SelectQuote, Inc. (SLQT) Q2 2022 Earnings Call Transcript

Thank you, and good afternoon, everyone. Welcome to SelectQuote's Fiscal Second Quarter Earnings Call. Before we begin our call, I would like to mention that on our website, we have provided a slide presentation to help guide our discussion this afternoon. After today's call, a replay will also be available on our website. Joining me from the company, I have our Chief Executive Officer, Tim Danker; and Chief Financial Officer, Raff Sadun. Following Tim and Raff's comments today, we will have a question-and-answer session. As referenced on Slide 2, during this call, we will be discussing some non-GAAP financial measures. The most directly comparable GAAP financial measures and a reconciliation of the differences between the GAAP and non-GAAP financial measures are available in our earnings release and investor presentation on our website. And finally, a reminder that certain statements made today may be forward-looking statements. These statements are made based upon management's current expectations and beliefs concerning future events impacting the company and therefore, involve a number of uncertainties and risks, including, but not limited to, those described in our earnings release, annual report on Form 10-K and other filings with the SEC. Therefore, the actual results of operations or financial condition of the company could differ materially from those expressed or implied in our forward-looking statements. And with that, I'd like to turn the call over to our Chief Executive Officer, Tim Danker. Tim?

Thanks, Matt, and thank you to everyone joining on the call. As you saw in our press release, SelectQuote had a disappointing quarter compared to our expectations. We will use the beginning of this call to discuss the challenges we faced with this AEP and how we are evolving our strategy going forward. Before we begin though, I'd like to be clear to shareholders that we view these results as unacceptable, unacceptable to us certainly, but also unacceptable compared to what we know is achievable within SelectQuote organization and our differentiated position within the shifting health care system. With that, let's begin on Slide 3. SelectQuote's consolidated revenue for the quarter totaled $195 million, and adjusted EBITDA finished at negative $163 million. Revenues decreased 45% compared to a year ago, and adjusted EBITDA declined significantly, driven by a number of unexpected factors this AEP season, which we will detail in a minute. Beyond the challenges within AEP in the quarter, we also recognized a cohort sale adjustment of $145 million in the quarter, which includes the potential risk previously disclosed. This earlier and larger adjustment reflects lower persistency primarily from higher intra-year loss rates we experienced during the calendar year 2021. Bottom line, these results were materially below our expectations. And given the significant weighting and importance of the second quarter, our full-year results will come in below our outlook range as well. As you saw in our press release, our new outlook range for revenue is $810 million to $850 million and the range of adjusted EBITDA is negative $235 million to negative $260 million given the headwinds we've realized to date. Raff will give more details on our outlook for 2022. But clearly, this will be a transitional year for our company. To that point, the SelectQuote management team and our Board of Directors are actively reviewing business strategy, especially within our senior Medicare Advantage distribution business. We will share our initial action plan on this call, but it's important to understand that this review will run through the remainder of the fiscal year and likely into next fiscal year as well. We are committed to getting the slide, not just for our Medicare Advantage business. But because of the value we know SelectQuote provides as a unique connector between policyholders and patients and the health care insurers and providers that pay for and provide their care. To that point, our population health initiative in SelectRx in particular, has been a bright spot for us. We continue to see strong consumer need and demand for a growing array of health care services we coordinate with the population health platform. Consumer interest in our SelectRx pharmacy solution, in particular, continues to ramp up. To date, we have completed over 40,000 gross customer enrollments, and we are beginning to hit our stride in terms of shipments and recently added 10,000 active members receiving prescriptions. We know we can address the challenges impacting our senior distribution business and grow our Population Health business simultaneously, but our highest priority is to deliver value to shareholders based on the meaningful synergy between these businesses and the thousands of senior Americans that our services touch every day. Let's turn to Slide 4 and discuss what happened this season in our senior Medicare Distribution business. If we work from left to right, the first headwind began during our preparation for AEP while we faced a very challenging labor market, as we discussed last quarter. In hiring for AEP, many prospective sales agents verbally accepted our offers but failed to complete the licensing process or took other employment. Filling these positions caused a delay to our hiring goals for the season, which we discussed during our last earnings call. We also indicated our expectation that those delays would impact effectiveness early in AEP, but we expected those agents would eventually achieve close rates more in line with historical SelectQuote processes. Although close rates did improve over the course of AEP, they did not improve as much as anticipated. Additionally, CMS mandated an industry-wide review of marketing materials immediately prior to the start of AEP which added delays to some of our marketing programs and more critically, masked the number of close-rate pressures that we experienced early on in the season. We believed at the time that the flex agent onboarding delays and the CMS marketing review process were the underlying reasons for our depressed close rates and that both dynamics would ultimately prove temporary in nature. On the right side of the page, this Medicare Advantage season was also unique because of the seeming parity in Medicare Advantage plan features. In prior years, several large carrier partners underwent a multiyear process of building new and richer benefits such as more expansive dental, prescription drug, healthy meal, and wellness programs into their MA plans. These new and exciting plan features created compelling reasons for customers to move into a new MA plan. This year's greater level of parity and planned features across our carrier partners negatively impacted our sales process, which slowed throughput and significantly lowered close rates. In hindsight, the greater parity in plan design ultimately proved to be a larger headwind to close rates and policy production than we initially believed early in AEP. Lastly, we experienced a higher-than-usual falloff in submitted to improved policies driven by increased shopping behavior among Medicare consumers. Put plainly, in many cases, we saw consumers consider a new plan only to remain with their existing plan, given the lack of disparity in new features. In sum, the impact was a significant decline in our close rates compared to past seasons. During this AEP season, our average close rate was down more than 20% from last season, which had an even greater detrimental impact on agent productivity. Taking a step back, these headwinds clearly impacted volume, but what might be less apparent is the pressure our model faces on unit profitability with the type of unexpected slowdown we've experienced this season. Put simply, our operating leverage was too high for this unique environment, and I'll touch on that as it relates to our strategy in a minute. Before I do, let's turn to Slide 5, and I'll give some context on how each headwind impacted our profitability relative to plan. On the left side of the bridge, we begin with our outlook for consolidated EBITDA and the implied 2Q forecast of approximately $150 million. If we work from left to right, again, first, you can see the impact of the $145 million cohort sale adjustment recognized this quarter. To be clear, this includes the potential risk of $65 million for a cohort sale adjustment that was included in our previous full-year 2022 outlook as part of our fourth-quarter estimates. Raff will provide more detail in a minute on the makeup of that adjustment as well as actions we are taking to change our LTV methodology given the shift in the environment. Next, as I mentioned, you can see the 20% plus decline in year-over-year AEP close rates accounted for the lion's share of our EBITDA shortfall outside of the tail adjustment. This EBITDA shortfall is a function of two things. First is the unexpected general parity in carrier plan design, which showed lower volumes and limited our throughput, which negatively impacted our top line. The second relates to the significant amount of operating leverage in our Medicare Advantage business. As you know, the AEP and OEP season for Medicare Advantage distribution is a compressed timeline that includes a number of fixed costs for the season including recruiting, training, agents, and marketing. When the season performs within a normal range, the results in profitability are more than attractive as we've exhibited over the past few years. The flip side is clearly true. And as a result of this season, we are reviewing what the appropriate balances between growth and risk as defined by operating leverage. If we move to the next section of the bridge, you can see the additional impact that we've experienced from senior LTV, primarily driven by lower persistency as well as the impact we've imposed with wider assumptions on our constraint as well as our first-year and renewal provisions. Raff will speak at length to those assumption changes in a minute. And lastly, we encountered some headwinds to other revenue, primarily made up of our Auto & Home and Life divisions. While we were able to save $43 million in expenses, that was not nearly enough to offset the revenue declines. And therefore, adjusted EBITDA came in significantly below our expectations. Again, clearly not what we expected when we prepared for the season, but we are using this experience in real time to realign our strategy. To that point, please turn to Slide 6, and let me offer our initial high-level assessment of SelectQuote's Seniors business model and the direction we need to take it, given the shift in environment. At the left, it is clear that many participants in the MA space, including SelectQuote, were organized for rapid growth against an addressable market that remains very large. It remains our view that SelectQuote has significant competitive advantages given our data-driven technology and agent-led model. That said, our historical philosophy for growth and operating leverage is not aligned with today's market. To be clear, we believe the market for Medicare Advantage policies is very large and will continue to grow with the aging of America. We plan to benefit from and execute against the strong demographic backdrop for years to come, but we also owe it to our shareholders to mitigate volatility in our results. As I mentioned, we are working hard with our Board to review our approach and we believe our ultimate strategy for the Medicare Advantage business will be to reset our growth philosophy with a stronger focus on repeatable unit operating margins and predictable cash flows within a wide range of market scenarios. Next year, we will likely build a plan that pulls back on submissions year-over-year to reset the baseline with the intention of growing modestly from there. This will allow us to operate more efficiently with a higher mix of tenured agents and lower flex agent hiring needs, which reduces volatility and lowers cost. It also improves cash flow significantly. While this year's AEP included a number of unexpected headwinds, we need to better plan for risk. And we believe SelectQuote has the ability to still grow at an attractive rate while also significantly reducing our operating leverage and downside risk. Moving down the page. As we have discussed in previous quarters, policyholder loss rates from season to season have also driven volatility in our results. Raff will discuss the changes we are making to our LTV assumptions to reset expectations here as well. Lastly, SelectQuote's real value and potential exists beyond just Medicare Advantage. SelectQuote's value as a connector, facilitator and intermediary within the shifting health care landscape is core to our strategy. If we flip to Slide 7, let me provide some initial thoughts on how we expect SelectQuote to shift strategically with the ultimate goal of driving shareholder value through improved margin predictability and cash flow. Beginning at the top of the diagram, as mentioned, we believe SelectQuote can continue to grow the Medicare Distribution business in the future to do so at slower rates after resetting the baseline next year. Most importantly, we believe we can ultimately achieve growth with better cash flow dynamics and less volatility of results. As mentioned, unexpected factors like we saw this season and increasing competition has clearly impacted the risk-reward balance at the very high level of growth the industry has sought in the past years. We maintain our conviction that SelectQuote has built the industry's best platform to capitalize on this large opportunity, and we are taking appropriate action to ensure that we deliver attractive returns to shareholders in a wide range of market conditions. Moving clockwise down to the right, we believe slower growth will also allow us to reduce the operating leverage risk in the Medicare Advantage business. Beyond operating leverage, we have identified a number of opportunities to reduce operational risk factors and will continue to do so to improve overall efficiency. At the bottom of the diagram, as I alluded to, the shifting market dynamics and policyholder behavior require us to review our LTV forecasting and moderate appropriately. Raff will give more detail on the changes and drivers there. And as I noted, it is our responsibility to shareholders to mitigate the backward-looking volatility we have experienced in certain cohorts as reflected through tail adjustments. Lastly, SelectQuote has the unique opportunity and capability to be much more than a Medicare Advantage distribution platform. To be clear, there is a significant value in the MA business, including as an on-ramp to additional population health services like SelectRx. That said, our ability to capitalize on synergies and the broader health care landscape will be at the forefront of our ongoing strategy review. Now I want to give some brief context about SelectQuote's history on Slide 8. First of all, we're clearly shifting our strategy as it relates to our Medicare Advantage business. But I want to be clear that what we are talking about with Population Health, and leveraging our platform to pursue new revenue streams is not new to SelectQuote. Over the past 3 decades, SelectQuote has continually evolved across end markets. But with a common strategy, at our core, SelectQuote is strategically built to leverage customer leads and the unique information we capture to offer value-added services while also optimizing revenue per marketing dollar invested. In the company's early days, we successfully leveraged our Term Life business to add Auto & Home insurance. More recently, the scale of our Medicare Advantage distribution business allowed for the expansion into our growing Final Expense product. And now we believe Population Health is the natural progression of how SelectQuote can best leverage our unique assets and customer base to add value. On that concept, let's turn to Slide 9 and briefly discuss what we believe SelectQuote can achieve with our unique set of assets, data, technology agents and partners. As we've discussed, we believe our Population Health initiatives position SelectQuote as a critical value creator across each of the important constituents in the health care spectrum. As you know, our Medicare Advantage business makes SelectQuote a first point of contact with a growing number of senior Americans each year. From this point of entry, our data-intensive and agent-led model can connect policyholders, patients, health care providers and payers across a wide array of health care services. SelectRx and a number of our value-based care initiatives are just the beginning of the broader population health strategy. And we believe SelectQuote has a number of strategic advantages to capitalize on this very large market. And I'd like to be very candid in saying that we provide this longer-term vision to give you a sense of our strategic direction. Based on our recent results, we and the Board completely accept it is our responsibility to shareholders to earn credibility for the strategy with tangible results. To that point, let me conclude my comments on Slide 10 and give investors and analysts some insight into what to expect from us in the coming quarters. As I mentioned, our strategic review will continue beyond this fiscal year. What I can tell you today is that SelectQuote currently plans to take the following actions. First, looking ahead to next year's AEP season and in line with our objective to reduce operating risk, we plan to hire the majority of our agent class for next AEP much earlier. Similarly, we expect a reduction in overall agent headcount, including a lower mix of flex agents by next year. Next, we plan to provide regular updates on our SelectRx membership and revenues. As I mentioned earlier, we remain well on pace with our original expectations of 25,000 members by the end of this fiscal year and plan to share more detail on our expectations for the business later in our fiscal year. Third, you can expect to see additional detail from us regarding how we intend to increase visibility to our cash flow and earnings beginning with the changes we are making to our LTV assumptions. Additionally, we plan to scrutinize our corporate expense structure with an eye to bringing costs in line with our forecasted policy production and revenue in light of our expected reset and the size of our Medicare distribution business. Lastly, as I mentioned on the previous slide, the growth in population health initiatives is a key focus, and we expect will be a growing contributor to our revenues and value over time. With that, Raff will now provide more detail on our financial and operational results for the quarter. Raff?

Thanks, Tim. Turning to Slide 11 and our consolidated results. As Tim already said, this was an extremely difficult quarter. We had multiple operational issues we had to deal with. And despite pulling many levers, we could not offset all the headwinds that we faced. In addition, we took certain proactive measures to address persistency like assessing the cohort tail adjustment and increasing the constraint and provision, which impacted the quarter. Consolidated revenue for the quarter came in at $195 million. This included a $145 million negative adjustment for the senior MA cohort tail adjustments. Given the visibility into the January renewal event and the lapse rates experienced during calendar year 2021, we determined an adjustment was probable and reduced our commission revenue in the second quarter. Excluding this cohort tail adjustment, revenue was $340 million, which was down about 5% year-over-year. Despite growing MA-approved policies 27%, lower LTV per policy improved lower revenue in our senior business year-over-year. As stated earlier, we incurred incremental costs associated with trying to produce more policies, but lower revenue associated with lower-than-expected policy production and the cohort tail adjustment. This drove adjusted EBITDA to negative $163 million for the quarter. Excluding the cohort tail adjustment, the adjusted EBITDA would have been negative $18 million. Needless to say, this has been a humbling quarter for all of us and has forced us not only to examine the current environment we find ourselves in, but also how we want to run the business going forward. While the margins of the business have certainly been compressed, we believe there are meaningful changes that we can make that will have a positive impact on the senior distribution business going forward. These include resetting the baseline of policy production. While we're not providing guidance for fiscal '23 yet, we anticipate creating a plan that will produce fewer policies year-over-year before getting back to modest growth in fiscal '24 and beyond. We anticipate this will have multiple immediate benefits, including reducing the number of flex agents we need to hire, which will lower our overall onboarding and recruiting costs, hiring those flex agents by midsummer, which we believe will take the variability out of hiring plans and allow for more consistent training and onboarding. This will also allow us to operate with a more tenured workforce, especially during AEP and OEP, which should positively impact average close rates and agent productivity; cutting back on policy production in the seasonally low periods of the first quarter and fourth quarter, which will preserve cash and lower overall operating costs; and finally, we continue to invest in our health care services business with additional products and services that set the unique needs of our customers and leverage the marketing spend we're already incurring on the distribution side to add additional revenue, most of which should come from products and services that are cash efficient, have quicker breakeven points and add value to the entire health care ecosystem, including our insurance carrier partners, health care providers, and more importantly, our customers. All of the changes I've discussed above should have a positive impact on cash flow and accelerate the timing of getting the cash flow breakeven relative to our expectations six months ago, albeit off of a lower adjusted EBITDA base to start with. And with that, let me now get into our operating results for the quarter. Moving on to our senior results on Slide 12. We grew our total approved policies 22% and MA-approved policies 27%. The MA approved policy growth was lower than our submitted policy growth as we saw significantly higher switching activity after we submitted a policy on a customer's behalf. This impact is submitted to approved conversion rates. As Tim alluded to, this year, agent productivity was negatively impacted by multiple factors, including higher flex versus core agent mix, a more competitive marketplace, and lower close rates associated with planned design parity. Over the past couple of years, we achieved steadily increasing agent productivity. But unfortunately, that trend reversed abruptly with the start of this AEP, indicating that something was fundamentally different in the market. We saw average agent productivity declining 45%, with 20-plus percent close rate declines for both core and flex agents. When we last spoke to you in early November, we felt that the softness in the first few weeks of AEP was driven by some CMS marketing changes that were made at the last minute and by the high number of less tenured flex agents that we had hired. We felt that the CMS marketing issue had mostly resolved itself. And as those less tenured agents gained more experience, we would see close rates pick up from there. We do normally see close rates increase during the course of AEP. Unfortunately, while close rates did improve, they did not improve nearly enough. We saw lower close rates across every marketing channel and every aging type, which points towards a general marketplace dynamic mostly driven by planned design this year. We've evaluated several years' worth of data, and in years where there is a greater planned parity, close rates are lower. When there are greater differences between plans, close rates are higher. This is difficult to anticipate as we only find out plan design very close to the beginning of AEP. As we think about how we want to run the business going forward, there are numerous operational changes that we are thinking that should help reduce volatility and improve profitability. With respect to MA LTVs, while we anticipated MA LTV to be down 10%, they ended up being down about 27%. This incremental decline was driven by three factors: lower persistency, higher constraints, and higher provision for intra-year lapses. For the lower persistency, which represented around 60% of the incremental decline, we actually updated our 36-month weighted average to include the preliminary lower overall persistency we've experienced this year. Normally, that wouldn't impact LTVs until the fourth quarter. However, to be conservative, we chose to use our preliminary review of persistency for the second quarter given the decline we're seeing to start seeing that lower expectation into our results as soon as possible. On the constraints, we have increased our constraints from 6% to 15%, a significant increase and one designed to try to reduce the likelihood and magnitude of future cohort tail adjustments for new policies written. The increase in constraint represented around 25% of the incremental decline. Lastly, we reflected higher lapse rates for both first-year and renewal-year lapses based on what we experienced this year. Now if we move to Slide 13, let me provide more detail on the $145 million cohort tail adjustment we set in the quarter. As a reminder, we had a potential risk of a fourth-quarter $65 million cohort tail adjustment. This risk was based on an assumption that persistency would be flat to last year but lower than what was originally projected when some of our cohorts were written. As a reminder, we had previously disclosed that we were seeing higher intra-year lapse rates during the course of the year. However, we did not know if that lapse rate pressure that we were experiencing could just be timing of when people lapse their policy versus truly a reduction in overall persistency. Lapse rates from October through the end of the year continued to increase year-over-year. The preliminary end-of-year aggregate renewal event seems to have come in better year-over-year but not enough to offset the lapses that had already happened throughout the year, especially for certain first-year carrier cohort combinations that used up all of their constraints. Now that we are several weeks past through an all event, we know enough at a cohort level to project with a high degree of confidence the impact of this lower overall persistency on our cohort tail adjustment. While it will take several months to have final persistency rates, we felt that given the known trends, it was prudent to recognize the cohort tail adjustment in the second quarter. As you can see, the vast majority, over 80% of the increase in the SDIC cohort tail adjustment is driven by fiscal '21 policies. This was driven predominantly by three specific cohorts that used all their constraints and triggered a cohort tail adjustment. These are large adjustments and reflect a pretty significant decline in persistency over the last three years, mostly concentrated in the first several renewal years in a policy. We are surprised at how quickly things have changed and the impact this has had over the last 18 months. As we have previously stated, we utilized 36 months of actual historical persistency results to determine the rates baked into our LTV calculations. We adopted this approach years ago to eliminate management discretion inherent in forecasting future persistency performance. Historically, persistency rates have been very stable and predictable. But clearly, the market has changed. While we are currently booking lower and lower persistency as we update our assumptions based on actual experience, we also made the decision to significantly increase the constraint 6% to 15%. All these changes weigh on LTVs and margins and impact how we make investment decisions going forward, as both Tim and I had referenced earlier. Now if we turn to Slide 14, let me provide an update on the significant progress we have made growing our SelectRx pharmacy business. Since we entered the space last May, we have invested in the business and have significantly increased our organizational and operational capacity to serve more customers with product conditions and polypharmacy needs. Most importantly, we are more excited than ever about the high level of consumer interest in and demand for the pharmacy services we offer. As the chart on the left demonstrates, as of January 31, we've already enrolled over 40,000 new members into our SelectRx offering. That demand was generated almost entirely from enrollments of new and existing SelectQuote Medicare Advantage customers with very low incremental acquisition costs for the company. There's typically a several-month lag between initial enrollment and then receiving their first shipment and then the falloff will occur during that time frame. However, the left-hand chart clearly shows there is significant demand for the service. As we have scaled the business over the last six months, we have learned the nuances of this business and made many operational improvements to lower falloff and speed up the onboarding process. You can see those efforts starting to take shape on the right-hand chart, which shows the growth in our paying membership. As of January 31, we now have over 10,000 active paying customers on the SelectRx platform. Importantly, we exited the month of January with over 75% more active paying members than we had at the end of November, demonstrating that our process enhancements are really starting to pay off. We remain excited about the positive and predictable cash flow impact this business can have on our overall results and we remain confident with our forecast to exit this fiscal year with around 25,000 active paying SelectRx members, over 10x what we started the year with. Now if we move to Slide 15, let me provide an update on our capital position. The second quarter is always our biggest quarter for use of cash as we have all the expenses of operating during AEP, marketing costs, and sales agent commissions. However, we don't start getting paid for the policies we sell until January. For the quarter, we used approximately $219 million of cash from operations and $12 million of CapEx. During the quarter, we did draw down $245 million from our delayed draw term loan. We brought on several new lenders into our revolver and increased our committed revolver capacity to $135 million. There's currently nothing drawn on that revolver facility. We also still have $100 million undrawn on our delayed draw term loan. As of December 31, 2021, we ended the quarter with $193 million of cash and $717 million of debt. We also ended the quarter with $1 billion of accounts receivable and short- and long-term commissions receivable balances. Finally, on Slide 16. Based on the performance in the second quarter and our new expectations for the rest of the year, we are adjusting our guidance for fiscal year 2022. We currently project revenue in the range of $810 million to $850 million; net loss in the range of $236 million to $255 million; and adjusted EBITDA in the range of negative $235 million to negative $260 million. As a reminder, we assess the cohort tail adjustment in the second quarter and we'll true up that calculation if required in the fourth quarter. As Tim noted, the coming year will be one of transition for SelectQuote. But I'll echo his confidence in the value we can create with our Population Health initiatives on top of the reset we are undergoing in the Medicare Advantage business. The health care market is very large and SelectQuote continues to be an important hub for policyholders, patients, providers, and payers. We look forward to proving our value to those constituents and our shareholders in the quarters and years ahead. And with that, let me turn it back to the operator for your questions.

We have your first question from Jailendra Singh with Credit Suisse.

I want to better understand the comment regarding greater parity and plan benefits for the 2022 benefit year affecting those rates. How do we reconcile that with statements from some insurance companies and your peers that Medicare Advantage plans are becoming more competitive, leading to a shift in market share for insurers? It seems there is increased shopping behavior among seniors. Please help us reconcile that commentary.

Yes, Jailendra, this is Tim. I'll share some insights and then have Bob elaborate on your specific question. This AEP was notably different from our extensive experience in the Medicare sector. We faced a combination of industry-wide CMS issues that obscured some underlying problems. We also mentioned the tight labor market, which delayed the onboarding of some of our agents. Initially, we believed these were the main issues, but as we examined the situation more closely during AEP, we realized that plan parity was a significant factor leading to a noticeable reduction in close rates that we discussed on the call. Bob, would you like to provide some insights from a sales and carrier perspective?

Yes. So really good question, Jailendra. And again, we've never really seen anything like this during AEP. And what we are describing as far as plan parity is, I guess, just less compelling reasons to buy a plan on each individual call. However, we are seeing a big increase in shopping behavior, which I know that sounds counterintuitive, but it's driving less close rates on each call that we have while still seeing people switch at a high level, which is really different than the environment we've really seen, Jailendra.

Okay. And then my follow-up. I would like to understand your comment about modest top line long-term growth you referred. Can you be a little bit more specific? Are you talking about like going in line with the MA market growth? And maybe I'd love to get any thoughts on your LTV longer-term. And more importantly, with the increase total on the distribution channel, pressure on LTV, fast pressure on marketing and specific costs, can the unit economics even work in this business, especially if there's no operating leverage?

Yes. I guess I'll address that. I think we're making lots of changes to the business going forward. I think this year is obviously going to be a challenging year but it's not reflective of what we think the business can do in the future. Clearly, the margins have been compressed, and we are going to be making changes to be able to operate in an environment that has lower close rates to the extent that, that continues and lower margins. But it will look very different than it did this year. That's on the distribution side. Obviously, it's important to have a healthy distribution business as an on-ramp for our growing health care services business. And so that is the plan going forward. Relative to growth rates and how we think about that. While we're not providing guidance with respect to fiscal '23, we are going to build a plan next year that has less policy production than we will produce this year and basically resetting the baseline there. And that has lots of immediate benefit that I think we talked about on the call. After that, we'll return to some level of growth, but it will be modest and certainly modest relative to the growth rate that we've seen before. Exactly what that growth rate looks like, we'll have more to share on that over the next couple of quarters as we work through our strategic plans.

I mean, Jailendra, just to double-click on Raff's comments. I mean, it's an understatement, it's an extremely challenging year for us, a transitional year for the company. But I don't think the return characteristics that we're seeing today is what they'll be moving forward. We alluded to changes that we're going to make and refinance to our strategy to take out some of the operating leverage, things that we're doing with respect to a higher percentage of core agents, marketing optimization to focus on unit profitability and a goal to accelerate our cash flow breakeven. We think as we're highlighting through some of the good early progress on SelectRx, Population Health can be an extension of the services that we provide, ultimately, to drive additional underlying value to consumers. But financially, a way for us to leverage the investment that we have in play. And we think that moving forward, we will still have a strong and robust MA platform. But strategically, we want to use that as the on-ramp into a broader health care services ecosystem.

I have a couple of questions. I understand there might be a reluctance to discuss individual carriers too much. However, given the clear visibility on Humana's AEP results, it seems the challenges you are experiencing contrast sharply with their perspective, which Jailendra briefly mentioned. My first question is whether any of your issues can be linked to Humana's results or if the relationship is more the opposite. I am trying to clarify this matter. Secondly, is there a sense that major carriers are increasingly opting to manage growth through their own channels and sales efforts, rather than relying on external telesales channels like SelectQuote and others in the industry?

Steve, this is a good question. And I'll address your second question first in terms of any type of pullback from other carriers. I think there could be pullback with respect to some direct-to-consumer brokers with various carriers. We certainly wouldn't expect to be part of that pullback. I think we have a very long and steady path with respect to our carriers. It continues to grow and expand. And I think as there's been more valuation, if you will, of brokers, as it is doing a better worse job, we've actually seen more engagement and more investment from our carrier partners. I think ultimately, there could be a flight to quality. I think that certainly benefits us. Bob?

Yes, I agree. And I think one thing that's interesting is the carriers are talking about a competitive landscape a lot where they're kind of targeting certain benefits and that is clarity and competitiveness, I know are a little bit different in our mind. The market is extremely competitive for me in a marketing standpoint, things like that. However, parity is driving lower flow rate. So I do want to comment on that first. And yes, we are seeing some of the same pressures that the carriers have seen in the fact that, that competitiveness at times with specific carriers is causing some pressure on churn rates to where we're not better there.

You clearly stated how you've been running the business for growth and EBITDA margin. And it sounds now like the focus is going to be shifting more to cash flow. So how should we think about the timeline with which you could reach cash flow at breakeven?

Yes, I'll take that. I guess, look, this quarter, obviously very challenging. We are going to make and are making multiple changes to the business, as we discussed. I think the biggest driver of that is really going to be resetting the baseline, which we will do next fiscal year. And as we've talked about, to some extent, achieving cash flow breakeven and timing all of that is relative to the growth that we choose and growth of the choice that we make. Obviously, the last couple of years, we've been growing at very fast growth rates. By pulling back next year, that will have an immediate benefit as the overall cost to write new business will be lower than it was this year, but you'll get the renewal dollars associated with policies that you sold this year coming to the business next year. So I think you'll start seeing that next year. There is obviously a working capital dynamic that I think we talked about on our last earnings call that it takes 12 to 18 months to play itself out. But some of the benefits you shall see as early as this year.

That makes sense. I'd like to follow up on the unit economics. You've mentioned your control over hiring, so I want to ask about customer acquisition. Can you share your observations regarding lead quality and costs during the quarter, as well as how you plan to approach acquisition moving forward? Additionally, is there a possibility of generating more leads internally?

Yes, I will address that. We are currently reviewing all our channels and analyzing the data regarding the current persistency rates as the market has changed very rapidly. For years, things were fairly consistent, but we are now witnessing significant changes. As we examine our marketing channels in detail, we see pressure across the board; no single channel is excelling while another is performing poorly. Each channel has its strengths and weaknesses, and we need to investigate each one to find ways to optimize them and address issues arising from the increasing number of super switchers—people who are becoming more comfortable with shopping around. We haven’t observed a significant rise in raw lead costs when comparing year-over-year on a like-for-like basis. This year, the primary concern has been the customer acquisition cost in relation to the close rate, rather than the costs themselves, which remained fairly stable and aligned with our expectations. When we assess our quality issues, most of the channels in question are ones we generate ourselves. It appears that a compelling reason for consumers to switch is lacking. Although our plans are still beneficial, there hasn't been that standout reason for someone to change, leading to lower close rates. I believe the slowdown will allow us to optimize our lead channels better by identifying which ones are performing well and improving upon them as we move forward.

My first question, probably just to Bob, you correctly noted that the higher shopping activity in the face of greater plan parity is counterintuitive. And admittedly, I still don't really understand the relationship. Could you maybe try to explain that again?

Yes. In response to Bill's point, there are carriers that excel in core benefits like maximum out-of-pocket costs and prescription drug savings. However, we're beginning to notice that there are many more intricate plan changes to consider, creating a wide array of marketing opportunities. As a result, there is significant activity and a rise in inquiries, reflecting increased demand. That said, it has become more challenging to identify a specific reason or a definitive factor that persuades someone to switch, leading to lower close rates in individual calls. Nonetheless, overall shopping activity during the Annual Enrollment Period is on the rise, making the sales environment more challenging while consumer demand for change remains strong. We are experiencing pressure on lapses due to consumer demands, but it is also difficult to pinpoint the exact motivations behind someone wanting to switch. In the past, we favored focusing on core benefits, such as ensuring proper alignment of maximum out-of-pocket costs and prescription drug savings. We have implemented several changes to tackle this issue and have noticed some progress, but the situation remains quite complicated.

Got it. And then on the idea or the strategy of pulling back growth to some extent, is that as simple as just trying to weed out some of the serial shoppers that are out there? Or are there other key differences or changes that you're contemplating?

Yaron, I'll hit that at a high level. And Bob, maybe you can walk through it. I think there's a series of things that we think that we can do to optimize our business and our engine as we have kind of pulled back on growth. I think we talked a little bit about a much higher percentage of core agents versus flex agents. It is one thing that we have learned over time that can help kind of moderate the volatility. I think Bill spoke about some of the marketing optimizations. I think we're taking a very hard look at our kind of unit costs and unit margins. And so there's multiple things we can do there. I'd also kind of highlight, and it's up to us to prove it to shareholders into the market. But our move into Population Health, Rx and other ways that we can solve consumer needs and more effectively monetize the marketing spend that's in play, I think that's another important consideration. Bob, anything that you'd add?

Yes. I'd just say, I want to reiterate Bill's point, the pulling back does allow you to kind of pinpoint what's working from a marketing standpoint and really optimize better. I would say though, the other thing that allows you to optimize more successfully is having more tenured agents. We always did have a lot of operating leverage but the later classes this year really hurt us because they're always lower close rates than tenured classes and earlier in the summer hires. However, we've always done quite well with those classes this year. With the adjustments on close rates, we didn't see very good results out of those later classes. And by having more stability, it allows us to make adjustments much faster, be a significantly more cash flow efficient and really hone into what exactly is working. And hindsight being 2020, what we should have done this year because we didn't get the normal operating leverage we do, and we would have been more successful with earlier hires and more core agents.

Your commentary on higher lapse rates and lower persistency suggests that while parity is making it harder to sell new policies, someone's doing it, someone is closing on these seniors or else we wouldn't have this increase in churn. So I'm curious where are they going? Who's closing them? Because they're obviously buying their plans from somewhere. Have you been able to track where these folks are going when they lapse from a policy that was previously sold by SelectQuote?

Yes, there's a couple of things here, and I'll turn it over to Bob. I mean, at two separate concepts with respect to what we saw in inter-year lapse rates that continued to mount throughout the year. And then the specific kind of convergence of plans that we saw during the AEP period. I think those are two different concepts I would just need to kind of get clarity on. Bob?

Yes, I believe our plans are well-aligned with consumers' health care needs. There is still significant switching, particularly among super shoppers and those who frequently switch. However, we're observing a good amount of stability in our other customer groups. The challenge lies in managing the impact of our older policies being switched and the increasing tendency of super shoppers and switchers to change plans.

Yes. I think as Bob said before, there are sort of two concepts here. The relative to the persistency and lapse rate issues that impacted the cohort tail adjustment. That's really associated with plans that were sold in prior years, not this AEP season. And the biggest driver of that adjustment is obviously lower persistency over a couple of years, but much higher intra-year falloff that impacted persistency this year. So going into AEP, we've already had so many policies that had already fallen off relative to people switching earlier on in the year. The planned parity, which impacted the close rates relative to AEP didn't really impact those prior cohorts, at least not yet. And while the intra-year lapse rates were higher year-over-year, which impacted overall persistency, the actual renewal event that happens at the end of the year was actually slightly better than last year, which certainly from a trend perspective was very different than the intra-year lapses, and we think was a function of the planned parity this year. So people sticking with plans that they had is just so many policies that lapsed throughout the year by AEP that, that renewal event at the end of the year wasn't enough to offset those lapses. Okay. Yes, that's helpful. And then on LTVs, it seems like you're taking the bulk of LTV degradation this quarter. On a sequential basis for the rest of the year, would you expect LTVs to further degrade or have you kind of set a floor with the increase in the constraint and the pull forward of the 36-month average? Yes, I believe regarding the LTVs, we've been as proactive as we can in addressing the lower persistency we're seeing from the renewal event in January, which typically wouldn't occur until the fourth quarter. We’re addressing this sooner to mitigate its impact. As you pointed out, we have significantly raised the constraint, nearly tripling it from 6% to 15%. This represents the largest drop in LTVs this year. In the upcoming quarters, we expect it to align more closely with what we have previously experienced, moving beyond general seasonality. There are specific times within the year when LTVs fluctuate, but the most significant decline has been compared to what we reported in the second quarter.

Great. And just following up on that last question. I understand that the churn in the older cohorts is the main issue. But it does look like churn is up in all the cohorts. So just kind of trying to square those comments away. And then just one modeling question. What is the tail revenue that you assume in the full year guide?

Yes. Based on our observations regarding persistency, it appears to be mainly concentrated in the first two or three renewal periods of a policy. After that initial phase, there is significantly less variability in the subsequent renewal years, and persistency rates tend to be higher with reduced variability. This pattern has been consistent, and it directly impacts the revenue collection once the early years of renewal are behind us. As for the cohort tail adjustment, we initially expected a potential adjustment of $65 million for the fourth quarter, but we have accelerated that expectation and increased it to $145 million for this quarter. Outside of any necessary adjustments in the fourth quarter when we conduct the calculation, that reflects the assumptions in our guidance from the second quarter.

Two, I guess, background questions, if I can. One, can you comment on agent retention, particularly core agents, not just the new ones that didn't show up, but we keep on hearing about the great resignation, wondering how you're seeing that with your experience making group?

Bob, do you want to take the lead on that?

Yes, absolutely. So we have seen a mild increase in agent accretion or retention issues, but nothing alarming or not what we're hearing on kind of the great resignation to your point. Our level one agents were in the high 80s and low 90s before. Now our level one agents are 83% for the last six months. So we are still retaining our good agents at a high level, a little bit of pressure, but that's just because it's a really competitive job environment. They're different than kind of what we've experienced before. But not to the tune of what others we think are experiencing and what we're seeing elsewhere.

Okay. No, that's very helpful. Second question, I don't know how to even ask this specifically. But as you talk about a slower growth rate anticipated for next year, what is the implication of that? If we're talking about fewer MA policies, what does that mean to Population Health and SelectRx over the next 2 or 3 years?

I'll address that first, Meyer, it's a significant question. As we've pointed out, we believe we will have a very meaningful Medicare Advantage platform as we work to optimize and really focus on accelerating cash flow breakeven. There is a lot of demand out there regarding Population Health. Our opt-in rates are extremely high. Additionally, one of the bright spots for the quarter is the progress we're making on SelectRx. We will continue to prioritize that. We are also developing other relevant services for our Population Health engagement platform. The good news is we will maintain a very meaningful Medicare Advantage platform, and I want to emphasize that clearly. However, there are opportunities for those we may not convert into a Medicare Advantage policy that can still be potential candidates for health services through Population Health, Rx, or other means. Therefore, we do not believe this will necessarily hinder the growth of our Health Care Services business.

I'm showing no further questions at this time. I would now like to turn the conference back to Mr. Tim Danker, CEO, for any closing remarks.

Yes. Thanks again for joining us today. As I mentioned, the entire SelectQuote organization is committed to realizing our potential that we know that our unique business is capable in today's health care ecosystem. We certainly believe we can improve the predictability of our core senior business. But more importantly, really leverage our position as a critical connector and provider across health care services beyond Medicare Advantage. We look forward to proving that potential to you and we'll take the significant challenges of this year to make our company stronger. Thank you again for your time, and we'll talk soon.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.