Lemonade Inc
NYSE:LMND
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Lemonade Inc
Earnings Call Analysis
Q2-2024 Analysis
Lemonade Inc
In the second quarter of 2024, Lemonade demonstrated impressive growth metrics, with total revenue increasing 17% year over year to $122 million. This growth was mainly driven by a 22% rise in gross earned premiums and a remarkable 45% surge in investment income. The company's in-force premium reached $839 million, marking a 22% increase, while the customer base expanded by 14% to approximately 2.2 million.
The company's gross loss ratio stood at 79%, improving significantly from 94% a year ago and maintaining the same rate as the previous quarter. This improvement can largely be attributed to Lemonade's strategic focus on reducing CAT (catastrophe) volatility and expanding offerings in lower CAT exposure segments like pet and renters insurance. Notably, when excluding CAT impacts, the underlying gross loss ratio was 62%, reflecting a 10 percentage point improvement year-on-year.
Operating expenses increased by 13% year over year to $107 million, driven principally by heightened acquisition spending in sales and marketing. Total gross spend surged to $26 million, doubling from $13 million last year. Despite these increases, the expense base remains stable, showcasing the company’s operational efficiency driven by advances in technology.
Looking ahead, Lemonade has outlined its expectations for the third quarter, forecasting in-force premium between $875 million and $879 million and revenue in the range of $124 million to $126 million. For the full year, in-force premium is expected to be between $940 million and $944 million, while gross earned premium will range between $818 million and $822 million. The adjusted EBITDA loss is projected to be between $151 million and $155 million.
Lemonade's annual dollar retention improved to 88%, up from 87% year-on-year. The firm has actively non-renewed customers with unfavorable lifetime values, particularly in CAT-exposed areas, which is expected to remove about $20 million to $25 million of in-force premium in the second half of 2024. This proactive approach aims to enhance medium-term cash flow and profitability.
Much of Lemonade's efficiency can be attributed to its technology-driven approach. The company is leveraging its advancements in AI to enhance underwriting and customer service, with aspirations to further amplify operational efficiencies with its upcoming technology platform, L2. This strategy is intended to position Lemonade favorably in a competitive market that relies increasingly on automation.
Importantly, Lemonade achieved net cash flow positivity in Q2, and the management anticipates this to continue barring Q4, when seasonal factors may affect cash balances. The total cash, cash equivalents, and investments held at the end of the quarter were approximately $931 million, underscoring a robust financial position.
Lemonade plans strategic non-renewals of CAT-exposed policies, which are expected to negatively impact in-force premiums in the short term but ultimately lead to a net positive value increment range of $50 million to $60 million. This decision is part of a broader strategy to ensure long-lasting financial health and profitability.
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Hello, and welcome, everyone, to the Lemonade Q2 2024 Earnings Call. My name is Maxine and I'll be coordinating the call today. (Operator Instructions) I will now hand you over to Yael Wissner-Levy, VP, Communications at Lemonade to begin. Yael, please go ahead when you are ready.
Good morning, and welcome to Lemonade's Second Quarter 2024 Earnings Call. My name is Yael Wissner-Levy, and I'm the VP Communications at Lemonade. Joining me today to discuss our results are Daniel Schreiber, CEO and Co-Founder; Shai Wininger, President and Co-Founder; and Tim Bixby, our Chief Financial Officer.
A letter to shareholders covering the company's second quarter 2024 financial results is available on our Investor Relations website, investor.lemonade.com. Before we begin, I would like to remind you that management's remarks on this call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in the Risk Factors section of our 2023 Form 10-Q filed with the SEC on May 1, 2024, and our other filings with the SEC.
Any forward-looking statements made on this call represent our views only as of today, and we undertake no obligation to update them. We will be referring to certain non-GAAP financial measures on today's call, such as adjusted EBITDA and adjusted gross profit, which we believe may be important to investors to assess our operating performance. Reconciliations of these non-GAAP financial measures to the most direct comparable GAAP financial measures are included in our letter to shareholders. Our letter to shareholders also includes information about our key performance indicators, including customers, in-force premiums, premium per customer, annual dollar retention, gross earned premium, gross loss ratio, gross loss ratio ex CAT, and net loss ratio. And the definition of each metric, why each is useful to investors, and how we use each to monitor and manage our business.
I'd also like to bring your attention to our upcoming Investor Day to be held on November 19, 2024 in New York City. We will be providing detailed updates on our strategic expansion plans, operating efficiencies, and growth trajectory. Hope to see you there. With that, I'll turn the call over to Daniel for some opening remarks. Daniel?
Good morning, and thank you for joining us to discuss Lemonade's results for Q2 2024. I'm happy to report continued consistent and strong progress across the board. Year-on-year, our top line grew 22%. Our adjusted EBITDA loss improved by 18%, and our gross profit grew by a remarkable 155%. Despite a quarter that saw elevated CAT losses across the industry, our loss ratio came in at 79%, improving 15 points year-on-year. This is no accident. We have been laser-focused on reducing CAT volatility by growing products with lower CAT exposure, notably pet and renters, geographic diversification of growth, including via Europe where we recently launched homeowners insurance in the U.K. and France, continuing to sell Lemonade homeowners insurance in the U.S. only where our AI predicts attractive LTVs and simultaneously placing some home premiums with third parties in selected geographies.
Tellingly, our trailing 12-month gross loss ratio continued its decline for the fourth consecutive quarter, also hitting 79%. We think this number in preference to the quarterly results neutralizes some of the volatility and provides a more bankable indication of our ongoing performance. But whatever your preferred metric is, the picture that emerges is the same. Great progress that enables us to deliver notably expanded gross margins.
I'm also pleased to share that Q2 was net cash flow positive. We expect cash flow to be positive consistently here on out, excepting only Q4 this year where various timing issues will make that quarter a one-off exception. In any event, we don't expect our cash balances to decline by more than 1% or maybe 2% before climbing consistently. With these updates, we feel exceedingly well positioned to continue investing in robust and profitable growth.
I also wanted to put a spotlight on our giveback program for a moment. A couple of weeks ago, we announced our contribution of more than $2 million to 43 nonprofits around the globe, our eighth consecutive year of giving back to dozens of local and global charities chosen by our customers. Social impact is a core pillar of who we are at Lemonade. Our contribution since inception now exceeds $10 million, and this program reflects the collective power of the Lemonade community and its ability to drive meaningful change. It's something we're very proud of, and we know this is only the beginning.
Next, I'd like to hand over to Shai to tell you more about our recent efficiency improvements unlocked by our technology. Shai?
Thanks, Daniel. On the expense side, we've continued to deliver on our autonomous organization vision with remarkable stability. Our operating expense base, excluding growth spend, which is now financed via the synthetic agents program, was unchanged year-over-year. This underscores the scalability of our tech vision, which leads to measurable efficiency in our operations. This dynamic we're witnessing, robust predictable IFP growth alongside an expense base that remains comparatively steady and even shrinks at times, isn't a short-term anomaly. We expect this trend to persist in the coming quarters and years as we approach sustainable profitability at scale. This trajectory is a testament of the power of our technology-first approach and our commitment to operational excellence.
Investors and analysts often ask about the practical impact of our investments in building our own tech-based insurance stack. I believe our recent quarterly results clearly demonstrate that. With large parts of our business running on code rather than people, I believe our tech obsession is paying off in a big way and helps separate us from incumbents in visible, measurable and impactful ways.
What we've achieved so far is just the beginning. Our team has been hard at work on our next-generation technology platform, codename L2, which is designed to bring step-change improvements to areas such as underwriting, insurance operations, compliance, and product development. With L2, we anticipate additional efficiency gains alongside acceleration of our product operations. These improvements should position us to adapt quickly to market changes as well as capitalize on new opportunities, products, markets and even business models. The potential impact of L2 extends beyond mere cost savings. It's about reimagining how insurance companies should operate in the AI era. We look forward to sharing more about all this at our Investor Day, November 19 in New York City.
And with that, let me hand it over to Tim to cover our financial results and outlook in greater detail. Tim?
Great. Thanks, Shai. I'll review highlights of our Q2 results and provide our expectations for Q3 and the full year, and then we'll take some questions. Overall, it was again a terrific quarter, with results very much in line with or better than expectations and continued notable loss ratio improvement across the board. In-force premium grew 22% to $839 million, while customer count increased by 14% to 2.2 million. Premium per customer increased 8% versus the prior year to $387, driven primarily by rate increases. Annual dollar retention or ADR was 88%, up 1 percentage point since this time last year. Gross earned premium in Q2 increased 22% as compared to the prior year to $200 million, in line with IFP growth.
Our revenue in Q2 increased 17% from the prior year to $122 million. The growth in revenue was driven by the increase in gross earned premium, a slightly higher effective ceding commission rate under our quota share reinsurance as well as a 45% increase in investment income. Our gross loss ratio was 79% for Q2 as compared to 94% in Q2 2023 and 79% in Q1 2024. The impact of CATs in Q2 was roughly 17 percentage points within the gross loss ratio, nearly all driven by convective storm and winter storm activity. Absent this total CAT impact, the underlying gross loss ratio ex-CAT was 62%, in line with the prior quarter and fully 10 percentage points better than the prior year.
Prior period development had a roughly 3% favorable impact on gross loss ratio in the quarter. Notably, the CAT prior period development was about 2% unfavorable while non-CAT was about 5% favorable, netting out to the 3% favorable impact.
Trailing 12 months, our TTM loss ratio, was about 79% or 12 points better year-on-year and 4 points better sequentially. From a product perspective, gross loss ratio improved notably for all products with year-on-year improvements ranging from 5% to 30%. Operating expenses, excluding loss and loss adjustment expense, increased 13% to $107 million in Q2 as compared to the prior year. The increase of $12 million year-on-year was driven predominantly by an increase in growth acquisition spending within sales and marketing expenses.
Other insurance expense grew 25% in Q2 versus the prior year, in line with the growth of earned premium, primarily in support of our increased investment in rate filing capacity. Total sales and marketing expense increased by $12 million as noted or 48%, primarily due to the increased gross spend, partially offset by lower personnel-related costs driven by efficiency gains.
Total gross spend in the quarter was about $26 million, roughly double the $13 million figure in the prior year. We continue to utilize our synthetic agents growth funding program and have financed 80% of our growth spend since the start of the year. As a reminder, you'll see 100% of our growth spend flows through the P&L as always, while the impact of the new growth mechanism of synthetic agents is visible on the cash flow statement and balance sheet. And the net financing to date under this agreement is about $44 million as of June 30.
Technology development expense declined 12% year-on-year to $21 million due primarily to personnel cost efficiencies, while G&A expense also declined 3% as compared to the prior year to $30 million, primarily due to both lower personnel and insurance expenses. Personnel expense and headcount control continue to be a high priority. Total headcount is down about 9% as compared to the prior year at 1,211, while the top line IFP as noted grew about 22%. Including outsourced personnel expense, which has been part of our strategy for several years, this expense improvement rate would be similar.
Our net loss was a loss of $57 million in Q2 or $0.81 per share, which is a 15% improvement as compared to the second quarter a year ago. Our adjusted EBITDA loss was a loss of $43 million in Q2, a roughly 18% improvement year-on-year. Our total cash, cash equivalents and investments ended the quarter at approximately $931 million, up $4 million versus the prior quarter, showing a nice positive net cash flow trend in the quarter. This positive net cash flow contrasts markedly with a net use of cash of $51 million in the same quarter in the prior year. With these metrics in mind, I'll outline our specific financial expectations for the third quarter and full year 2024.
Our expectations for the full year remain unchanged as compared to our guidance on our Q1 earnings call. As has been the case in some prior years, there's a notable seasonal difference in our expected results in Q3 and Q4. Specifically, Q3 is typically our highest growth spend quarter, which tends to drive up sales and marketing spend, and also, typically a higher expected loss ratio as compared to Q4. Our third quarter guidance and our implied Q4 guidance reflect these seasonal themes.
From a gross spend perspective, we expect to invest roughly $25 million more in Q3 as compared to Q3 in the prior year to generate profitable customers with a healthy lifetime value. At the same time, we will be proactively nonrenewing customers with unhealthy lifetime value, specifically certain CAT-exposed homeowners policies. As our AIs have become increasingly good at identifying such policies, and as our latest underwriting rules have been approved by regulators, we now have the ability to identify older policies that we wouldn't write today. We expect this to remove between $20 million and $25 million of IFP from our book in the second half of 2024, dampening growth in the immediate term while concurrently boosting cash flow and profitability in the medium term and further reducing CAT volatility. Importantly, though, our IFP guidance for the year reflects these plans and remains unchanged.
For the third quarter of 2024, we expect in-force premium at September 30 of between $875 million and $879 million, gross earned premium between $208 million and $210 million, revenue between $124 million and $126 million, and an adjusted EBITDA loss of between $58 million and $56 million. We expect stock-based compensation expense of approximately $16 million, capital expenditures approximately $3 million, and a weighted average share count for the quarter of approximately 71 million shares.
And for the full year of 2024, we expect in-force premium at December 31 of between $940 million and $944 million, gross earned premium between $818 million and $822 million, revenue between $511 million and $515 million, and adjusted EBITDA loss of between $155 million and $151 million. And we expect stock-based compensation for the full year of approximately $64 million, CapEx of approximately $10 million, and a weighted average share count of approximately 71 million shares.
And with that, I'd like to hand things back over to Shai to answer some questions from a few of our retail investors. Shai?
Thanks, Tim. We now turn it over to our shareholders' questions submitted through the safe platform. I'll start with Matthew H. who asks, how are we leveraging AI technology to improve underwriting, claim processing, and overall customer experience? And are there any major business risks or challenges to further leveraging AI?
Thanks, Matthew. We've spoken about this at some depth in prior shareholders' letters. As I shared in the past, we're well underway to leverage AI at every stage of the customer journey as well as in many areas of our internal operations. We do that to drive efficiency, improve our underwriting, and enhance customer experience with fast and always available smart service. Our underwriting, customer service and claims management, even employee management, administration, engineering, product operations, all use AI heavily. As an example, in just over a year, we went from a standing start to having a comprehensively rolled out generative AI platform to handle incoming customer communications. We handle e-mail and text communications coming in, and we're now handling more than 30% of these interactions with absolutely no human intervention.
Progress to date is the tip of the iceberg though, and I expect us to continue to focus on additional applications of these technologies, delivering concrete measurable impact to the business and helping us widen the gap between our tech and the competition's.
Nomi K. asks if we can share the performance metrics and customer feedback from states where all 5 of Lemonade's insurance products are available and what are the main challenges or limiting factors preventing a broader rollout to additional states, and how do we plan to address these?
Thank you, Nomi. The specific order of state expansion is generally based on growth potential and expected profitability in those markets as well as prioritization aspects that have to do with focus and resource allocation. We expect cross-selling activity to be an increasingly powerful driver of growth as a result. In Illinois, for example, where we have all of our products available, we're seeing multiline customer rates that are roughly double the rest of the book. We also see other metrics improve, such as superior retention rates after bundling and outstanding customer feedback as measured by NPS.
There were several questions about car rollout timing and expectations. And I'll just say that the organization is running around car in a remarkable way, and we're expecting the growth rate of car to begin accelerating in the near future as a result. We plan to roll out car several additional states during 2025, with our main considerations being profitability predictions and regulatory approval rates. We aim to operate first in states where we can move quickly and write new business profitably.
In the second half and beyond with the unlock of rate adequacy in multiple geographies, we'll be expanding investment in new customer acquisition as well as cross-selling to our existing user base. And now I'll turn the call back to the operator for more questions from our friends from the Street.
(Operator Instructions) Our first question today comes from Jack Matten from BMO.
Just wondering if you could provide some more details on the non-renewals of the CAT-exposed home business. In which states are your actions primarily taking place? And are there particular years of business that you're focused on? I guess in general, if you can talk about any insights that you've learned from your more recent models that led to your decision.
Yes. A couple of thoughts there. In terms of the distribution across states, it's really more of a -- it can be concentrated in states. It's really focused -- tends to be focused more on expected lifetime value, which tends to be quite driven by a higher than target loss ratio that tends to be concentrated within the home book almost entirely, which is the most challenging loss ratio we have. We've talked a little bit about in the letter the range that we're targeting, which is 20 to 25. We talk about a range because it's not a hard number, but it's based on what we know and as we're kind of developing that analysis, that feels like the most appropriate range. Important to note that while it puts downward pressure on IFP growth, as all of our -- every customer kind of adds up to that total IFP number, from a cash perspective or a value perspective, it's got a very high ROI. We're taking out much more expected cost than we are taking out contribution from the premium, so it's definitely ROI positive. If you take out, for example, $25 million of IFP with an elevated loss ratio, you can generate, using our own model, something like $50 million or $60 million in net positive value. A little short-term pressure on IFP, but over the medium term, long-term value. In terms of timeframe, these tend to be older policies, so our underwriting rules and our AI models get a little bit better every day and so the concentration tends to be business we wrote 2 or 3 or 4 years ago in some cases. And as noted, the vast majority, if not 100% of this business, would be business we wouldn't write today under our current underwriting guidelines.
That's helpful. Thank you. The second question is on capital. Can you talk about the premium to surplus ratio that Lemonade expects to maintain as your business mix evolves? And I guess somewhat relatedly, it looks like your invested asset balance has been falling in recent quarters. Is that something that the company expects to continue doing moving forward? I think just trying to get some insights into that investment income. Thank you.
Sure. On the capital surplus, we've not talked about that for a while because things are essentially unchanged. Our target is and continues to be a roughly 1:6 ratio of acquired surplus to gross earned premium. And we've got at least a couple of very effective tools in place to help us drive that number to what is arguably sort of best-in-class in the industry. This is what many insurance companies shoot to do. And I think we're performing quite well on that metric. Our quota share structure, our Cayman captive structure, these are really designed not only to mitigate volatility, but more importantly to drive -- to enable significant capital surplus efficiency. That's really unchanged at that 1:6 ratio. From a cash investment standpoint, yes, you will note if you kind of charted out the cash balances has increased somewhat as a percentage of the total. That's not so much a concerted strategy. I would expect that trend to moderate or even flatten out before too long. However, the interest rate environment is what it is. We're expecting what you and others are expecting in the market, that there will be perhaps more downward pressure on interest rates than upward pressure, and we factored in sort of the most current forecasts into our guidance in terms of what the expected investment income is likely to be. The good news is, our cash investments balance actually went up this quarter in total. We're earning really strong returns on the cash as well as the investments. And so that's something that I would highlight. We foresee that cash and investments balance basically troughing, might drop another 1% or 2% as we noted, but that puts us well above a $900 million total cash investments balance from here on out as far as we can see. Compare that to 3 or 4 years ago when there was quite a bit more uncertainty as to our growth trajectory and where that balance might end up, that's a dramatic change, and I think it probably has a tremendous foundation for us going forward.
The next question comes from Michael Phillips from Oppenheimer.
A question first on auto and kind of follow-up from the opening comments about new state expansion as you get into next year. The last 10 I had, I think you were in 11 states. I'm not sure that's still right. As you look out over the next maybe 18 months, given kind of the decent rate environment for auto, it might be slowing down. But should we expect state expansion by say yearend '25 to being close to like 20 states or 40 states or just kind of how aggressively you want to be over the next 18 months?
Hey, Mike. No, I don't think we'll be at 40 states. And of course, to state the obvious, not all states are born equal. We will be expanding throughout 2025. We haven't given specific numbers, and so my answer today is going to remain a little bit vague still. One of the driving factors is going to be the graduation of renters to be car customers. We will be looking, and one of the guiding principles Shai spoke about, regulatory environment and some predictive loss ratios. Another one is where we have the largest footprint of renters who have cars but don't have car insurance with us, and that will be another driving force. But we're not ready to disclose numbers of states yet.
Okay. I can appreciate that. Thanks, Daniel. I guess continuing with that, maybe a follow-up on that is, typically, as we're growing in new states, there can be some pressure on our margins in auto. Maybe for you guys, I guess I want to see what -- do you think that might be a bit muted than what normally is the case, given -- I think you've talked about knowledge that you have from your current renters and homeowners customer base and how that can translate into more information in your initial pricing for auto as that starts to grow?
Yes. Look, we are -- I sort of mentioned this before, but we are very bullish in the medium to long term on car. We think it's a highly differentiated product with a strong and structural competitive advantage given that at first approximation, all our customers use telematics on an ongoing basis. And whereas at first approximation for the incumbent that's none or 0. This is really a very powerful differentiator quite beside or in addition to the fact that we have really spectacular user experience, very high customer satisfaction levels, etc. Going back to my comment earlier about the renters aspect here, yes, we are seeing that renters who buy car insurance have a much, to use your words, muted loss ratio, In fact, their whole economics are dramatically different. The cost of acquisition is effectively 0. You might even conceive a bit as being negative cap because our renters book is very profitable. And then you've got existing customers who ostensibly have paid to be Lemonade customers, but they are profitable at the outset and then we get to sell them a car policy with no incremental cost. Again, I'm rounding here, but I think a price approximation that holds true. And we have found them to be not only highly profitable because of the absence of any customer acquisition cost, but much better because we do use the factors that you said, much better risks. We can price them effectively. We don't see the new business penalty that you see when you usually grow a book. So very, very different unit economics and lifetime value of existing customers. This is really, I think, a strategic pillar that we will expand on during our Investor Day as well later in the year. We do have over 2 million existing customers, many of whom have car insurance, just not with Lemonade. And that opportunity translates into a very, very sizable, and ultimately we expect, very profitable opportunity for us.
Probably also worth noting that the external environment is improving as well. For some time, we and other car providers were chasing a target with inflation's unfavorable impact on cost of repairs and cost of claims. The data is now really showing that that trend has slowed, if not stalled, and in some cases may even reverse. And so, chasing that target is now much -- the impact of our rate increases, both those already in place, and those we are continuing to work on, have an even greater impact, and that really provides a higher level of confidence comfort in our planning for car for the rest of this year and well into next year as well. We noted that our gross loss ratio improvement across our product lines improved anywhere from 5% to 30%. Car was right at the upper end of that range, so we're seeing lots of great indicators.
The next question comes from Tommy McJoynt from Stifel.
Tim, kind of going back to the first question that you got on the nonrenewal side, you mentioned the $25 million of non-renewed IFP, and that's going to be offset by it sounded like I think you said $50 million to $60 million of sort of net positive value. Let's call it $50 million. Sorry, is that saying that the LTV of those policies, instead of being presumably positive when you wrote it, is now being sort of reassessed at negative $50 million? And hence, by not writing, nonrenewing that business, it will now be 0? Just kind of help explain sort of what that $50 million to $60 million number that you mentioned actually is.
Yes. In rough strokes, the way you described it is right. If a customer has an expected lifetime value let's say of 3x its acquisition cost, which is often typical for us, that means over the course of their lifetime, 2, 3, 4 years depending on the product or more, we expect to generate that incremental cash flow or value. What this says is we expect that lifetime value to be a negative $50 million or $60 million in the case I described for an IF, so think of that ratio as sort of a negative 2:1 ratio. I mean it's really almost entirely driven by the elevated loss ratio. If a customer has an expected 150% loss ratio for example, and you carry that customer out for a couple 3 years or more, that's the driver. I think you have the analysis right, it's rough justice, but it's notable -- notably positive ROI for those changes.
Okay. Got it. And do you know what the impact on the loss ratio from that sort of $25 million in IFP was in the first half of the year? Or even in absolute dollars, kind of how much sort of operating loss that business generated, contributed?
Hard to really put a precise number on that. I would think of that range of $20 million to $25 million is over the course of the year, the vast majority in Q3 and Q4. It's really a forward-looking number and expected impact. We have started the process. There was a nominal amount in Q2 but I would say it probably rounds to pretty close to 0. It's really a Q3, Q4 and forward expectation, a little more concentrated in Q3 than Q4. Our loss ratio does -- has borne the burden of that business, and so it's really notable I think that our loss ratio improved mid-double digits year-on-year with some of that downward pressure. And so all of these changes, not just rate changes, will have a favorable -- continued favorable impact on the loss ratio going forward.
And Tommy, maybe I'll just add -- sorry, just one other kind of vantage point of color, and Tim mentioned this briefly in his comments, this is really a homeowners focused fix. It's the one part of our business that has had pockets of sustained negative LTV. And in addition to being negative in LTV, there have also been an environment that oftentimes we could not get the rate approval. In theory, any risk can be priced adequately, but we don't always find regulators affording us that luxury. This is part of the business where we just were not able to get the approvals and don't expect to in any fashion. Otherwise, we would have been kind of shown more forbearance if we thought it was on the cusp of turning profitable. But in addition to being stubbornly unprofitable, it also tends to concentrate very much in volatile parts of the country. Even some of this business were we to get to long-term average profitability, we've always sought to avoid the most CAT-exposed part of our business -- of the country rather, sorry, and we have avoided writing in the most CAT exposed places really since our inception in places where we have still found that the volatility is higher than we want now, knowing what we know. We're also taking this opportunity to non-renew that part of the business.
And maybe just to put a fine point on it based on a couple of questions I've gotten already, I'll answer a question that has not been asked, which is, if this number is 25 as we expect it to be, the question might be, would your IFP expectations have been $25 million greater if not for the impact of this? The answer is yes. Yes.
Okay. Got it. Appreciate that color. And then just quickly, you mentioned the expectations for growth spend in 3Q to be $25 million up year-over-year. Did you give a 4Q number? Or do we have the full year kind of expectation?
Yes. I would think of the full year as really unchanged. The timing over the course of the quarters has changed somewhat. The guidance we gave historically is sort of between $100 and $110 million, $105 million is the number we've mentioned. I think we're still sort of on track and planning to spend that rough amount over the course of the full year. We have adjusted the timing of that somewhat a little bit more than initially planned in Q3 than otherwise. Q3 is typically the highest gross spend quarter in any case in most years. And the fourth quarter, obviously, if you kind of do the math, will be somewhat elevated as well. Q1 was really the ramp-up quarter, and so it's a pretty steep climb and we expect Q3 to be at the rate we disclosed.
The next question comes from Bob Huang from Morgan Stanley.
Great. First one is on your 17 points of improvement in CAT losses, which was -- I mean, sorry, 17 points of the impact on CAT losses, which is a 5-point improvement. Directionally speaking, that's obviously similar to the industry. As you non-renew the homeowner side, is there a run rate expectation on what CAT losses should look like going forward? Can you give us a little bit more color on just like how we should think about that impact? I know that you already talked about quite a bit on the impact on the other side of things on the homeowner renewal. Just to see if there's any additional color on the CAT side.
That's probably a little bit beyond some of the guidance we've given. I can give a little bit of the way you might think about it. Our home business as a share of the total business is coming down as a percentage, but just modestly. I think it came in the quarter, and this is home and condo combined, came in about just under 20%, and it's down a couple of points year-on-year. And so, you can kind of back into -- if we were to take $25 million of IFP out, back into what that impact might be. In terms of the specific reduction on loss ratio, it's a little tricky to do that. I'm not going to venture that far. But CAT is really isolated almost entirely to home, not quite 100%, but primarily home. And really, these are the most challenging policies obviously that we'll go after. I'll leave it to you to kind of do some math, but that's how I would go about it.
Okay. Maybe second one on just how we should think about ceding commission. If we look at a ceding commission as a percent of premium last call it 5 quarters, it's generally about 20%. This quarter was notably lower than that. Is this more of a one-time thing? What's driving that? And should it go back to about 20% of premium going forward?
Yes. A couple of ways to think about the ceding commission. Year-on-year there is a change because there was a change in the structure. The prior year was a fixed structure up through our July renewal a year ago, and so you saw in the face of the P&L roughly a 20% effective commission. Now our commission, because of the way we do the accounting, it's split into 2 pieces, so our effective commission rate was about -- running about 23%. But the most important thing was it was static. It was a fixed number. That's now variable. That's helpful in some ways, but a little less -- a little trickier when you're building a model. But the net difference over -- I think one way to think about it is to look at Q1 and Q2, the net commission was about 18% versus 20%, so modestly lower, but just by a couple of points. But more volatility, more variability, so Q1 was a fair bit lower, Q2 was higher. We'll continue to see that move around a little bit quarter-to-quarter, but that gets trued up as you go through the course of the year. I would expect -- we'll give as much of an indication on that as we can, but I would think of it as a couple of points lower than prior year, but there are some offsets to that as well. Our renewal this year was similar. It is also a sliding scale that begins this month, began in July. But the scale and the expected effective rate will actually be a little bit better. At this point, it's hard to say if it gets back to the prior level, but it should be up maybe 1 point or 2 on any sort of apples-to-apples comparison so slightly better terms in this renewal. Probably also -- probably also worth answering another -- I like answering questions that weren't asked, so I'll throw in another one which is, because a loss ratio varies obviously quarter-to-quarter, the typical pattern has been a Q4 loss ratio that's the lowest of the 4 quarters. That's happened often in prior years. We expect it will happen this year. And if that plays out as expected, that has a pretty strong favorable impact on that commission rate. And so again, a little more volatile quarter-to-quarter, but if things play out as expected and as historical patterns, you'd see a nice favorable impact over the course of the year. It gets us back on track versus some of the prior quarters. It can be a little bit lower commission rate.
Thank you. The next question comes from Matthew O'Neill from FT Partners.
I just wanted to ask a little bit about premium per customer. It's been growing impressively, but the rate may be decelerating slightly. I was just curious if you could give us an assessment of kind of how far through the rate increases you are on the in-force book?
Yes. That can vary quarter-to-quarter. It has been a pretty steady contributor, but our customer count was a stronger contributor to growth this year quarter-on-quarter than the price increase. It varies by product. As I mentioned in car, you're seeing a pretty dramatic impact in rent, much less so because it's really so optimized. The loss ratio is such a strong loss ratio as it is and pricing is quite good. So it varies by product. In terms of where we are, I think 2 or 3 quarters ago we mentioned that we were sort of halfway through. There's $100 million or so remaining to earn in. That's more or less unchanged because as we -- the pace of us earning in rate and the pace of us filing for new rates has been roughly in balance. I think of us in a similar spot now where there's still plenty of rate to earn in. Obviously, that doesn't last forever. There will always be rate filings and always increases even in a low or no inflation environment, but we're quite a ways away from that. That is factored into our -- the Q3, Q4 guidance that we'll continue to earn at that pace, and it will go into next year. Things that are approved and in place will earn well into next year.
Thanks, that's very helpful. And maybe just a quick one, and I realize I may be jumping the gun on potential Investor Day content, but I know you've spoken about the long-term or ultimate target for the loss ratio in the high 60s to 70s. I don't know if there's kind of an internal or a way to think about the ultimate target for the expense ratio going forward.
Matthew, hi. We are determined to have an expense load that will be absolutely better than the industry. We're beginning to look less at ratios because we also intend to be a price leader. And that might not give you as clear a picture of just how advantaged we think we're becoming due to our technology, but it will reflect itself in I think best-in-class expense ratio and even more dramatically in actual expense load. If you kind of put it on an apples-to-apples basis with the same premium and that's being charged by competitors, it will manifest itself more powerfully still than when you look at it against our own lower premiums because we think we get to pass some of those savings on to our customers, and that can accelerate growth, accelerate retention, lower cost of acquisition, and allow us to achieve our ultimate and rather ambitious goals for the company. But if I answer your question kind of more straightforwardly, we think that at scale, we will be in the teens. We disclosed last quarter that the LAE component of our expense stack has already achieved parity with the very best in the industry. We reported a 7.6% LAE last quarter. Shai mentioned some of the efficiencies that we're gaining through automation, and we're really seeing these rollout very, very powerfully in some of the numbers that we shared earlier about what's happened to our headcount expense, what's happened to our what we're calling IFP per human, how many people were needed to gen -- as we've doubled our book, we've been able to over the course of the last few years, we've been able to halve the ratio of people needed to generate every dollar of premium. We're seeing very dramatic advancements, all of which will ultimately reflect themselves in our competitive expense structure, some of which will manifest as lower prices and some of which will manifest we believe still as best-in-class expense ratio. That said, I'll add to that, and there was reference to this in the letter as well, we think of for structural reasons that may be obvious and some that are less than obvious, we think of growth as the gift that keeps on giving. We really think that the number that I just gave and the direction that I just outlined will become -- at the moment, you can look at various numbers in the field in action, and I referenced a few of them. I think a few years from now, it will be unmissable. It will be kind of glaringly obvious and the difference between now and then is that will continue to grow. And as we continue to grow, as we've doubled our business while holding our expense structure flat, we kind of shared that over the course of the last few years, we've seen expense net of customer acquisition actually decline even as we've enjoyed record growth. Clearly, that moving forward, holding expenses relatively flat and really start seeing how this generates a very, very profitable business. But that dynamic will continue to manifest with ever greater force as we continue to grow. When we double our business, you will see it with greater clarity. When we 10x our business, as I say, it will be glaringly obvious.
Thank you. The next question comes from Yaron Kinar from Jefferies.
This is Charlie on for Yaron. A couple of questions. The first one, with the decision to non-renew certain CAT-exposed homeowners, was that previously contemplated in guidance?
No.
Okay, thanks. And then are you guys able to give us CAT prior year development and LAE on a net basis?
The prior period development, you can split into 2 pieces. It was 3 points favorable. It was 2 points unfavorable from a CAT perspective and 5 points favorable from a non-CAT perspective. Netting out to the 3 favorable.
Okay. Sorry. And just to clarify, was that gross CAT or net CAT impact?
That is gross.
Gross, okay. And are you guys able to give it net?
Yes. And then that breakdown would be roughly similar on a net basis, the prior period development. The total CAT impact on a net basis was about 15 points, whereas on a gross basis, it was about 17 points. LAE came in about 8%. It's been 7 point, mid-7s, edged up a little bit, but in that sort of 7% to 8% range, by 8% this quarter.
Okay. Great. And then last one if I could, just looking at the underlying loss ratio, it looks like contemplating those components, you guys saw about 22 points of underlying improvement. But if we look at the first quarter of 24% on a year-over-year basis from first quarter of '23, it looks like it was relatively flat. Is there anything underlying that that you guys could provide some color on?
Pretty distinct quarters. Yes, on a full quarter basis, it was pretty stable. I think that it's really important to look at the year-on-year comparison from a seasonal perspective. And on a trailing 12 months basis obviously continued significant improvement. Any given comparison of quarters, you might see some trends that are interesting, but not necessarily indicative of a longer-term trend. Nothing in particular to call out that was distinct between Q1 and Q2. Q2 was a really interesting quarter as it evolved, really significant impacts early in the quarter and really dramatic favorable outcomes by the end of the quarter, netting out to what ended up to be a quarter that was even better, just modestly better than our expectations. The months can be pretty unpredictable, but the quarters are a little more predictable.
(Operator Instructions) We have a follow-up question from Bob Huang from Morgan Stanley.
Maybe just a follow-up on the PYD question. 5 points of favorable on everything else and 2 points unfavorable on the CAT PYD. On the 5 points, can you give us maybe a little bit more color on the geography of those? Like what are those 5 points coming from if possible? Sorry if I missed this a little earlier.
We did not. It's a little more concentrated in the pet product, but it was distributed across products other than home. The CATs are primarily a home dynamic and the increase was driven by those really significant storms from a year ago and a bit earlier this year that have evolved, continue to evolve. But the underlying favorable development I think is really testament to the non-CAT portion of the business, which is really all the product lines other than home.
Okay. Basically, CAT was unfavorable and dogs were favorable. Thank you for that, that's very helpful. On the other one, maybe on the LTV to CAC side. I know that you talked about previously, you kind of mentioned LTV to CAC is about 3x, then that would be the ratio. And then I think one thing we're trying to figure out is that if you have these homeowner non-renewals, going forward, does that 3x LTV to CAC equation still holds? How should we think about that renewal impact on the LTV to CAC?
Yes. LTV to CAC is an important metric, but it's a forward metric. It's based on a model. It's based on all the information we collect. it improves a little bit every day, every week, every month as we go forward. When we acquired that business, when our models were by definition less sophisticated than today, 2, 3, 4 years ago, we expected those to be profitable customers. As we learn more in our models and our existing customer base and claims activity, invariably a certain portion of the customer base, their expected LTV will change. For newly acquired customers, there is no change, so we expect customers we acquire today and tomorrow to be fully profitable. We've seen a ratio greater than 3:1. 3:1 is a good rule of thumb, but we've seen certainly periods where it's 3.5 or 4 or more. There tends to be a little bit more pressure when you spend more. We're spending double today what we spent a year ago and that tends to put downward pressure on LTV to CAC, but that's a good thing. And we earn our way in, and we develop channels, we expand our spending. And overall, 3:1 is a good metric to think about. I'll add one other comment in that area, which I think is helpful, which is LTV to CAC is kind of policy by policy focused. And if you look at our spending per net added customer, you might think things got more expensive for us in the quarter. And while that exact math is correct, it's important to look at IFP. Net added IFP, gross added IFP really is what we're acquiring with that tax spend. And by that measure, we were actually more efficient in the second quarter than we were in the year-ago quarter and even in the prior quarter. All around, that number is stable, and that's what's enabling us to really say we're very comfortable with growth rates that are accelerating. You started out the year in the low 20s, going into the mid-20s and now we're pushing towards the high 20s growth rate, and that's a core driver for them.
Maybe I'll talk about a comment of color commentary, Bob, as well. LTV to CAC, you always want it to be as high as possible per customer. But truly, you want to keep growing it until you hit the marginal customer where the LTV equals CAC. In other words, if you could spend $1 and get $1.10 instead of getting $3, that is still marginally good for the business, you're still growing profitable business. And since our LTV calculations take onboard the time value of money that's already factored in at a fairly robust discount rate. While LTV to CAC is 3, that's our average, we have many higher customers than that. We acquired many customers in the double digits of LTV to CAC as well. When we'll stop investing is when we hit the marginal customer who's closer to an LTV to CAC of 1. We take a bit of a margin of safety, but conceptually, that is the philosophy. We want every marginally profitable customer, we want them, and we will continue to grow using that. We have never deviated from that. We have never tried to acquire customers of a negative LTV. Sometimes, we find this confusing to some investors because in the short term, they do customer acquisition can impact our financials negatively in the short term. The year in which you spend that CAC, because we are not an agent-based business and we pay all -- we take all our pain upfront, we earn it back over time. Therefore, when we grow, sometimes it can appear to be a near-term loss, but that is just the nature of the flow of time. Fundamentally, it's about spending $1 now and getting $3 back in today's terms. And if that means that in the near term, we take a hit to our EBITDA, we're okay with that. We don't take a hit to our cash because we've got a synthetic agent program in place, so we've neutralized the trough in terms of the cash, in terms of EBITDA. Those things will work their way out during the course of the lifetime of the customer. At any rate, because of that, we have always sought to grow customers on an LTV to CAC basis, never acquiring knowingly negative LTV business. Over the course of the last couple of years with inflationary pressures and others, larger swaths of the nation and of our portfolio were hard to grow in an LTV positive environment, and we've spoken about that, and we slowed our growth, which we're now reaccelerating. And much of those segments of our business have become profitable over time as we got to adequacy, and we've spoken about this, we were able to recover them back to where we thought they would be all along. What we're talking about today for the first time is that in addition to being conservative and careful and never knowingly writing negative business and proactively working to bring back into profitability any business that fell out of it, and largely succeeding, we're also not tolerating business that has fallen between the cracks and we've not been able to bring back to profitability. Not only are we not writing knowingly unprofitable business, as we never have, we are now not renewing such business either, having in some places, exhausted in the near term what rate can deliver. And therefore, the philosophy is the same philosophy, the profitability focus of the business has been the same consistently. But now actually not really slowing down in places that aren't profitable, but even potentially going into reverse markets that don't contribute. And Tim's earlier comment that, yes, you may see a hit, a potential hit of $25 million to IFP, we're reiterated guidance. We think we're going to manage that within the guidance already given. We think that we're overdelivering for the year, and we have that spare to be able to hit guidance notwithstanding this. You won't see a hit to the IFP, but it could have been much higher, as Tim said. But we've always been focused not mainly on growing IFP, but in growing the total value of the book, and this really as a boon to that, as Tim said, $50 million, $60 million of LTV added to our business because of this decision.
Thank you. That was our final question for today, so this does conclude today's call. Thank you all for joining. You may now disconnect your lines.