Earnings Call Transcript - OSCR Q3 2022

Operator, Operator

Good afternoon. My name is Josh, and I will be your conference operator today. I would like to welcome everyone to Oscar Health’s 2022 Third Quarter Conference Call. Thank you. I would now like to turn it over to Cornelia Miller, Vice President of Corporate Development and Investor Relations, to begin the conference.

Cornelia Miller, Vice President of Corporate Development and Investor Relations

Thank you, Josh, and good afternoon everyone. Thank you for joining us for our third quarter 2022 earnings call, where we will discuss our performance to date, our path to profitability, and the recently announced management transition. Mario Schlosser, Oscar’s Co-Founder and Chief Executive Officer; and Scott Blackley, Oscar’s Chief Financial Officer and soon-to-be Chief Transformation Officer, will host this afternoon’s call, which can also be accessed through our Investor Relations website at ir.hioscar.com. Full details of our results and additional management commentary are available in our earnings release, which can be found on our Investor Relations website at ir.hioscar.com. Any remarks that Oscar makes about the future constitute forward-looking statements within the meaning of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those indicated by those forward-looking statements as a result of various important factors, including those discussed in our quarterly report on Form 10-Q for the quarterly period ended June 30, 2022, filed with the SEC, and our other filings with the SEC, including our quarterly report on Form 10-Q for the quarter period ended September 30, 2022, to be filed with the SEC. Such forward-looking statements are based on current expectations as of today. Oscar anticipates that subsequent events and developments may cause estimates to change. While the company may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so. The call will also refer to certain non-GAAP measures. A reconciliation of these measures to the most directly comparable GAAP measures can be found in the third quarter 2022 press release, which is available on the company’s Investor Relations website. With that, I would like to turn the call over to our CEO and Co-Founder, Mario Schlosser.

Mario Schlosser, CEO

Thank you, Cornelia, and good evening everyone. Thanks again for joining us today. I will provide updates on several topics, including our financial results for the quarter, our outlook on open enrollments and recent market dynamics, our strategy for a profitable insurance business in 2023, and more detail on the news updates that we shared earlier today. We will start with a look at the quarter. We see strong evidence of the continuing progress in our business. We increased membership and direct policy premiums dramatically year-over-year. At the same time, we have seen meaningful improvements in our medical loss ratio and administrative expense ratios year-to-date. Those improvements are particularly noteworthy against the backdrop of strong membership growth. So overall, we’re executing our plan. We are seeing the benefits of scale and of our infrastructure, and we have confidence about the future. We will discuss our full year 2022 outlook later in the call. As we look into open enrollments and as we think about our perspective on a positioning for 2023, we are, first of all, excited about the ACA markets. The long-term sustainability of the marketplace is, to us, evidenced by what looks to be record-high membership and the return of many traditional players for this open enrollment. We at Oscar have experienced 2 years where the markets were stable. And even against the complex backdrops, we’ve been grinding out improved performance. Hence, we don’t grow tired of saying this, but the individualized ACA market looks to us much more like the future of a competitive U.S. healthcare system than any other health insurance markets. So it is smart to be really good at it. We see the recent competitive developments as positive, as there are more opportunities for the players that remain. That being said, recent competitor exits demonstrate just how hard it is to navigate the ACA without having a profitable insurance business and without owning modern-day infrastructure. Oscar is, of course, paying attention to these lessons. Now I’d like to share some insights on how we are thinking about 2023 performance. In our individual business, we build our pricing to deliver margin expansion while covering higher cost trends and the impact of Medicaid redeterminations. 2022 year-to-date medical costs are trending slightly below budgets, and utilization is largely flat year-over-year. Thus, we have additional confidence in the assumptions we put in the pricing for 2023. As we told you last quarter, our approach to 2023 has long been focused on profitability over growth. We are targeting effectuated membership at the conclusion of enrollment to be around 1 million members, plus or minus 10%. That being said, this is a particularly challenging year to forecast given the recent market exits. And so in this context, we have built an operating and a capital plan that is designed to allow us to deliver a profitable insurance company in 2023 and to minimize parent cash outflows. That plan includes significant improvements in medical loss ratio driven by pricing for margin expansion and planned total cost of care improvements driven by our technology and strong operational execution. We also expect to drive down our total company adjusted administrative expense ratio through variable cost improvements and fixed cost savings. In pursuing profitability, we continue to focus on how we leverage our technology and our strengths to get us there. Let me give you a few examples. In this past quarter, the team deployed a number of infrastructure enhancements to drive further automation. We refactored our customer service experience so that our members who have the most complex needs are automatically routed to highly trained care guides, while members with less complex issues can resolve matters through automated options. We continue to see our product resonating with those who choose us, with our Net Promoter Score reaching 45 in the third quarter of this year, which is an all-time high. We also updated our policies to reduce readmissions to better align clinical incentives within our network. We enhanced our prior authorization and claims matching logic to increase our auto rates. We also continue to work with our major vendors to find in-year efficiencies. With our increased scale, we expect vendor contracts to be a source of additional savings in the years to come. All of this contributes to the progress we have made driving down MLR and our administrative ratios even with the massive membership growth we saw this year. As we look towards closing out 2022 and the execution steps we have laid out for 2023, we are confident about these opportunities for continuing to drive dramatically improved results next year. These improvements will also give us additional leverage as we look to the future of our Plus Oscar business. As we said, we expect that we will have a profitable insurance business next year with a combined ratio below 100%. We are also excited to share that we are now targeting total company profitability in 2024, a year earlier than previously expected as we continue to drive cost savings across the business. With that, I will turn the call over to Scott to walk us through the financials.

Scott Blackley, CFO

Thank you, Mario, and good afternoon, everyone. Our third quarter results show the benefits of our increasing scale. As Mario noted, we have roughly doubled our membership year-over-year and expect meaningful margin improvement. We continue to deliver against our 2022 plan throughout the first nine months of the year. I will discuss the puts and takes of our guidance updates in more detail in a few minutes. We ended the third quarter with over 1 million members, an increase of 81% year-over-year, driven primarily by growth in our individual business and our small group offering, C+O. We are pleased with the strong traction of C+O. We ended the quarter with 53,000 members, and we believe we’ve demonstrated that our innovative products are resonating and meeting the small employer market where the demand is. Our net churn continued to trend positively in the quarter, driven by higher retention and lower lapse rates, as well as increased special enrollment additions compared to last quarter. Third quarter direct and assumed policy premiums increased 87% year-over-year to approximately $1.7 billion, driven by higher membership, rate increases, and business mix shifts towards higher premium silver plans. Turning to medical costs, our medical loss ratio was 89.9% in the quarter, an improvement of roughly 10 points year-over-year. The improvement was largely driven by lower year-over-year COVID costs versus the Delta wave last year, as well as by pricing actions and targeted cost of care initiatives. In the quarter, we had $3.5 million of net unfavorable development versus approximately $20 million in the same period last year. On a year-to-date basis, we had approximately $50 million of unfavorable prior year development. Switching to utilization, we saw direct COVID costs decline significantly year-over-year while remaining fairly consistent quarter-over-quarter. Specifically, COVID costs in the quarter were both lower than the Q1 2022 peak and just 30% of the Delta peak at this point last year. Direct COVID costs were offset by lower non-COVID utilization, which continued to be below expectation and below baseline this quarter. With respect to administrative costs, our third quarter 2022 insurance company administrative expense ratio was 20.7%, an improvement of 240 basis points year-over-year, driven by fixed cost leverage from greater scale and variable cost efficiencies, which was partially offset by higher distribution expenses associated with the higher-than-expected membership. We also saw even greater operating leverage from higher premiums in our adjusted administrative expense ratio, which improved 510 basis points year-over-year. As we enter the final months of the year, we are focused on driving administrative cost savings that position us to reach our profitability targets. This includes having already optimized our distribution spend for next year, renegotiating key vendor contracts based on our scale, and improving automation with our technology. Our overall combined ratio, which is the sum of our medical loss ratio and the insurance company administrative expense ratio, was 110.6% in the quarter, a 12 point year-over-year improvement driven by the MLR and the insurance company administrative expense ratio improvements that I previously mentioned. Our third quarter 2022 adjusted EBITDA loss of $160 million improved $28 million year-over-year and improved as a percentage of premiums before ceded reinsurance by 16 points from being at 28% of premiums last year to 12% this year. Turning to the balance sheet, we ended the quarter with over $3 billion in total company cash and investments, including $420 million of cash and investments at the parent and another $2.6 billion of cash and investments at our insurance subsidiaries. At the end of the quarter, we had $694 million of statutory capital at our subsidiaries, including approximately $170 million of excess capital. Moving on to guidance. Based on our traction in membership, we are updating our full year direct and assumed policy premium guidance to the range of $6.7 billion to $6.9 billion, an increase of roughly $550 million at the midpoint. Distribution expenses are also trending higher as more members have come through the broker channel than was anticipated, and our insurance company administrative expense ratio is now projected to be at the high end of our 19.5% to 20.5% range. Our medical loss ratio is projected to be around the midpoint of our 84% to 86% range. Excluding prior year development, MLR would be towards the low end of the range. While we expect premium growth of approximately 100% year-over-year, we are also projecting roughly 5 points of combined ratio improvement, which speaks to our ability to operate at scale. Moving to the total company performance, we expect our adjusted administrative expense ratio to be at the midpoint of the range as fixed cost discipline is driving operating leverage. All in, we are now projecting our 2022 adjusted EBITDA loss to be modestly above the $480 million high end of our prior range of losses of $380 million to $480 million. Notably, this still reflects roughly a 7-point year-over-year improvement as a percentage of premiums before ceded reinsurance. I will also reiterate a few key points on our preliminary views on 2023 performance. We are targeting effectuated membership at the conclusion of open enrollment to be around 1 million members, plus or minus 10%. We’re expecting that we will drive significant improvements in MLR driven by pricing for margin and total cost of care initiatives we have planned, and we have identified over $120 million in total company administrative expense cost savings based on our membership outlook. When we take these factors together, we expect that we will have a profitable insurance business next year with a combined ratio below 100 and a dramatically lower adjusted EBITDA loss versus what we are guiding to for 2022. With the positive leverage we see in our business, we are also now targeting total company profitability in 2024, a year earlier than we previously expected. Given the membership expectations and targeted improvement in profitability, we believe we have sufficient cash and liquidity to fund the company into 2024, as we previously signaled. Our financial plan for 2023 is to focus on driving bottom-line improvement and reduce parent cash outflows. We continue to utilize reinsurance as a risk and capital management lever and note that our $200 million revolver remains undrawn. We will provide detailed guidance for 2023 and more detail on our path to profitability during our fourth quarter earnings call next year. And with that, let me turn it back to Mario.

Mario Schlosser, CEO

Thank you, Scott. Before we close, I’d like to talk about how we will be organizing as a leadership team to further strengthen our focus on our near-term priorities and ensure we are building a future beyond them. Effective December 1, Scott will take on a new role as Chief Transformation Officer. In this role, Scott will focus on how we align our overall revenues with our costs for both insurance company and total company profitability. Scott will be working across the organization to ensure that we are executing our business plan and aligning our operational strategy with our tech expenditure. He will also be partnering with me on the approach for how we leverage our technology stack and the larger strategic considerations for these segments of the company, including our go-to-market strategy for Plus Oscar. This move is about maximizing the capacity of a leadership team that is already aligned and executing. The team has demonstrated focus and discipline this year, laying the tracks for the critical milestones of insurance company profitability in 2023 and total company profitability in 2024. Given the importance of these goals, we wanted a member of the senior team to focus exclusively on these goals. I want to thank Scott for the excellent work he has done in the CFO role, and I’m excited to have him provide his experienced leadership in this critical role. High five, Scott. With Scott transitioning, we asked our former CFO, Sid Sankaran, to rejoin Oscar as Interim CFO. Sid has stayed very closely with the business and our finances as a member of our Board and the Chair of our Finance Risk and Investment Committee. Given his familiarity with our finances and our strategy, we felt that Sid was a natural choice to step in. Sid will join us at Oscar immediately and will transition into the CFO role effective December 1. We will be starting a search for a permanent CFO. Sid, would you like to say a few words?

Sid Sankaran, Interim CFO

Thanks, Mario. The Oscar team has a great plan in place, and I’m excited to step in as the Interim CFO and help us execute on our goals. As a member of the Board, I’ve remained highly engaged and closely aligned with Mario, Scott, and the rest of the executive team. I’m thrilled to step back in to help and look forward to reconnecting with our investors and the analyst community.

Mario Schlosser, CEO

Thanks, Sid. And just in closing, we at Oscar have navigated a lot of complexity in our 10-year history, but what has remained the same is a fundamental belief in the changes that are needed in the healthcare system and the role we can play in bringing those about. The U.S. healthcare system is moving towards a more consumer-driven, more digital and virtual, and more value-based system. This kind of future market is going to be defined by those who best engage members, help members save money, and have the technology to incentivize better outcomes and earn the resulting risk premium. That’s exactly the kind of system for which we have built our infrastructure. And while we’ve been doing that, we have navigated an entirely new insurance market as a startup. We have absorbed numerous regulatory changes and seen unprecedented growth, all while solidifying our cost structures in our care models. That depth of experience sets us up very well for achieving our financial goals and fulfilling our mission to make a healthier life accessible and affordable for all. We remain steadfast in this approach, and we remain humble as the members continue to choose and stay with Oscar. We are also fully committed to and excited about the close partnerships we have built with the providers who serve Oscar members and the brokers who sell Oscar products, and we deeply value their support. For the plan we’re executing against, and this management team structured to focus on it, we are confident that we can live up to our promise as a company refactoring healthcare for many decades to come. And finally, before we go to the Q&A, I want to thank the Oscar employees who have powered Oscar with genius, grit, and member focus for the last decade. I’m proud of all that we’ve achieved. I’m looking forward to the next chapter of building Oscar together. And with that, we will turn it over to the operator for the Q&A portion of the call.

Operator, Operator

Your first question comes from the line of Michael Ha with Morgan Stanley. Your line is open.

Connor Massari, Analyst

Hi, this is Connor Massari on for Michael. Just looking at growth here. You have family glitch fix, Medicaid redeterminations, and subsidies extended, peers exiting the market, obviously, a seemingly large number of growth tailwinds in 2023. And I believe the last we spoke here, internal estimates for exchange industry growth were 10% to 15%. But given all these tailwinds, how are you looking at that now? Has that changed at all? And are there any headwinds that we should consider?

Mario Schlosser, CEO

Yes. Connor, let me start with that. Maybe, Scott, you can add a bit more perspective to it. So Connor, we’ve been making decisions very clearly all year long. We want membership that fits in our capital operational plan. We are, therefore, managing the outcome of enrollments into the cone we talked about, 1 million members, plus/minus 10%. That considers all those growth factors that you just mentioned and all those various factors. I’d say in the medium to long-term, we’re very excited, as we said, about our position in the market. We’ve got great brands, great distribution relationships, and members really like being with Oscar as aided by the NPS. Therefore, we can always revert to higher growth in years to come. That’s certainly the plan. But for this year, with a focus on profitability for next year in the insurance business, we want to be in that cone managing towards that.

Scott Blackley, CFO

Connor, I would just add maybe a couple of other points. First of all, going back to our pricing, we have built in pricing to improve margin this year. While we have a competitive position across a variety of markets, we are slightly less competitive than we’ve been in the past, which I’d anticipate is one of the factors that will drive our membership. Secondly, we’ve also adjusted our distribution strategy. We’ve already put that into the market. That’s part of our expectations for improved 2023 performance. While we are still competitive with the market there, we’ve reverted to distribution spending that looks a lot more like pre-COVID levels versus what we experienced last year.

Connor Massari, Analyst

Thank you.

Stephen Baxter, Analyst

Hi, thanks for the question. Just, I guess, two. First, on the health plan profitability in 2023. I just want to make sure, when we’re thinking about the improvement in the combined ratio that you need to drive, just roughly, what are you thinking will be the bigger driver? Are you expecting it to be MLR or SG&A? And the $120 million of identified costs that you cited at the end of your prepared remarks, is that for the overall business or just for the health plan component of it? And I guess the last piece is just what will really make sure I understand why the EBITDA loss guidance is increasing. It doesn’t necessarily seem like you missed your internal MLR expectations. I hear you on distribution expenses coming in higher. It feels like that’s something that you would have been aware of for most of the year at this point. Just help us understand the moving parts there and anything I might be missing in that analysis. Thank you.

Scott Blackley, CFO

Sure. We will try to address most of those. A couple of big topics there. So starting with 2023 improvement, I would expect to see significant improvements in both MLR and admin. On the MLR side, I would point to pricing that we put into the market for next year, which was designed to cover trends, was designed to cover redeterminations, and create margin expansion. As I mentioned, we do have a number of total cost of care initiatives that we are executing right now. On the admin side, we are expecting significant improvements and would expect to see that both in the insurance company as well as our total company adjusted administrative expense ratio. The $120 million that I spoke to is total spend for the company. I would just highlight a few things that will drive the admin improvements. First is distribution, which will be a significant driver of the improvement in the insurance company. Second is vendor relationships; we use a number of vendors as part of our business, and we have already negotiated many of those arrangements based on our larger scale. We expect that we will be able to continue to do that. Third, we anticipate additional fixed cost leverage as we move into 2023. To go to your question on adjusted EBITDA in terms of where we are coming in at above the high end of our range, we expect it to be modestly over the $480 million top end of the range that we previously disclosed. A few things to note: The first is that higher distribution cost we saw was associated with additional new members. We had eliminated broker commissions as of the beginning of the second quarter. Towards the tail end of the second quarter, CMS provided updated guidance to the industry prohibiting differentiating your broker compensation for the same effectuation year. We have restated that. That was not implicit in our original guidance. This has created a headwind to our administrative expense ratio and driven up the adjusted EBITDA loss. We have already put distribution pricing into the market for next year. The second thing to note is that we have hoped to be at the bottom end of our MLR range, but with new membership, that also comes with some MLR pressure—much less than what we experienced last year. Overall, it’s not a big impact to our current quarter results, but it did take up some of the cushion we had in our MLR guidance. We had predicted to be at the bottom of the MLR range but it has pushed us to the middle of the range due to various pressures, including the distribution expense in the third quarter.

Stephen Baxter, Analyst

Thank you very much.

Nathan Rich, Analyst

Hi. Good afternoon. Thanks for taking the questions. Maybe just following up on that last one as it relates to 2023. I think you had talked about taking high-single digit type price increases for next year. Now, that you kind of have a better view of the competitive landscape, how do you feel about your positioning and the ability to hit the membership target that you gave? Do you think that membership outside of the range that you gave would have a negative impact on your profitability, or do you see flexibility within the organization to hit your profitability goals even if that does fall outside of that 1 million, plus or minus 10% range? Thank you.

Mario Schlosser, CEO

Yes. Nathan, let me hit the first part of this, and then Scott, you can talk a bit about the range and what happens if we fall outside it. So, let me put on the long-term hat there first, which is just to reaffirm, we think we have an attractive product. It’s innovative, has great distribution partners, and is very committed. We spend a lot of time with them and have a good brand in the market. We continue to put new products in the market, including expanded virtual primary care offerings in 2023 and other initiatives. This entire year, we have been managing, as I said before, for confirmation of outcomes. So, we are targeting slight shrinkage to moderate growth—around 1 million plus or minus 10%. To illustrate, we are currently in the high-single digits this year. The market is probably coming in around 6% or so on average across the country. We did go above the market, which speaks to our focus on profitability and margin compared to growth. Last year, for comparison, our increase was around 2%, and the market was around 1% to 3%. Pricing is always a nuanced and localized decision-making process. As we are deeply tied into the local communities there, we generally feel good about where we are priced to land right in the middle of that cone in all states and geographies where we want to remain competitive and gain the right memberships.

Scott Blackley, CFO

Sure, Nathan. In terms of membership, I would just point out two things. Obviously, larger membership should positively impact earnings. Bigger membership equates to more fixed cost leverage and greater potential for generating earnings in our insurance business. On the flip side, that requires growth capital, and we are very focused on ensuring that we do not create additional demands on parent cash, while leveraging the capital we already have in our subsidiaries. This is an important part of our strategy for landing in that 1 million member range we discussed.

Mario Schlosser, CEO

Yes. If we fall outside of that range, we have levers we can pull on both the upside and downside to ensure we mitigate the impact on our financial outcomes.

Josh Raskin, Analyst

Hi. Thanks. Good afternoon or evening. I guess first, from a strategic standpoint, I didn’t hear about Plus Oscar this quarter. I am curious, have you guys thought about putting Plus Oscar on hold or even divesting Medicare Advantage at this point and really focusing on the individual and family plans and small groups? Are there strategic or regulatory reasons that make sense for you to stay in MA at this point? And then my second question would be—I should preface this with a welcome back, Sid; good to hear your voice. I noticed the interim title. So, maybe you could talk a little bit about the plans for the permanent CFO role. I would be curious to know who is working on forecasting and financial planning specifically. Thanks.

Mario Schlosser, CEO

Yes. Josh, let me hit the Plus Oscar question first. The biggest thing we think we can do right now to make Plus Oscar an attractive product is to just use it in the absolute best possible way. I think that’s what we have been doing this year. If you recall, entering this year, we were somewhat surprised by our large growth and had to put in a lot of work to ensure our operations could handle it effectively. I think we have managed this well because, as you see, our metrics are landing, whether it be our MLR or combined ratio metrics. We believe this is the best marketing argument for Plus Oscar. We think that this will continue into next year. It’s also how we think about growth, which is more important for us to demonstrate that we can manage membership and achieve profitability than focusing on anything else. We can always return to growth in the insurance business later on. This is how we prioritize Plus Oscar at the moment. The plan is as we have mentioned at various conferences: focus on not rolling out any more significant Plus Oscar deals until 2024. We must solve how we can sell Plus Oscar more effectively and partner with other parties in more efficient ways. Both of these questions require partnerships and they are what Scott will focus on as Chief Transformation Officer, among other responsibilities. So, that’s where we stand right now with Plus Oscar. We are currently in discussions about using our Campaign Builder module, which is our first product. We have retained some physician groups, and we are already utilizing this internally and for physician groups in our network connected to value-based care arrangements. Regarding MA, we have largely exited our organic MA business in New York and Texas. This was not materially significant for membership, but it improved our insurance company performance regarding the MLR and administrative ratios for next year. We did that to focus on our ACA plans and family business. While we want to return to the MA market, doing so will be through partnerships moving forward.

Scott Blackley, CFO

And Josh, regarding the 2023 planning and outlook, I have been leading that process and been producing our internal budgets and outlook for the coming year. I will be working closely with Sid to ensure he transitions smoothly into this role where he will take the lead. As we mentioned, Sid will officially transition into the CFO position on December 1st, and I expect to be in the office promptly at 8 a.m. tomorrow to start the transitioning process. Having someone who is already very familiar with the company makes this process significantly easier, allowing me to focus on driving the execution of key plans we have set in place for 2023.

Mario Schlosser, CEO

Josh, the final point you asked about the permanent CFO. As I've said, this is mainly about focusing on achieving our 2023 profitability goals and total company profitability by 2024. We believe we have good visibility into 2023, allowing us ample time to determine the next steps beyond that. We are excited to work collaboratively with everyone involved including Sid, Alexa, Ramli, and the entire team as we embark on this journey together.

Josh Raskin, Analyst

Makes sense. Thank you.

Operator, Operator

There are no further questions at this time. This concludes today’s conference call. Thank you for joining. You may now disconnect.