Earnings Call Transcript
Lemonade, Inc. (LMND)
Earnings Call Transcript - LMND Q3 2025
Operator, Operator
Good morning, and thank you for joining the Lemonade Q3 2025 Earnings Call. My name is Brika, and I will be your moderator today. I will now pass it over to the Lemonade team to get started.
Unknown Executive, Unknown
Good morning, and welcome to Lemonade's Third Quarter 2025 Earnings Call. Joining us on our call today, we have Daniel Schreiber, CEO and Co-Founder; Shai Wininger, President and Co-Founder; and Tim Bixby, Chief Financial Officer. A letter to shareholders covering the company's third quarter 2025 financial results is available on our Investor Relations website at lemonade.com/investor. I would like to remind you that management's remarks made on this call may contain forward-looking statements. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in our letter to shareholders and the Risk Factors section of our Form 10-K filed with the SEC on February 26, 2025. 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, including adjusted EBITDA, adjusted free cash flow and adjusted gross profit, which we believe may be important to investors to assess our operating performance. Reconciliations of our non-GAAP financial measures to the most directly comparable GAAP financial measures are included in our letter to shareholders. Our letter to shareholders also includes information about our certain performance metrics, a definition of each metric, why each is useful to investors and how we use each to monitor and manage our business. With that, I'll turn the call over to Daniel for some opening remarks.
Daniel Schreiber, CEO
Good morning, and thank you for joining us to review Lemonade's results for Q3 '25. I'm happy to report another very strong quarter. Our in-force premium grew to $1.16 billion, marking our eighth consecutive quarter of accelerating growth. Our revenue was up 42% year-on-year, while our in-force premium enjoyed 30% growth, growth rates we were not expecting before 2026. Happily, our strong top line metrics were matched by our profitability KPIs. Our gross margin climbed into the 40s, while our gross profit more than doubled to $18 million, propelling us steadily and predictably towards EBITDA profitability in Q4 of next year. All our products and regions contributed to this dynamic of accelerating top line and improving profitability, though it is worth spotlighting car, which saw 40% growth with more than half of that coming from existing Lemonade customers essentially CAC-less acquisition. That's transformative to car's unit economics as is the 16% year-on-year improvement in car's loss ratio, which came in at a lovely 76%. Staying with loss ratios, our company-wide gross loss ratio in Q3 was 62% and our trailing 12-month loss ratio was 67%, both our lowest ever. If nothing unexpected happens in the coming weeks, I anticipate that we will set a new record once more this quarter, Q4. Against this backdrop, it's worth remembering that while declining loss ratios and expanding gross margins are a thrill, they are not per se what we are solving for. As I explained at some length during our Investor Day one year ago, the metric we are looking to maximize is gross profit dollars. Loss ratios always affect gross profit but not always as a simple counter movement, whereby lower loss ratios yield higher gross profit. In reality, the relationship is non-monotonic, meaning that often a higher loss ratio will yield higher gross profit. The underlying mechanics are obvious when you think about it. Given the incredible price sensitivity in insurance, each percentage reduction in price can often yield outsized returns in terms of conversion and retention. Lower prices worsen gross margins and loss ratios, yes, but the attendant boost in revenue often more than makes up for that. This means that for some parts of our business, certain products, certain channels, certain segments, a higher loss ratio and slimmer gross margins will actually translate into higher gross profit. Given the choice, we will always privilege dollars over percentages, which is why when we see an opportunity to trade higher loss ratios and slimmer gross margins for higher absolute gross profit dollars, we will take that trade 10 times out of 10. And indeed, as noteworthy as our loss ratio progression has been in these past two years, during that time, our gross profit has surged by 261%. The full significance of this comes into sharp relief when paired with the fact that during the same time, our underlying expenses increased by single digits. This means that we've essentially transformed our variable expense into fixed costs. That's extraordinary. It's the hallmark of an AI-first company, and it is the reason why our gross profit trend line charts our path to profit and beyond. And with that, I'll hand it over to Shai.
Shai Wininger, President
Thanks, Daniel. I wanted to shed some light on something that captures one of the ways AI shows up in our results, the LAE ratio. For those less familiar with our industry, LAE or loss adjustment expense measures the cost of handling claims as a percentage of premiums. It's a simple but powerful indicator of operational efficiency, and it is one of the few metrics that truly allows apples-to-apples comparison of the underlying efficiency of different insurance companies. It should be noted, though, that this metric is influenced by economies of scale. And so the larger the insurer, the more they are expected to have a good LAE ratio. For reference, large carriers typically report around 9% LAE. In other words, they spend about 9% of their premium dollars to handle claims on top of the claim payment itself. I'm happy to report that our investment in automation has been paying off. And despite our relatively small size in comparison to the largest U.S. carriers, we reached a superior level of efficiency with an LAE of 7% on average across all of our products. In fact, in the past 3 years alone, we've cut our LAE ratio in half and the number of Lemonade claims adjusters actually declined, all this despite our claim volume growing 2.5-fold. Using Blender, our AI-powered insurance operating system, claim adjusters are able to handle 3x the claim volume they could before, all while providing our customers with a more transparent and instant experience. But having the best-in-class LAE is not where we stop. We wanted to take this further and expect to cut the LAE ratio in half yet again in parallel with our next doubling of the business. With that, I hand it off to Tim, who will cover our financial performance and outlook. Tim?
Timothy Bixby, CFO
Thanks, Shai. Let's begin with our Q3 performance overview. In-force premium increased by 30% year-over-year to $1.16 billion, driven by a 24% growth in customer numbers and a roughly 5% rise in premium per customer. We welcomed over 176,000 new customers this quarter, setting a record. The gross loss ratio stood at 62%, which is an 11-point improvement from last year and a 5-point improvement sequentially. For the trailing 12 months, the gross loss ratio improved by 3 points sequentially, reaching 67%. Prior period development was favorable by 5%, influenced by a 2% unfavorable CAT prior period development and a 7% favorable non-CAT prior period development. The total CAT for the quarter, excluding the prior period development, was 4%. The favorable prior period development primarily stemmed from our home, car, and EU operations, while the adverse CAT development mainly related to the California wildfires earlier this year. On a net basis, prior period development was consistent, with non-CAT showing about 6% favorable and CAT at 4% unfavorable, resulting in a net impact of approximately 2% favorable. The prior year development we report on a net basis was favorable by $6.3 million in Q3 and $18.9 million year-to-date. Gross profit more than doubled to $80 million while adjusted gross profit also surpassed $80 million, yielding gross margins of 41% and adjusted gross margins of 42%. These figures use revenue as the base. Adjusted gross profit related to gross earned premium was 29% in Q3, up 11 points from 18% the previous year. Revenue rose 42% to $195 million, and our adjusted EBITDA loss improved by nearly 50% year-over-year to a loss of $26 million. Notably, revenue growth outpaced IFP growth by 12 percentage points, a trend we anticipate will continue at least until Q2 next year, primarily due to our increased retained business through the quota share reinsurance that renewed on July 1. Our Q4 revenue guidance suggests a potential growth rate of approximately 49% year-on-year at the upper end of the range. Importantly, adjusted free cash flow was positive for the second consecutive quarter at $18 million, with operating cash flow positive at $4 million. We closed the quarter with nearly $1.1 billion in cash and investments, of which $278 million is allocated as regulatory surplus. Annual dollar retention, or ADR, began to rebound as anticipated, rising by 1 point to 85% compared to the previous quarter. Operating expenses, excluding loss and loss adjustment expenses, increased by $17 million or 13% to $141 million in Q3 compared to the prior year. Breaking down those expenses further, other insurance expense increased by $4 million or 22% in Q3 compared to the previous year, while total sales and marketing expenses grew by $6 million or approximately 12% due to heightened growth expenditures compared to last year. In Q3, that growth spending reached about $46 million, a 16% increase year-over-year. We expect Q4 growth spending to remain at a similar level, amounting to around $180 million for the year. We're seeing strong returns on investment and diversity across growth channels, maintaining our LTV to CAC ratio above 3:1 across products, channels, and regions. Technology development expenses rose by 13% year-on-year to $25 million, largely due to staffing increases, whereas G&A expenses increased by 11% year-over-year to $35 million, primarily due to higher interest costs. Our headcount decreased slightly from 1,274 in Q2 to 1,259 in Q3; however, it was still up about 3.5% compared to the previous year and flat compared to two years ago. Our net loss was $38 million in Q3, translating to a loss of $0.51 per share, compared to a net loss of $68 million or $0.95 per share in the prior year. The adjusted EBITDA loss was $26 million in Q3, showing significant improvement from the $49 million EBITDA loss of the previous year. We are well positioned to sustain this growth, expand geographically, and diversify our customer base. With over $1 billion in cash investments, effective management of capital surplus, and positive adjusted free cash flow, we are set to finance our growth strategy without needing additional capital. In light of our strong performance year-to-date, we are raising our full-year 2025 guidance for in-force premium, gross earned premium, revenue, and EBITDA loss. Our expectation for positive adjusted EBITDA for the entire quarter of Q4 2026 remains steady. Following the recent adjustments to our quota share ceding ratio, we anticipate our ceding rate will decline further in Q4 to around 40%. Our Q3 outcomes demonstrate our continued execution on our goals, including 30% premium growth, improvements in loss ratios, a doubling of gross profit, revenue growth significantly exceeding premium growth, recurring positive cash flow, and a stronger balance sheet. We are achieving a unique blend of growth and profitability enhancement while doing so at scale and with discipline. Now, let's discuss our expectations for Q4 before moving on to any questions. For the fourth quarter, we anticipate in-force premium as of December 31 to be between $1.218 billion and $1.223 billion, gross earned premium between $283 million and $286 million, revenue between $217 million and $222 million, and an adjusted EBITDA loss between $16 million and $13 million. We expect stock-based compensation expenses to be about $18 million, with a weighted average share count of approximately 75 million for the quarter. This implies for the full year gross earned premium between $1.044 billion and $1.047 billion, revenue between $727 million and $732 million, and adjusted EBITDA loss between $130 million and $127 million, with stock-based compensation expenses totaling around $61 million and a weighted average share count for the full year of about 74 million shares. Now, I will turn it over to Shai to address questions from our retail investors.
Shai Wininger, President
Thanks, Tim. We now turn to our shareholders' questions submitted through the Say platform. Paper Bag asked, with the Local and L2 announcement, what tangible things will be accelerated as the number of car states we plan to launch in 2025 and beyond changed? Are there any new products planned to be coming out faster? And will we see further operating leverage in our engineering teams? Thanks, Paper Bag. The local platform represents a major leap forward in how we build and evolve our insurance products. And yes, it's already accelerating a lot of what we do. For those who aren't familiar, Local is what we call our next-generation LLM first no-code insurance product builder. And it effectively gives our teams a new way to configure, design, test and launch complete insurance products and experiences without needing to write or deploy code. Local is being built in a modular way. It is already deployed and delivering value in some parts of the business, even though much work remains before local is complete. And based on the rollout so far, processes that used to take weeks can now happen in hours. And yes, it accelerates our operating leverage by freeing our engineering teams to focus on higher impact initiatives since much of the product improvements and tests we're doing can be handled directly by our product and actuarial teams with no engineering involved. Paper Bag also asked, what is the reason or rationale for the recent board seat nominations of PayPal's CMO and Meta's VP of AI Product and are there potential partnerships with either company in the works? Paper Bag, the rationale for the additions of Jeff and Prashant to our Board is that both of their areas of expertise, AI and brand, are central to Lemonade's strategy. Jeff and Prashant each bring exceptional experience that aligns directly with where we are headed as a company. Prashant is Meta's VP of AI Products, prior to which he was Meta's VP of Generative AI, giving him a unique insight into how cutting-edge AI can be deployed at scale. Jeff is CMO at PayPal and Venmo and was previously Global Head of Marketing at Airbnb. So he has shaped some of the world's most loved and enduring consumer brands. As we continue to leverage AI to deliver delightful customer experiences and ultimately transform the insurance industry, their experience and perspectives will be invaluable in helping guide our next phase of growth. There are no specific partnerships with either company to highlight at this time. Our rationale is strategic expertise and not corporate collaboration. There are several questions about the future of FSD and how we are positioning our car insurance product in that shifting landscape. So I'll share some thoughts responsive to that general theme. This is an area we pay close attention to. The timeline for widespread autonomy is uncertain. It could take longer than the optimists predict or accelerate faster than most expect, and we're building with that range of scenarios in mind. Whenever autonomy reaches its tipping point, we believe we are well positioned to capture what many incumbents might see as a threat. The shift toward autonomy plays to our strengths. The future of car insurance is increasingly about pricing per mile driven and distinguishing between human and system-driven miles. Our system is built around usage-based pricing, real-time data and flexible coverage, precisely the infrastructure needed for that future. And we don't have any legacy systems or traditional business models holding us back. Lastly, there were a number of questions about our Tesla integration. We recently announced a direct integration with Tesla's API, which with proper customer consent allows us to pull driving data straight from the vehicle. This gives us access to a much richer and more precise array of data than what's possible through a phone app or plug-in device. Things like seatbelt usage and more accurate trip insights, for example. It's the kind of granular telemetry that becomes critical as cars get smarter and more autonomous, data that not only sharpens our pricing and underwriting precision today but also positions us to learn directly from the evolution of FSD systems over time. As for ensuring FSD miles at near 0 cost, we aren't able to share material updates on that at the moment but promise to do so when we can. What we can say is that integrations like these are early building blocks for the future where usage-based and system-driven pricing becomes the norm and where our platform is already designed to adopt. And with that, I'll pass it over to the moderator, and we will take some questions from the Street.
Operator, Operator
We have the first question from Tommy McJoynt with Keefe, Bruyette, & Woods.
Thomas Mcjoynt-Griffith, Analyst
You noted about half of new car customers were existing Lemonade customers and thus were effectively CAC-less. How does that level compare to prior periods? And is the plan for the majority of new car customers for the foreseeable future to be CAC-less?
Timothy Bixby, CFO
I would say that, that 50% rate has been consistent, plus or minus for a few quarters now. So it's a good number. It's a stable number. The CAC-less approach is without question, part of our focused, driving customers to multiple policies. We've seen growth in the multiply policy rate above 5%. It has increased sequentially every quarter for quite some time. But I would think of that 50% plus or minus number is a good stable number that we expect can continue.
Daniel Schreiber, CEO
In addition to these customers being CAC-less, they are exceptional in other respects. They exhibit significantly better loss behaviors and patterns, making them less expensive to acquire and service. Their retention rates are also higher. There are many advantages to having these cross-sold customers. In the letter and in my comments, we refer to them as CAC-less; however, it would be more precise to consider them as having negative CAC. These customers tend to be profitable, regardless of the line of business through which we acquire them, and then they often add a car policy. This aspect is crucial to our business. While more than half of our customers coming this way is significant and remains a core part of our strategy, this part tends to grow organically. In contrast, the segment we target is less organic, and we can adjust our marketing efforts accordingly. Consequently, increasing our spending on acquisition will impact those ratios over time.
Thomas Mcjoynt-Griffith, Analyst
Got it. And then switching over, looking at the ceding commission revenue line, was there a contingent or profit share tailwind in that ceding commission in the third quarter? It looks like it was a higher percentage of ceded premium than it had been running at.
Timothy Bixby, CFO
The bulk of that ceding commission is driven by loss ratio and because the loss ratios came in quite nicely, a record low in the quarter. As you know, there's a sliding scale of commissions. So the commission varies somewhat up and down based on the loss ratio. There's a cap and a floor, a high and a low. So at some point, you cap out when your loss ratios get really, really good. So that was the main driver in the quarter. And probably worth a reminder, the ceding commission that you see on the face of the P&L is about 4 points different than the actual ceding commission, and that's an accounting nuance. I think you'll see an effective ceding commission rate of about 28% in the quarter. But on a P&L basis, because of the accounting nuance, you see about 24%. So you're exactly right, a couple of points better both year-on-year and sequentially.
Operator, Operator
Your next question comes from Jason Helfstein with Oppenheimer.
Jason Helfstein, Analyst
I'm going to try to sneak in like 2 and then a quick housekeeper. So obviously, we're seeing like impressive improvements in kind of the contribution ratio efficiency. No doubt you are finding ways to use AI to make the business more efficient. That being said, where would you rate yourself on like at a 10, this would be us using all of the AI tools out there that we could and where you are? That's question number one. Question number two, again, you've got the business dialed in now between kind of growth and marginal contribution improvements. Is there anything philosophically to think that you're going to lean more into growth because of the way the business is and the metrics are playing out? And then lastly, Tim, just expenses were up on a year-over-year basis and sequentially in the third quarter, like OpEx, i.e., technology and G&A more than we've seen in a while. Just is there just anything to call out from an expense standpoint in the quarter?
Daniel Schreiber, CEO
The impact of our AI deployments is now evident across nearly every aspect of our profit and loss statement. You are correct in noting this trend; it’s visible in a variety of areas. We highlighted the Loss Adjustment Expense (LAE) to provide a straightforward comparison, showcasing how significantly it differs from traditional methods. Notably, our gross profit has increased tenfold over the past three years, while our headcount has remained stable or even slightly declined. This suggests substantial changes driven by AI, which enhance our efficiencies. In the customer engagement process with Lemonade, AI plays a pivotal role. It starts with how we allocate marketing funds to attract customers. Approximately 90% of the marketing dollars referenced earlier are influenced by AI, utilizing about 50 different machine learning models that optimize our spending based on lifetime value to customer acquisition cost predictions for every customer, segment, and advertising campaign. Once a customer interacts with us, our product recommendations and upselling during the purchase process are AI-driven. Moreover, a significant portion of our claims are processed without human involvement, thanks to AI. On a scale of 1 to 10, I believe we rank very high in our use of AI throughout the organization. Most of our software engineering code is now generated by AI, demonstrating its pervasive influence. However, looking ahead, it’s clear that while we've accomplished a lot, there's still much potential we have yet to realize. As we work on maximizing this potential, the landscape is evolving rapidly, with models becoming increasingly intelligent and faster. In this context, it’s accurate to say we’ve achieved considerable progress, yet still have much to explore, particularly compared to where the industry currently stands and the opportunities we foresee in the coming years. Regarding your second question, Tim, do you have that information?
Jason Helfstein, Analyst
Yes, it was about just philosophically now that everything seems to be kind of working would you consider leaning into more growth and pushing out like kind of profitability targets and then there would be housekeeping expense.
Daniel Schreiber, CEO
We believe we will be EBITDA profitable in the fourth quarter of next year, and we don't expect that to change. This has been our goal for about three years, and it is becoming clearer to others why we are confident in this. While this particular profitability metric seems stable, other metrics like gross margins are more flexible. Our focus is on maximizing gross profit dollars, and to achieve that, we may allow the loss ratio to increase in certain areas if it leads to higher demand and retention, which can compensate for tighter margins. Depending on the metric you choose, I can provide more details, but we are committed to maximizing gross profit dollars and do not plan to ease up on that goal. The timeline for reaching EBITDA breakeven remains set for the fourth quarter of next year, and we do not foresee any changes.
Timothy Bixby, CFO
Great. A few notes regarding expenses. The increase this quarter was somewhat higher than usual, and while it can fluctuate from quarter to quarter, I don't believe this is a permanent change. In this quarter, growth spending is notably higher compared to the previous year, and we have outlined that. We are investing more in technology personnel, which is balanced by efficiencies elsewhere. Isolating that line will show a year-on-year increase over time, partly due to inflation. The team size isn't dramatically increasing, but costs are rising modestly. In general and administrative expenses, interest expenses also grow in alignment with our growth spending since we finance about 80% of it. This highlights our expenses, but overall, it significantly benefits our cash flow and internal rate of return measures. There are some fluctuations in our merchant fees, which can be seasonal and may vary more or less than the typical premium in the quarter. While there are several small factors at play, the overall picture remains steady: single-digit expense growth paired with over 30% top-line growth, as illustrated in the chart we shared, and we expect this to continue going forward.
Operator, Operator
Your next question comes from Katie Sakys with Autonomous Research.
Katie Sakys, Analyst
A couple from me. I guess, first, it sounds like there's a bit more growth scheduled for 4Q than previously messaged the last time you hosted a call. So I guess I'm just trying to reconcile the change in the IFP guide for the full year '25 given the magnitude of 3Q results relative to previous guidance. It doesn't sound like you're messaging necessarily a pull forward in growth into 3Q from 4Q, but it kind of does seem like the full year guide implies a bit of a sequential deceleration next quarter back down below the 30% growth rate. So I'm just looking for some additional color there on the change in the full year guide when 3Q IFP netted out relative to the previous guide.
Timothy Bixby, CFO
Sure. Katie, your math is right. So when we have a big beat on a key metric in a quarter, then obviously, we evaluate how much of that we expect to continue forward and how much we want to make certain adjustments on the top line, that IFP number captures the entire business, not just the additional sales or the new sales or the growth rate. So while our growth spend has increased and our new sales, we expect to increase as well, we're cautious about retention. Our Q3 results were actually quite good, and we're able to overperform but we're somewhat thoughtful about that top line going into Q4 because that captures the entire business. The opposite is true on the other line items. So in gross earned premium and revenue, we captured not only the beat in Q3 but additional increase in Q4. So there's a little nuance there between the metrics, that's what's going on.
Katie Sakys, Analyst
Okay. Yes. No, that makes total sense. It's just that the ADR improved compared to last quarter, indicating upward progress. I understand that some of this improvement is due to the reduction of nonrenewals from last year. However, it seems that you are performing well in terms of retention compared to the beginning of this year. I'm curious about the cautious outlook, especially since you were able to exceed the 30% IFP growth rate this quarter. What aspects of the financial plan appear to be less favorable as we approach the end of the year, particularly with retention on the rise?
Timothy Bixby, CFO
I would think of it as all quite positive if you're looking for our view and how we see things rolling out, particularly in the fourth quarter where we're a month plus in. We have pretty good visibility. I'd remind that we continue to be really thoughtful about our home book of business. The underlying numbers actually look quite good, the loss ratio and the other metrics. But we continue to work through what we've called our clean the book exercise. That continues unchanged. Actually, it will have a level of impact in the second half that's similar to the first half. But that continues, and that's part of our plan. So we're growing at a 30% rate despite that sort of pruning of our customer base. So all your questions are fair, but I think we're quite optimistic I just want to be thoughtful about the parts we know about and the parts we don't yet know about, which is the remainder of the quarter.
Daniel Schreiber, CEO
And maybe, Katie, sorry, just for the benefit of people listening on who haven't done the math as you have, our guide does anticipate a 30% next quarter at the high end of the guide. We've guided at something between 29% and 30% growth for Q4. So we're certainly not anticipating or guiding to any considerable reversal or slowdown as guided.
Katie Sakys, Analyst
Okay. And then if I could just sneak in one more. I can appreciate that the trailing 12-month gross loss ratio is trending well below the 73% target you guys have previously messaged. Just kind of thinking about that in the context of the changes to the quota share structure and ongoing maximization of gross profit dollars. Is 73% gross loss ratio still the right target for the business at this point? Or do you eventually see a pathway to taking that target down lower?
Daniel Schreiber, CEO
It's a great question, Katie. To be honest, we've tried to respond to questions like this and provide a target loss ratio. However, I want to share our perspective, which is that we don't have a specific target. The loss ratio serves as an input, not an output. It's a lever we use to optimize the business. It doesn't necessarily indicate that the business is operating at its best. Because of our efficiency and the decline in other cost structures, we can lead in pricing, a concept we thoroughly discussed nearly a year ago during our Analyst Day on November 20. We believe Lemonade has a structural advantage in a price-sensitive market like ours, where even a 1 percentage move in price can lead to a fivefold increase in conversion or other metrics. It makes sense for us to continually refine our pricing in certain markets and segments to become very competitive, which may pressure our gross loss ratio. For instance, I previously mentioned acquiring great customers in the car business without any acquisition costs. Why should we aim for a 73% loss ratio or any specific target for these customers when there are no acquisition or service costs? It's conceivable that we could reduce prices significantly and still be profitable with a 90% loss ratio. Our mathematical flexibility in this regard is considerable, making it challenging for traditional competitors to replicate. We're using data to guide us in optimizing gross profit. Sometimes, that will involve selling more at lower margins, and sometimes it won't. Different products exhibit varying price elasticities, as do different campaigns. This will result in a loss ratio we report quarterly. However, we are increasingly viewing the loss ratio not as a single aggregate number with a target but as a way to finely tune optimization by product, campaign, and region, leading to varying loss ratios for different product lines, all aimed at maximizing gross profit. I hope this helps clarify our approach to your question.
Operator, Operator
We now have Zachary Gunn with FT Partners.
Zachary Gunn, Analyst
So I also just wanted to follow up on the gross loss ratio, so down 5 points overall, up 13 points in Europe. So can you just talk a little bit about what drove that decrease in Europe? Is it benefits of scale? Was it product mix? And then just I'll get my follow-up on that topic as well. I think previously, you've talked about U.K. being really strong in Europe from a growth perspective, maybe Germany being a little bit weaker. Any updates there within the European market of what you're seeing?
Daniel Schreiber, CEO
Our European business is performing exceptionally well. We highlighted this a couple of quarters ago, and it's true. We're experiencing around 170% growth in our European sector this quarter, with our customer base doubling year-on-year and a very healthy loss ratio. In our last quarter, if I remember correctly, we mentioned that when our American business was at a similar size, its loss ratio was 30 points worse than what we currently have in Europe. Our European operations are progressing similarly to those in the U.S., but we've learned valuable lessons and established effective systems. Additionally, the nature of the European market enables us to operate more swiftly. In the U.S., as you know, regulations differ across the 50 states, imposing various requirements. Consequently, we face several systems and hoops to jump through before implementing price changes, which is not the case in Europe. Although there are regulatory constraints in Europe, we enjoy significantly more freedom to adjust prices dynamically. This allows us to address pricing inaccuracies without the delays we experience in the U.S., enabling instant course corrections. Our systems are designed for this responsiveness. Overall, our European business is more agile in reacting to signals. Moreover, we have a fantastic team and have learned from past mistakes, which has contributed to our ability to move at a pace that is not possible in the U.S. Tim, would you like to add anything?
Timothy Bixby, CFO
Yes. Just general good news across the board, I think, and particularly from a loss ratio perspective, we're starting to see some mix benefit. So as the U.K. grows and in particular, the renters book in the U.K., that supports a nice effectively low loss ratio, that starts to show up in the total. So that's part of the driver. Some of it is prior period impact, also favorable in the quarter, and that's good news. That just means when you have a younger book of business and you're more thoughtful in your reserving, you can at times have a favorable release of prior period. We saw a bit of that in our French book, which is a smaller book of business. With the U.K. heading in aggregate above the 50% level, that bodes well. But we're also seeing nice improvements in other territories as well. We've gone from having really no home business in Europe to having a really nice and effective home product now in 3 of the 4 territories. So Europe is really hitting on all cylinders. It's still a relatively small portion of the book but it's become material, and you'll likely hear more about it from us as we go forward.
Operator, Operator
Your next question comes from the line of Andrew Andersen with Jefferies.
Andrew Andersen, Analyst
Just looking at pet, it's been growing pretty well and the loss ratios seem pretty stable there. I was wondering if you could just touch on kind of the competitive environment you're seeing with pet, maybe how you feel your pricing is relative to some of the industry? And if you could maybe touch on what you're seeing in terms of loss trends there.
Timothy Bixby, CFO
Yes, I feel like I'm repeating myself. What I mentioned about the EU also applies to the pet sector, where we currently have stable and predictable loss ratios, with a bit of seasonality. Our collaboration with Chewy continues to progress well, with nearly 5% of our business generated through that partnership. In terms of competition, we've achieved what it has taken strong pet-only providers 10 to 12 years to accomplish in just 4 or 5 years. We're encouraged by our performance in the pet market. Regarding pricing, we aim to be competitive without underpricing our products or using them as loss leaders. We may not always be the lowest price, but we usually offer a competitive rate. While we do lose business that doesn’t meet our lifetime value model requirements, we typically remain very competitive with the top players in the industry.
Andrew Andersen, Analyst
And I just want to go back to some of the LAE comments and the potential for improvement in that ratio over time. I'm just trying to think about how you are managing kind of maintaining a similar customer service level but also taking into consideration, I imagine at some point over time, there will be a pivot back towards some more homeowners and auto will be a different or a higher mix of the book. So how do you kind of manage through the different customer service levels and the changing needs there, but also using automation efforts?
Daniel Schreiber, CEO
Andrew, in the letter, we provide a breakdown of the LAE by product. You'll notice that all the curves, across all products, including the more complex ones you mentioned, show a consistent downward trend. We're successfully implementing AI across our entire product line, leading to significant advancements in automation. A major advantage of using AI for this work is that it enhances customer service rather than detracting from it, pleasing our customers. Most of the complaints we receive—over 90%—are related to human actions rather than AI. When we incorporate AI, it’s not like the experience of previously interacting with machines where you had to repeat yourself multiple times to get understood. We only adopt this technology once it achieves high customer satisfaction levels. When it meets those standards, it often surpasses human performance due to increased speed and lower error rates. We're witnessing AI managing increasingly complex tasks. Regarding the scale of 1 to 10 that Jason mentioned earlier, it applies here as well. While we’ve made significant progress, we believe there is still much more potential for enhancement. We see a vast array of opportunities to improve further. We are optimistic about the future of AGI in the next few years, suggesting that machines will eventually be able to perform every task that humans currently do. Thus, while some products may seem complex and require human intervention now, this will change in the coming years. We expect to deploy systems that will meet all our customers' needs, resulting in reduced costs and increased customer satisfaction.
Timothy Bixby, CFO
I want to add a thought, and I apologize for the interruption. There are a couple of notes in the letter that elegantly address the idea of shifting variable costs to fixed costs. From the perspective of customer satisfaction and experience, in the past, even with automated responses or interactions, a human had to assess and enhance those responses. This human involvement became a variable expense as they had to review, analyze, and make judgments, even if they weren't directly responding to every request using the AI tools we now have available. That review process can now be automated, allowing improvements in responses to be distributed to our entire customer base in real time. The idea of continuously finding variable expenses to convert to fixed expenses may seem straightforward, but in the realm of AI, it significantly clarifies how these changes can be reflected on the financial statements.
Operator, Operator
We have Jack Matten with BMO Capital Markets. With the AI tools we now have at hand, even that review process with human intervention can be automated so that an improvement in the response can filter out to our entire customer base in real time. This concept of constantly looking for variable expenses that we can convert to fixed expenses sounds simple, but in the world of AI, it really helps to sharpen the focus on how these things actually translate into items you can see on the P&L.
Unknown Analyst, Unknown
This is Charlie on for Jack. I'm sorry, we joined late, so apologies if you addressed this. But we saw Shai tweeted this morning that Lemonade plans to start lowering rates. Can you elaborate more on the timing and magnitude of when you may plan to file for these rate cuts and which lines of business are you talking about specifically?
Daniel Schreiber, CEO
Charlie, yes, we've discussed this in my opening comments and in response to previous questions, so I'll keep it brief. I didn't see Shai tweet what was alleged. What Shai was trying to convey is that we have achieved everything we aimed for regarding loss ratios, which are at record lows, and we expect them to potentially drop even lower in the upcoming quarter. However, we don't always perceive lower as better. While we are excited about our current success, it's important to note that reducing loss ratios doesn't necessarily optimize our business. There are instances where higher loss ratios can enhance gross profit, which may seem counterintuitive because lower numbers are typically associated with increased profit. However, lower loss ratios can negatively affect conversion and retention, impacting growth. Our strategy focuses on optimizing for gross profit rather than fixating on a specific loss ratio. This means that different products, campaigns, and regions may have varying loss ratios over time. We're not signaling any imminent changes or setting new loss ratio targets. We believe that the loss ratio will continue to improve in the near term, but it's essential for our investors to understand the key metrics that matter. We are focusing on gross profit, with loss ratio being a component of that. I hope that clarifies matters.
Unknown Analyst, Unknown
Yes. Sorry about that. And I guess for my second question, I know you've already adjusted your main quota share program to retain 80% of top line. Are there any other changes regarding your broader reinsurance program that you're thinking about heading into the new year given the expectation for reinsurance costs to continue to moderate?
Timothy Bixby, CFO
Yes. I would say we're right on track with our typical approach to reinsurance, which is we're constantly thinking thoughtfully about what we might change or improve. But structurally, that renewal comes in July. We have the opportunity to add or subtract things during the course of the year, which we do almost never but we certainly have that opportunity. So we're constantly looking at those ways that we might help manage both the benefits of reinsurance from a volatility standpoint as well as managing capital surplus, and that really is the driver there. But we are in a great position with the renewal that came through July 1. We're heading towards a point by midyear next year where we'll be ceding just about 20% of our premiums and losses to our quota share partners. As you know, it takes a while to flow through the book once you get to a renewal as the business renews over the course of the year. The impact of that will be such that in Q4, our effective overall seed rate might look more like around 40%. So you're seeing, as expected, that decline as we move closer and closer to the next renewal. In the early part of the year next year, we'll start to get more serious with our partners as we have in the past and think through what that next renewal might look like.
Unknown Analyst, Unknown
If I could just sneak in one more. Any color on the competitive environment in pet? It feels like we've been hearing more public insurance carriers talking about that business more and more.
Timothy Bixby, CFO
Nothing notable. I think we're still finding it interesting to observe the market from a competitive standpoint. We hear about changes in Google algorithms or competitors becoming more aggressive, and these things do occur from time to time. However, when we look at our Q2 results, our Q3 results, and our guidance for Q4, things remain steady. The frequency and severity of claims this quarter were not significant, which is good news for that part of our business as it continues to grow in its overall share. While we monitor our competitors, it's not our top priority. The strategies we are implementing are effective and producing positive results. Pet insurance has consistently been a key pillar that supports our growth of over 30%.
Operator, Operator
Our final question from the phone lines comes from Luke Nelson with Cantor Fitzgerald.
Unknown Analyst, Unknown
I just have a couple of brief questions this morning. My first question being with card, it's roughly around 15% of IFP today. Where do you guys kind of see that mix trending long term? So is 25% the right ceiling? And are there limits on auto exposure we should be thinking about?
Timothy Bixby, CFO
The best indicator, I think, is to look back at our recent Investor Day, which was about a year ago. During that event, we outlined a plan to drive growth from $1 billion in premiums to $10 billion. At that time, we projected a CAR component of approximately 40%. I see that as a theme but a strong one. It could vary, but the total addressable market for cars in the U.S. alone is enormous, not to mention Europe, where we currently don’t have a car product. Even our existing customer base presents a substantial market opportunity. There are no real limitations from a total addressable market perspective; it’s about optimizing the lifetime value to customer acquisition cost and driving cross-sell efforts, which are essential for retention. The improvement in gross loss ratio has been impressive. If you consider a mid-teens ratio today with a 40% CAR share at $10 billion, your estimate is reasonable. A range in the low 20s is certainly feasible in the next couple of years. One advantage of Lemonade is the diversified mix of business, so that figure can fluctuate but we should still be able to meet our overall growth targets. I believe CAR will fall within the range you mentioned.
Unknown Analyst, Unknown
Got you. That makes sense. And then just my last question is a 2-parter, and you might have touched on it previously, but I noticed retention increased to 83% but ceding commission increased as well despite the reduction in reinsurance. So can you kind of walk us through that dynamic? And where do you expect retention to trend over the next few quarters?
Timothy Bixby, CFO
Yes. There are a couple of metrics worth discussing. We have disclosed a retention metric, specifically annual dollar retention, which reflects the dollars retained from any given cohort of business one year later. This number has steadily increased from the 70s to the high 80s over many quarters. It dipped a couple of points recently due to our efforts to clean the book, which resulted in some non-renewals that affected the number. However, we have started to see that trend reverse, with an increase of one point this quarter. This suggests we may be on track for continued improvement in customer retention. Regarding ceding commissions, this aspect of the business relates to the premium and losses we share with our quota share partners. As mentioned earlier, on June 30, we were ceding about 55% of our business, but this will decrease to about 20% over the next 12 months. The commission we earn is a variable rate commission, which is detailed in our 10-Q disclosures. Currently, we continue to earn a commission rate in the mid-20% range on all the premium ceded to our partners. Consequently, although we will see fewer dollars, this is positive as we maintain a healthy commission rate on all the premium ceded.
Operator, Operator
Thank you. I can confirm that does conclude our question-and-answer session here. And I'd like to conclude the call. Thank you all for your participation. You may now disconnect, and please enjoy the rest of your day.