Our Trupanion Thesis Is Not About The Regulators
Some short sellers, notably Seeking Alpha contributor The Capitolist, have done a commendable job calling out irregularities at Trupanion. (We mention The Capitolist again in the next part, Part 2; Trupanion management appears to have lied as part of a menacing email to The Capitolist.) There are numerous concerns about Trupanion covered elsewhere, including Trupanion’s regulatory situation and the status of at least one active investigation.
Indeed, regulators have called out Trupanion before: in 2016, for example Trupanion’s insurance subsidiary was fined for having “no audit policies or procedures in place”; charging customers’ credit cards after policy cancellation or pet death; committing hundreds of rate violations; engaging in “false, deceptive and misleading” marketing, as well as other infractions. However, we want to make it clear that Trupanion’s regulatory gaffes and questionable business practices are not why we’re short.
In our view, Trupanion’s main problems aren’t their regulatory / compliance stumbles or 30-something-year-old chief actuary. These amusements are mere symptoms of Trupanion’s deeper issue: two decades of unprofitability. Trupanion’s vision for selling animal health insurance in cahoots with the pet hospital, with no payout caps, is an insurance train wreck. The math has never worked, and we don’t ever expect it to.
...Rather, The Pet Hospital Is A Dumb Place To Sell Health Insurance
There is a reason the pet hospital “channel” wasn’t popular before Trupanion; it’s a dumb place to sell health insurance. You don’t need to be a rocket scientist to see why.
First, think of the last hospital you visited. When seeing your GP, surgeon, or orthopaedist, did they grab your arm on the way out and offer you a free trial for an Anthem, Cigna or Aflac health policy, touting a no-cap, no-questions-asked insurance plan? No, of course not. Not only would this be highly unprofessional, but hospitals have captive customers with high-probabilities of health problems. Likewise, signing up scores of sick pets willy nilly in the vet aka pet hospital isn’t hard...of course sick customers want insurance. Signing up lots of profitable customers at the hospital is what’s improbable. A doctor or vet incentivized (via rebates, vacations to Hawaii, point programs, or any other form of compensation or gift of value, as Trupanion has done for vets) to sign up patients seems likely to bring in a book of more-sick-than-average policies. Duh.
(In one of Trupanion's more amusing advertisements attacking Nationwide, Trupanion boasts of not having to "approve" pets for insurance. Lol!)
Trupanion’s revenue growth seduces longs. Boring concepts like underwriting standards, profits and book value are ignored by the Trupanion faithful. But insurance is the business of liabilities, where customer premiums are paid first for the promise of payouts later, and revenue growth without profits is a red alert. For example, you could sell tons of fire insurance to residents in burning buildings. The problem, despite lots of sales, is those policies won’t turn out profitable. If you need evidence Trupanion’s “sell in the pet hospital” approach isn’t working, just look at the income statement: Trupanion has been in operation for 20 years. 8+ years of public financials indicate Trupanion has lost money the entire time.
Book value is needed to support ever-more insurance growth. Perpetually unprofitable underwriters like Trupanion resemble Ponzi Scheme operators, using working capital from customer premiums and the capital markets to finance ongoing operations. (What’s more, Trupanion aggressively takes minimal to no reserves for future claims. This makes Trupanion’s margins look less-bad, comping yesterday’s smaller book of claims against today’s enlarged revenues.) Trupanion’s promotional management helps kick the can down the road with lots of non-GAAP metrics and not-so-subtle references to Warren Buffet, captivating gullible longs who bid up Trupanion’s shares. But there is no free lunch writing bad insurance business; you can only delay Armageddon by underwriting ever-more bad business.
-> Pets visiting the vet are more likely to have health issues than otherwise.
-> Insurer revenue growth is irrelevant if policies are unprofitable. Anyone can sell a dollar for $0.50. Book value is needed to support underwriting growth. Lack of profitability is fatal.
Second, in the pet hospital it’s not a stretch to imagine vets recommending insurance for pets with suspected-but-undiagnosed conditions, a situation known as “anti-selection” or “adverse selection” in the insurance business. Like how Fido’s limp - noticed casually during a visit for food poisoning - turns into Fido needing a hip replacement. And the hip replacement is helpfully diagnosed by the vet a month after Trupanion insurance is unwritten, avoiding the scarlet letter of pre-existing conditions.
-> People lie. It’s hard to catch pre-existing conditions. Trupanion’s pet hospital selling practices incentivize and exacerbate cheating.
Third, a final issue selling in the pet hospital - and the book of sick pets thus acquired - is the “rate spiral”. Trupanion, offering inexpensive teaser rates at customer sign-up, is left with a US-style healthcare insurance dilemma: sick pets acquired in the hospital are more likely than healthy ones to file claims; price increases are required to offset high claim rates; healthy customers quit due to high prices; only sick customers are willing to pay high rates; spiral continues.
-> Rate increases are both necessary and fatal for Trupanion. At sign-up, Trupanion is promising something - no-caps, nil/minimal verification - they can’t deliver profitably. And by accepting everyone in a sick fishing pond, Trupanion exposes itself to a dreadful book of business.
Because of these factors, we never really cared much for the “Trupanion is in trouble with regulators” thesis. To us a perpetually unprofitable pet insurer trading at >9x book value, selling health insurance in the pet hospital, with virtually nil equity breathing room, run by deceptive management, all while executives and insiders dump shares on longs, was enough for us to think this is a mess that won’t end well.
But as we mentioned above, some other short sellers have done a commendable job. And then Trupanion sued to keep certain regulatory investigation documents private….which piqued our curiosity. If those regulator issues were so unimportant we wondered, then why was Trupanion filing a restraining order to keep them private?! We admit to being curious now. Our findings from the initial 4 documents are covered in Part 2.
Disclosure: I am/we are short TRUP.