eHealth, Inc. | A review

I had an inquiry from a friend earlier this week about my impressions of eHealth, Inc ($EHTH) as a possible investment. I was aware of the existence of this broker, but never looked closely at the business. So, I offered to take a look. I have been interested in the continued investments being made into insurtech. I am curious to investigate the business models being built by firms like Lemonade, Policygenius, and Ladder, as well as investments being made by firms like Mass Mutual into operations like Haven.

The performance of eHealth since its IPO has certainly been impressive. So, I spent some time over the past few evenings (rather late into the evening Friday) to attempt to glean some insights about eHealth’s business, its targeted market segment, and its future prospects.

I typically learn something from reviewing a business this way. To conduct this review, I spent time on the eHealth’s website, reviewed the most recent 10-Q and 10-K, and reviewed various investor relations power-points included on the IR website. I have found EHTH to be a particularly interesting business; Two details that stand out to me are eHealth’s marketing mix decisions and revenue recognition policy.

Here are some notes from my review over the past few evenings.

Who is eHealth, Inc.?

This company was founded in 1999. eHealth, Inc. is a publicly traded organization which trades on NASDAQ under the ticker $EHTH. From eHealth’s investor relations web-page, the following business description is provided:

eHealth is a leading online marketplace offering consumers a broad choice of insurance products that includes thousands of Medicare Advantage, Medicare Supplement, Medicare Part D plans, individual and family health insurance, small business insurance and ancillary health insurance products from over 170 health insurance carriers. We are transforming what has traditionally been a confusing and opaque purchasing process into a transparent and highly efficient experience helping consumers obtain the health insurance product that meets their individual health and economic needs. Through its omni-channel platform eHealth enables consumers to use our services online, through interactive chat, or by telephone with a licensed insurance agent.

My initial question as I read the above was about distribution of revenue. How much of eHealth’s business is allocated to these various segments? Based upon a review of financials, the answer is very clear: the game they are focused on is Medicare! I took a look at the trend lines in revenue across the two segments eHealth reports on and pasted below.

Here is a comparison of commission revenue in pie-chart format across a few years:

I think the marketing mix chosen by eHealth is interesting. The product focus has increasingly been in Medicare and the place for distribution, though they reference OMNI channel marketing, is seemingly focused on nascent trends in online, mobile, and an owned distribution. Of the 1500 employees at the end of 2019, 860 were in customer care, 370 in technology and content, 210 in G&A, and 60 in marketing/advertising.

The Q2 earnings call included reference to its promotion strategy:

The 2019 10-k states, “We focus on building brand awareness, increasing individual, family and small business customer visits to our websites, increasing Medicare customer visits to our websites and telephonic sales centers and converting these visitors into members.” Examples offered of modes of accomplishing this include direct marketing, online advertising, and marketing partnerships.

It is not clear to me that eHealth is finding economies of scale as they grow in their CCE area, though they appear to be continuing to grow at high rates with improving yield on marketing and advertising expenditures.

Market structure

I spent some time in April 2020 looking at the market structure for insurance agencies. That post can be found here. eHealth, Inc. has been interesting to me because it addresses a large niche, Medicare, that I haven’t been deeply involved before, beyond the limited sales and service of such plans that we did at Hartman (less than 1% of our net revenue).

Medicare

One quick reminder: Health care is big business in the United States! In fact, US health care services may be the biggest market in the world at nearly 20% of US GDP. Medicare is a substantial part of the payor mix involved in financing our huge annual healthcare expenditures.

Medicare enrollments overall are growing substantially. As the US population continues to age, enrollment in Medicare will continue. As reported by the US Census, since 2010, 10,000 Americans per day have turned 65 years old, and by 2030 all 74 million baby boomers will be eligible for Medicare.

One insurance solution available to Medicare beneficiaries is a type of policy sold by private insurers referred to as Medicare Advantage, or MA. These policies have grown in popularity over the years.

eHealth has chosen a large segment of a growing niche in which to compete. This decision seems compelling to me as one aspect of an investment narrative. I like it. 🙂

Competition

There is some good content on page 12 of the 2019 10-K about eHealth’s competition.

The market for selling health insurance plans is highly competitive. Our competitors include government entities, including government-run health insurance exchanges established as a result of health care reform; health insurance carriers; other health insurance agents and brokers; and companies that use the Internet and other means to attract individuals interested in purchasing health insurance and generate revenue by referring these individuals to us or one of our competitors.

They break it down into the following categories:

• Government – “In connection with our marketing of Medicare related health insurance plans, we compete with the federal government’s original Medicare program. CMS also offers Medicare plan online enrollment, 13 information and comparison tools and has established call centers for the sale of Medicare Advantage and Medicare Part D prescription drug plans. CMS has regulatory authority over the Medicare Advantage and Medicare Part D prescription drug program and can influence the competitiveness of Medicare Advantage and Medicare Part D prescription drug plans compared to the original Medicare program, as well as the compensation that health insurance carriers are allowed to pay us.“
  • Well, this sounds like a meaningful risk to me…
• Insurance carriers – “Many health insurance carriers directly market and sell their plans to consumers through call centers and their own websites. Although we offer health insurance plans for many of these carriers, they also compete with us by offering their plans directly to consumers and, to a much lesser extent, to small businesses.”
  • Again, this sounds like a meaningful risk to me…
• Other agents and brokers – “We compete with agents and brokers who offer and sell health insurance plans utilizing traditional offline distribution channels as well as the Internet. Our current competitors include the tens of thousands of local insurance agents across the United States who sell health insurance plans in their communities. A number of these agents operate websites and provide an online shopping experience for consumers interested in purchasing health insurance. In addition, a number of online health insurance agents like us generate demand over the Internet and sell health insurance to individuals over the Internet and using call centers.“
  • I will point back to this section when considering the strategy of eHealth. There is virtually zero barrier to entry and a ton of established, local agents promoting enrollments of these products. This must be a headwind to any nascent strategy to take share.
• Internet marketers and other advertisers – “There are many internet marketing companies and other advertisers that use the Internet and other means to find consumers interested in purchasing health insurance and are compensated for referring those consumers to agents and health insurance carriers. We compete with these companies for individuals who are looking to purchase health insurance.“
  • It is very interesting that the folks at eHealth view Internet marketing firms funneling leads to agents as a competitor, but do not make reference to enabling Field Marketing Organizations (FMO) as a major factor. It seems like an error by omission…

The competitive landscape eHealth finds itself in is highly fragmented. While eHealth brings scale and capabilities not possible at the field agent level directly, it isn’t clear to me that the field agent lacks such tools and resources by way of strong FMO relationships. The advantage to eHealth’s positioning, consequently, is unclear to me.

Preliminary financial review. A rabbit hole of epic proportions.

I took a look at a few insurance broker rivals to compare metrics. I recognize the mix of revenue across lines of business will very considerably from eHealth’s, but I thought it would still be useful to compare.

Item	EHTH	WTW	AJG	Brown and Brown
P/S (ttm)	3.23	2.95	3.14	4.95
Revenue (ttm)	$591,200	$9,300,000	$7,000,000	$2,600,000
Employees	1,500	46,600	33,247	10,083
Enterprise Value	$1,820,000	$28,340,000	$23,670,000	$13,460,000
Market Cap	$2,000,000	$27,400,000	$22,300,000	$12,700,000

At first blush, the 3.23x revenue multiple seems within a reasonable range of the other brokers on this list. As I reviewed past financials and the 2019 10-K, though, I found myself feeling a bit turned around. For example, the balance sheet shows some substantial changes in size, as well as makeup, during 2018.

The introduction of the highlighted receivable line and magnitude of change of total assets surprised me. Based upon this, I converted to common-size against total assets.

So revenue jumps in 2018 coincident with an increase in goodwill, which corresponds to the acquisition of GoMedigap; Cash plummets while receivables spike; Also, 2019 brings a divergence between net income and CFO. My head was spinning. My precise thought was, “WTF?”

I wondered if there might be an explanation in the acquisition accounting of Gomedigap. This exhibit did not suggest as much:

I noticed amongst the descriptions of eHealth’s business reference to “constrained lifetime value,” or constrained LTV, for customers. A “search” in the 2018 10-K led me to this very interesting language about revenue recognition under ASU 2014-09, Revenue from Contracts with Customers (ASC 606). You can find this here.

Summary of Business and Significant Accounting Policies (Policy)

Commission Revenue—
Our commission revenue is primarily comprised of commissions paid to us by health insurance carriers related to insurance plans that have been purchased by a member through our health insurance exchange service. We define a member as an individual currently covered by an insurance plan, which include Medicare-related, individual and family, small business and ancillary plans. We are compensated by the health insurance carrier, which we define as our customer.
...
We utilize a practical expedient to estimate commission revenue for each insurance product by applying the use of a portfolio approach to group approved members by the effective month of the relevant policy (referred to as a “cohort”). This allows us to estimate the commissions we expect to collect for each approved member cohort by evaluating various factors, including but not limited to, contracted commission rates, carrier mix and expected member churn.
...
For Medicare-related, individual and family and ancillary health insurance plans, our services are complete once a submitted application is approved by the relevant health insurance carrier. Accordingly, we recognize commission revenue based upon the total estimated lifetime commissions we expect to receive for selling the plan after the carrier approves an application, net of an estimated constraint. We refer to these estimated and constrained lifetime values as the "constrained LTV" for the plan.

This was a surprise; Over my years in the insurance business as an agency principal, I have never heard of an agency booking revenue in this fashion. I wondered if this approach to revenue recognition was new in 2018; It turns out the policy was changed in 2017, per the 2017 10-K (ref. page 57 under Adoption of ASC 2014-09, Revenue from Contracts with Customers (Topic 606)). So, what happened to create this dramatic change in the 2018 balance sheet?

So, I started reviewing late Friday evening the 10-K forms for each year and compared to my spreadsheets via CapitalIQ and EDGAR; I found errors in EDGAR (e.g. income and revenue off by a factor of 1,000 for 2019 and 2018) and variances on balance sheet entries. Bingo – this must be the explanation. See here for the 2017 Form 10-K:

Now, look at the 2017 values on the 2018 Form 10-K. In particular, the 2017 values below do not “tie out” to the 2017 values above, and the delta is footnoted by, “(a)s adjusted for the adoption of ASC 606 using the full retrospective method.”

So, here is a consolidation of my Frankenstein like review: before and after adjustments following the ASC 606 adjustments:

Aside – eHealth did raise $102,141 from financing activities during 2019, according to its annual cash flow statement, as well as $203,555 during the first 9 months of 2020. Cash and short-term marketable securities at the close of Q3 ’20 were $196,470.

So, what does this mean? Altogether, I think the key issues raised by the change in revenue recognition policy taken by eHealth connects cash flow, growth, and risk. Of course, if LTV estimates are materially incorrect, the economic position of eHealth will be misstated. Additionally, though, even if LTV is properly estimated, even profitable growth can create cash drains, as only a portion of the LTV is received during the initial year of the customer relationship. In fact, during Q3 2020, unit-level customer acquisition cost was $1,181 compared to the estimated LTV of $898 for MA customers and $1071 for Medicare Supplement customers. So, it is good eHealth pulled down roughly $300 mm from the capital markets, because continuing aggressive growth at these rates will likely require cash reserves to draw from.

How will they find efficiencies to create profitable growth? I imagine the answer has to include finding ways to improve CC&E expense while continuing to deliver great customer experiences. Yea, this is a puzzle.

Strategy

The fundamental question I was curious about when I started reviewing eHealth was whether they had a great outlook to take share in the insurance market and create value to shareholders. Some additional thoughts on this from a perspective of 5-Forces:

• Buyer power – Despite eHealth’s assertion above that its customers are the insurers, the actual buyers of said insurance are individuals. The good news for eHealth is with ‘Estimated Ending (Paying) Membership 421,237 as of 9/30/2020, there is very little influence any buyer is going to apply to eHealth’s business. [Ref. page 11 of the slide deck corresponding to the Q3 2020 earnings call.]
• Supplier power – In contrast to buyer power, there is a high level of concentration of supplier power. I think this creates exposure for eHealth.

• Rivalry – There is a ton of rivalry in this space, as reflected in earlier comments about competition above.
• Threat of substitutes – There should be limited risk of substitution for brokerage, except to the extent of direct marketing by carriers or the government.
• Risk of entry – This business has virtually no barrier to entry.

There are five primary sources of risk and opportunity to incumbents in a given market structure. A few thoughts on these specific to eHealth, Inc.:

• Technology – eHealth should have the people and position to effectively monitor and exploit emerging trends in technology. It seems unlikely they will be disrupted as a result of technological shift.
• Regulation – All players in Medicare are at risk of changes in the regulatory environment. CMS manages in a manner unique in the insurance business the rules around sales and marketing for Medicare business. Every incremental rule and procedure required to comply will likely drive profitability lower for the involved players. Of course, CMS could ease these requirements and create a tailwind to profitability, but with a transition at hand with the Biden administration, I imagine we are unlikely to see increasingly laissez faire market conduct standards released.
• Consumer Preferences – eHealth should continue to have access to the relevant products released by insurers into the market. To the extent that there are changes in consumer preferences, that risk is more likely to be borne by insurers competing for enrollment. As related to consumer preferences for purchasing modality, eHealth should benefit by incremental shifts towards online purchasing by older Americans.
• Globalization – I imagine globalization will have limited impact on eHealth. Aside from possible efficiencies with operations and IT, the market it is positioned for in 2020 is primarily domestic, and it isn’t obvious to me there are better opportunities for its capabilities by extending beyond the US.
• Capital Markets – eHealth should not be disrupted by capital markets in the near term. The firm has adequate cash to finance growth and no long-term debt.

In my previous blogpost about insurance agency structure, I commented about trends in consolidation. In particular, aging principals with substantial value “locked up” in their firm’s stock, and younger staff with limited experience managing a firm, and limited financial resources to finance an acquisition, are opting to monetize their assets through merger with larger firms (including but not limited to our firm: USI Insurance Services.) Also, there is incentive to merge to improve positioning for target market clients in mid-market P&C and EB; There are assets and capabilities requiring a certain MES to compete effectively in these markets. In individual Medicare, though, I would argue the incentives to merge as a downstream distribution agent, dealing directly with customers, is very limited. But, there is the possibility that such consolidation could be justified at FMO, such as Ritter Insurance, SMS, and Premier.

I wonder if eHealth could create improved value through acquisition of a large FMO, or insurance software provider like iPipeline, to create value.

Some concluding thoughts

I found the review of eHealth to be interesting. I am curious to see how the firm performs. On the one hand, its focus on the enormous US health care market, particularly in Medicare products, gives the firm huge upside if it can build differentiated assets and capabilities. There appear to be attractive investment opportunities for eHealth. Some questions I have:

• Can eHealth leverage its technology to build out additional profitable growth as a FMO (and thereby reduce CCE expense)?
• Can eHealth leverage its technology to create a service line for third-party FMO organizations (and thereby reduce CCE expense)?
• Can eHealth leverage its brand and Internet traffic into additional non-commission revenue?
• Can eHealth find adjacent products to sell into its customer base? Notable areas for consideration include homeowners, pet, life, and renters insurance.
• Can eHealth find synergy in partnership, or merger, with other organizations? I wonder about the possibilities for Bank of America-ML, Amazon, or Mass Mutual to acquire a firm like eHealth and seek synergies (for cross sales of deposits IRA rollovers or simple revenue synergies as part of another well branded organizations value prop.)

Well, it is lunchtime and Camilla and Holger are looking to create some trouble together. So, I am going to close my review of eHealth for today and go discuss their views on the virtues of being a spy!