Operator: Good afternoon, and welcome to Alignment Healthcare Q3 2026 earnings conference call and webcast. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. To ask a question during the session, you will need to press star one one on your telephone. You will then hear an automated message advise your hand is raised. To withdraw your question, please press star one again. Please be advised that today's conference is being recorded. Leading today's call are John Kao, Chairman and CEO, and Jim Head, Chief Financial Officer. Before we begin, we would like to remind you that certain statements made during this call will be forward-looking statements as defined by the Private Securities Litigation Reform Act.
Operator: These forward-looking statements are subject to various risks and uncertainties and reflect our certain expectations based on our beliefs, assumptions, and information currently available to us. Descriptions of some of the factors that cause actual results to differ materially from these forward-looking statements are discussed in more detail in our filings with the SEC, including the Risk Factors sections of our annual report on Form 10-K for the fiscal year ended 31 December 2025, and our Form 10-Q for the fiscal quarter end 30 September 2026. Although we believe our expectations are reasonable, we undertake no obligation to revise any statements to reflect changes that occur after this call. In addition, please note that the company will be discussing certain non-GAAP financial measures that they believe are important in evaluating performance.
Operator: Details on the relationship between these non-GAAP measures to the most comparable GAAP measures, that reconciliation of historical non-GAAP financial measures can be found in the press release that is posted on the company's website in our Form 10-Q for the fiscal quarter ending 30 September 2026.
John Kao: Good afternoon, and thank you for joining us on our Q3 earnings conference call. For Q3 2026, health plan membership of 301,200 represented growth of 31% year over year and drove overall revenue of approximately $1.4 billion, a 37% increase year over year. Adjusted gross profit of $142 million represented an adjusted MBR of 89.5%, a 240 basis point increase year over year. Meanwhile, adjusted SG&A of $120 million represented an SG&A ratio of 8.9%, which improved by 70 basis points year over year. Taken together, Adjusted EBITDA was $22 million, within the range of our guidance. I want to spend a few minutes on the headwinds that emerged this quarter and the actions we have taken in response.
John Kao: As part of our broader scaling initiatives, we began a comprehensive claims system migration last year designed to improve our payment speed, auto adjudication rates, and payment integrity capabilities. During this transitional period, we experienced greater volatility in claims processing. As this volatility normalized, we identified a notable increase in aggressive provider appeal and disputes in our paid claims data, which resulted in higher cost trends. Separately, during the quarter, we saw pockets of higher costs in areas such as catastrophic cases and skilled nursing, which also pressured medical expenses. To address the headwinds we experienced, we acted swiftly over the past several months to build out a more robust payment integrity function, including industry-standard prepay claims edits and more rigorous post-pay review.
John Kao: Additionally, we have moved quickly to manage and deploy our clinical resources more effectively and are making targeted investments to ensure our clinical best practices and operating rigor are applied systematically across our markets to reduce the variability in member outcomes. We are confident that the actions we are taking to scale our clinical programs will enable us to achieve the level of clinical effectiveness that we are accustomed to. We are pleased with the progress we have made across our multiple initiatives and saw institutional acute cost trends stabilize as we closed out September and entered October. Furthermore, we have experienced positive momentum across other cost categories. Despite our progress, we are taking a prudent approach to the increased trend seen in Q3 and assume that higher costs in the third quarter will continue to weigh on our results for the remainder of the year.
John Kao: Given this position, we lowered our annual guidance to no less than adjusted gross profit of $575 million and Adjusted EBITDA of $100 million. I want to emphasize that the guidance we have provided today is a guidance that we are confident in delivering. Furthermore, we have thoroughly reviewed each market to identify the issues that impacted our financial performance this year and mobilized quickly with plans to address them. Our revised outlook reflects both a prudent posture toward the cost pressures we are seeing today and a disciplined approach to forecasting the balance of the year. Our focus is now on execution, delivering against the commitments we are making today, and positioning ourselves well for 2027. As we enter 2027, we feel well-positioned to achieve our top-line growth target of at least 20%, given the early results of this AEP.
John Kao: Importantly, we bid prudently, reconciled those assumptions in the bids to the trends we are seeing today, and have made adjustments in areas we saw room for improvement. At this time, we have a firm grasp of the underlying market dynamics we faced in 2026 and the actions required to address them. Taken together, we believe we will strike the right balance between growth and margins for 2027. We will share our thoughts in greater detail following AEP results in January. I would like to take a moment to address our Star Ratings for payment year 2028, which reflects performance for 2025 dates of service. We maintain a four-star or higher rating in six of our seven eligible plans, demonstrating our ability to deliver strong Stars performance across much of our portfolio. At the same time, our California HMO contract earned a 3.5-star rating, which is below our expectations.
John Kao: The shortfall in our California HMO contract was primarily driven by misses on several triple-weighted measures, particularly in HOS and Part D, as well as higher than expected industry cut points. We have already identified data and workflow opportunities within our Stars infrastructure and initiated actions across our enterprise to drive better and more consistent Stars performance. We have conducted more provider and member engagement initiatives to improve performance in survey measures, address data issues that impacted gap closure in Part D, and accelerated our progress in HEDIS gap closures to further strengthen our position in these metrics. These changes are in place and operationalized for the 2026 performance cycle. In conclusion, we continue to demonstrate profitable growth and are addressing the challenges that impacted our performance this year.
John Kao: We have taken decisive action in those areas, and our revised outlook reflects a prudent view of the cost pressures we're seeing today. At the same time, we continue to invest in capabilities and operational changes that are important to support our next phase of growth. Over the past couple of years, we have evolved our leadership, processes, and technology architecture to support greater scale. We are already seeing benefits from some of these changes. This includes greater visibility and control over inpatient utilization through our partnerships with the providers to de-delegate institutional acute UM functions. We also continue to seek opportunities to assert more control over our pre-service UM for outpatient and professional costs where appropriate. Additionally, our clinical model remains a core strength of our business and primary driver of our unit cost advantages. The investment in claims processes, clinical operations, and Stars infrastructure build on that foundation.
John Kao: With that, I'll turn the call over to Jim to further discuss our financial results and outlook. Jim?
Jim Head: Thanks, John. I'll dive into our Q3 results. For the quarter ended September 2026, health plan membership of 301,200 increased 31% year over year, supported by strong member additions and high retention in our existing membership base. This drove revenue of approximately $1.4 billion in the quarter, representing approximately 37% growth year over year. Q3 adjusted gross profit of $142 million represented an Adjusted MBR of 89.5%, approximately 100 basis points above the implied midpoint of our Q3 guidance, and an increase of approximately 240 basis points year over year. Approximately half of the year over year increase in MBR was driven by changes in Part D seasonality and additional clinical model investments, consistent with the comments we made on the Q2 call.
Jim Head: As John mentioned earlier, we also observed a notable increase in provider-led appeals and disputes in the quarter, along with elevated costs within our skilled nursing and catastrophic case categories. These components drove the remaining increase in MBR. Turning to operating expenses, our adjusted SG&A was $120 million, an increase of 27% year over year. As a percentage of revenue, adjusted SG&A of 8.9% improved 70 basis points year over year and outperformed the midpoint of our guidance range by approximately 90 basis points. We delivered this result even as we made incremental investments in our business previously mentioned in the Q2 call and John's commentary today. Additionally, included in the quarter was the benefit from lower incentive compensation accruals given our year to date performance against targets. Taken together, Q3 Adjusted EBITDA of $22 million produced an Adjusted EBITDA margin of 1.6%.
Jim Head: Moving on to cash flow and the balance sheet. We generated $158 million in operating cash flow during the first 9 months of the year, and our liquidity profile remains strong. We concluded the quarter with $743 million in cash equivalents, and short-term investments. Overall, our reserves remain well-positioned in both current and prior years, and we are confident our cash flow generation will continue to support our growth going forward. Lastly, our funded leverage ratio at the end of Q3 was 2.4x our trailing 12-month EBITDA. Moving to our guidance. For the Q4, we expect health plan membership to be no less than 305,000 members, revenue of no less than $1.32 billion, adjusted gross profit of no less than $104 million, and Adjusted EBITDA of no less than -$28 million.
Jim Head: For the full year 2026, we expect revenue of no less than $5.25 billion, adjusted gross profit of no less than $575 million, and Adjusted EBITDA of no less than $100 million. Our Q4 adjusted gross profit guidance of at least $104 million implies an MBR of 92.1%. In our guidance, we have assumed a continuation of the elevated medical claims expense we experienced in Q3, with no contemplation of the stabilizing trends we observed in both September and October. Furthermore, while we are not including any benefits from the initiatives currently in progress, the cost of these initiatives are fully burdened in our guidance. Lastly, on seasonality. Our revised guidance continues to embed an assumption for increased costs relative to typical medical expense and Part D seasonality.
Jim Head: Additionally, we are assuming a continuation of the higher costs we experienced in the Q3 related to elevated appeals and disputes activity, along with increased costs in certain categories. On SG&A, we expect higher expenses during the Q4 associated with growth-related costs and marketing expenses related to AEP, consistent with our past experience. In closing, our updated outlook reflects prudence in our positioning as we address the pressures we discussed today, as well as the seasonal factors typical of the Q4. We expect the actions we have taken this quarter to provide visibility and control and support improved performance as we position ourselves for 2027.
John Kao: With that, let's open the call to questions. Operator?
Operator: Thank you. At this time, we will conduct a question and answer session. As a reminder, to ask a question, you will need to press star one one on your telephone and wait for your name to be announced. To withdraw your question, please press star one one again. Please stand by while we compile the Q&A roster. Our first question comes to the line of Matthew Gillmor of KeyBanc. Your line is now open.
Matthew Gillmor: Hey, thanks, guys. I guess I just wanted to start off with the cost trends that you have identified. There was a discussion that John started off with in terms of this new claims processing system, I think it is called Facets, and the deploying of that system sort of led, I think, to the better identification or sort of faster claims processing. I was just hoping you could talk a little bit about that new system and how that is either contributed to you identifying these claims or was that just concurrent with you sort of seeing higher claims? Just hoping you would unpack that a little bit. Thanks.
Operator: Speaker, you are on mute, if you can just unmute your mic.
John Kao: Sorry, guys. Yeah, Matt, Facets is the industry-leading claims adjudication application. We migrated off of something that we thought was subscale. One of the benefits of this is we felt that we needed better auto adjudication rates so we could pay our providers faster. We needed to make sure that we had state-of-the-art payment integrity programs to offset the AI initiatives from a lot of the larger providers. Anybody that has gone through one of these conversions knows it is a messy process. I am actually pretty happy with where we ended up in terms of getting through most of this in July. We are 3 months past that now, and I feel very happy about where we are from a stability point of view. What happened is we saw volatility in our paid claims, and we started seeing that in July.
John Kao: Once we realized we had a lot more appeals and disputes coming through, we had to react on that. I am happy to say that the amount of appeals has dropped off significantly in August, September, and October. As Jim said, in spite of that stabilization, we are still taking a very prudent approach toward the rest of the year. I feel good about where we are in that regard. I feel good about where we are with our reserves. That is the main issue on Facets.
Matthew Gillmor: Great. Just to make sure we understand, was it the case that the claims just happened to be running higher after you had implemented Facets, or was Facets helping you identify some of these higher cost trends?
John Kao: It created volatility. When you go through one of these system conversions, what happened was we were making sure that the configuration of the system was correct. You had some timing differences between when claims were coming through and we saw a higher trend, it really peaking in July. Once we saw that, we made all the requisite changes and got all of that through, in terms of getting paid claims stabilized, but that created the higher trend really starting in July. We started seeing that and the actually trends is starting to actually tail off a little bit in August, September, and October. Again, we are just being extra careful to make sure that we are assuming that trend continues into Q4, despite the fact that I think some of the trends are already starting to stabilize.
Matthew Gillmor: Great. Thanks a lot.
John Kao: You got it.
Operator: Thank you. One moment for our next question. Our next question comes from the line of Kevin Fishbeck of Bank of America. Your line is now open. Kevin Fishbeck, your line is now open. If you could just unmute your mic, can I hear you?
Joaquin Martinez: Hi, this is Joaquin on for Kevin Fishbeck. Can you guys hear me now? Sorry about that.
John Kao: Yeah. Hey, Joaquin.
Joaquin Martinez: Yeah. Could I just get your initial thoughts on 2027 bid positioning to start off?
John Kao: Yeah, it is a good question. We did a deep dive, as you might expect, on the assumptions that we made into the bids. We kind of compared that to the trends that we anticipate and the mitigation efforts that we have in place for the balance of this year, which just to underscore, we did not factor into the guidance. The result of that is we made some changes with respect to certain networks. We made some changes with respect to how fast we are going to grow certain products or not grow certain products specifically. But overall, we feel good about where we are in 2027. We feel good about finding, again, that balance between growth and margin expansion. I think we have been pretty good at that over the years, and we will get back to that same cadence.
John Kao: You can imagine, we did a pretty thorough dive as to how much we should grow, and how we are positioned relative to competitors in Plan Finder. Again, I think we feel pretty good with solid, profitable growth at that 20% level.
Joaquin Martinez: Got it. Thanks. Just last one. A lot of companies have taken action to diversify their membership across plans. Is that something you guys are looking to do, and do you have any targets on how big any one contract as a percentage of membership should be? Thank you, guys.
John Kao: Well, I think with respect to us, we have so much membership in the California H number. That is something that we are looking at, obviously. I am not going to comment too much on the tactics associated with that, but more so focused on really getting to the root issues in Stars. Really what I think is going on is we still got six out of seven 4-starred above. We got three 4.5 star plans, just to remind everybody. But those are still being well run, really, because we are smaller in those markets. California has gotten so big that we just have to continue to invest in automation. We have to continue investing and really incentivizing our provider partners and our IPAs to work with us and focus on Stars more and better. But that is kind of where we are zeroing in on.
John Kao: It is like we might have some kind of crosswalk types of tactics. But we got to get to the root issues. We got to get to the root and fix it. Just to remind everybody, when we started the company, we bought a plan that was 3.5 stars. It dropped to 3. This was way before we had anything to do with it. We are still the only company to get from 3 stars to 4.5 stars. The way we did that was underscore the fact that Stars is not a functional department. Stars is a cultural requirement. We have so many new people here. We are growing so big with new people, new leadership. That is something that we are going to be underscoring yet again, is this is something that everybody in the company has to focus on, serving that senior.
John Kao: We will get this fixed. That I can promise you.
Operator: Thank you. One moment for our next question. Our next question comes from the line of John Stansel of J.P. Morgan. Your line is now open.
John Stansel: Great. Thanks for taking the question. Just thinking about the reduction in guidance here in the back half. Appreciate that, generally speaking, your profit is a little bit more front-half weighted. Can you just spend a little bit of time thinking about, I appreciate the conservatism in the back half of the year, but what the jumping off point is when we think about kind of like a fully burdened gross profit and EBITDA number to grow off of in 2027?
Jim Head: Yeah. John, I'll take this one, and then John Kao can fast follow. But just in terms of developing our Q4 guidance, we did want to reflect the cost trends that we identified in the call, and put ourselves in a position where we could deliver on the revised expectations. And obviously, you're seeing some prudence in that. In our guide, we're assuming a couple things, and we're not assuming a couple things. So that's important to understand from a jumping off point. In our guide, we're assuming that we're continuing the higher appeals and disputes at what I would describe a peak rate. Okay? So putting some prudence in the appeals and disputes expectation. As John mentioned, John Kao mentioned, that's already starting to come down.
Jim Head: We also are assuming a continuation of the SNF length of stay issues that we've talked about, but also CAT cases kind of continuing. As we exited Q3, we saw both of these things kind of moderate. What we are not assuming is any favorability from payment integrity or payment accuracy activity. So that's not in the assumption. We're not assuming any returns from the clinical investments that we called out in Q2. So, in that, we're kind of making sure that we can deliver and not baking in any of what we think is going to be run rate benefits for 2027. Then finally, we just put an extra layer of conservatism on it. So the question, and maybe I'll push this over to John Kao, is does that seem like starting point for 2027?
John Kao: Yeah. John, I would strongly advise not to use the Q4 MLR as an annualized starting point for 2027. That would be, I think, a mistake. We have a lot of initiatives going on. Again, just made a decision that this is a bit of a reset, and if we're going to do the reset, let's just make sure we can convey confidence to the street as to what we can achieve, and I think there's potential for upside. We're going to be focusing on that. That would be my suggestion for you, without getting into 2027 guidance.
John Stansel: Got it. Then just thinking about as you think about 2027 AEP, how are you thinking. I know 2026 was a year where you had kind of a higher mix of chronic and higher acuity enrollment. As you think about your 20% growth in 2027 as a baseline, your confidence there, do you think the mix will look more like 2026 or more of a normal year where it's maybe less skewed to chronic and high acuity enrollment?
John Kao: Yeah, that's a great question. Just to underscore one piece of detail, the margins associated with that C-SNP membership, even in year for this year, has been pretty good. That's a big deal. So really, I think the points that we highlighted with respect to appeals, disputes, revenue cycle, aggressiveness of providers, a couple of outpatient kinds of costs, were the drivers. The mix issue is not something that we think contributed to this. Having said that, for 2027, I think you're going to see a more balanced on HMO products. I think there are still some pockets that we think C-SNP makes sense for us. But yeah, that was the first thing I looked at is as part of this mix, and it's actually performing quite well in year. Does that answer, John, your question?
John Stansel: Yep, very helpful. Thank you.
John Kao: Yep.
Operator: Thank you. One moment for our next question. Our next question comes from the line of Justin Lake of Wolfe Research. Your line is now open.
Justin Lake: Thanks. Just following up there on the Q4. One way to look at it is your Q3 MLR was up about 200 basis points year over year. It looks like the Q4 implied is up closer to 400 basis points year over year. Is there any way to parse out that extra 200 bps? Is that just, like you said, conservatism? Is there increased spending on initiatives that you have added for the Q4 that was not there in the Q3? Anything more that you can give us there?
Jim Head: I think the one thing that we would say that was present in Q3 as well, in terms of a little bit extra burden that was in the baseline, was just Part D, which has a little bit of an uptick in the MBR in the Q4. That is just structural and kind of how the bids work out and the risk scores, et cetera. We did have a little extra layer of investment in the clinical side. So that is, if you are doing a year over year, you have to kind of apply that same factor. Then sequentially, you have, I would call it a pretty full run rate of these costs that we described, the appeals and disputes, CAT cases, and the SNF kind of pushing into Q4.
Jim Head: What we are really doing is saying it is a bit one-sided, which is we are putting a full count for what we think the trend could be without any offset that we have already been actioning and actually starting to see some results. Data integrity is a perfect example of that. So, we are being prudent on that, but that is how the build came about, Justin.
John Kao: Yeah, Justin, I would add to Jim's comments, really, the operative word from our point of view is prudence. We really looked at the Q3 numbers. We saw uptick in those appeals and disputes. Those are in our world called adjustments with respect to claims payment. We have seen a positive trend with those coming back down, starting in August, September, and October, stabilizing. We see ADK stabilizing. We have initiatives with respect to CAT case management, SNF length of stay management. All of the blocking and the tackling is implemented. But really, we are just like, let's just be super prudent and not assume any of that is going to start being reflected until we actually get the paid claims in place.
Justin Lake: Okay. Then kind of same question on SG&A. Looks like it is relatively flat Q3 to Q4, typically up $12 million to $15 million, which kind of makes sense just given selling costs during AEP. What is going on Q3 to Q4 that is keeping SG&A flat despite that?
Jim Head: Well, for a little bit of incentive comp that we mentioned on Q3, it is tracking exactly as to what our expectations were in terms of quarter-over-quarter. We were $120 million in Q3 and $132 million, I believe, in Q4. So it actually does tick up, Justin.
Justin Lake: How much was the incentive comp benefit for Q3?
Jim Head: We said it would track according to plan, so maybe we would be in the high 120s in Q3, I think was our guide, our original guide. It is ticking up to 132. So we really have not made any material changes. In fact, we have been investing in the SG&A areas because we want to position ourselves for 2027. We called that out in Q2, that it was going to be a little extra investment made in Q3 and Q4.
John Kao: Thanks, Gus.
Operator: Thank you. One moment for our next question. Our next question comes from the line of Michael Ha of Baird. Your line is now open.
Michael Ha: Hey, thank you. So I know you are pursuing Stars litigation now, but assuming no litigation release, is restoring 4 Stars in time for next October impacting payment year 2029 achievable? Are there any milestones from now till next October that would demonstrate that to us? Also, can you help us frame the gross Stars funding headwind for 2028 and the portion that would remain after things like provider sharing and benefit cost actions, and if you would take benefit cuts potentially in 2028?
John Kao: Yeah. With respect to dates of service 2026, payment 2029, obviously it is a bit early to comment on that. I will give you some input that we feel good about our HEDIS gap closure initiatives. We feel good about our Part D data issues that got cleaned up. Just really as a reminder, even heading into Plan Preview 2 just a couple of months ago, I was feeling optimistic just because we had such a good CAHPS score come in. We really got a little bit blindsided with HOS. That is still one area that is a little bit elusive for us, which really causes me to pause about 2026 in aggregate. A lot of the changes in operations I am comfortable with.
John Kao: Give us a little bit more time. Obviously, I think CAHPS and HOS is going to be more and more important. I think our Part D is going to be strong this year in terms of dates of service. With respect to, I think your third question, you got to remind me what the second one was. Yeah, I think we are going to look at this like we always do, finding the right balance between growth and margin. I will say that the confidence I have with our ex-California markets and our operationalizing of those markets, I feel good about.
John Kao: I think we have a handle on the issues, we have a handle on utilization, and we have so much growth in those areas that the embedded earnings is going to start to go steer the right way with us in those ex-California markets that would allow us to grow there. I think there is still more room for us in California to still get decent growth. I do not think we need to slow down growth in California maybe a little bit, particularly given where everybody else is. We will make the right decisions with respect to benefit design. We are pretty good at that. Michael, what was your second question again?
Michael Ha: Second question, I guess just the gross Stars headwind, after provider sharing benefit HOS actions, like mitigation plans you have in place, and it is just how you are thinking about that.
John Kao: Yeah. Let us get back to you on that one, please, because the mitigation initiatives is pretty material. I underscore two areas. One is embedded earnings. A lot of the investments that we made in obviously 2026 in the C-SNPs, I think is going to start paying off. It's going to help bridge some of that gap with respect to Stars. MRA, I think we are, as we have shared with you in the past, pretty conservative as it relates to risk adjustment, and I think that there's lots of opportunity for us. We took a very, I would just say, conservative approach philosophically to coding. We did not want to be dependent on that, but I think it's also fair to say we can do a better job, and we're doing. I think we're starting to dive into that.
John Kao: We've determined there's lots of opportunity for us on risk adjustment. We'll be in a position to share a lot of that with you when we give you the full plan. We expect to do that after this Q4 call.
Michael Ha: Got it. Thank you. I want to just clarify, I know you're still targeting 20% membership for next year, but I just want to clarify your Star rating decline in California, has it not affected early AEP sales at all or even broker feedback? For 2028.
John Kao: Not yet.
Michael Ha: Okay.
John Kao: It's a great question. The answer, it has not. The brokers are fine. We have such a strong set of relationships with them built over the last 12 years. We've earned their respect. We do what we say. They have confidence in us, and we feel really good about 2027 AEP. I mean, really good. I'd say the right products in the right markets with the right margins. I'm very happy about that. Just to note a couple of things that we've announced. We've added some pretty important provider partners this year. Hoag Memorial is a premier delivery system in Orange County in our backyard. We've got a very good win-win contract with them. Then our expansion in LA with Astrana. I feel really good about that.
John Kao: There's a couple of other markets with certain products we're going to probably de-emphasize heading into 2027. Even with that, I feel good about the growth. Even the providers, particularly the one I just mentioned, are going to work with us because they have confidence in us that we'll get this thing corrected. That is a very good question. The next logic was, okay, how do you think about the growth in 2027? How do you think that'll impact your bids and your product strategy in 2028? I think we've contemplated that, and I think we're going to be fine. I think it's really going to be, what does the margin profile look like in California with respect to benefit design relative to how much we grow ex-California? I think that's what we'll start looking at as we head into 2028.
Michael Ha: Got it. Thank you. If I can squeeze one more in on 2028. It sounds like you're still focused on growth in California, but, does your Stars shortfall change your thinking at all on your plans for new state, new market expansions? I know you are sort of slated for that in 2028 or will you delay it?
John Kao: Yeah.
Michael Ha: Okay.
John Kao: The whole point of this, everybody, is to get this care model everywhere in this country. It is a good care model, and we needed to do this. We needed to scale. We needed to put these processes in place, and to automate more of what we do so that we can get this model in more states. I feel good about where we are and what we have done so far heading into 2027. We are going to be entering San Antonio and Charlotte. Again, that was a bit prudent on our part that we could have added additional states. We chose not to in 2027. In 2028, we are working very diligently to add a couple of states.
John Kao: The whole point of this is what we have been talking about, is to scale this model. I think that you are going to be happy with what we end up with. We are going to get back to this kind of beat and raise cadence. Everything is going to be bigger and much more reliable. We got to get through this kind of transformative phase.
Michael Ha: Got it. Thank you so much, John.
John Kao: Yeah, you got it, Michael.
Operator: Thank you. One moment for our next question. Our next question comes from the line of Jonathan Yong of UBS. Your line is now open.
Jonathan Yong: Hey, thanks for taking the question. I guess just on the stabilization that you are speaking to in medical cost trend, I guess is it stabilizing back towards your kind of original guidance and assumptions that you came into for the year, or is it still tracking above your original guidance assumptions? To any extent, can you frame how much above it currently is tracking?
Jim Head: Well, in the quarter, we definitely saw some elevation, and you can kind of think about that in terms of the MBR 120 basis points that we called out. We are seeing it stabilize, and I would say that probably exiting the quarter below the peak of the quarter. In our guidance for Q4, we are certainly predicting or guiding towards that maintaining at essentially a peak level just in an effort to improve. The trend level we think is going to come down over time clearly as we go into 2027 based on the actions we are taking. That is things like data integrity initiatives, the clinical model initiatives that we have talked about, and just getting sharper in some of these spots, CAT case management, et cetera. For the next 3 months, we will just be improving.
Jim Head: We do think that this will get back to normal in 2027 in terms of our typical trend.
Jonathan Yong: Okay, great. Then just going back to kind of the mitigation efforts to try to get back your Stars and just kind of G&A, are there any additional investments that you need to make either within this upcoming quarter or throughout 2027 to kind of get your Stars back, or is that kind of within your overall planning process already such that there is no real change with respect to that? Thanks.
John Kao: No. It is a good question, Jonathan. We are putting more boots on the ground in the markets. That is the kind of the short answer. Again, to reiterate what I said earlier, we have to just get back to the fact that this is a cultural requirement. It is not a functional department. This is like everybody in the entire company needs to believe in serving that senior as best we can, partnering with the providers as best we can. So it stems from the top, from the board to me. I am going to be sitting on this daily. I have got great leadership in place now to sit on it daily. It really is numerators and denominators for every single measure that we track daily. I think we just got away from that.
John Kao: So we got to put more bodies in the markets, have more consistency around how we close these gap closures, and engage the providers, particularly in California, much more tightly. Those are the things we have invested in. Those are embedded in the guidance numbers.
Jonathan Yong: Thank you.
Operator: Thank you. One moment for our next question. Our next question comes on the line with Scott Fidel of Goldman Sachs. Your line is now open.
Scott Fidel: Hi. Thanks. Good evening. First question, just on product selection and having diversified into more of the higher acuity products with the SNPs and with the C-SNPs and the D-SNPs. Just curious around your thinking for 2027 in terms of ultimately, with the bids and then ultimately, since you've identified some of the cost pressures. Are you continuing to stay with the original trajectory of what you were thinking on the growth? Or have you made any adjustments in terms of how intensively you're pursuing that? In particular, also just curious around your assessment of the competitive environment on the D-SNP side. That felt like within an overall pretty conservative and less overly aggressive market for 2027. It did feel like in the landscape data that D-SNP did seem to be an area where competition was still looking pretty intense or maybe even increasing for next year.
Scott Fidel: I'm curious on your view on that.
John Kao: Yeah, Scott, it's a great question. We do well in the C-SNPs. A concern I had heading into this year, I thought we bid appropriately, but was, were we going to get negative trends there worse than we budgeted? What's interesting is I think we're pretty much spot on in terms of contemplated margin for the C-SNP in year for 2026. So I think you can expect us in 2027 to have good growth in C-SNP in selected markets. I think you're going to see more HMO growth, more traditional HMO growth. If you look at the Plan Finder, I think you'll find that our benefits were pretty good relative to our competition. That speaks to our confidence in all the different initiatives we're working on. I just can't emphasize the importance of getting through this kind of claim system conversion.
John Kao: That was a big deal. It took a huge effort. We started it like 3 years ago. We went live last July. We are 17, 16 months into it now, and that part of it is starting to work. I would say one area that is going to be a huge opportunity for us is just the payment integrity part. Shout out to our team working on that. They are doing a great job. It is going to be more and more important as you hear of the providers deploying more sophisticated AI tools. We had to go through this in order to get to our long-term growth objectives. Getting that kind of stabilized is going to bring into focus everything that we have been so proud of in terms of visibility and control.
John Kao: With respect to the competitive dynamic, yeah, I think things are going to get tougher, I think in 2027. We do not have another year of V28, and so I think you are going to get some good lift in that regard. I am not sure the industry is getting rewarded for any kind of large or huge revenue benchmark increases. I think in that new world, I think we win still. I really do. I think we just get all these transformative changes in place. Biggest one is the Facets conversion. Very proud of the team. They worked their wits off on that, and shout out to that team as well. I do not know if I answered your question, Scott, but
Scott Fidel: Yeah, absolutely. Maybe you can answer it a little more in my follow-up question. With the follow-up question, with hope to maybe just sort of, I guess maybe reconcile or just align, I guess, no pun intended, in terms of around the provider delegation and then risk sharing and in terms of where exactly you are at that. You guys talked about in certain markets centralizing more and sort of moving with the new system. Then in the lawsuit, and then also in your 8-K, you guys also emphasized in terms of where the mitigation efforts and value could come from or would be around adjusting the provider sort of risk sharing and delegation arrangements looking out to 2028.
Scott Fidel: Just would love to sort of have a level set around where exactly you guys are in that journey and sort of how many bullets in the chamber you may still have left in 2028 in terms of leveraging that.
John Kao: That is the best question so far. We deemed about 2 years ago that it was strategically important that we build a core competency of doing the UM work. We still have this kind of shared risk delegated model in California. What that means is we have delegated UM to our IPAs. The UM is really 2 parts. There is the inpatient, acute institutional determinations, and then there is the, what we would call pre-service, and that is really the outpatient and the professional. What strategically we decided was we could not be in a place where we were entirely dependent upon the global cap providers, right? Because you could see that with V28, there was going to be a lot of margin pressure because the revenue is going down.
John Kao: In that world, we were accustomed to is that the providers, they are a global cap, want more money, and they are going to squeeze our margins. We had to move away from that and move away from that kind of dependence. What we did was we started to de-delegate the IPAs and the medical groups for the acute inpatient part of the UM. We have done a very good job with that. Again, shout out to the team for working so hard to develop that competency. We are about 80% through our process. The key thing we have done is do that in a way that is aligning with the providers. Because if we do better, they do better. That is a key thing. The area that there are more opportunities for us, and we have alluded to this, is in the pre-service, right?
John Kao: If we go outside of California, there is going to be less dependency on IPAs that are going to take any kind of downside risk, whether it be shared risk or global cap. Our ability to do pre-service and to integrate more care navigation, okay, into our processes for pre-service is going to do huge amounts of improvement for us, I think, on MLR, particularly on outpatient and professional spend. The way we want to do it is we want to use that capability to route people to the right high-performing providers. It is not a matter of denying care. Our denial rates are very low. It is about getting them to the right care, the right timely provider, in a timely basis. That is going to be the next frontier.
John Kao: We need to do that very carefully with our IPAs in California, and we need to execute that very quickly ex-California. I think that would be a big opportunity for us. I think then what we will have is the ability to operationalize our networks as we expand throughout the country. Whether it is fee for service, we can make that work. Whether it is shared risk, we can make that work. I got nothing against global cap. Global cap works as long as we have durability to that rate. That can work. The whole idea of this is to be able to enter any market with any kind of contracting with providers, overlay our clinical model, and then get the same reliable growth that we have experienced for the first, whatever, 5 years of being public and 12 years of being a company. Great question.
Scott Fidel: All right. Thank you. No, that is a lot of intel. Thank you.
Operator: Thank you. One moment for our next question. Our next question comes from the line of Matthew Shea of Needham. Your line is now open.
Matthew Shea: Hey, thanks for taking the question. Maybe back to Stars. HOS was a notable hit to the 2027 Stars, and it seems like the remediation effort is to do more on provider and member communication both this year and next. I guess it was not clear to me, were you able to make changes before the 2026 fielding window? If so, what were they? How is that informing your recovery view? Within the big H3815 contract, did members actively manage through AVA and Care Anywhere score differently on HOS versus members not managed by those offerings?
John Kao: The answer to both is I need to get back to you as a follow-up. Those are good questions. I do not have the degree of visibility I would have liked for the 2026 dates of service, or measurement year, really, because you are talking about 24 dates of service. I am hunting that down. I know that the work that we are doing now for 26 dates of service is a lot of work around town halls. I think we have touched over, I think the last number I saw was like 70,000 members in some capacity. So it is obviously a concerted effort, but I need to follow up with you on that one.
Matthew Shea: Okay, fair enough. I guess maybe just asking a similar question, I guess, to the last one, but under your percent of premium deals, your California IPAs are also up to lose bonus dollars in 2028. Has the Stars downgrade changed your conversations with the delegated groups or with new partners like Hoag or Astrana? Are they asking to reopen terms? It sounds like they are eager to help in the remediation work. Just curious to get any color on kind of what the feedback or conversations with your provider partners has been so far.
John Kao: Yeah, it is another good question. Yeah, it is a concern for providers, but I will say our market management team has done a very good job. We are collaborating with all of them. All of them. They get it, and I think there is upside opportunity. Remember, this is not going to affect them until 2028, and so there is a lot of work that we can do now and through 2027 in terms of trend vendor initiatives. I think there are opportunities for inpatient acute, candidly. I think there is lots of opportunity for just getting back to basics of how we did the CAT case management with them. There are incentive strategies being put in place with respect to Stars. Because part of it is the alignment or misalignment is because of the IPAs on some of these Stars issues.
John Kao: We got to get them more aligned with us to see what they can do to help us with respect to transitions of care initiatives and access to care and timeliness of care. Those kinds of things, again, in California, are delegated to a lot of the IPAs. It is like we are aligned to solve the problem together, and there are other levers, not the least of which is risk adjustment, by the way, that they are very collaborative in working with us on ensuring that we capture encounters in a more timely way, et cetera. I think it is kind of in this category of not let any crisis go to waste. It has allowed us to really have very constructive dialogues with the IPAs, and it is forcing us to get even more and more aligned with them.
John Kao: Again, I think our market management team has done an excellent job in that regard.
Matthew Shea: Makes sense. Thanks, John.
John Kao: Got it.
Operator: Thank you. One moment for our next question. Our next question comes from the line of Andrew Mok of Barclays. Your line is now open.
Tiffany Ranen: Hi, this is Tiffany Ranen for Andrew. I think you recorded favorable prior year development in Q1, negative in Q2, and a modest favorable benefit this quarter from the latest 10-Q. Can you help us understand what is driving that variability, and is there anything specific to call out on Q3 reserve positioning?
Jim Head: Yeah, very good question. The Q3 reserve position, let's start with the statement that we made in the script, which was, we feel very good about our reserves. As we migrated through this claims transformation, there was a lot of volatility, and as a result, it was more difficult to predict how the run out for dates of service 2025 was going to play out. So in Q2, we said we are going to be prudent and make sure we bolster our reserves for those dates of service in 2025 and prior. That is that prior year. So we did that in Q2. Q3, we are flat. I would say that we feel actually very well positioned at this juncture. We are essentially at 99% run-out on those dates of service, and very little new date claims coming in the door.
Jim Head: What is continuing to help us is we are getting payment integrity recoveries still coming through. So feel good about the 2025 reserves. So you are right. We are kind of migrating or managing through the claims transition, but the reserve position, again, that is quite good at this point.
Tiffany Ranen: Okay, got it. Then just a quick numbers follow-up. Last quarter, you called out double digit millions worth of clinical investments impacting the H2. Is that still the right number to anchor to for 2026? Can you help guide
Jim Head: Yeah, we have not changed any of our investments that we called out in Q2. In fact, we have been investing back in the business on a variety of initiatives, but we are absolutely sticking to our guns on those clinical and SG&A investments. Those are in our Q3 numbers and in our Q4 guidance.
Tiffany Ranen: Okay. Then if I could just squeeze one more in. Could you help size how much investment spend flowed through in Q3?
Jim Head: Oh, we talked about it on the last call of double digit, kind of split 50/50 between clinical and SG&A, and it was weighted towards Q3. But that obviously when it comes in, then it is going to start running.
Tiffany Ranen: Okay, got it. Thank you.
Operator: Thank you. One moment for our next question. Our next question comes from the line of Jessica Tassan of Piper Sandler. Your line is now open.
Jessica Tassan: Hi, guys. Thanks very much for the question. Can you all maybe explain what you mean by the assertion that 2027 bids are appropriately calibrated? Does that mean appropriately calibrated to deliver kind of flat MBR versus the 89% 2026 floor on 20% growth? Does it mean flat versus the initial 2026 guide? When you say appropriately calibrated, are you all assuming that the incremental 260 basis points, call it, of implied H2 MBR pressure abates next year? Or are there kind of specific examples of benefit design that you've introduced that are expected to drive margin expansion? If so, could you point us to some of those elements of benefit design that might not be so obvious from just a cursory look at the landscape? Any color just to give us confidence on the 2027 pricing would be great.
John Kao: Hey, Jess, can you repeat that, please?
Jessica Tassan: Yeah.
John Kao: I'm joking. I'm joking. No, I got it.
Jessica Tassan: Okay.
John Kao: No, I got it.
Jessica Tassan: 2027 pricing, yeah.
John Kao: No, what we had to do was we looked at the bids, right? The bids were obviously done in April, May, June. They are submitted in June. What I mean recalibrate is, how far were our MLR assumptions for each product in each market? Were those numbers consistent with our current trend, and more specifically, our current trend that we think is going to lead into 2027? We are sharing with you guys a very prudent kind of Q4 guide. I will just reiterate, I would not peg Q4 MLR, I would not annualize that for next year. We have not done that either. We are factoring in all the different initiatives that we are going through, then I had to look at that on a product-by-product and market-by-market specific basis.
John Kao: What we concluded is in certain markets, for example, we kind of said, "This does not make sense. What was assumed in the bid did not actually was consistent with what our current trends are." We made the decision, while they may be a product, we are not going to grow that product. Just as an example. I obviously cannot speak to which products and which markets, but that is an example. Another example is, okay, another market was, do we have the right engaged network, right? The conclusion was not really. We had to move and grow with a different network in that market. Just as another example, okay? A third, on the other side of the equation is, I think we are too conservative with respect to our assumptions in the 2027 bid, so we then double down on growth assumptions in that market.
John Kao: The only way you can do this is in a detailed product-by-product, market-by-market review. When you kind of tally all those puts and takes up, we are still pretty comfortable about the 20% growth that we are telling you guys. That is probably as much as I can get into without getting into 2027 guidance. Again, just to underscore, do not annualize Q4 trends or MLR.
Jessica Tassan: Got it. That's helpful. Then just a quick follow-up. I know you gave some color on the expanded network relationships, but just interested if you could offer some color on the new physician relationships you're announcing for 2027. We've noticed some of these partnerships seem to expand into new counties over the course of several staggered announcements in a single week. Is the network truly evolving in real time as it appears to be? How should we think about the economics of those new arrangements, whether from the perspective of capitated concessions? Because those providers are ostensibly feeling some of the pressure in 2026, or in terms of additional incentives to help you guys recover or return H3815.
John Kao: Yeah. No, it's a good question. I would say the common theme with all of these different providers is a commitment to quality healthcare. I know that sounds a little Pollyanna, but really, I think that's what they like about us. They know we're going to do the right thing. They're obviously not happy with the 3.5, but we're going to work together to get that solved, so much so that they're also willing to expand geographically with us. The key to the whole thing is long term. We're not doing this just for the short term. We own and take accountability for Stars for 2028 payment. We're going to get that fixed. It's very, very serious. I take it very personally, actually. Our leadership team is fully on board.
John Kao: What's equally important is the providers on their leadership team is collaborating with us. They know they have input and a say in how they drive our Stars. We got to do that better together. That's really the approach that we've taken. The whole name Alignment Healthcare was building alignment with the providers for the benefit of the beneficiary. That's the whole reason for this. I think it's a wake-up call for everybody. We've had nine years of four Stars or above, and if anything, that's what I'm taking away from this. It is a wake-up call. We got to get back to basics, and there's urgency in all of it. We'll get there.
Jessica Tassan: Got it. Thank you.
Operator: Thank you. This concludes the question and answer session. Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.
