Alignment Healthcare, Inc. (ALHC) Earnings Call Transcript & Summary

Great. Good morning, everyone. My name is Cheri Mowrey. I run the U.S. Healthcare Investment Banking business for Morgan Stanley. I am thrilled to have the team from Alignment Health. With me to my left, I have John Kao, who is the Founder and Chief Executive Officer of the company. And Jim Head, who is the Chief Financial Officer of the company. So great to have you guys this morning.

Morning, Cheri.

There's a few things going on in the industry.

A few.

Well, it's good to see that Alignment is having continued success.

Thank you.

So this year has been a very interesting year. It's a continuation of some of what we saw last year in terms of your success. Can you talk a little bit about what's going on in the industry that you've been able to achieve above average growth and really accelerated growth relative to others in the industry?

Yes. I mean if you look at just the raw unit economics, we really started looking at this in 2023. We could tell that we're going to have a Stars advantage with all the changes going on in Stars. We also knew heading into 2024, it would be the first year of V28 phase-in and we knew that we had tailwinds with respect to both Stars and risk adjustment. And we factored that in, in really the summer of 2023 heading into 2024 with our bids. And we had, as you guys know, something like a 60% growth rate in 2024, and we tilted toward growth that year. And then in 2025, we kind of tilted toward margin expansion, both of which are very good decisions, I think, that we made. And the industry is going through a paradigm change. I mean there's just no doubt about it. And the way I'd think about it is what has worked for the sector for the last 10 years is not going to be the same going forward in the next 10 years. V28 really is similar to what happened in 2012, where they had really adjustments to reimbursement for MA back in 2012 is 15%. When you think about the full phase-in of V28 heading now ending in 2026, it's going to be about 20%. And so those memories were very fresh in our minds. And so we're very conservative on risk adjustment and very aggressive on Stars. And I think those are the right decisions that translated into very good growth, very good margin expansion. And I think going forward, it's -- it's going to be -- the keys to success are, do you have the ability to actually manage care and control costs. And the kind of reduction of revenue associated with V28 is really compromising the ability to have, I would call it, global cap, it tightens up the global cap providers. And I think the third thing that is going to change is prior auth. What people have done in prior auth for the last 10 years is not going to be something that's going to be acceptable from Stars perspective or from a public perception perspective. And so you have to be really good at providing quality Stars at a low cost without just driving that low cost through dumping risk on the provider groups. So I think it's a paradigm shift that you're witnessing now, and I think it's going to play out over the next couple of years.

Talk about medical cost trend because you guys have done an unbelievable job of managing medical costs relative to your peers, right, who have not had that same experience this year. How are you thinking about cost trend in the industry? And how are you planning for it for the end of '25 and '26?

Yes. No, we feel really good about our ability to manage costs. For Q2, we announced that our admissions -- acute admissions per thousand dropped from 150. We've been in the 150 range for the last 6, 7 years. It actually dropped to about 140-ish. And so we were not immune to utilization hotspots in some of our markets. What differentiates us is because of the data architecture that we have, we have visibility to hotspots very quickly. And we, as an organization, meet on markets every single day. Every single day, we're going through markets, grinding through metrics, looking at utilization, looking at disenrollment, looking at sales, looking at all the markets. That gives us the ability to make adjustments real time. It's literally visibility to good and bad. And then if it's bad, we have the control boots on the ground to make changes through our clinical leadership and our network leadership. And so it's -- I don't think there's a kind of a silver bullet to any of this. It's having the data that's actionable that when you know what needs to be done, you do something about it. And for those of you that are new to the story, the whole thesis of the company is do well by doing good. And the doing good part is take care of those individuals that need the care. And it's usually the 10% of the polychronic population that really are your sick patients. And so when we use our data and we identify who that 10% is, that's basically costing you 75% to 80% of your MLR. You then envelop them with care at home, okay, and that does 3 things. It really increases your customer satisfaction. It really implements kind of chronic disease management throughout that population and it lowers your admissions into the hospital. It's kind of just like do the right thing, take care of people like your mom or your dad. You're not going to treat your mom or your dad like a number. You're going to treat your mom like your dad -- like your mom and your dad, you are going to do whatever it takes to make sure they're taken care of. That's kind of the mindset that we have and the organization has done a very good job of managing that care, thus controlling costs.

Great. So we're about halfway through the V28 implementation. Can you talk a little bit about the impacts and the progression of the model you're expecting?

Yes, yes. So for those of you who don't know, V28 is the new risk adjustment model that was implemented in 2024. It was phased in '24, '25, so you're 2/3 of the way through. '26 will be the last year. The impact is generally on a national basis, about 6% to 7% reduction per year. So when you kind of head into 2026, you're looking at like a high teens to 20-plus percent reduction in premium revenue. That's what's creating a lot of the compression in premium right now. And what it's doing is when you take away that premium, the trickle-down effect is huge because the plants are not in the same ability to globally cap downstream providers. There's not enough money in that supply chain is what I say. We experienced this same phenomenon back in the '90s. And so what's happening is the government is basically looking at MA and they're saying, the one area that we think we need to clean up is to mitigate any potential gaming associated with risk adjustment. I'd say gaming very distinctly rather than -- I don't think people are doing anything "illegal," that's my opinion. I think people are pushing the limits of what is legal. And I think the intent of CMS is to make sure that the spirit of risk adjustment is actually adhere to, which is to make sure that they pay the plans more money for people that actually need it and need more care. And so they're focusing on ensuring that if you -- if we pay you plan for a higher-acuity patient, make sure the care plan is in place and make sure you can correlate the revenue that you get to the care that, that member receives. It's a very simple square deal. And I think the industry is not accountable for that. And so I think V28 you're going to see more pressure on everybody and heading into 2026 when the third phase-in comes in. We saw this coming. And so we were very by very intentional of being conservative on our risk adjustment. And we knew that with kind of whatever changes that were going to happen, we didn't want to be exposed to it. If you think about this business overall, government reimbursement is your #1 risk, right? And so we had to design a business model that would win in either scenario. If rates go up, the whole -- all boats rise on a rising tide, the rates go down, we are exposed less because we have the lowest cost structure, not the lowest cost structure plus the highest RAF. That wasn't the strategy. So that's we are advantaged and we're compromised much less than others. We've been public and we've said our RAF scores are about 1.1 and it's just not that high, but it's by intention. You contrast that to others that are 1.5, 1.7, 2.0. There's just a further distance to fall, so to speak, when you apply that 20% hit. I think RADV is something you've probably heard of. RADV audits are going on right now. They started dates of service in 2018 for 2019 payments and then they're going to go through '19, '20, '21, '22, '23, '24 over the next 9 months or so. And so through that process, everybody is validating their HCCs. That's -- it's a huge process. And if you cannot validate your HCCs that you submitted, CMS is going to say, we want our money back. That's what's happening right now. We feel very well positioned in that regard because of the care model because the entire thesis of the business is risk adjustment is not rev cycle to us. It's actually documentation of the care model. That's what I think about V28. And once they kind of clean this RADV process up, this is going to take us to the first half of next year, it will remain to be seen what happens next, if they're going to make any changes to risk adjustment going forward. And I think whatever things they do, they're going to try to minimize any gaming on that. That's what I think. And so those that can be well positioned on that, I think, are going to be positioned well in the future.

Happy to agree as we've seen. So one of the unique elements of 2025 and MA is implementation of IR. Can you talk a little bit about what you're seeing in your part business and what your expectations are?

Yes. So think about V28 IRA and all the changes going on in the environment. So that was first 100 days has been really fun. But as it pertains to Part D, we came into the year with a cautious stance because we wanted to make sure we could keep our MBR intact. And so we -- I would say we came up with cautious guidance for the year. And as we roll through 7 months, we feel very good about landing that. We were a little bit ahead in the first half but we feel like we'll deliver on the results for the year. And that's really a testament to us being conservative but also kind of staying on top of it. This idea of active care management permeates throughout the organization. I think in Part D, the challenges are typically around a few classes of drugs where price has risen, and that's harder to manage from our care model perspective. But utilization has been pretty reasonable notwithstanding a few pockets. And so we feel good about Part D. I know that was a big issue at the beginning of the year. We feel, as we're kind of crossing the halfway mark, quite good about it.

So one of the unique things about Alignment, and this has been the case for quite some time. You continue to grow above market while maintaining costs. Can you talk a little bit about what you're seeing in the progression of the MBR for members as they come on to the platform and how that's changed over time?

Yes. I mean it's something that we've disclosed publicly, which is really our cohort analysis. Year 1 members really come in at something like high 80s to low 90s MLRs. Year 5 members are kind of in the high 70s, low 80 MLRs. And that's really a function of a combination of a little bit of the -- just kind of proper coding, just not aggressive, just proper coating. But really the adoption of the care model, the engagement of that 10% and then the care of that 10% and it's -- the whole thing is working. The key takeaway, I think, that is -- that right now, about 50%, a little bit over 50% of our members are still in a year 1 or year 2 cohort, right? So they're not even fully matured. And what that implies is you've got this huge embedded earnings potential on the existing members that you have. And, i.e., if we grew like 0, which is not going to be the case, we'll talk about growth in a second. But if you didn't grow just the gross margin potential of the existing population is going to keep going up because, again, the adoption of the care model. So we're happy about that. And so what you'll see in the future is more and more of the proportion of the business is going to be what we call loyal members who have been with us for at least a couple of years, and that margin profile is going to get very strong. That embedded earnings is what happened really this past year, and you saw that.

So beyond MLR, you guys are also maintaining one of the lowest ratios of the SG&A in the business, which is an impressive feat. Have you been able to drive that savings and kind of maintain that SG&A ratio while squeezing it over time?

We had the benefit of a clean sheet when we design the data architecture. And we don't have what the incumbents have, which is multiple back-end legacy systems that have to get reconciled. And so we have a single unified data architecture. We're making investments in that to get that even better, by the way. And the kind of actionable nature of the data allows us to have very high productivity of our existing employees. And the other thing -- I mean we're going to invest and have invested over the last 3 or 4 years, huge amounts in automation, workflow design, process improvements, I mean just all the operational excellence stuff of the back-end systems is starting to pay off. And this year, we just put in a new claims adjudication application that integrates into AVA. And we think of AVA as our core system, and it's a single source of truth. And then you have different apps that plug into AVA. That's work -- that's well. So the data architecture, the systems architecture is just a huge advantage from what the legacy guys have. And the switching costs that they have is just a surmountable number. I think we will continue to get operating leverage heading into '26 really, you'll see in '25 and even into '26. I think that will be offset by we starting to invest in the brand. Just because we really haven't invested in the brand that much. And I think we'll still be below 10% overall SG&A. But I think we're not going to drive it too much further below that because whatever operating leverage benefits we have, we're going to invest in the brand. And that's in the context that we're going to be big enough, and we're going to get bigger through that investment of the brand.

And what about for open enrollment this coming year? Your competitors are talking about plans and PPO rationalization. How are you guys approaching is an enrollment plan?

Pretty much the same as prior years. We do a lot of market research. We do a lot of analytical work. We look at what our competitors do, what our competitors have, where we think the competitors are getting compromised, et cetera. And we kind of have always been disciplined about 50% growth, 50% margin and some years, will tilt one way or the other. I think we've pretty much been balanced heading into '26 there's going to be a lot of dislocation, this coming AEP, as you all have read. But we're still cautious. We're not chasing bad business. They're exiting products. They're exiting markets and you go, well, why? Well, because they're losing money on it. So we have to be very thoughtful about not just going out and growing and picking up that business. So we're very thoughtful about that. The other thing is you still have the smaller players and some of the not-for-profits that I think are going to be very aggressive and I think we've all learned that these kind of periods of being aggressive in light of V28 in light of RAB in light of all this stuff is has not proven to be sustainable. Some of these smaller ones, some of these not for profits, they're very aggressive on product design and as some of the large players have demonstrated, you pay for the next year through trend increases and they just missed price. So we're watching all that. We feel good about our 20% long-term growth. So there's no change there. And the fact that we've had 3 years -- kind of our 3-year CAGR is about 31% growth. So we're being a little bit conservative. I think that's fair to say. But you just kind of never know what's going to really happen in AEP. We feel good about it though. Our benefits are solid and we'll let the games begin. So I mean, we're geared up for it.

Great. You've been phenomenally successful in California, which in and of itself is a massive market. you've continued to expand outside of California. And talk a little bit about your success in replicating the success in California. Yes. No -- how you're thinking about that?

Yes. Yes. The big question for us, and we're very conscious of this is portability of the model and viral growth. How big can we get this? And we've always said we think we can grow this and make it viral. We think we can get we can get twice as big in the next, call it, 3 years. The goal always is to get for us in the short term is how do we get to $10 billion in revenue. It's going to require we achieve about 600,000 in membership. And I think as we go on that journey, we're going to also be expanding our margin profile. We feel good about that. I think the sequencing of -- we're going to continue focusing on margin expansion, which the answer is yes, vis-a-vis growth. Can we get to $7 billion or $8 billion in the next 3 years? I feel pretty comfortable with that actually. Can we get to $10 billion? That's going to require a little bit additional market expansions or any M&A. We'll talk about that. We're not going to do crazy M&A, so be careful. I think that -- I think portability of the new markets is a priority in the company right now. But we have so much lessons learned that we're being very disciplined about where we go, with what partners do we go? Do we have the right broker distribution network? And we're finding that our Stars are solid, really good. The care model is portable through the ADK of all of the ex-California markets, the ADK is really even better than California. The margin expansion opportunity for us outside of California is even higher than in California because we don't have the same degree of IPAs that we work with, right? And when you work with IPAs, either globally shared risk ones, there's some margin that's flowing through to them, which is fine. But outside of California, we pretty much are the IPA and the margin profile is even better. Nevada is going to -- is growing nicely. I mean, Nevada, I think, is going to take off this year. Arizona, I think, is doing well. Texas is doing well. North Carolina, all the markets are starting to get toward 10,000 members or above, and in some cases, even close to 20,000. So we're starting to get the kind of the reputation in these markets. It takes about 3 years and it's starting to work. That's given us the confidence to do what we also said we were going to do, which is we're going to fund any new markets through free cash flow from operations. And we're a year early on that in 2025. So again, very disciplined, very controlled consistent, reliable kind of growth and margin expansion.

So you do continue to outperform on Stars. 100% of your members are in 4-plus star rating markets. There are upcoming changes to the Star Ratings program. How are you going to continue to maintain that differentiated Stars platform?

Yes. Well, for those of you that don't know, the Plan Preview 2 on Stars came out yesterday afternoon, which is why you hear some of what the other MCOs are starting to share what do you think their Stars are. What happens is they give you a Plan Preview and if there's any disagreements or discrepancies between your data and CMS' data, you talk about it between Plan Preview 2 and the end of the month. And so October 1 is when I think the final star ratings in Plan Finder come out, right? So we're in that process right now. I can share with you -- I think I can share -- I got a legal counsel here. I think we can share based on Plan Review 2, we will still maintain at least 100% of the members of 4 stars and above and we're working on even improving that. But I'm very, very comfortable with that. So 100% of 4 stars and above throughout the company, you're going to have some increases in a couple of markets also. Just to remind you, we have 5 stars in North Carolina, Nevada now, and we're working on moving toward that 5-star rating in other markets. So we're pretty happy about that. I think the key to this is it's -- Stars is not a departmental function. Stars is a enterprise-wide cultural commitment to actually doing what Stars has intended to do, we just take care of seniors, right, and make seniors happy, take care of them that their customer satisfaction should be good. I think that as we have taken more and more control over some of the key functions associated with how we manage medical management vis-a-vis what we've done in the past, which we've delegated to some of these IPAs. The more that we're taking over a lot of that, you can see a stronger performance across some of our CAPS scores. And I think that's already starting to manifest itself this year.

So let's talk a little bit about priorities for 2026. You mentioned expansion?

They are not going to get easier. I think they're going to get tougher I think one of the things to think through for us is how they're thinking about HealthEquity index and how that impacts reward factors. Our California business is 4 stars now, and we get no reward factor. I think based on the calculations from the HealthEquity index that we think we are very well positioned to get a reward factor. And I think we publicly said we think that could be worth up to 23 basis points. I think that, that would benefit us in that regard. But with respect to cut points, we just got the planned preview. We're still waiting on some of the details on the cut points.

Let me make sure that I do take any questions from the audience. So if anybody does have a question, please do alert us.

Expectations, do you expect -- right, you're going through '19, you're going to go through the next 5 years. When we get preliminary rates in January, February time, timeline and final, do you expect any type of B30 like some other coding changes to be implemented where we got very excited over the trend assumption that catching up to the industry with V28? Do you think there's something else that could potentially come?

My -- the answer is I don't know. Is this the -- I don't know. I know there's been a lot of discussion at CMS around looking at the risk adjustment model potentially just making it more modernized. And for those of you that know, I mean, it's -- this existing model was developed 20 years ago, literally 20 years ago by Dr. McClellan. It was based predominantly against free-for-service data. And 20 years ago, Medicare Advantage represented about 15% market share of total seniors in the market today, it represents 53%. So over the last 20 years, MA has really taken off in terms of market share acceleration, but that creates an opportunity for people to look at how that data is going to be reviewed differently. My hunch is the administration is going to kind of -- with -- they kept V28 intact. We didn't make any change in the 28. That was something that you could have done. They're going to keep V28 8 intact. They're going to implement RADV audits, both of which I think is really good because it normalizes the playing field. And I think you think about -- are they pro MA or not pro MA, and then look at the benchmark rates. They give you 9%, right? So what I think is happening is good for the sector. Cleanup coating, eliminate the gaming, supported with benchmark increases, they account for some of the utilization increases as you've talked about. And I think -- if you think about what happened in 2012 to 2024 when the last time they had -- we went through this cycle, everything just went up once they cleaned it up. That's what I think is going to happen. I would not bet against MA. Anybody that bets against MA loses. The market forces of the aging seniors is not going to slow and I think the market share penetration, the slope will kind of flatten a little bit, but market share is still -- I think it's going to be 65% when all's said and done, of MA in terms of total seniors. So I think seniors are going to keep going up. MA percentages keep going up. I think that the value proposition to seniors as measured by benefits relative to fee-for-service in each market is still material, even though it's lower than in the past, it's still material enough to increase that market share. Steve, does that answer your question?

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I'm not sure what that means.

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Yes. I'm not sure that's just a California phenomenon. I think that the product design around -- if you're talking about HMO versus PPO. Yes, I think you're going to see a lot of PPO exits. And when all said and done, PPO exits, PPO exits in markets. I think there's -- I think I just -- I think that's an industry-wide phenomenon. I think you're going to see more HMO across the board. And if -- I just paused on the word gatekeeper because I've heard that in like 40 years. But 40 years ago, you didn't have stars. I mean -- so if you kind of -- if you're denying care or blocking care, your stars are going to suffer. And so -- and we kind of think about that in the context of concierge services actually. Meaning you can't think of the PCP as blocking or being a gatekeeper. You have to support that PCP and make their practices better and more efficient. That's where this whole care anywhere model comes into play. But yes, I think you're going to see PPO exits across the board.

We only have about half a minute. Can you just quickly summarize what you're expecting to see for '26, what your priorities are? And you mentioned M&A, so we got to get a comment on that.

Yes. I think -- I mean, as you can imagine, we're looking at a lot of potential M&A opportunities being very, very discerning. Our Board is like you guys are doing really, really well, don't create problems for yourself. Having said that, we can have -- we're looking at membership that have overlay networks to ours, where the integration is pretty easy. We're thinking about it. I would say we're being very, very discerning around that. I would say for 2026 and beyond, we feel really good about our growth in AEP. We feel good about Stars. I think our core operational system implementations are going really well. So I think the operating leverage opportunity is good. I think one thing around M&A that I'll touch on that's kind of new to what we've shared with you is in the context of captives. And so the large MCOs right now have -- most of them, I would say, have captive businesses that are ancillary in nature, ancillary or supplemental benefits. So dental PPO, behavioral HMO, transportation, flex card fulfillment, all those kinds of things. Surprisingly, those account for like 5% of your MLR, 5%, right? So we're sitting at whatever, 87-ish, 87%, 88% MLR, 5% of that is supplemental benefits. That's kind of an industry phenomenon. They have captives already embedded into their MLR. We don't -- we're paying external vendors for that 5%. And so we're at a size now we're big enough that we can start investing in or buying some of these vendors ourselves. So we're paying ourselves. And so for example, if we went out and bought a small dental PPO, this is just an example. And then we would see that with 250,000 lives right off the bat as customers everybody that's a very accretive win for everybody, right? And so I think you're going to see margin expansion opportunities for us in the context of focus on 2026. I right? And ultimately, if you -- if we own all of that supplemental ancillary kind of captive, we're going to improve our MLR by up to 5%. So I think if we can do that and we're going to maintain our advantage on just medical management, which to me is the core of what we do is medical management. I think the opportunity for us to improve our bid position will even be greater. So the bigger we get, the stronger we're going to get, add that to the embedded earnings potential associated with the gross margin expansion. I think that's the big picture. We feel very well positioned if that makes sense.

We are out of time. Thank you so much for being here today. John and Jim.

Thanks, everyone.

Thank you.