Trupanion: $ 8 price target, unfavorable selection exposed in records (NASDAQ: TRUP)

I have written extensively on Trupanion (TRUP). More recently, I published an important article questioning the health of the company detailing the deterioration of internal financial parameters (ICI). Totally unrelated to my post, a previously enthusiastic holder (Ensemble Capital) posted a blog on why they chose to sell their position in TRUP (HERE).

While our analysis differs on several levels, the most important commonality that we each highlight is the fact that TRUP offers the most expensive pet insurance on the market. I suggested it was because the company had undervalued its insurance offering and was forced to raise prices to cover losses from inherited policies, Ensemble Capital proposed that TRUP had the most coverage. scope available and therefore fought against inferior products. Either way, we agree that the business grows slower than the market, and uncompetitive pricing dynamics are a big factor in this loss of market share.

There are two basic ways for an insurance company to enter a rate spiral that forces it to increase the price of new policies – well above the market rate – to compensate for losses it previously had. subscribed.

  1. A company may undervalue its insurance offering to gain market share, thereby risking the long-term viability of the insurance portfolio in favor of short-term market share.
  2. A business may encounter a problem of adverse selection when setting up a business. In this case, the insurer does not know that it is underpricing its activity because it has made incorrect assumptions about the health of the population it insures.

In the case of TRUP, both may play a role in the current problem of the unsustainable price disparity between players in the pet insurance market.

According to the Ensemble’s letter: “Much of our thesis was Trupanion’s benefit of having ‘active’ referral relationships with nearly 10,000 North American veterinary hospitals and its success in installing its automated claims software, Trupanion Express, in 4,000. hospitals. “

Selling insurance inside a hospital – veterinary or otherwise – generates a significant risk of adverse selection. Especially when the company offers rich payments. According to Ensemble: “However, the reason Trupanion is expensive is that it offers more generous payouts – Trupanion’s wastage rate is 70% versus 50% on average in the industry.”

Vets are paid based on visits and procedures, if they are your sales team, you can run into issues quickly.

According to TRUP – This dynamic has become a problem

In a document filed with the State of Florida, TRUP requested a material change to its insurance offering, they want to be able to offer a product that has a coinsurance toggle. Currently, TRUP pricing is based on a series of inputs such as age and race, but more importantly the size of the franchise you choose. Now TRUP wants to offer a separate toggle that allows you to degrade the payments that TRUP will be responsible for over time.

This new product, described as the “Trupanion Agreement” in Florida filings, has received some reluctance from Florida insurance regulators. In a file named “Response to Objection 1”, TRUP states:

We believe that in our existing Trupanion product we are experimenting Adverse selection and not enough insight into low penetration areas.

Figure 1: “Response to objection 1” Page 1

Source: Florida Insurance Regulatory Authority

Figure 2: “Response to objection 1” Page 2

Source: Florida Insurance Regulatory Authority

Adverse selection is a serious problem for an insurance company, the rule of thumb is that your policyholders are sicker (and therefore will draw more capital from you over time) than you anticipated when the policy was originally established and subscribed. The result is that the policy book that one subscribes generates more capital drawdown than cash profits. Remember that an insurance company is just a pile of contracts, if those contracts don’t make money … the business is worthless.

Conclusion

In my previous reports, I detailed my rationale for short selling TRUP and how I derive a price target of $ 8 from it. This document supports some of the main concerns of the company.

Further observations regarding this disclosure are warranted:

  1. Changing the coinsurance rate is contrary to the company’s claim that it offers the best coverage in the business. This ditch, it seems, is dead.
  2. A key aspect of the bull thesis is that Trupanion (via Trupanion Express) has a significant competitive advantage due to the proprietary data generated at the point of sale. However, the above document bares this argument as the company admits that in geographies with opportunities for expansion, it has no quick fixes. This ditch, it seems, is dead.
  3. Coinsurance doesn’t solve adverse selection, it doesn’t even solve the underlying problem regardless of which sales channel is causing the adverse selection problem. All that has been emphasized here is that selling insurance through a network of vets causes adverse selection from your insurance pool. This ditch, it seems, is dead.

What I find surprising here is that TRUP did not say anything about changing its investor program. For a company that sells itself as the highest payout to vets, changing its coinsurance is a big and significant change in strategy. Investors should demand more transparency from a company whose price is so far removed from the competition, I shouldn’t have to dig up obscure documents to find out that TRUP’s only product offering has problems with it. adverse selection. Invest at your own risk, I stay short.

Martin E. Berry