Health Insurance Innovations' (HIIQ) CEO and Chairman Michael Kosloske envisions "tremendous year-over-year growth in '13 and a home run in '14." Actually more like a grand slam, as our projections of industry evolving tailwinds indicate a potential 93% upsurge in 18 months. We believe the recent sell-off due to cautionary guidance and increasing competition from bigger players, WellPoint (WLP), is short-sighted and overblown. Our FY2014 estimated fair value of $17.22 is based on a forward P/E of 14x.
COMPANY OVERVIEW
Health Insurance Innovations was founded by Michael Kosloske in 2007 and IPO'd this past February. Kosloske is an industry pioneer in online health insurance as he presided over HPA (founded by his grandfather) from 1987 to 2007 when he sold-out to IHC. HIIQ operates similar to HPA in designing affordable Short-Term Medical (STM), Hospital Indemnity, and Ancillary Product insurance plans that are sold online. STMs are a niche product within the individual insurance market that provides a low-cost alternative to the traditional Individual Major Medical (IMM) plans. The STM health insurance plans are appealing to individuals outside employer group plans which include small business owners and their employees, early retirees, part-time and seasonal workers, and the unemployed. Hospital Indemnities are insurance plans that pay hospital patients cash for the days spent in the hospital and are typically targeted at individuals with high-deductible policies. Ancillary Products are stick-on plans such as dental, critical illness, pharmacy benefit cards, and cancer plans. Each plan is underwritten by top-shelf insurance carriers: CIGNA (CI), ING, Markel, Starr Indemnity, United States Fire, and Companion Life, therefore, HIIQ assumes no underwriting risk, no reimbursement risk, does not have to settle claims, and is not held to any minimum loss ratios. Thus, HIIQ is less risky and very lean compared to the industry as there is no need for claims or underwriting departments. The company has a wide and growing distribution network with 54 agent call centers (up from 32 last November), 274 wholesalers including Marsh&McLennan (MCC), eHealthInsurance, Aon (AON) and MasterCard (MA), and 8965 licensed brokers.
The business model is constructed around a proprietary online platform that provides a win-win-win proposition for the insurance carriers, distributors, and policyholders or 'members.' The platform allows members quick and easy access to health insurance at HIIQ.com and distributor web-sites. Plans can be quoted, bought, and printed in a matter of minutes for about half the cost of a IMM health plan. The "wins" for distributors are: attractive compensation in a declining commission environment, turnkey solutions to customize and bundle plans among carriers through one website, and real-time sales conversions. The "wins" for carriers include access to a large member base with no pre-existing conditions and real-time sales for quicker cash conversion. Management credits this model with building strong relationships in which the team has not lost a carrier in over 10 years. The model is also highly scalable with strong operating leverage as customer care personnel are unnecessary.
INDUSTRY OVERVIEW
Beginning January 2014, the Affordable Care Act (ACA) will require Americans to possess a health insurance plan or suffer a monetary penalty come tax day 2015. The ACA's goal is to have each individual's health covered and eventually reduce the cost of healthcare over the long term. Several surveys suggest the current number of uninsured is ~50 million individuals. A 2011 McKinsey survey approximates an additional ~40-50 million people will enter the uninsured pool in 2014 due to being dropped from their employer's group plans. The reasoning is that employers with >50 employees will get hit with only a $2000 penalty for dropping coverage, which is meaningfully less than the estimated $10,000+ per employee health plan (employers with <50 employees face no penalty). Adding the two pools is 90+ million people and combining the current ~14 million people with individual health insurance creates a 100+ million addressable market for 2014. The estimated spend on the ~14 million individual health insurance plans is $50 billion annually and reaching 100+ million would result in a projected $350+ billion spend.
Competition is very intense and highly concentrated as 30 states had one carrier controlling over half the individual insurance market. The online marketplace is also heating up as Blue Cross - Blue Shield, a major licensor to WellPoint, just announced a plan to open online exchanges in several states beginning October 1st. However, HIIQ management believes its online platform provides an edge by creating a value-added proposition for each constituent and should primarily benefit members as a lowest-cost policy provider. The closest competitor is the largest online health insurance provider/exchange, eHealthInsurance, which is also a partner of HIIQ.
The recent decline in stock price began on the Q1 earnings call when management issued cautionary guidance that triggered a one-day drop of nearly 15%. The cautionary guidance referenced an LA Times article concerning a loophole within the ACA that allows health insurers to extend existing individual health policies into the year 2014. It was previously believed that as of January '14 all insurance plans would be switched to fall under ACA guidelines. An excerpt from the earnings call:
"Starting second quarter of 2013 some industry participants are temporarily taking advantage of an ACA loophole? what's happening is a few of the insurance companies are lowering their individual major medical premiums. They are paying full commissions, they are advancing those commissions nine months and they are paying a $500 bonus in addition to that, which we do not feel is economically feasible. So there are some headwinds moving forward that started in April. We know that this will end by January '14, because it will not be legal once ACA takes effect and we think that this is a temporary headwind? We have taken into account these new circumstances that have created some headwind. We have taken a conservative approach in projecting 25% to 35% organic premium equivalent growth year-over-year." - CEO Kosloske
In other words carriers are paying up in an effort to retain their healthiest members. We want to emphasize the choice words of 'few' and 'temporary' and 'conservative' as later in the Q&A the CEO responded to a related question, "I see a few, a very few carriers that are taking advantage of that loophole." From this, while we are delighted with a conservative approach, the resulting month-long sell-off of over 45% (as of last Thursday's close) is unmerited as we believe the overall big picture remains soundly intact.
INVESTMENT SUMMARY (TOP-DOWN)
ACA reform transforms the health insurance landscape shifting employer group policies to the individual insurance market. This is directly beneficial to HIIQ as its products are specifically designed for individuals. Projections for the shift from employer plans are an increase of 40-50 million people to the individual market. We believe the people dropped from their employers' coverage are more likely than the current uninsured to purchase a new individual plan by 2014. Reasons could be they are more accustomed to carrying health insurance and realize the benefits of having coverage. We conservatively assume 20 million of the people dropped from group plans will obtain an individual plan by 2014. For HIIQ, this is a direct increase to their addressable market and alleviates some fears surrounding big industry players entering the STM market. Since the larger competitors are concentrated on providing group policies, they are the ones losing market share upon the shift. Hence, the best they can accomplish by moving into the individual market is to maintain share. If we assume HIIQ will also maintain their current market share, which is miniscule: $75 million in premium equivalents / $50 billion individual market = .15% share x 20 million people = 30,000 new policies for 2014. Q1 '13 STM revenue per policy in force was: $291.30 x (30,000 new) = $8,739,000 new STM revenue for 2014. In Q1 '13, STM revenue was 57% of total revenue, if we assume the recent trend in the product mix continues, STM revenue at 50% of total suggests ~$17.5+ million in new revenue from the individuals that are dropped from employer plans.
The estimated 50 million currently uninsured will be required to obtain health insurance or face a penalty. The penalties are extremely light until 2016:
2014 | 2015 | 2016 | |
Flat Penalty | $95 | $325 | $695 |
or % of income | 1% | 2% | 2.5% |
avg. income $42,693 | $427 | $854 | $1,067 |
break even income to pay flat penalty | $9,500 | $16,250 | $27,800 |
The stipulations are the greater of the flat penalty or the % of income, which elevates as each year passes. The average American with income of $42,693 would be paying the percentage of income penalty in all years for not carrying a health plan. The bottom row shows how much an individual can earn before being charged the percentage of income penalty. The average STM plan is believed to be a cost of $1800/year, but on eHealthInsurance.com the average cost in 2011 was $804. The lowest price in our zip code for a 30-year old non-smoking male was $360. With an assumption near the middle of $600 annually ($50/month), it would be cheaper for the currently uninsured person (earning up to $59,999) to continue for all of 2014 without health insurance and pay the penalty, which would cost $599. In 2015 and 2016 the income limits would be $29,999 and $23,999, respectively. The uninsured by income earned is:
Income | % of Uninsured |
<$11,500 Fed. Poverty Level | 29% |
$11,500 - $23,000 | 30.00% |
$23,000 - $46,000 | 28.20% |
>$46,000 | 13.10% |
Therefore, 2014 is concerned with only the portion of the earners at >$46,000 income or 13.1%. Additionally, of the ~50 million uninsured, only 25.5 million are employed (excluding children and military) which results in ~6.5% or just over 3 million. Of the ~18 million Americans that are both uninsured and unemployed, we assume 9 million will obtain a plan through subsidies. Adding the two numbers represents ~12 million of the currently uninsured that is assumed to obtain health insurance for 2014. Using the same math/method from the above section suggests revenue from the uninsured portion would be ~$10.5 million.
(000's) | 2014E Revenue |
Dropped from coverage | 17.5 |
Previously uninsured | 10.5 |
2013E * 79% retention | 43.5 |
Total | 71.5 |
INVESTMENT SUMMARY (BOTTOM-UP)
Greater penetration through strategic growth initiatives focused on increasing awareness should (at a minimum) allow HIIQ to maintain its current growth level as the industry dynamics play out. Most Americans and even some insurance brokers are perceived as having no awareness to the existence of STMs. In order to build this awareness, HIIQ is expanding distribution channels and lead generation methods. The two key initiatives are partnering with 10-20 new call centers per year and advancing commissions to proven brokers for paying upfront lead costs. Both initiatives have been highly successful as the number of call centers has grown from 32 to 54 in ~six months and policies in force have grown 52.5% y/y. In addition, the company is seeking to increase market share in Hospital Indemnities and Ancillary Products through cross-selling and expanding offerings. This strategy has also been a success with Hospital Indemnity and Ancillary plans in force growing 62.3% and 93.5% y/y, respectively.
Plans In Force | Q1 12 | Q1 13 | % y/y |
STM | 20,044 | 24,459 | 22.0% |
Hospital Indemnity | 5,370 | 8,714 | 62.3% |
Ancillary Products | 13,631 | 26,372 | 93.5% |
Total | 39,045 | 59,546 | 52.5% |
Aside from future industry tailwinds and the increase in selling agents, HIIQ grew premiums over 40% in 2012. Therefore, it is easy to foresee as the addressable market experiences a giant influx in 2014, that HIIQ has the potential to compound its small footprint at a rapid pace. Thus, management's mention of a 'home run' could actually be a 'grand slam.' However, we remain highly guarded as to the risks of the uncertain regulatory future and also to the fact the business model could be quickly replicated; thus, we assume a growth level in line with updated guidance of 30%.
2012 | 2013E | 2014E | |
Premium Equivalents | $75,782 | $98,517 | 128,072 |
Less: Risk Premium and 3rd Party payments | $33,932 | $43,348 | $56,352 |
Revenue | $41,940 | $55,169 | $71,720 |
Highly scalable platform provides significant operating leverage from an expected boost in volume. In the Q1 earnings call management cited, "we can grow our revenue $100 million and only add a handful of administrative staff and systems specialists?with minimal capex." As stated above, HIIQ operates with zero need for claims, or underwriting, or customer care personnel and thus, only has 79 employees. This is compared to large competitors with 50,000+ employees. During Q1, management bought out Ivan Spinner of TSG Agency, a director of growing the call center business, for a cash expense of $5.5 million, which will reduce third-party commissions by an expected $1 million in 2013, and incrementally going forward.
2011 | 2012 | 2013E | 2014E | |
Revenues | 29,878 | 41,940 | 55,169 | 71,720 |
Third-party commissions | 21,704 | 27,858 | 32,787 | 38,172 |
ACH fees | 670 | 963 | 1,269 | 1,650 |
G&A expenses | 4,762 | 8,611 | 8,882 | 9,137 |
D&A | 298 | 1,012 | 903 | 954 |
Total op. expenses | 27,434 | 38,444 | 43,841 | 49,913 |
Operating income | 2,444 | 3,496 | 11,328 | 21,807 |
% of revenue | ||||
Third-party commissions | 72.64% | 66.42% | 59.43% | 53.22% |
ACH fees | 2.24% | 2.30% | 2.30% | 2.30% |
G&A expenses | 15.94% | 20.53% | 16.10% | 12.74% |
D&A | 1.00% | 2.41% | 1.64% | 1.33% |
Total op. expenses | 91.82% | 91.66% | 79.47% | 69.59% |
Operating income | 8.18% | 8.34% | 20.53% | 30.41% |
VALUATION
Base Case. Referencing the McKinsey survey, management provided analysts with a top-down view suggesting reform could expand the individual insurance market from ~14 million people spending $50 billion to ~100+ million people spending $350+ billion. In our view, considering the level of uncertainty surrounding reform changes and people's desire to obtain health insurance, we predict a lower addressable market for 2014 of 46 million people. Our computation of market share and premium equivalent growth led to an estimated revenue of $71.7 million. In our bottom-up view, despite the high probability of industry tailwinds creating a grand slam for HIIQ, we remain cautious to the stated risks and increased competition, and extrapolate management's guided mid-point, resulting in forecasted 2014 revenue of $71.5 million. The two views are very close and using the bottom-up number we get:
2011 | 2012 | Adj. 2013E | 2014E | |
Premium Equivalents | 53,206 | 75,872 | 98,517 | 128,072 |
Revenues | 29,878 | 41,940 | 55,169 | 71,20 |
Oper. Income | 2,444 | 3,496 | 11,328 | 21,807 |
EBITDA | 2,742 | 4,508 | 12,231 | 22,761 |
Net Income | 2,373 | 3,260 | 10,768 | 18,406 |
EPS | 0.24 | 0.74 | 1.23 |
Forward P/E multiple of 14 x $1.23 = $17.22 PT
The closest competitor, EHTH, is trading at a FY2014 forward P/E of 32.5. Larger carriers, though not as comparable, are trading at a FY2014 forward P/E around 9x - 10x. Considering HIIQ is less risky, leaner, and has the ability to grow exponentially, we believe it deserves a higher multiple than the average. Though, we also realize the level of uncertainty holds significant weight and choose to apply a 14x forward multiple, resulting in our 2014 price target of $17.22. We treat 2013 as a transition year due to a number of one-time expenses and IPO related costs, in which our forecasted expenses are adjusted to best estimate. Therefore, it is more appropriate to give an 18 month price target. Also, on account of industry uncertainty and HIIQ's microscopic footprint, the effort to forecast a long-term horizon is tremendously difficult. Hence, we choose to wait until further developments take place.
COMMON STOCK STRUCTURE
HIIQ has two classes of stock: Class A and Class B. The float consists of Class A and has ordinary claims on operations and voting rights. Class A represents ~39% of total or about 5.2 million shares. Class B represents Chairman and CEO Michael Kosloske's stake of ~62 of total or about 8.6 million shares. Class B also has claims on operations and the same voting rights as Class A. Class B can only be extinguished by conversion into Class A stock, which contains tax implications for HIIQ. The purpose of this structure is most likely to ward off takeover attempts. We view HIIQ's Class A shares as an excellent opportunity to invest alongside a highly capable owner that is a pioneer to the online health insurance market. We also believe since Mr. Kosloske has a controlling interest and previously sold his last company, that HIIQ may be an eventual buy-out target.
RISKS
The most prevalent risk is the uncertainty of the reform's acceptance amongst individuals and each state government. In addition, delays and lack of detailed enforcement by the government can create increased confusion. Any partnership terminated or renegotiated by a large carrier or distributor may adversely affect HIIQ's operations; at year end 2012, Starr Indemnity, United States Fire, and Companion Life accounted for 46%, 25%, and 22% of premium equivalents, respectively. A third-party association, Med-Sense Guaranteed had 80.9% of HIIQ's business become members of the association. Any disruption with Med-Sense would significantly impact operations. We view this as limited as CFO Hershberger was previously president of Med-Sense. Another widespread risk is the expected increase in competition for the lower-end market, which we believe is limited due to the size of the industry tailwinds in relation to HIIQ's footprint. If the lack of awareness of HIIQ and its products persists, then growth might not be as high as expected. HIIQ's business model is easily replicable.
CONCLUSION
The probability of Health Insurance Innovations hitting a grand slam in 2014 is more likely than not. HIIQ's build out of distributors and call centers should effectively penetrate an expanding health insurance market allowing growth rates to remain elevated. At currently oversold levels we believe shares represent a highly attractive risk/reward especially given our use of cautiously low assumptions and a lower multiple of only 14x.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in HIIQ over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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