exceeds $10 million, and this program reflects the collective power of the Lemonade community and its ability to drive meaningful change. It's something we're very proud of, and we know this is only the beginning. Next, I'd like to hand over to Shai to tell you more about our recent efficiency improvements unlocked via our technology. Shai.

Shai Wininger (President and Co-founder)

Thanks, Daniel. On the expense side, we've continued to deliver on our autonomous organization vision with remarkable stability. Our operating expense base, excluding growth spend, which is now financed via the Synthetic Agents program, was unchanged year-over-year. This underscores the scalability of our tech vision, which leads to measurable efficiency in our operations. This dynamic we're witnessing, robust, predictable IFP growth alongside an expense base that remains comparatively steady and even shrinks at times, isn't a short-term anomaly. We expect this trend to persist in the coming quarters and years as we approach sustainable profitability at scale. This trajectory is a testament to the power of our technology-first approach and our commitment to operational excellence. Investors and analysts often ask about the practical impact of our investments in building our own tech-based insurance tech. I believe our recent quarterly results clearly demonstrate that.

With large parts of our business running on code rather than people, I believe our tech obsession is paying off in a big way and helps separate us from incumbents in visible, measurable, and impactful ways. What we've achieved so far is just the beginning. Our team has been hard at work on our next-generation technology platform, codename L2, which is designed to bring step-change improvements to areas such as underwriting, insurance operations, compliance, and product development. With L2, we anticipate additional efficiency gains alongside acceleration of our product operations. These improvements should position us to adapt quickly to market changes, as well as capitalize on new opportunities, products, markets, and even business models. The potential impact of L2 extends beyond mere cost savings. It's about reimagining how insurance companies should operate in the AI era.

We look forward to sharing more about all this at our Investor Day, November 19th, in New York City. With that, let me hand it over to Tim to cover our financial results and outlook in greater detail. Tim?

Tim Bixby (CFO)

Great. Thanks, Shai. I'll review highlights of our Q2 results and provide our expectations for Q3 and the full year, and then we'll take some questions. Overall, it was again a terrific quarter, with results very much in line with or better than expectations and continued notable loss ratio improvement across the board. In-force premium grew 22% to $839 million, while customer count increased by 14% to 2.2 million. Premium per customer increased 8% versus the prior year to $387, driven primarily by rate increases. Annual dollar retention, or ADR, was 88%, up one percentage point since this time last year. Gross earned premium in Q2 increased 22% as compared to the prior year to $200 million, in line with IFP growth. Our revenue in Q2 increased 17% from the prior year to $122 million.

The growth in revenue was driven by the increase in gross earned premium, a slightly higher effective ceding commission rate under our quota share reinsurance, as well as a 45% increase in investment income. Our gross loss ratio was 79% for Q2 as compared to 94% in Q2 2023 and 79% in Q1 2024. The impact of CATs in Q2 was roughly 17 percentage points within the gross loss ratio, nearly all driven by convective storm and winter storm activity. Absent this total CAT impact, the underlying gross loss ratio ex-CAT was 62%, in line with the prior quarter and fully 10 percentage points better than the prior year. Prior period development had a roughly 3% favorable impact on gross loss ratio in the quarter. Notably, the CAT prior period development was about 2% unfavorable, while non-CAT was about 5% favorable, netting out to the 3% favorable impact.

Trailing 12 months, or TTM, loss ratio was about 79%, or 12 points better year-on-year and 4 points better sequentially. From a product perspective, gross loss ratio improved notably for all products, with year-on-year improvements ranging from 5%-30%. Operating expenses, excluding loss and loss adjustment expense, increased 13% to $107 million in Q2 as compared to the prior year. The increase of $12 million year-on-year was driven predominantly by an increase in gross acquisition spending within sales and marketing expenses. Other insurance expense grew 25% in Q2 versus the prior year, in line with the growth of earned premium, primarily in support of our increased investment in rate filing capacity. Total sales and marketing expense increased by $12 million, as noted, or 48%, primarily due to the increased gross spend, partially offset by lower personnel-related costs driven by efficiency gains.

Total gross spend in the quarter was about $26 million, roughly double the $13 million figure in the prior year. We continue to utilize our Synthetic Agents growth funding program and have financed 80% of our gross spend since the start of the year. As a reminder, you'll see 100% of our gross spend flow through the P&L as always, while the impact of the new growth mechanism of Synthetic Agents is visible on the cash flow statement and balance sheet. And the net financing to date under this agreement is about $44 million as of June 30. Technology development expense declined 12% year-over-year to $21 million, due primarily to personnel cost efficiencies, while G&A expense also declined 3% as compared to the prior year to $30 million, primarily due to both lower personnel and insurance expenses. Personnel expense and headcount control continue to be a high priority.

Total headcount is down about 9% as compared to the prior year at 1,211, while the top line IFP, as noted, grew about 22%. Including outsourced personnel expense, which has been part of our strategy for several years, this expense improvement rate would be similar. Our net loss was a loss of $57 million in Q2, or $0.81 per share, which is a 15% improvement as compared to the second quarter a year ago. Our adjusted EBITDA loss was a loss of $43 million in Q2, a roughly 18% improvement year-over-year. Our total cash, cash equivalents, and investments ended the quarter at approximately $931 million, up $4 million versus the prior quarter, showing a nice positive net cash flow trend in the quarter. This positive net cash flow contrasts markedly with a net use of cash of $51 million in the same quarter in the prior year.

With these metrics in mind, I'll outline our specific financial expectations for the third quarter and full year 2024. Our expectations for the full year remain unchanged as compared to our guidance on our Q1 earnings call. As has been the case in some prior years, there's a notable seasonal difference in our expected results in Q3 and Q4. Specifically, Q3 is typically our highest gross spend quarter, which tends to drive up sales and marketing spend, and also typically a higher expected loss ratio as compared to Q4. Our third quarter guidance and our implied Q4 guidance reflect these seasonal themes. From a growth spend perspective, we expect to invest roughly $25 million more in Q3 as compared to Q3 in the prior year to generate profitable customers with a healthy lifetime value.

At the same time, we will be proactively non-renewing customers with unhealthy lifetime value, specifically certain CAT-exposed homeowners policies. As our AIs have become increasingly good at identifying such policies, and as our latest underwriting rules have been approved by regulators, we now have the ability to identify older policies that we wouldn't write today. We expect this to remove between $20 million-$25 million of IFP from our book in the second half of 2024, dampening growth in the immediate term while concurrently boosting cash flow and profitability in the medium term and further reducing CAT volatility. Importantly, though, our IFP guidance for the year reflects these plans and remains unchanged.

For the third quarter of 2024, we expect in-force premium at September 30 of between $875 million-$879 million, gross earned premium between $208 million-$210 million, revenue between $124 million-$126 million, and an adjusted EBITDA loss of between $58 million-$56 million. We expect stock-based compensation expense of approximately $16 million, capital expenditures approximately $3 million, and a weighted average share count for the quarter of approximately 71 million shares. For the full year of 2024, we expect in-force premium at December 31 of between $940 million-$944 million, gross earned premium between $818 million-$822 million, revenue between $511 million-$515 million, and adjusted EBITDA loss of between $155 million-$151 million. We expect stock-based compensation for the full year of approximately $64 million, CapEx of approximately $10 million, and a weighted average share count of approximately 71 million shares.

With that, I'd like to hand things back over to Shai to answer some questions from a few of our retail investors. Shai?

Shai Wininger (President and Co-founder)

Thanks, Tim. We'll now turn over to our shareholders' questions submitted through the Say platform. I'll start with Matthew H. who asks, "How are we leveraging AI technology to improve underwriting, claim processing, and overall customer experience? And are there any major business risks or challenges to further leveraging AI?" Thanks, Matthew. We've spoken about this at some depth in prior shareholders' letters. As I shared in the past, we're well on the way to leverage AI at every stage of the customer journey, as well as in many areas of our internal operations. We do that to drive efficiency, improve our underwriting, and enhance customer experience with fast and always available smart service. Our underwriting, customer service, and claims management, even employee management, administration, engineering, product operations, all use AI heavily.

As an example, in just over a year, we've went from a standing start to having a comprehensively rolled-out Generative AI platform to handle incoming customer communications. We handle email and text communications coming in, and we're now handling more than 30% of these interactions with absolutely no human intervention. Progress to date is the tip of the iceberg, though, and I expect us to continue to focus on additional applications of these technologies, delivering concrete measurable impact to the business and helping us widen the gap between our tech and the competitions. Nomi K. asks if we can share the performance metrics and customer feedback from states where all five of Lemonade's insurance products are available, and what are the main challenges or limiting factors preventing a broader rollout to additional states, and how do we plan to address these. So thank you, Nomi.

The specific order of state expansion is generally based on growth potential and expected profitability in those markets, as well as prioritization aspects that have to do with focus and resource allocation. We expect cross-selling activity to be an increasingly powerful driver of growth as a result. In Illinois, for example, where we have all of our products available, we're seeing multi-line customer rates that are roughly double the rest of the book. We also see other metrics improve, such as superior retention rates after bundling and outstanding customer feedback as measured by NPS. There were several questions about car rollout timing and expectations, and I'll just say that the organization is rallying around car in a remarkable way, and we're expecting the growth rate of car to begin accelerating in the near future as a result.

We plan to rollout car to several additional states during 2025, with our main considerations being profitability predictions and regulatory approval rates. We aim to operate first in states where we can move quickly and write new business profitably. In the second half and beyond, with the unlock of rate adequacy in multiple geographies, we'll be expanding investment in new customer acquisition, as well as cross-selling to our existing user base. Now I'll turn the call back to the operator for more questions from our friends from the street.

Operator (participant)

Thank you. If you would like to ask a question, you may do so by pressing star followed by one on your telephone keypad now. If you do change your mind, please press star followed by two. When preparing to ask your question, please ensure that your line is unmuted locally. Our first question today comes from Jack Matten from BMO. Please go ahead, Jack. Your line is now open.

Jack Matten (VP of Equity Research)

Hey, good morning. Just wondering if you could provide some more details on the non-renewals of the CAT-exposed home business and which states your actions primarily taking place and other particular years of business that you're focused on. I guess, in general, if you talk about any insights that you've learned from your more recent models that led to your decision.

Daniel Schreiber (CEO and Co-founder)

Yeah, so a couple of thoughts there. In terms of the distribution across states, it's really more of a it can be concentrated in states. It's really focused tends to be focused more on expected lifetime value, which tends to be quite driven by a higher-than-target loss ratio that tends to be concentrated within the home book almost entirely, which is the most challenging loss ratio we have. So we talked a little bit about in the letter the range that we're targeting, which is 20-25. We talk about a range because it's not a hard number, but it's based on what we know. As we're kind of developing that analysis, that feels like the most appropriate range.

Important to note that while it puts downward pressure on IFP growth, because all of our every customer kind of adds up to that total IFP number, from a cash perspective or a value perspective, it's got a very high ROI. We're taking out much more expected cost than we are taking out contribution from the premium. So it's definitely ROI positive. So if you take out, for example, $25 million of IFP with an elevated loss ratio, you can generate, just using our own models, something like $50 or $60 million in net positive value. So a little short-term pressure on IFP, but over the medium term, long-term value. In terms of time frame, these tend to be older policies. So our underwriting rules and our AI models get a little bit better every day.

And so the concentration tends to be business we wrote 2, 3, or 4 years ago in some cases. And as noted, the vast majority, if not 100% of this business would be business we wouldn't write today under our current underwriting guidelines.

Jack Matten (VP of Equity Research)

That's helpful. Thank you. The second question's on capital. Can you talk about the premium-to-surplus ratio that Lemonade expects to maintain as your business mix evolves? I guess somewhat relatedly, it looks like your invested asset balance has been falling in recent quarters. Is that something that the company expects to continue doing moving forward? I think you're trying to get some insights into that investment income. Thank you.

Tim Bixby (CFO)

Sure. So on the capital surplus, we've not talked about that for a while because things are essentially unchanged. Our target is and continues to be a roughly 1:6 ratio of required surplus to gross earned premium. And we've got at least a couple of very effective tools in place to help us drive that number to what is arguably sort of best-in-class in the industry. This is what many insurance companies shoot to do. And I think we're performing quite well on that metric. Our quota share structure, our Cayman Captive structure, these are really designed not only to mitigate volatility, but more importantly, to drive to enable significant capital surplus efficiency. So that's really unchanged at that 1:6 ratio. From a cash investment standpoint, yeah, you will note if you kind of chart it out that the cash balance has increased somewhat as a percentage of the total.

That's not so much a concerted strategy. I would expect that trend to moderate or even flatten out before too long. However, the interest rate environment is what it is. We're expecting what you and others are expecting in the market, that there will be perhaps more downward pressure on interest rates than upward pressure. And we've factored in sort of the most current forecasts into our guidance in terms of what expected investment income is likely to be. The good news is our cash investment balance actually went up this quarter in total. We're earning really strong returns on the cash as well as the investments. And so that's something that I would highlight. We foresee that cash investment balance basically troughing. It might drop another 1 or 2%, as you noted.

But that puts us well above a $900 million total cash investment balance from here on out, as far as we can see. Compare that to three or four years ago when there was quite a bit more uncertainty as to our growth trajectory and where that balance might end up. That's a dramatic change, and I think probably has a tremendous foundation for us going forward.

Jack Matten (VP of Equity Research)

Thank you.

Operator (participant)

Thank you. The next question comes from Michael Phillips from Oppenheimer. Please go ahead, Michael. Your line is now open.

Matthew O'Neill (Managing Director and Co-Director of Research)

Thank you. Good morning, everybody. A question first on auto and kind of follow-up from the opening comments about some new state expansions as you get into next year. The last count I had, I think you were 11 states. I'm not sure if that's still right. As you look out over the next maybe 18 months, given kind of the decent rate environment for auto, it might be slowing down. But should we expect state expansion by, say, year in 2025 to be close to like 20 states or 40 states, or just kind of how aggressively do you want to be over the next 18 months?

Daniel Schreiber (CEO and Co-founder)

Hey, Mike. No, I don't think we'll be at 40 states. And of course, to state the obvious, not all states are born equal. So we will be expanding throughout 2025. We haven't given specific numbers, and so my answer today is going to remain a little bit vague still. One of the driving factors is going to be the graduation of renters to be car customers. So we will be looking at one of the guiding principles Shai spoke about, regulatory environments and predictive loss ratios. Another one is where we have the largest footprint of renters who have cars but don't have car insurance with us. And that would be another driving force. But we're not ready to disclose numbers of states yet.

Matthew O'Neill (Managing Director and Co-Director of Research)

Okay. I can appreciate that. Thanks, Daniel. I guess continuing with that, maybe a follow-up on that is typically as we're growing in new states, there can be some pressure on our margins in auto. Maybe for you guys, I guess I want to see what do you think that might be a bit muted than what normally is the case, given I think you've talked about knowledge that you have from your current renters and homeowners customer base and how that can translate into more information in your initial pricing for auto as that starts to grow?

Daniel Schreiber (CEO and Co-founder)

Yeah. Look, we are. I've talked about this before, but we are very bullish in the medium to long term on car. We think it's a highly differentiated product with a strong and structural competitive advantage given that at first approximation, all our customers use telematics on an ongoing basis, whereas at first approximation for the incumbents, that's none or zero. So this is really a very powerful differentiator, quite besides or in addition to the fact that we have a really spectacular user experience, very high customer satisfaction levels, etc. Going back to my comment earlier about the renters aspect here, yes, we are seeing that renters who buy car insurance have a much, to use your word, muted loss ratio. In fact, their whole economics are dramatically different. The cost of acquisition is effectively zero.

You might even conceive of it as being negative CAC because our renters book is very profitable. And then we've got existing customers who ostensibly have paid to be Lemonade customers, but they are profitable at the outset. And then we get to sell them a car policy with no incremental costs. Again, I'm rounding here, but I think at first approximation that holds true. And we have found them to be not only highly profitable because of the absence of any customer acquisition costs, but much better because we do use the factors that you said, much better risks. So we can price them effectively. We don't see the new business penalty that you see when you usually grow a book. So very, very different unit economics and lifetime value of existing customers.

This is really, I think, a strategic pillar that we will expand on during our Investor Day as well later in the year. We do have over 2 million existing customers, many of whom have car insurance, just not with Lemonade. And that opportunity translates into very, very sizable, and ultimately, we expect a very profitable opportunity for us.

Shai Wininger (President and Co-founder)

Probably also worth noting that the external environment is improving as well. So for some time, we and other car providers were chasing a target with inflation's unfavorable impact on cost of repairs and cost of claims. The data is now really showing that that trend has slowed, if not stalled, and in some cases may even reverse. And so chasing that target is now much the impact of our rate increases, both those already in place and those we're continuing to work on, have an even greater impact. And that really provides a higher level of confidence, comfort in our planning for car for the rest of this year and well into next year as well. We noted that our gross loss ratio improvement across our product lines improved anywhere from 5%-30%. Car was right at the upper end of that range.

Matthew O'Neill (Managing Director and Co-Director of Research)

So we're seeing lots of great indicators. Yeah, perfect. Okay. Great. Thank you, guys. Appreciate it.

Operator (participant)

Thank you. The next question comes from Tommy McJoynt from Stifel. Please go ahead. Your line is now open.

Tommy McJoynt (Director of Equity Research)

Hey, good morning, guys. Thanks for taking my questions. Tim, kind of going back to the first question that you got on the non-renewal side. So you mentioned the $25 million of non-renewed IFP, and that's going to be offset by, it sounded like, I think you said $50 million-$60 million of sort of net positive value. Let's call it $50 million. Sorry. Is that saying that the LTV of those policies, instead of being presumably positive when you wrote it, is now being sort of reassessed at negative $50 million? And hence, by not writing non-renewing that business, it will now be zero? Just kind of help explain sort of what that $50 million-$60 million number that you mentioned actually is.

Tim Bixby (CFO)

Yeah. Yeah. In rough strokes, the way you described it is right. So if a customer has an expected lifetime value, let's say, of 3x its acquisition cost, which is often typical for us, that means over the course of their lifetime, 2, 3, 4 years, depending on the product or more, we expect to generate that incremental cash flow or value. What this says is we expect that lifetime value to be a negative $50 million or $60 million in the case I described for an IFP. So think of that ratio as sort of a negative 2:1 ratio. And it's really almost entirely driven by the elevated loss ratio. If a customer has an expected 150% loss ratio, for example, and you carry that customer out for a couple of 3 years or more, that's the driver. So I think you have the analysis right.

It's rough justice, but it's notably positive ROI for those changes.

Tommy McJoynt (Director of Equity Research)

Okay. Got it. And do you know what the impact on the loss ratio from that sort of $25 million IFP was in the first half of the year or even in absolute dollars, kind of how much sort of operating loss that business generated, contributed?

Tim Bixby (CFO)

Hard to really put a precise number on that. I would think of that range of 20-25 as over the course of the year, the vast majority in Q3 and Q4. So it's really a forward-looking number and expected impact. We had started the process. There was a nominal amount in Q2, but I would say it probably rounds to pretty close to zero. So it's really a Q3, Q4, and forward expectation. A little more concentrated in Q3 than Q4. Our loss ratio has borne the burden of that business. And so it's really notable, I think, that our loss ratio improved mid-double digit year-over-year with some of that downward pressure. And so all of these changes, not just rate changes, will have a continued favorable impact on the loss ratio going forward.

Daniel Schreiber (CEO and Co-founder)

Can I just add?

Sorry, just one other kind of vantage point of color. And to mention this briefly in his comment, this is really a homeowners-focused fix. It's the one part of our business that has had pockets of sustained negative LTV. And in addition to being negative in LTV, there've also been environments that oftentimes we could not get the rate approval. In theory, any risk can be priced adequately, but we don't always find regulators affording us that luxury. So this is parts of the business where we just were not able to get the approvals and don't expect to in any fashion. Otherwise, we would have been kind of shown more forbearance if we thought it's on the cusp of turning profitable. But in addition to being stubbornly unprofitable, it also tends to concentrate very much in volatile parts of the country.

So even some of this business where we to get to long-term average profitability, we've always sought to avoid the most CAT-exposed part of our business, of the country, rather, sorry. And we have avoided writing in the most CAT-exposed places really since our inception, in places where we have still found that the volatility is higher than we want now, knowing what we know. We're also taking this opportunity to non-renew that part of the business.

Tim Bixby (CFO)

And maybe just to put a fine point on it, based on a couple of questions I've gotten already, I'll answer a question that has not been asked, which is if this number is 25 as we expect it to be, the question might be, would your IFP expectations have been $25 million greater? If not, for the impact of this, the answer is yes. Yes.

Tommy McJoynt (Director of Equity Research)

Okay. Got it. Appreciate that color. And then just quickly, you mentioned the expectations for growth spend in 3Q to be $25 million up year-over-year. Did you give a 4Q number, or do we have the full-year kind of expectations?

Tim Bixby (CFO)

Yeah. I would think of the full year as really unchanged. The timing over the course of the quarters has changed somewhat. The guidance we gave historically is sort of between 100 and 110, 105 is the number we mentioned. So I think we're still sort of on track and planning to spend that rough amount over the course of the full year. We have adjusted the timing of that somewhat, a little bit more than initially planned in Q3 than otherwise. Q3 is typically the highest gross spend quarter in any case in most years. And the fourth quarter, obviously, if you kind of do the math, will be somewhat elevated as well. Q1 was really the ramp-up quarter. And so it's a pretty steep climb. And we expect Q3 to be at the rate we disclosed.

Tommy McJoynt (Director of Equity Research)

Got it. Thanks.

Operator (participant)

Thank you. The next question comes from Bob Huang from Morgan Stanley. Please go ahead, Bob. Your line is now open.

Bob Huang (VP and Research Analyst)

Great. Thank you. So the first one is on your 17 points of improvements in CAT losses, which was, I mean, sorry, 17 points of impact on CAT losses, which is a 5-point improvement. Directionally speaking, that's obviously similar to the industry. As you non-renew the homeowner side, is there a run rate expectation on what CAT losses should look like going forward? Can you give us a little bit more color on just how we should think about that impact? I know that you already talked about quite a bit on the impact on the other side of things on the homeowner renewal, just to see if there's any additional color on the CAT side.

Tim Bixby (CFO)

That's probably a little bit beyond some of the guidance we've given. I can give a little bit of the way you might think about it. Our home business as a share of the total business is coming down as a percentage, but just modestly. I think it came in the quarter, and this is home and condo combined, came in about just under 20%, and it's down a couple of points year-on-year. And so you can kind of back into if we were to take $25 million of IFP out, back into what that impact might be. In terms of a specific reduction on loss ratio, it's a little tricky to do that. I'm not going to venture that far, but CAT is really isolated almost entirely to home, not quite 100%, but primarily home.

Really, these are the most challenging policies, obviously, that we'll go after. I'll leave it to you to kind of do some math, but that's how I would go about it.

Bob Huang (VP and Research Analyst)

Okay. Maybe second one on just how we should think about ceding commission. So if we look at a ceding commission as a percent of premium, last call it 5 quarters, it's generally about 20%. This quarter was notably lower than that. Is this more of a one-time thing? What's driving that? And should it go back to about 20% of premium going forward?

Tim Bixby (CFO)

Yeah. So a couple of ways to think about the ceding commission. So year-on-year, there is a change because there was a change in the structure. The prior year was a fixed structure up through July renewal a year ago. And so you saw on the face of the P&L, roughly a 20% effective commission. Now, our commission, because of the way we do the accounting, it's split into two pieces. So our effective commission rate was running about 23%. But the most important thing was it was static. It was a fixed number. That's now variable. That's helpful in some ways, but a little trickier when you're building a model. But the net difference over, I think one way to think about it is look at Q1 and Q2. The net commission was about 18% versus 20%, so modestly lower, but just by a couple of points.

But more volatility, more variability. So Q1 was a fair bit lower. Q2 was higher. We'll continue to see that move around a little bit quarter to quarter, but that gets trued up as you go through the course of the year. So I would expect we'll give as much of an indication on that as we can, but I would think of it as a couple of points lower than prior year. But there are some offsets to that as well. Our renewal this year was similar. It is also a sliding scale that begins this month again in July. But the scale and the expected effective rate will actually be a little bit better. At this point, it's hard to say if it gets back to the prior level, but it should be up maybe a point or two on any sort of apples-to-apples comparison.

Slightly better terms in this renewal.

Bob Huang (VP and Research Analyst)

Got it. Very helpful. Thank you very much.

Operator (participant)

Thank you.

Tim Bixby (CFO)

Probably also worth.

Another question from Tim.

Also, probably also worth answering another. I like answering questions that weren't asked, so I'll throw in another one, which is because a loss ratio varies, obviously, quarter to quarter, the typical pattern has been a Q4 loss ratio that's the lowest of the four quarters. That's happened often in prior years. We expect it will happen this year. If that plays out as expected, that has a pretty strong favorable impact on that commission rate. So again, a little more volatile quarter to quarter, but if things play out as expected and as historical patterns, you'd see a nice favorable impact. Over the course of the year, it gets us back on track versus some of the prior quarters; it can be a little bit lower commission rate.

Operator (participant)

Thank you. The next question comes from Matthew O'Neill from FT Partners. Please go ahead, Matthew. Your line is now open.

Matthew O'Neill (Managing Director and Co-Director of Research)

Yeah. Thank you so much for taking my question. I just wanted to ask a little bit about premium per customer. It's been growing impressively, but the rate may be decelerating slightly. So I was just curious if you could give us an assessment of kind of how far through the rate increases you are on the in-force book?

Tim Bixby (CFO)

Yeah. So that can vary quarter to quarter. It has been a pretty steady contributor, but our customer count was a stronger contributor to growth this year, quarter-over-quarter, than the price increase. It varies by product. So as I mentioned, in car, you're seeing a pretty dramatic impact. In rent, much less so because it's really so optimized. The loss ratio is such a strong loss ratio as it is, and pricing is quite good. So it varies by product. In terms of where we are, I think two or three quarters ago, we mentioned that we were sort of halfway through. There was $100 million or so remaining to earn in. That's more or less unchanged because the pace of us earning in rate and the pace of us filing for new rates has been roughly in balance.

I think of us in a similar spot now where there's still plenty of rate to earn in. Obviously, that doesn't last forever. There will always be rate filings and always increases, even in a low or no inflation environment, but we're quite a ways away from that. That is factored into our Q3, Q4 guidance that that will continue to earn in in-force base. And it will go into next year. Things that are approved and in place will earn well into next year.

Matthew O'Neill (Managing Director and Co-Director of Research)

Thanks. That's very helpful. Maybe just a quick one, and I realize I may be jumping the gun on potential Investor Day content, but I know you've spoken about the long-term or ultimate target for the loss ratio in the high 60s-70s. I don't know if there's kind of an internal or a way to think about the ultimate target for the expense ratio going forward.

Daniel Schreiber (CEO and Co-founder)

Matthew, hi. So we are determined to have an expense load that will be absolutely best in the industry. We're beginning to look less at ratios because we also intend to be a price leader. That might not give you as clear a picture of just how advantaged we think we're becoming due to our technology. It will reflect itself in, I think, best-in-class expense ratio and even more dramatically in actual expense load.

If you kind of put it on an apples-to-apples basis with the same premium that's being charged by competitors, it would manifest itself more powerfully still than when you look at it against our own lower premiums because we think we get to pass some of those savings onto our customers, and that can accelerate growth, accelerate retention, lower cost of acquisition, and allow us to achieve our ultimate and rather ambitious goals for the company. But if I answer your question kind of more straightforwardly, we think that at scale, we will be in the teens. We disclosed last quarter that the LAE component of our expense stack has already achieved parity with the very best in the industry. We reported a 7.6% LAE last quarter. Shai mentioned some of the efficiencies that we're gaining through automation, and we're really seeing these roll out very, very powerfully.

Some of the numbers that we shared earlier about what's happened to our headcount expense, what's happened to our what we're calling IFP per human, how many people we've needed to as we've doubled our book, we've been able to over the course of the last few years, we've been able to halve the ratio of people needed to generate every dollar of premium. So we're seeing very dramatic advancements, all of which will ultimately reflect themselves in our competitive expense structure, some of which will manifest as lower prices and some of which will manifest, we believe, still as best-in-class expense ratio. That said, I'll add that, and there was reference to this in the letter as well. We think of, for structural reasons that may be obvious and some that are less than obvious, we think of growth as the gift that keeps on giving.

We really think that the numbers that I just gave and the direction that I just outlined will become. At the moment, you can look at various numbers and see it in action, and I referenced a few of them. I think a few years from now, it will be unmissable. It will be kind of glaringly obvious. The difference between now and then is that we'll continue to grow. As we continue to grow, as we've doubled our business while holding our expense structure flat, we kind of shared that over the course of the last few years. We've seen our expense net of customer acquisition actually decline, even as we've enjoyed rapid growth. Play that movie forward, holding expenses relatively flat, and you really start seeing how this generates a very, very profitable business.

But that dynamic will continue to manifest with ever greater force as we continue to grow. So when we double our business, you will see it with greater clarity. When we 10x our business, I would say it will be glaringly obvious.

Matthew O'Neill (Managing Director and Co-Director of Research)

Thank you for that detailed answer. Really helpful. I'll jump back in the queue.

Operator (participant)

Thank you. The next question comes from Yaron Kinar from Jefferies. Please go ahead. Your line is now open.

Speaker 9

Hi guys. Good morning. This is Charlie on for Yaron. A couple of questions. The first one, with the decision to non-renew certain CAT-exposed homeowners, was that previously contemplated in guidance?

Tim Bixby (CFO)

No.

Speaker 9

Okay. Thanks. And then are you guys able to give us CAT prior year development and LAE on a net basis?

Tim Bixby (CFO)

The prior period development, you can split into two pieces. It was 3 points favorable. It was 2 points unfavorable from a CAT perspective and 5 points favorable from a non-CAT perspective. Netting out to the 3 favorable.

Speaker 9

Okay. Sorry. And just to clarify, was that gross CAT or net CAT impact?

Tim Bixby (CFO)

That is gross.

Speaker 9

Gross. Okay. And are you guys able to give it net?

Tim Bixby (CFO)

Yeah. And then that breakdown would be roughly similar on a net basis, the prior period development. The total CAT impact on a net basis was about 15 points, whereas on a gross basis, it was about 17 points. LAE came in about 8%. It's been mid-sevens, edged up a little bit, but in that sort of 7%-8% range, but at 8% this quarter.

Speaker 9

Okay. Great. Thanks. And then last one, if I could. Just looking at the underlying loss ratio, it looks like contemplating those components, you guys saw about 22 points of underlying improvement. But if we look at the first quarter of 2024 on a year-over-year basis from first quarter of 2023, it looks like it was relatively flat. Is there anything underlying that that you guys could provide some color on?

Tim Bixby (CFO)

Pretty distinct quarters. Yeah. On a full quarter basis, it was pretty stable. I think it's really important to look at the year-on-year comparison from a seasonal perspective. And on a trailing 12-month basis, obviously, continued significant improvement. Any given comparison of quarters, you might see some trends that are interesting, but not necessarily indicative of the longer-term trend. So nothing in particular to call out that was distinct between Q1 and Q2. Q2 was a really interesting quarter as it evolved, really significant impacts early in the quarter and really dramatic favorable outcomes by the end of the quarter, netting out to what ended up to be a quarter that was even better, just modestly better than our expectations. So the months can be pretty unpredictable, but the quarters are a little more predictable.

Speaker 9

All right. Great. Thank you guys for the answers.

Tim Bixby (CFO)

Thank you.

Operator (participant)

Thank you. As a final reminder, if you would like to ask a question, you may do so by pressing star followed by one on your telephone keypad now. We have a follow-up question from Bob Huang from Morgan Stanley. Please go ahead, Bob. Your line is now open.

Bob Huang (VP and Research Analyst)

Hi. Thanks for this. Just maybe a follow-up on the PYD question. Five points are favorable on everything else and two points are unfavorable on the CAT PYD. On the five points, can you give us maybe a little bit more color on the geography of those? What are those five points coming from, if possible? Sorry if I missed this a little earlier.

Daniel Schreiber (CEO and Co-founder)

We did not. So it's a little more concentrated in the pet product, but it was distributed across products other than home. The CATs are primarily a home dynamic, and the increase was driven by those really significant storms from a year ago and a bit earlier this year that have evolved, continued to evolve. But the underlying favorable development, I think, is really testament to the non-CAT portion of the business, which is really all the product lines other than home.

Bob Huang (VP and Research Analyst)

Okay. So basically, CATs was unfavorable and dogs were favorable. Thank you for that. That's very helpful. On the other one, maybe on the LTV to CAC side, I know that you talked about previously you kind of mentioned LTV to CAC was about 3x. And that would be the ratio. And then I think one thing we're trying to figure out is that if you have these homeowners non-renewal going forward, is that 3x LTV to CAC equation still holds? How should we think about that renewal impact on the LTV to CAC?

Tim Bixby (CFO)

Yeah. So LTV to CAC is an important metric, but it's a forward metric. It's based on a model. It's based on all the information we collect. It improves a little bit every day, every week, every month as we go forward. And so when we acquired that business, when our models were by definition less sophisticated than today, 2, 3, 4 years ago, we expected those to be profitable customers. As we learn more in our models and our existing customer base and claims activity, invariably, a certain portion of the customer base, their expected LTV will change. For newly acquired customers, there is no change. So we expect customers we acquire today and tomorrow to be fully profitable. We've seen a ratio greater than 3:1.

3:1 is a good rule of thumb, but we've seen certainly periods where it's 3.5 or 4 or more. There tends to be a little bit more pressure when you spend more. So we're spending double today what we spent a year ago, and so that tends to put downward pressure on LTV to CAC. But that's a good thing. We earn our way in, and we develop channels, and we expand our spending. And overall, 3 to 1 is a good metric to think about. I'll add one other comment in that area, which I think is helpful, which is LTV to CAC is kind of policy-by-policy focused. And if you look at our spending per net added customer, you might think things got more expensive for us in the quarter.

And while that exact math is correct, it's important to look at IFP. Net added IFP, gross added IFP really is what we're acquiring with that CAC spend. And by that measure, we were actually more efficient in the second quarter than we were in the year-ago quarter and even in the prior quarter. So all around, that number is stable, and that's what's enabling us to really say we're very comfortable with growth rates that are accelerating. We started out the year in the low 20s, going to the mid-20s, and now we're pushing towards the high 20s growth rate. And that's the core driver for that.

Daniel Schreiber (CEO and Co-founder)

Maybe I'll just add something.

Bob Huang (VP and Research Analyst)

Okay. Thank you very much.

Daniel Schreiber (CEO and Co-founder)

Comment on color commentary as well. LTV to CAC, you always want it to be as high as possible per customer, but truly you want to keep growing until you hit the marginal customer with the LTV equals CAC. In other words, if you could spend $1 and get $1.10 instead of getting $3, that is still marginally good for the business. You're still growing a profitable business. And since our LTV calculations take on board the time value of money that's already factored in at a fairly robust discount rate. So while our LTV to CAC is 3, that's our average. We have many higher customers than that. We acquire many customers in the double digits of LTV to CAC as well. When we'll stop investing is when we hit the marginal customer who's closer to an LTV to CAC of 1.

We take a bit of a margin of safety, but conceptually, that is the philosophy. We want every marginally profitable customer. We want them, and we will continue to grow using that. We have never deviated from that. We have never tried to acquire customers of a negative LTV. Sometimes we find this confusing to some investors because in the short term, the customer acquisition can impact our financials negatively in the short term. The year in which you spend that CAC, because we are not an agent-based business and we take all our pain upfront, we earn it back over time. Therefore, when we grow, sometimes it can appear to be a near-term loss, but that is just the nature of the flow of time. Fundamentally, it's about spending a dollar now and getting $3 back in today's terms.

If that means that in the near term we take a hit to our EBITDA, we're okay with that. We don't take a hit to our cash because we've got our Synthetic Agents program in place. So we've neutralized the trough in terms of the cash, in terms of EBITDA, those things will work their way out during the course of the lifetime of the customer. At any rate, because of that, we have always sought to grow customers on an LTV to CAC basis, never acquiring knowingly negative LTV business. Over the course of the last couple of years, with inflationary pressures and others, larger swaths of the nation and of our portfolio were hard to grow in an LTV positive environment. We've spoken about that, and we've slowed our growth, which we're now re-accelerating.

Much of those segments of our business have become profitable over time as we got to a rate adequacy. We've spoken about this. We were able to recover them back to where we thought they would be all along. What we're talking about today for the first time is that in addition to being conservative and careful and never knowingly writing negative business and proactively working to bring back into profitability any business that fell out of it and largely succeeding, we're also not tolerating business that has fallen between the cracks and we've not been able to bring back to profitability. So not only are we not writing knowingly unprofitable business as we never have, we are now not renewing such business either, having in some places exhausted in the near term what rate can deliver. Therefore, the philosophy is the same philosophy.

The profitability focus of the business has been the same consistently, but now we're actually not merely slowing down in places that aren't profitable, but even potentially going into reverse in pockets that don't contribute. And Tim's earlier comment that yes, you may see a potential hit of $25 million to IFP with reiterated guidance. We think we're going to manage that within the guidance already given. So we think that we're over-delivering for the year, and we have that spare to be able to hit guidance notwithstanding this. So you won't see a hit to the IFP, but it could have been much higher, as Tim said. But we've always been focused not merely on growing IFP, but in growing the total value of the book.

This really is a boon to that, as Tim said, $50 million-$60 million of LTV added to our business because of this decision.

Bob Huang (VP and Research Analyst)

Okay. Thank you very much. Really appreciate it.

Operator (participant)

Thank you. That was our final question for today. This does conclude today's call. Thank you all for joining. You may now disconnect your line.