Earnings Call Transcript - LMND Q2 2022

Operator, Operator

Hello, everyone, and a warm welcome to the Lemonade Inc Q2 2022 Earnings Call. My name is Melissa, and I'll be your operator. I now have the pleasure of handing over to our host today, Yael Wissner-Levy, to begin. Yael, over to you.

Yael Wissner-Levy, VP Communications

Good morning, and welcome to Lemonade's second quarter 2022 earnings call. My name is Yael Wissner-Levy, and I am the VP Communications at Lemonade. Joining me today to discuss our results are Daniel Schreiber, Co-CEO and Co-Founder; Shai Wininger, Co-CEO and Co-Founder; and Tim Bixby, Chief Financial Officer. A letter to shareholders covering the company's second quarter 2022 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 Form 10-K filed with the SEC on March 1, 2022, 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 directly comparable GAAP financial measures are included in our letter to shareholders. Our letter to shareholders also includes information about our key operating metrics, including 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, who will begin with a few opening remarks. Daniel?

Daniel Schreiber, Co-CEO and Co-Founder

Good morning, and thanks for joining us to review our Q2 results and our outlook for the second half of 2022. We'll touch on a few important themes this morning. Some of these are laid out in more detail and with accompanying graphs in our shareholder letter. So if you haven't read it this quarter, I do encourage you to. Let me start by saying that our second quarter was strong, with both bottom and top lines beating our expectations. In-force premium or IFP was $458 million, and our adjusted EBITDA came in at negative $50 million. Overall, we feel that our business is beginning to hit its stride with improving loss ratios, increasing cross-sells and upsells, and a seasoning book. All three lead us to believe we will see peak losses this quarter, with losses declining in Q4 and even as we continue to grow an expectation of shrinking loss year-on-year thereafter as we progress on our path to profitability. Let me expand briefly on each of the three drivers I mentioned: loss ratios, cross-sells, and seasoning. Beginning with loss ratio. At 86% in Q2, our loss ratio is still showing the strains of inflation, though a favorable trend line has emerged as we've shared 10 percentage points of loss ratio over the past two quarters. In our shareholder letter for the first time, we provide an overview of our machine learning models and the projected lifetime loss ratios these generate. These are hugely powerful tools for managing our business and may be unique in our industry. I'll expand on why these are leading indicators rather than the garden variety loss ratios that we use in our day-to-day management at Lemonade. The upshot is that our leading indicators strongly suggest that the business we are writing today will prove profitable even if lagging indicators take a few years to fully reflect this. Indeed, an analysis of our new cohorts gives us confidence to reiterate our expectation that our business will operate on a multi-year average loss ratio below 75%. As we explained in the letter in a deep sense, it already is. Notwithstanding this positive trend, we do expect some bumps along the way. For one, we expect the acquisition of Metromile, about which Shai will expand shortly to add something like 3 percentage points to 5 percentage points to our loss ratios for the next few quarters. For another every now and then, a catastrophic event will put an unforeseen dent in our loss ratios. And thirdly, while inflation persists, regulatory approval cycles can create a lag between us identifying the need for price change and our ability to implement it. We're being very proactive in managing this risk. But thinking with regulatory cycles in an inflationary environment is an imperfect science and short-term mismatches of risk and rate are liable to recur. If they do, these two will present as a bump in our loss ratios. To state the obvious, expecting occasional reversals is entirely consistent with our expectation that on a multi-year average, our loss ratios will be sub-75%. And as a reminder, we have a robust reinsurance program that shields our EBITDA from the worst effect of short-term spikes in loss ratios. Shifting to cross-sells and upsells. In Q2, almost one quarter of our sales were cross-sells or upsells. That's an all-time record for us, and it's part of a steady upward progression that we've been tracking for some quarters. In a few markets where Lemonade car has launched, the numbers are better yet, and about one-third of our business in those states is from cross-sells and upsells, sales that typically have zero marketing costs associated with them. In this end, too, the acquisition of Metromile and our continued rollout of Lemonade car bode well. While accounting for a quarter or even one-third of new sales, only about 4% of our approximately 1.7 million customers have more than one Lemonade product today. I say this to highlight that while we're making solid strides, we've barely begun to unlock the potential of growing with our customers. This has long been a core plank in our strategy, and it's gratifying to see the impact it's having in recent quarters, let alone to extrapolate to where this can go over time. The third trend I wanted to highlight is that we are fast approaching the tipping point where the return on our earlier investments outstrips the costs of new investments. It's not just that more and more of our sales are zero-cost cross-sells or upsells. It's also that more and more of our book consists of seasoned products and customers. We have said all along that while the cost of launching new products, new markets, and acquiring new customers are heavily front-loaded, these will prove profitable in the fullness of time. That's what's happening. The passage of time is steadily moving more and more of these undertakings from the investment column to the return on investment column. Here too, it's early days, and that's good news. To underline the point, consider that almost three quarters of our premiums in Q2 were from customers who have been with us less than two years, and none of our pet or car customers have been with us that long. So while our book is more seasoned than it was, it remains unseasoned by comparison to what it will be, and indeed in comparison to what our competitors enjoy today. The passage of time, in other words, is on our side here, too. The upside is that even as we continue to launch new products in new territories to new customers, we have turned a corner. We expect our losses to peak this quarter, Q3, and to continue to shrink thereafter, starting a clear path to profitability. And that path to profitability brings me to my final update. Being public with a highly liquid stock means that capital is readily available to us, but the cost of capital has jumped considerably, and with about $1 billion in the tank, we see no need to be dependent on further capital raises. So we've changed gears with the aim of reaching profitability without having to top up. This means we've decelerated our spending on growth and hiring. As Tim will detail in our guidance, this will result in a more rapid improvement in our EBITDA, a slower rate of growth, and we believe no need for further fundraising. To be clear, we will continue to execute on our strategy just at a moderated pace. We're changing pace; we're not changing course. And even as our losses shrink, we will continue to grow, though not at our full potential. We think that's the right trade-off while costs of capital are elevated, though it's a trade-off we will revisit as the costs of capital wax and wane. To wrap up my comments, I'd say that our business is doing what it was designed to do. Our past investments in new products, customers, and markets are bearing fruit. We believe we are nearing the point of peak losses and on a path to profitability, and we've moderated our pace so that we can reach the end of that path without being forced into raises of capital. And on that note, let me hand over to Shai for some updates on our acquisition of Metromile. Shai, over to you.

Shai Wininger, Co-CEO and Co-Founder

Thanks, Daniel. We closed the Metromile acquisition just under two weeks ago and are feeling very good about how the deal shaped up. Let me start with some numbers. We issued less than $145 million worth of stock for this acquisition, and in return, received over $155 million in cash and equivalents, nearly 100,000 new customers, over $110 million of IFP, a 49-state licensed insurance entity, and telematics driving data from about 0.5 billion road trips. There are a number of states where we are live with our car insurance product, jumped from 3 to 10, and this segment leaped from 1% of our IFP to about 20% overnight. Daniel touched on the cross-sell implications of a wider footprint for our car product. And this still is certain to pay dividends in how fast we can go with our customers. But probably the most exciting part of the transaction is the data, the data science models, and the car experience teams that are now part of Lemonade. Ten years ago, Metromile pioneered the use of continuous driving data feeds to predict losses per mile driven. It is this decade-long head start, now powered by the Lemonade experience and technology, that makes this combination so promising. Metromile's car-mounted sensors have been driven across billions of miles, generating unique and proprietary data sets. These were cross-referenced with hundreds of thousands of claims, closing the loop and enabling driving behaviors to be scored for risk with great granularity. Auto insurance is an extremely competitive market with a steep learning curve that can prove to be unpredictable and costly. The most vulnerable time in the life of an insurance product is during its early years before data accumulates. Incorporating Metromile's decade-long data and knowledge means reducing that risk and spending less cash along the way. In addition to skipping some of the painful learnings of the car business, the deal also delivers some meaningful synergies. Having a single tech stack, a single brand, a unified team, and a unified product line is far cheaper than funding competing brands, competing teams, competing systems, and siloed products. For all these reasons, we have high expectations from this deal and from the Lemonade car more broadly. But it's important to note that we're not planning to rush it. And for those of you who are looking for hints on how car is doing based on the number of policies sold, please note that we deliberately throttle the growth of the car and plan to take the next several quarters to ensure we grow with a healthy loss ratio and acquisition economics. And with that, let me turn it over to Tim. Tim?

Tim Bixby, CFO

Great. Thanks, Shai. I'll give a bit more color on our Q2 results as well as expectations for the third quarter and the full year, and then we'll take your questions. We had another strong quarter of growth, driven by additions of new customers as well as a continued increase in premium per customer. In-force premium grew 54% in Q2 as compared to the prior year to $458 million. We believe that this metric is useful to understand the full scope of our top line growth before the impact of reinsurance and regardless of the timing of customer acquisition during the quarter. Premium per customer increased 18% versus the prior year to $290. This increase was driven by a combination of increased value of policies over time as well as a continuing mix shift toward higher-value homeowner, car, and pet policies. As in the prior quarter, roughly 80% of the growth in premium per customer in Q2 was driven by this product mix shift, including cross-sells, and the remaining 20% from increased coverage levels and pricing. Gross earned premium in Q2 increased 60% as compared to the prior year to $107 million, roughly in line with the increase in in-force premium. Revenue in Q2 increased 77% from the prior year to $50 million. The growth in revenue is driven by both an increase in gross earned premium as well as a modest reduction in the proportion of premium ceded to reinsurers, which was 70% in the quarter as compared to 75% in the prior year. Also of note, our quota share reinsurance structure changed as of July 1, 2022, as it did a year ago at this time such that we began to cede 55% of our premium to reinsurers for the treaty year that ends June 30, 2023. For the year just ended at June 30, 2022, we were ceding 70% as noted. And our guidance does reflect this change. Our gross loss ratio was 86% for Q2 as compared to 96% in Q4 2021 and 90% in Q1 2022. Operating expenses, excluding loss and loss adjustment expenses, increased 28% to $87 million in Q2 as compared to the prior year, and this is primarily driven by increased personnel expenses, stock-based compensation expenses, and legal and professional fees, partially offset by the impact of increased sales and marketing efficiency. We also continued to add new Lemonade team members across the company in support of customer and premium growth and to support geographic product expansion, and thus, saw increases in each of the other expense lines compared to the prior year. Global headcount grew 52% versus the prior year to 1,135, with a greater growth rate in product development and underwriting teams. Notably, our headcount is essentially flat versus six months ago, up less than 2% as we continue to see efficiency gains in personnel expenses. Our net loss was $67.9 million in Q2, or $1.10 per share, as compared to the $55.6 million we reported in the second quarter of 2021. While adjusted EBITDA loss was $50.3 million in Q2, compared to $40.4 million in the second quarter of 2021. Our total cash, cash equivalents, and investments ended the quarter at approximately $1 billion, reflecting primarily a use of cash for operations of $80 million since year-end 2021. With these goals and metrics in mind, I'll outline our specific financial expectations for the third quarter and an updated view of the full year of 2022. For the third quarter of 2022, we expect in-force premium at September 30 of between $595 million and $600 million; gross earned premium between $127 million and $129 million; revenue between $63 million and $65 million and an adjusted EBITDA loss of between $74 million and $69 million. We also expect stock-based compensation expense of approximately $16 million, capital expenditures of approximately $3 million, and we also note that we expect our share count, which will be weighted for additional shares issued in connection with the Metromile acquisition, to total approximately 67 million shares at the end of the third quarter. For the full year of 2022, we expect in-force premium at December 31 of between $610 million and $615 million; gross earned premium between $476 million and $480 million; revenue between $236 million and $239 million; adjusted EBITDA loss between $245 million and $240 million; and we expect stock-based compensation expense of approximately $60 million, capital expenditures of approximately $10 million and a share count weighted again for the additional shares issued in connection with the Metromile acquisition, totaling approximately 70 million shares for the fourth quarter. And as Daniel noted, we do continue to expect that Q3 will be our quarter of peak EBITDA losses. And with that, I would like to turn the call over to Shai. Shai?

Shai Wininger, Co-CEO and Co-Founder

Thanks, Tim. We'll now turn to the top-voted shareholders' questions submitted through the platform. And we'll start with Paper Bags, who's asking how we expect Lemonade car to be rolled out in terms of availability in customer accounts, specifically calling out Texas, California, and New York. Some others, including Matthew, are also asking about Lemonade car and the impact of Metromile on the mix. So I covered much of this in my earlier comments, and I'll let Tim touch on the two. So I hope you feel you've received answers, but let me add this. We plan to proceed expanding our car business with both excitement and humility. Excitement because the opportunity appears endless. People love the product, and we can't wait to see it used across the nation. But there's also humility because we appreciate the complexity involved in getting a car insurance product growing fast while achieving profitability. Going back to our comments in the shareholders' letter, we use machine learning LTV models to decide where we spend every marginal marketing dollar. Our models take many parameters into consideration, including the cost of acquisition, churn loss ratio, and even potential cross-sells. Right now, our latest model, LTV6, is pointing our growth teams towards more profitable targets like our pet product. This brings me to another point, which is competitiveness. Beyond having a superior experience that's key to creating a competitive car product and growing it fast is price. Now it's important not to confuse having the best pricing with having the lowest prices. These two are not the same. And to be able to compete on price while achieving profitability, you need to be able to separate the good drivers from the risky ones better than the competition does. And that's where telematics comes in. The industry using telematics for insurance has been around for a long time. But for traditional insurers, incorporating telematics is easier said than done. Two decades after Progressive introduced telematics, their usage of that technology massively lags our own. In fact, it has been estimated that less than 4% of Americans with car insurance have telematics, and even those 4% almost always turn it off after two weeks. Because two-thirds of drivers drive less than average, most drivers who use telematics could see 30% to 40% savings if they were properly passed on to them. That's great news to us, but not really for incumbents with tens of billions of auto insurance dollars on their books. For them, wholesale adoption of telematics and surely matching rate to risk would likely lead to huge losses of revenue as they'll require massive rate cuts for most of their books. It also means they'll likely need to do a major rate hike for the remaining third of the books, which can lead to massive churn. Unlike the 4% telematics adoption in the market, we are seeing a number closer to 90%, and the option of that is that our wholesale adoption of telematics allows us to graduate from pricing, which is mostly based on car make and model as others have done for generations, to a pricing that's based on actual driving behavior. Having said all that, we're still looking to be very intentional about how we grow this business. And with car now being 20% of our book and over $100 million in IFP, we need to improve its loss ratios before we seek to grow it aggressively. Going to the question about availability of car in Texas, California, and New York. As the Metromile deal closed, we're now live in California. We're actively working on Texas and New York and expect to be live in both states, among others, within one year.

Daniel Schreiber, Co-CEO and Co-Founder

The next series of questions were around our cash flow. More specifically, Darin asked if our risk of failure is substantially lower today than it was at the time of our IPO just a bit over two years ago. Jacob Jay asked whether we will need to raise capital again. So Daniel's introductory comments in our shareholders' letter detail how we're thinking about the cost of capital and how we believe that we're putting ourselves on a course to be cash flow positive without additional raises. I trust that this answers most of the questions on this topic. But in a more direct answer to Darin, our business has derisked significantly since the IPO. What we described as our expectations and aspirations at the time has, by and large, turned into reality. For example, at the time of our IPO, we were a monoline business with a plan to launch additional products and turn into a multiline carrier. In two years since, we've launched not one nor two, but three products: pet, life, and car, making us the only multiline insure tech in the U.S. At the time of our IPO, we told shareholders that a big part of our strategy was actually growing with our customers, meeting their insurance needs as they go through predictable life cycle events. Two years later, our cross-sells and upsells account for about a quarter of our sales and growing. At the time of our IPO, we had under $300 million in the bank. Today, we have approximately $1 billion. So by all measures, Lemonade is significantly derisked. At the same time, we don't for a second believe that we have delivered on our potential and believe that we have decades of growth potential ahead of us. Derisking is nice, but it isn’t our destination. Becoming one of the largest, most advanced, and definitely most loved insurance brand in the world is.

Shai Wininger, Co-CEO and Co-Founder

Lastly, we have some questions around our stock price. Jacob Jay asked if Lemonade shares are fairly valued at the value of $20. And if we see a buyback plan at these levels as being a good capital allocation. To be honest, with all that's going on with the world and the markets right now, our share price doesn't really preoccupy us. Our job is to manage the company and not the stock, which is a good thing because share prices are overwhelmingly driven by factors beyond our control, such as monetary policy and investor sentiment. As for buybacks, those are excellent for companies with excess capital rather than excess opportunities. That's not us. Our capital is there for growing our business and where it will go. And with that, let me hand the call over to the operator so we can take some questions from our friends.

Michael Phillips, Analyst

First question is a general one. If we look back to the early days of Lemonade, your target audience included those customers that traditional insurers either neglected or couldn't serve due to cross-industry complexities. Many of these customers were first-time insurance buyers and your intention was to engage and satisfy them over time, hoping that as they grew, they would continue to choose Lemonade for their car, home, and pet insurance. This led to a specific marketing approach focused on these target customers. The question now is, since you’re no longer just a single-line insurer and have made significant progress in expanding your offerings, how does this change your marketing strategy and the customer base you're targeting, especially those who are interested in multiple policies instead of just one?

Daniel Schreiber, Co-CEO and Co-Founder

Thank you for the question. I appreciate your recall of our discussions from years ago. It's rewarding to see that. Fundamentally, our strategy has not changed. We continue to attract the majority of our customers not from competitors, but rather from new customers who are purchasing their first policy. This core aspect of our approach remains strong and constitutes the majority of our business, as well as a significant portion of our new sales. However, a few things have evolved. We now have multiple entry points; in the past, renting was our sole entryway. If someone wasn’t entering through rentals, we likely couldn’t attract them. Today, potential customers may come to us first through car insurance or even life insurance if they’ve just had a child. The new products we offer are not just opportunities for cross-selling but also serve as new entry points. Most of these customers still appear to be first-time insurance buyers. Additionally, a growing share of our policies is being sold to our existing customer base rather than to new customers. With around 1.7 million customers after the Metromile acquisition, we have significant potential in selling to them. This shift in sales reflects our strategy and represents a more mature execution of that approach.

Michael Phillips, Analyst

I have a second question that I would like to start by acknowledging my limited understanding of your machine learning and AI, which is clearly more advanced than mine. I need some help here. You frequently discuss predicting lifetime loss ratios, and I understand that you can do this for each customer you onboard. I'm curious about how that works. If I had to choose between two companies, one being company A, which has been around for a long time with stable customers and little change in its mix, versus another company that does face changes, I would feel more confident in the predictions made by the first company. So, with a company where 73% of the premium comes from customers who have been with you for less than two years, how do you have confidence in predicting these lifetime loss ratios given the changing mix of business? I simply want to understand this better.

Daniel Schreiber, Co-CEO and Co-Founder

Sure. It may seem contradictory, but for a company like ours, which has less historical data, that data is even more crucial. In a stable business where this quarter resembles the same quarter from the previous year or even ten years ago, lagging indicators provide decent insights because not much changes. The results might come in later, but the present has strong similarities to the past, making lagging indicators effective. However, because we are rapidly evolving, we require leading indicators instead of lagging ones. This is important for managing our business. If we had to wait several months, or even quarters, to understand the impact of the changes we are making in our product, processes, rate changes, and marketing campaigns, our ability to adapt quickly would be severely restricted. We've made 12,000 software updates in the last year alone. If we had to delay assessing the success of each change, it would hinder our capacity to adjust and move swiftly. That’s why we focus on leading indicators internally. To address your question directly, we now have sufficient confidence in the reliability and predictive capability of our machine learning models to depend on them. While they are not perfect, and we continuously identify flaws in older models with each new generation, we are confident that they hold statistical significance and offer enough precision to guide our corrective actions more effectively than traditional methods. The speed at which we operate and our ability to quickly iterate based on these leading indicators, even if they aren't flawless, leads to outcomes that are closer to perfection than if we relied solely on lagging indicators.

Michael Phillips, Analyst

It's probably worth throwing in.

Tim Bixby, CFO

I wanted to add a comment about our unit economics that I think is important for this discussion. Companies often consider their current lifetime value and potential future lifetime value and how to optimize that. There are various factors in those calculations, but one aspect that is particularly unique to insurance, especially at Lemonade, is our price points. Our average customer premium or premium per policy begins with a two and will soon start with a three due to the addition of Metromile. In an industry context, if we take one hypothetical customer of ours with all our policies—of which we have a few—that would represent a $3,000 premium per year, while our average is around $300, resulting in a tenfold increase. Although it’s challenging to achieve that tenfold ratio for every customer, we can definitely target a good number of customers over time. This tenfold ratio significantly alters the evaluation of lifetime value and its potential over time. If we consider that $3,000 customer and they accumulate more wealth and perhaps acquire another car or a bigger house, that premium could grow to $10,000 annually. This level of scaling is not typical in the tech industry, where achieving a 30 times increase is rare, but it happens more frequently in insurance. When we review our metrics, this particular aspect of starting from a $300 figure and its growth potential in the coming years often gets overlooked. It truly shifts the understanding of our lifetime value dynamic.

Michael Phillips, Analyst

Yes, that makes a lot of sense. Last question. Regarding your comments about not spending much on marketing for new Metromile customers in the near term, I understand your points about the factors affecting your loss ratio. However, could you clarify what this decision signifies about your confidence in the customer base, as well as the data and technology you've acquired?

Daniel Schreiber, Co-CEO and Co-Founder

No, not at all. Not at all. The integration is real work. We have a pretty good sense of what's involved, and it's well underway. But today, any money that we spend on Metromile is not spent on the Lemonade brand for one. So suddenly we'd be investing in another brand. Our goal is to have a single brand. Shai spoke about the efficiencies of having a single brand. And we haven't moved over to our tech. We are going to have a single tech stack. We're determined to do that, which means we have to port everything over. We're always going to have a unified single tech stack. And the policy that we sell would still be on the old system, et cetera, et cetera. So just as you go through each of the elements. We haven't got a lot of filings done where we can do bundling across the Metromile product and Lemonade product. So in each area, there's work to be done. And when that is done, we'll be very happy to spend against this, but we just think it would be suboptimal to spend those dollars today. We're going to wait until the integration is complete.

Thomas McJoynt, Analyst

Are there any updated statistics on the graduation phenomenon from renters to homeowners that you could share? I understand the timelines there can be long and somewhat lumpy from quarter-to-quarter. But what are the concrete signs of that graduation playing out as expected? And just to confirm, is the incremental customer acquisition cost truly zero for those graduates?

Tim Bixby, CFO

Thomas, the graduation has continued unabated. So we have seen a steady upward growth, if I'm not misremembering every single quarter since certainly since prior to our IPO, we've seen the percentage of our homeowners book that has come in through graduation has increased. The latest numbers that I saw this may be very approximately wrong, but it's almost precise, is that 20% today of our 806, which is the condo sales, 20% of that book are people who graduated. They started with us as renters, and they graduated and for homeowners, which is the kind of next leg in people's graduation, it's north of 10%. So it is pretty significant and continues to grow in a steady period. The incremental cost is not truly zero but not far off. Sometimes they'll have a question that they want to ask, or they'll need a bit of customer support or things like that. But in terms of the marketing spend, which is where the real spend tends to be, the overwhelming majority of these cross-sells and upsells happen without any CAC expenditure at all, without any marketing spend. Perhaps some customer support. But I think it would not be far off if you rounded that down to zero.

Thomas McJoynt, Analyst

And then just one other area of questions. You mentioned having processed about twice as many claims in the last 12 months as the prior four years combined. What gives you confidence that your fraud detection and appropriate claims handling has kept pace with the substantial increase in claims volumes, especially as you think about perhaps tightening the belt on the expense side going forward?

Daniel Schreiber, Co-CEO and Co-Founder

That's a great question. And perhaps during our Investor Day, I'll expand on that because there's been a tremendous amount of work done in this regard. So let me not take too much time out to delve into the depth of the technology there. And in general, when we talk about our fraud detection, we're always a little bit cautious just because we don't tip our hands to potential fraudsters. As I'm sure you can understand. Having said all of that, actually, the volumes tend to play to our favor rather than to our detriment. The systems train on volume. So if it was humans that were doing all the fraud detection, then maybe they'd be overwhelmed by volume, and since increasingly, we're getting systems that are smart, machine learning-driven identification of fraud, and using new technology, the volume tends to be a wind in our back rather than a force that we have to fight against.

Jason Helfstein, Analyst

Just want to ask a bit more about car. So just as you think about kind of getting the kind of unit economics up, how much of this is you think you can leverage the kind of the underwriting that Metromile had already figured out? And then as just opposed to leveraging the marketing versus needing to build your own intelligence around underwriting for Metromile. So just, I guess, how fast do you think you can kind of scale that relative to scaling that we've seen in your other historical businesses?

Daniel Schreiber, Co-CEO and Co-Founder

Jason, the data that Metromile has gathered is quite significant. We believe it is ready to be utilized. Their data can evaluate risk and claims based on miles driven with an impressive level of detail. The main challenge in leveraging this data lies in regulatory approvals. While we are skilled at deriving insights and setting appropriate prices from the data, the approval process by regulators can take months. This is where we encounter delays. Although these issues can eventually be resolved, they present challenges. Additionally, these delays are exacerbated by notable inflationary pressures in the automotive sector. Car manufacturers and repair shops are experiencing supply chain disruptions, and while nationwide inflation is around 8% to 9%, some areas have seen increases of 20% to 30%. The loss ratios faced by car insurance companies are largely tied to this issue. The question becomes how to convince regulators to approve necessary rate increases in line with inflation, which is a critical hurdle.

Andrew Kligerman, Analyst

Just curious, just statistically, what percent of your non-car business is in California? And what percent of Metromile's car business is in California?

Daniel Schreiber, Co-CEO and Co-Founder

Andrew, so the Lemonade car product was never live in California. The only business we have in California for car is Metromile. And the overwhelming majority of that business is in California. They're live in a few states, I think 7 or 8 states. But California is the largest state by far.

Andrew Kligerman, Analyst

And the non-car business in California, is that a big proportion?

Daniel Schreiber, Co-CEO and Co-Founder

For Lemonade?

Andrew Kligerman, Analyst

Yes, yes.

Daniel Schreiber, Co-CEO and Co-Founder

California represents roughly what you would expect just on a prorated basis population size; maybe it's skewed slightly disproportionately but not out of whack.

Andrew Kligerman, Analyst

One thing I was really curious about you had mentioned in the shareholder letter, the sixth-generation lifetime value machine learning. And you indicated that the fifth-generation model had a disposition toward California and the sixth-generation model indicated that some of that business wouldn't be profitable. And as I thought about it, there's been, over the last few years, a lot of concern in California, whether it's the regulators not giving adequate rate at times, whether it's the weather conditions it's been a very tough market. So the question is what is the new generation lifetime learning pick up that the fifth generation didn't? What was it that the fifth generation hasn't seen?

Daniel Schreiber, Co-CEO and Co-Founder

Thank you, Andrew. The fifth-generation model clearly identified the trends you mentioned, showing that California had many areas that were not profitable for business. We were already aware of this and were cautious in California's homeowners' sector for those reasons. I don't want to suggest that we just realized California is a challenging market; that is not the case. Each generation of the LTV provides a more detailed perspective. Previously, we might have identified a region in California that seemed promising, but with LTV5 we had a certain level of detail. LTV6 gives us an even finer level of analysis. What once appeared uniform can now be broken down to reveal profitable and unprofitable pockets. Using the telescope and microscope metaphor illustrates that we can see things with greater detail. This analysis showed us the mix of profitable areas in California consists of both strong and weak segments. We use extensive data to inform our model, involving close to a million parameters in the neural networks and hundreds of millions for training. While it's tough to pinpoint one factor, I believe the key was improved granularity in catastrophic modeling. LTV6 is more precise in predicting catastrophic events, particularly fires in California, which can cause significant losses. If I had to identify the main reason for the model's increased precision, I would highlight that aspect.

Andrew Kligerman, Analyst

And maybe we could even get into more on that in the Investor Day, but that was very helpful.

Katie Sakys, Analyst

My first question, I wanted to touch on the full year in-force premium guidance that you guys shared because it implies a pretty significant slowdown in IFP added across both legacy Lemonade and Metromile versus the second half of last year. Could you walk us through what you're contemplating for auto IFP over the back half of the year? What's driving the slowdown?

Tim Bixby, CFO

Sure. This reflects our adjusted strategy for capital deployment. We've discussed the main factors driving this, with the primary one being our growth investments to attract new customers, which is the most significant factor influencing IFP growth. However, it's not the only factor. As mentioned, we're now seeing a substantial portion of new sales, in the high 20% range, coming from cross-sells, and we anticipate this trend will continue growing, although most new sales still originate from growth investments. We've also observed a slower pace of hiring, which is helping us improve our bottom line while continuing to grow. Regarding IFP, we don't plan to spend much additional capital to boost IFP at Metromile, and we expect it to remain a strong segment of our business. In the first half of the year, the legacy Metromile IFP was significantly above $100 million, exceeding $110 million. While we anticipate some churn in the second half of the year, we believe this sets a strong foundation for the majority of car IFP moving forward. We will continue to invest across all our products, including car, with approximately one percent or nearly 20% of the business expected in Q3 and Q4 as we finalize the numbers with Metromile. The growth rate compared to last year is largely driven by our growth spending. If you look at the dollars spent in the second half of the year, this is reflected in our guidance. Our marketing efficiency remains consistent with previous quarters, and we believe that the growth capital we deploy in Q3 and Q4 will be just as efficient, if not more so, than in recent months, though we’ll be using fewer dollars. As Daniel mentioned, we're expecting a double-digit growth rate for a long time. The growth rate forecasted for the second half of the year, even considering adjustments for Metromile, remains strong. We will monitor our overall capital base, and as we have the ability to raise capital, we can adjust our growth pace accordingly. It’s a balancing act, and we expect positive results in Q3 and Q4.

Katie Sakys, Analyst

Do you care to give us any anticipation of when you expect to turn growth back on?

Tim Bixby, CFO

We are not stopping our growth spending, but we are moderating the pace. Instead of eliminating growth spending, we will still allocate substantial amounts, though we won't see the same level of increase as in the second half of the last few years. We will continue to invest and monitor our growth alongside our path to profitability, balancing the two. If we see an increase in efficiency, we have often ramped up spending because conditions are favorable. As Daniel mentioned, we have numerous opportunities for expenditure, and we are committed to ensuring we can raise capital. We look forward to increasing our spending rate once we have data that supports it.

Katie Sakys, Analyst

If I could just sneak one more in. I was wondering if you could help us understand the path forward for your reinsurance programs. I believe the letter indicated a gradual reduction down from the 55% session that you've reached today. But if I remember correctly, last year, we also discussed a gradual reduction down from the 70% level at the June 2021 renewals. So how much risk are you looking to retain over the next couple of years? And should we expect another 10- to 15-point reduction in your session right next year? And then additionally, do you anticipate any material changes to the way the Metromile business is being reinsured when it's rolled into the Lemonade structure next summer?

Tim Bixby, CFO

It may be a bit early to consider reinsurance beyond the next year, although internally we are thinking about it. Our reduction over the past two years has been both strategic and structural. By strategic, I mean we've been comfortable taking on more risk as our portfolio grows, our loss ratios become more predictable, and the mix becomes clearer. Looking back at our reinsurance structure from two years ago, we had one-year contracts and a significant three-year agreement. The decrease from 75% to 55% primarily comes from not renewing one-year contracts. We renewed one of these contracts a year ago, which brought us down from 75% to 70%. This past July, we chose not to renew a couple of other one-year agreements, resulting in a reduction from 70% to 55%, effective from Q3 onward. Next year, we anticipate a broader perspective. Historically, we have indicated that, from a risk standpoint, we can operate without reinsurance and still feel secure with our capital of $1 billion, which we are comfortable with. In fact, at times we have foregone potential profits due to our reinsurance arrangements. Additionally, as Daniel mentioned, looking at cohort loss ratios shows we are building a business that over time has a more appealing loss ratio, which is becoming increasingly relevant. As we approach Q1 and Q2 next year, we will get a clearer picture of the reinsurance market and our interests. It's premature to commit to a systematic reduction in percentage points, but we certainly have the opportunity to evaluate our options based on the terms available to us, and we will know more as the quarters progress.

Daniel Schreiber, Co-CEO and Co-Founder

Insurance is not primarily focused on risk management. While risk concentration is a factor, and addressing unexpected events that affect weather patterns and the economy is a benefit of reinsurance, a more significant driver in recent years has been capital efficiency. This includes the regulatory capital requirements and the cost of capital, which differ greatly between us and reinsurance companies. Aside from the ongoing issue of risk concentration, which is gradually improving as we expand into multiple lines and geographies, bringing more stability to our operations, the challenge remains capital efficiency. Now, the focus is on balancing profit margins since reinsurers aim to be profitable by addressing our needs, which involves managing margins against the cost of capital. Therefore, the emphasis is much more on financial optimization than solely on risk.

Operator, Operator

Thank you for your question. That was our final question today. So at this time, I'd like to hand back to the management team for any closing remarks.

Yael Wissner-Levy, VP Communications

Great. Thanks so much. We have no additional remarks. Great to catch up today, and we look forward to seeing you next quarter. Thanks so much.

Operator, Operator

This concludes the call today. You may now disconnect your lines.