We terminated that business [Dorfman] and we still have record third party sales. That should be very reassuring to everybody.
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We are short Health Insurance Innovations (NASDAQ: HIIQ).
A recent court filing made by the Federal Trade Commission reveals that HIIQ has continued to charge consumers millions of dollars for thousands of “virtually worthless insurance products” issued by HIIQ to families who the FTC says were defrauded by boiler rooms run by Steve Dorfman’s Simple Health companies. We believe these new documents contradict management’s assertions and suggest the company is still harvesting cash from the victims of a giant alleged fraud. We therefore believe that HIIQ may have juiced its recently released financials by booking millions in revenue from policies fraudulently sold by Dorfman, even after HIIQ management told investors that the company had terminated this relationship.
In documents filed on March 18th, the FTC states that “thousands of Dorfman’s victims continue to be charged each month by the third-party administrator that issued Defendants’ virtually worthless insurance products”. The FTC now specifically names Health Insurance Innovations as the administrator and states that “HII continues to charge consumers despite the TRO [Temporary Restraining Order]. From December 2018 through February 2019, HII has charged consumers 165,798 times, totaling approximately $14.6 million”.
Source: Selections from FTC court filing. A declaration by an FTC investigator (here) states that this total is based on spreadsheets HIIQ’s counsel turned over to the receiver and includes additional commissions owed to Dorfman. It is unclear to us if the spreadsheets includes collections on policies sold by Dorfman’s downline of brokers and affiliates.
In a press release issued on November 2nd, HIIQ claimed it “had immediately suspended our relationship with Simple Health” and declared that “HIIQ does not expect a negative financial impact relative to the company’s recently issued guidance”. As explained in our initial report last year, we found this statement puzzling because documents clearly show that Dorfman was a major distributor of HIIQ policies, with HIIQ making more than $145 million in cash payments to Dorfman’s companies since 2015. But HIIQ apparently mitigated the financial impact of Dorfman’s termination by continuing to charge thousands of consumers who the FTC says were defrauded and “likely do not even know they are essentially uninsured and thus are at risk for incurring crippling medical debt due to serious illness or hospitalization”.
This all strikes us as highly problematic. Why would HIIQ continue to bill customers who the government says were defrauded, even after management told investors it had terminated the relationship with Dorfman? How could it be appropriate for HIIQ to continue to book revenues on policies the government says were fraudulently sold and “virtually worthless”, especially without any corresponding reserve or disclosure? Could the company have met Wall Street financial targets without continuing to charge these victims?
We note that the FTC’s stated goal is to “stop the fraud and to return as much money as possible to Dorfman’s victims”. The court documents suggest the receiver may soon be seeking to address “the situation with HII’s continued billing of consumers who were victims”. The FTC also states that “these consumers need to be notified and given the opportunity to cancel” noting that “it is difficult to overstate the devastating and irreparable impact Dorfman’s scam has had and continues to have on its victims”. It would therefore not surprise us if the receiver or the FTC move to claw back the entirety of the monies paid to HIIQ by these consumers. Because HIIQ has paid more than $145 million in cash to Dorfman since 2015, we estimate it may have collected more than $240 million dollars from consumers on policies sold by Dorfman and his affiliates (assuming a 60% commission rate).
Furthermore, are investors really supposed to believe that Dorfman is a mere anomaly? How many other brokers have made similar misrepresentations to consumers when selling HIIQ policies? How much has HIIQ charged these families?
Because we are not aware of HIIQ disclosing any reserve, provision, or loss contingency related to policies fraudulently sold by any of its brokers, we also wonder if the company’s auditors, Grant Thornton, were fully aware of these details when they signed off on the company’s audit last week. Importantly, PCAOB Audit Standard 2805 requires the auditor to obtain written representations from management including:
“Knowledge of any allegations of fraud or suspected fraud affecting the entity received in communications from employees, former employees, analysts, regulators, short sellers, or others.”
We note that Grant Thornton expressed an adverse audit opinion of internal controls in the 10-K filing, which disclosed a material weakness related to revenue accounting. Irregularities included “one customer contract with unique terms that was canceled” and various errors that “resulted in post-closing adjustments”.
In our opinion, Dorfman is only one player inside a vast ecosystem of unscrupulous actors who have fueled HIIQ’s sales. We continue to believe it is now only a matter of when, not if, HIIQ’s business will implode. We therefore see enormous downside potential.