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Operator
Ladies and gentlemen, thank you for standing by for CIGNA Corporation's second quarter 2002 results review.
At this time all callers are in a listen only mode.
We will conduct a question and answer session later during the conference and review procedures on how to enter queue to ask questions at that time.
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As a reminder, ladies and gentlemen, this conference, including the Q&A session, is being recorded.
We'll begin by turning the conference over to Mr. Greg Deavens.
Please go ahead Mr. Deavens.
- Vice President Investor Relations
Good morning, everyone and welcome to CIGNA Corporation's financial results review meeting for the second quarter of 2002.
I'm Greg Deavens, Vice President of Investor Relations.
And with me this morning are Ed Hanway, CIGNA's Chairman and Chief Executive Officer, and Jim Stewart, our Chief Financial Officer.
Jim will begin the call with a review of the consolidated and segment financial results for the quarter.
Ed will then provide some observations relative to our second quarter performance and our financial outlook for third quarter and full year 2002.
Following Ed's remarks, we will respond to questions.
As a courtesy to others on the call, we would prefer that any detailed questions on the statistical supplement, be deferred until after the meeting, when we can address them individually, as these questions may not be of interest to all of the conference participants.
In our remarks today we will be making some forward-looking comments regarding segment and company outlooks.
We would remind you that there are risk factors that could cause actual results to differ materially from our current expectations.
Those risk factors are discussed in a Form 8-K filed this morning with the Securities and Exchange Commission.
With that, I'll turn it over to Jim.
- Chief Financial Officer, Execuitive Vice President
Good morning.
In my remarks I will describe CIGNA's second quarter 2002 consolidated earnings and segment results.
Operating income on a consolidated basis, excluding one-time items was $1.95 for the quarter.
That's in line with our expectations and the consensus estimate.
Before getting into the details, two preliminary items.
First, comparisons to 2001 results that I will use will be stated as though required goodwill accounting applied during the 2001 period.
In other words, I will add back goodwill amortization when citing 2001 results, so you can get an apples to apples view of the results.
Second, the operating income excludes -- that I will talk about -- excludes accelerated gain on the sale of a portion of our reinsurance business.
Those gains amounted to $2 million in the second quarter of this year, and $22 million in the second quarter of '01.
We have spiked these items out on page 1A of our statistical supplement so you can see the underlying trends in our results.
My remarks on operating income and operating income per share will exclude the gains that I just mentioned as well as realized results.
These items are included in GAAP net income but not in the operating income numbers that I will talk about.
As an overview, operating income for the quarter was $279 million.
On a per share basis that's $1.95, versus $1.81 in the second quarter of 2001, an increase of 8%.
I would note on a same store basis -- in other words, excluding the Japanese Life -- earnings in 200- -- in the second quarter of 2001, earnings per share increased 11%.
Moving onto the segment results, I will start with the healthcare, life and disability results segment.
The operating income in the second quarter of this year was 228 versus -- 228 million versus 216 million, an increase of about 6%.
The total membership in this segment, medical membership, was about 14.1 million members, that's a decline of 1% from the results a year ago.
Within the totals of operating income I'm going to talk about indemnity separately from HMO.
The indemnity results in the operating income results were $100 million in the second quarter, which is essentially level with what they were in the second quarter of 2001.
The results reflect continued improvement in our long-term disability business offset by lower earnings for our experience-rated healthcare business.
Covered medical lives and indemnity were down 2% from what they were a year ago.
From a revenue perspective indemnity premium and premium equivalents were up 5% from the 2001 level.
As to the HMO piece of the segment, the earnings were 131 million.
That compares to 120 a year ago.
On a year-over-year basis the earnings were up 9%, reflecting continued strong growth in our specialty healthcare businesses and improvement in the commercial HMO or guaranteed cost medical loss ratio.
These factors were partially offset by higher operating expenses for the service or non-risk HMO business, with the higher expenses being related to customer service initiatives.
The medical costs for our commercial HMO business continued to trend in the 14% range, consistent with our expectations.
The commercial HMO medical loss ratio improved 110 basis points from the second quarter of '01, and 20 basis points sequentially, largely due to the effects of premium increases.
Total HMO medical membership was up slightly from the second quarter of last year and essentially flat with the fourth quarter year-ending balance in '01 at about 7 million lives.
The enrollment trends reflect continued demand for our non-risk managed care offerings, offset by attrition in the commercial HMO business, primarily due to price increases.
HMO revenues, including premium equivalents, were up 16% quarter over quarter or year-over-year, reflecting fee increases and higher medical costs for the ASO business, commercial HMO premium increases, as well as strong specialty growth.
As announced in July, we have an agreement to sell our New Mexico-based Loveless health systems, which includes a health plan, a hospital and a physician practice, to Arden Health Services for $235 million.
This transaction allows us to exit the healthcare delivery business, the hospitals and doctors in this market, which is a non-strategic area for us.
I would also note that what will go with the sale is 175 million commercial HMO, Medicare and Medicaid members.
We will retain 75 million medical members enrolled in our PPO, traditional medical indemnity and point of service plans as well as all specialty healthcare members.
We expect the sale to close later this year.
Moving onto the employee retirement benefit and investment services segment, results were 57 million versus -- this is operating income -- results were 57 million versus 53 a year ago, and flat sequentially.
The year-over-year improvement of 8% was largely due to higher asset-based fees, reflecting business growth, higher interest margins, partially offset by the effects of the equity market declines.
Ending assets under management were up 2% from the second quarter of a year ago, with our average daily assets, which is the basis on which we collect fees, being up 1% year-over-year.
The international life, health and employee benefits, excluding earnings from the Japan Life operations, which were fully divested in 2001, operating income in this segment was 8 million, versus a break even result in the second quarter of last year.
The increase in operating income was due to improved results in our life, accident and health operations as well as our ex-Patriot employee benefits business, and in addition, lower healthcare losses in this year's period versus last year.
Moving onto other operations, this segment includes several components.
The individual insurance and reinsurance amortized gains from prior sales, results from runoff reinsurance and leveraged corporate-owned life insurance businesses and certain investment operations.
The operating income was 14 million versus 16 million a year ago.
The decline is primarily due to lower results in the runoff reinsurance business.
Relative to the runoff reinsurance business, I would call your attention to our plan second quarter 10-Q disclosures regarding reinsurance treaties covering death benefits on certain variable annuity accounts -- what is known as the variable annuity death benefit coverage.
In prior disclosures we had said that we established reserves for these liabilities that are considered likely to arise from these contracts, and that the guarantees under these contracts are subject to equity market risk in the event of significant and sustained market decline.
Given the significant market decline, we will expand our disclosures to say that if the stock market were to remain at, or fall below current levels for a sustained period, we would be required to increase reserves in the amounts that could be material to financial condition.
To put this into a little bit of context, the reserves for these coverages are a function of when people die, what the stock market levels are at the time of death, as well as anuatant behavior.
And using reasonable assumptions about future stock market returns, the reserves were adequate at the end of 2001 and remained adequate at the end of 2002.
Since the end of the quarter, we have seen significant volatility in the stock market.
And looking ahead, there is a set of scenarios where the current reserves are okay.
There's also a set of scenarios where the reserves would not be adequate.
The reserves for these exposures are complicated as they involve predicting future stock market levels at the time of an anuatant contract holder's death.
We continue to monitor the situation and will evaluate ways for addressing the exposures.
In the corporate segment, which includes unallocated investment income and parent company expenses, an operating loss in the second quarter of this year versus -- of 28 million, versus 21 a year ago.
The increased loss was primarily driven by a decline in net investment income, primarily due to lower short-term interest rates and higher expenses.
To recap the second quarter, $1.95 in the quarter, an increase of 8%.
When you remove goodwill amortization from 200- -- from the second quarter of 2001, this represents an increase of 11% on a same store basis, excluding the Japan Life operations, from 2000- -- second quarter of 2001.
The healthcare results in the quarter, I would characterize as mixed.
Growth was below our expectations and goals, and we saw some softness in the experience rated indemnity and non-risk HMO profitability.
We did see continued improvement in the medical loss ratio and the guaranteed cost HMO business and disability earnings continued to improve.
We did also see growth in our specialty healthcare businesses, which continued at an attractive pace.
Our retirement business achieved good results given market conditions.
And one final comment, we continued our share purchase program during the quarter, buying about 1.6 million shares for approximately 170 million during the quarter.
In July, our Board of Directors authorized 500 million in additional share repurchase.
That's dollars.
The remaining repurchase authority is $570 million.
Our cash position at the end of the quarter at the parent company level, remains strong at about 430 million and overall return on equity results remain strong at above 20%.
And with that I'll turn it over to Ed.
- Chairman, Chief Executive Officer
Thanks, Jim.
Good morning, everybody.
I thought this morning that I would provide my thoughts on our results and also review our earnings outlook for the balance of the year.
I'm going to comment on the results for each of our businesses and then I will discuss the outlook for full year and third quarter.
Starting with employee healthcare life and disability benefits, earnings in this segment were essentially in line with expectations, but there are aspects of the results with which we are not satisfied.
On the positive side we continue to achieve strong pricing in our commercial HMO business.
And our medical loss ratio in the quarter, as Jim noted, has improved.
We continue to see strong results in our specialty healthcare businesses, including our pharmacy, case management and behavioral operations, reflecting increased penetration and good business growth and margins.
And the earnings in our group disability business continued to improve, as a result of better claim execution and quite disciplined pricing.
On the other hand, profitability in our experience rated indemnity business and the nonrisk HMO business was not as strong as we would like.
And we're also not satisfied with our medical membership results and outlook.
Specifically membership at the end of the second quarter was down slightly from last year and from year end.
And our expectation is that year end 2002 membership will be close to or slightly below current levels.
As you know we made a change in the leadership of our healthcare operations during the quarter.
In May, Pat Welch joined the company as President of CIGNA healthcare.
Pat is a seasoned insurance exec with a track record of growing profitable businesses.
And I'm confident that Pat and his management team in healthcare will drive efforts to accelerate profitable growth.
Relative to transformation, our healthcare technology and service initiative, customer demands here for our enhanced product, service and technology capabilities, remains high.
And our July 1 customer conversions went well.
We also continue to add new customers to the new platforms, and as of July 1st we had 4.3 million members on the new platform.
We continue to expect that over 6 million members will be on the new platforms by January of 2003.
Now, this large scale conversion with its attended process and technology changes is challenging, and we've had some customer service issues.
But we continue to address these, I think with very appropriate actions, including some additional levels of staff, and we are making progress.
I remain confident in our abilities to achieve the goals of transformation.
It is a long-term investment which will pay off in enhanced customer service capabilities, reduced operating costs and expanded product flexibility.
Now let me turn to the retirement segment.
The retirement earnings were consistent with our expectations and relatively strong considering the equity market conditions and the new account sales environment.
Through June 30th, equity markets as measured by the S&P 500, were down 19% year-over-year.
Our retirement assets for the comparable period were down 2%, reflecting our asset mix, which includes stable value investments as well as underlying business growth.
I'm pleased with the series of recent client wins in the retirement business.
These wins were achieved in an environment where employers are really reluctant to change retirement service providers.
And it's important to note that some of these new accounts are CIGNA healthcare customers, as well, and this ability to cross-sell our products and services is one of the advantages of our employee benefit strategy.
The volatile equity markets continue to present a challenge to our retirement business, however our broad array of investment options are providing plan participants with attractive choices.
Profitability in this business remains at attractive levels, and we continue to focus on driving profitable growth in assets under management.
Our international operations contributed to earnings growth.
Performance here was driven by good results in our life, accident and health operations and in the ex-Patriot benefits business.
And we continue to see good growth opportunities for CIGNA in the international markets that we serve.
Now let me turn my attention and provide our earnings outlook for the remainder of 2002.
For full year 2002, we currently expect consolidated after tax operating income, excluding any non-recurring items, of $7.85 to 8.15 per share.
And that's consistent with our prior guidance.
As Jim noted, we will monitor the [inaudible] runoff situation and are evaluating ways to address that exposure.
After tax earnings expectations by segment are as follows: for the employee healthcare, life and disability segment, total earnings of 925 to 955, after amortization of non-goodwill and intangibles, are what we now expect, which is consistent with our prior guidance.
The pieces here are going to be a little different with the HMO ranges about $10 million higher and the indemnity ranges about $10 million lower than our prior guidance.
Therefor HMO's going to be in the 550 to 565 range and Indemnity will be in the 390 to 405 million range.
For the retirement business we expect earnings in the range of 225 to 235 million.
For international, 25 million to 30 million.
Other operations will be in the 50 to 55 million range.
And the loss in corporate, about 95 to 105 million, in that range.
Adding it all together, we expect full year consolidated after tax operating income of 1 billion 120 million, to 1 billion 180 million, or $7.85 to $8.15 per share.
Now, for the third quarter of this year, of 2002, we currently expect consolidated after tax operating income of $1.90 to $2.05 per share.
And after tax earnings expectations by segment would be as follows, in the employee healthcare, life and disability area total segment earnings of 230 to 240 million.
And that's after amortization of the non-goodwill intangibles.
Within the segment it breaks out: HMO 140 to 145 million, and indemnity 93 to 98 million.
For the retirement business, we expect earnings in the range of 53 to 58 million dollars.
For international, 6 to 7 million.
Other operations 10 to 12.
And then the loss in corporate, the range is 23 to 26 million.
If you combine the parts, then, we expect consolidated after tax operating income of 275 to 295 million, or $1.90 to $2.05 per share.
And that's for the third quarter of 2002.
To recap, our consolidated second quarter earnings were generally in line with expectations and 11% higher than last year's result on a same store basis.
Within this result I think there are a number of areas in which we achieved good to strong results and there are several areas in which we need to improve results.
With new management in place, we expect to improve healthcare performance, with particular emphasis on achieving membership growth which is consistent with our capabilities.
And in our other businesses, we intend to maintain a strong focus on growth coupled with strong profitability.
And with that, Jim and I will be glad to take your questions.
Operator
Ladies and gentlemen, at this time if you do have a question, you must press the 1 on your touch tone phone and you will hear a tone acknowledging your request.
Your questions will be taken in the order they are received.
If someone answers your question ahead of you, you can remove yourself from queue by press being the pound key.
Also, if you are using a speakerphone, please pick up your handset before press being the buttons.
One moment please for our first question.
Our first question comes from Christine Arnold of Morgan Stanley.
Good morning.
My first question relates to your HMO division.
Your at risk commercial enrollment was down 6% year-over-year, and yet your medical premiums and fees rose 18%.
Can you help us understand how that happened?
Was there new experience rated membership in the HMO division?
I know specialty was strong.
Did it contribute all of that $200 million sequential increase?
- Chief Financial Officer, Execuitive Vice President
Christine, this is Jim.
When you said -- just to make sure that I'm answering your question.
The overall revenues on a premium and premium equivalent basis in the second quarter for the total was up 16.
You referenced --
Premiums and fees and not the equivalents.
- Chief Financial Officer, Execuitive Vice President
For the medical HMO business?
Yeah, that's -- the numbers there are primarily driven by the increase in the Medicare and Medicaid business.
Okay.
But the Medicare enrollment really didn't increase sequentially by all that much.
- Chief Financial Officer, Execuitive Vice President
No, but the numbers that you cited, Christine, are the year-over-year numbers.
And the year-over-year numbers --
Okay.
Sequentially there was an incremental $200 million, by my calculations, associated with the business despite the fact that the enrollment sequentially was down.
- Chief Financial Officer, Execuitive Vice President
I guess I don't have those numbers at my fingertips.
Why don't we get back to you on that?
Okay.
And then secondly, have you had experienced rated accounts in deficit choose not to renew?
Does that account for some of the change your outlook for indemnity?
- Chief Financial Officer, Execuitive Vice President
Generally the answer to that question -- well, there's a couple answers to the question.
Yes, we do get some customers who choose not to renew who are in a deficit position.
Our experience is that most customers do renew, that we have a good experience relative to persistency.
And in general the reserve balances that we have for customers who are in a deficit position, tend to be conservative on a runout basis.
So, the deficits on a GAAP bases are different than they are on a cash basis.
But generally we like the experience rated business.
We think the risks associated with deficit positions is a manageable one, and net-net we're happy with the results.
Are you getting more failures to renew this year on that experience rated book than last year?
- Chief Financial Officer, Execuitive Vice President
I wouldn't say we've seen any particular trend at this moment in time.
Okay, and last question is on Loveless.
Does that change -- the sale of Loveless change the earnings outlook, was that operating at a loss?
- Chief Financial Officer, Execuitive Vice President
No.
The -- in terms of the earnings outlook, the impact -- our expectation would be that Loveless would probably not close until the fourth quarter.
The Loveless sale would not close until the fourth quarter.
The impact from an operating income viewpoint would be felt in 2003.
And yes, it makes money.
So, it would have an adverse effect on the '03 outlook.
Now, net-net, it has a, in our judgment, a positive both strategic and financial outlook for us.
Great.
Thank you.
Operator
Thank you.
Our next question comes from Ellen Wilson of Sanford Bernstein.
Hi.
Thanks.
I was wondering if you could give us any kind of visibility for what the enrollment picture might look like in '03, or even specifically going into January of '03.
Obviously you have had negotiations now, I'm assuming that some have concluded.
You know, and specifically as far as account renewals as well as new account wins, you know, of course in shortage, what we're seeing now, should we have hope that this is really going to turn itself around in January?
- Chairman, Chief Executive Officer
Yeah, Ellen, it's a little early to be definitive relative to enrollment 1/1.
I can give you some color to that, though.
National accounts, for example, I think we feel reasonably okay with.
We talked about this year that retention has improved there, and we expect that to continue.
Sales are okay there.
So, I think from a national account standpoint where we had the visibility at this point, we're feeling okay.
Middle market, it's a little bit early.
Our challenge there this year has been both kind of flat new business sales and retention that we don't like.
And we're working pretty aggressively on both of them.
But it's a little early to have a sense of what that might look like as we come up to 1/1.
Okay and also, what -- you know, for the rest of this year and for your preliminary discussions for next year, what are you finding that's different about what accounts are looking for in terms of, you know, level of benefit buydowns and types of products that they want?
- Chairman, Chief Executive Officer
Yeah, I guess what I would say there, Ellen, is we are seeing a lot more willingness and desire to talk about multiple alternatives for dealing with cost.
And, you know, we have a good spread of product.
We have some new capabilities like medical savings accounts and so forth, but I would say the most aggressive actions are still in the discussion stage.
We see some people going to try a few things, but no major movement.
We do see continued discussion around co-payments, co-insurance, benefit levels, and I would expect that will continue.
And are you feeling the trends related to that that employers are talking to you about, you know, consolidating their number of plans that are being offered, and perhaps that you could be the beneficiary of -- you know, being the primary or only offering?
- Chairman, Chief Executive Officer
Well, there's no question that employers have been consolidating the number of plans.
And that's clearly our intention, to be the consolidator within a larger employer's program.
So, that trend continues.
Okay.
Thanks.
Operator
Thank you.
Our next question comes from Terry Schue of J. P. Morgan.
Yeah, I'm sorry.
I have two questions.
But the second one hopefully is quick.
The first one, Jim, can you explain again why the indemnity earnings were weaker?
Why -- if you look at the margins, you had a slight deterioration in your year-over-year comparison in margins even though the medical loss ratio improved by the commercial HMO book.
Can you explain the underlying causes?
The second quick question is on this variable annuity guaranteed death benefit issue, the comment that any reserve increase can be material, when you say "material," can you at least size it for us?
And what is's the current reserve balance?
- Chief Financial Officer, Execuitive Vice President
Relative to your first question, Terry, about the patterns in the indemnity, and I would say the patterns apply both to the second quarter results as well as to our full-year outlook.
And I would say there are maybe four things at work on the indemnity results.
One would be that we do have, as we mentioned, in the first quarter, we have a higher proportion of experience-rated indemnity business as distinct from ASO business.
And as we have discussed in the past, there are first year accounting losses on experience-rated business.
That's one influence.
But that comes back, right?
- Chief Financial Officer, Execuitive Vice President
That's correct.
Okay.
- Chief Financial Officer, Execuitive Vice President
Subject to the question that Christine asked about whether you have good persistency, which I expect that we will.
Secondly, volume is down.
Our medical membership is down year-over-year.
And that has obviously a depressing effect on, or a dampening effect on growth.
We do have a couple of individual case issues that weren't underwritten quite as well as they were.
That has an impact on it.
And the fourth impact is, as I mentioned in my prepared comments, offsetting those three factors in terms of dollars of operating income, is the improvement in our group insurance operations, particularly in the disability area.
So, it's those kinds of things are working on both the quarter and, as I said, on the full year.
But those are kind of addressable issues.
The first one reverses.
The second, two and three, are issues that you've had all along which you're trying to address.
- Chief Financial Officer, Execuitive Vice President
Well, I think the -- yeah, certainly the volume question is at the top of our list in terms of improvement.
And that's something that we need to work on.
And the other things are -- we can deal with.
Okay.
And then the question on the guaranteed death benefit issue, the reinsurance book, can you size it for us?
How big is the current reserve balance?
- Chief Financial Officer, Execuitive Vice President
The -- in terms of sizing it for you, I would say that at this point I'm not prepared to quantify that, other than to say that our disclosure says that this could be material to our financial condition.
The translation of that in accounting terms is that it could be more than 5% of our net worth, which in this case is about 5 billion.
So, the reserve increase could be in excess of $250 million.
That's what that means.
And to go beyond that I would -- we're not prepared to go beyond that.
I would say that we have been working on this and are evaluating ways to address it.
We still have some work to do in this area.
We expect to complete it expeditiously and in a responsible fashion.
And I would anticipate that we will finish this work before the end of the third quarter.
Okay.
Thank you.
Operator
Thank you.
Our next question comes from James Lane of Salomon Smith Barney.
Hi.
Good morning.
I had a quick question about the -- in the employee health, life and disability business.
Your operating expenses were lower sequentially.
I was wondering if you could comment as to whether or not that's a function of the volumes in membership, or are you starting to get to the point where some of the transformation spending might be tailing off?
And then I have another question.
Thanks.
- Chief Financial Officer, Execuitive Vice President
On the -- on the expenses I would say that that is not driven by the trailing off and transformation expenses at this point.
I do think that there is a volume impact.
If you look at the quarter over quarter expense numbers, they do tend to bounce around a little bit.
But the second quarter I would characterize as relatively favorable.
But I wouldn't draw a lot of conclusions from that.
Okay.
And then my second question is related to the earlier question about January '03 enrollments.
I was wondering, Ed, if you could comment further on national accounts since you pointed to that.
I was just wondering how much of your book of medical business is national accounts, and what percentage of that up for renewal, and maybe a little bit about the size of the book that you're bidding on for 1/1/03?
- Chairman, Chief Executive Officer
Yeah Jim, I can give you a little bit of a background on that.
I think, first of all, just to size it, probably just north of 50% of the book maybe is national accounts.
And we have seen more activity in the national accounts area, as I think most people have.
There's been a lot of the -- the RFP flow has been a bit higher.
As I said, I think we are comfortable that retention is okay.
And we have some decisions on new business that we're pleased with.
There's still a few out there.
The ones that we probably haven't heard about yet are the new business decisions.
So, I would say overall relative to national accounts, we feel relatively good.
And I think we'll see some improvement in national accounts.
We haven't got all the decisions there yet, but from what we've seen, it's reasonable.
Okay.
Thanks.
- Chairman, Chief Executive Officer
And as you know, you know, a fairly high percentage of that business is 1/1.
Yeah, if I could just -- one more.
Are you primarily competing on -- bidding on how much the national account is going to spend on claims, or are you bidding on the basis of the up front admin fee, which I realize the two are somewhat linked?
- Chairman, Chief Executive Officer
I think our basis of competition, Jim, there, first and foremost, particularly in this market, is how well can you help me manage medical costs.
That's really what will determine if someone is successful or not.
And that's a function of a number of things: contracts, medical management, disease management and so forth.
And then obviously fees are important.
But I would -- I would point to both.
Okay.
Thank you.
Operator
Thank you.
Our next question comes from Josh Raskin of Lehman Brothers.
Hi.
Thanks.
Good morning.
I just want to quickly touch on the Loveless sale there.
I was wondering if we could just get any sort of statistics, I appreciate the membership numbers there.
But maybe any revenues, and then, you know, what we can assume for a margin.
i.e., was it in line with other operations?
And then also, you know, if we could talk a little about the motivation, was this simply getting rid of your last provider-owned system, or should we think about any other potential sales of assets going forward?
- Chairman, Chief Executive Officer
Let me take the motivation piece, and then I might ask Jim to comment on the numbers here.
Josh, from a strategic standpoint this was kind of very unique in our portfolio in terms of, as Jim noted, the provider system, the facilities themselves.
There's a hospital down there.
And that's just not an area that we feel is on strategy for us, or that we really have the, if you will, expertise to add real value.
So, I would not read anything into this other than the fact that for some time we have believed that if we could find an attractive economic situation that we would divest of those operations.
We're very pleased with the transaction, and we also are pleased that we will continue to be able to meet the needs of our multisite members down there in terms of the ASO business and so forth.
So, it's just a very good strategic move for us.
And then, Jim, I guess on the financial side --
- Chief Financial Officer, Execuitive Vice President
On the Loveless sort of statistics, just to repeat them, with the sale, will go about 175 million -- 175,000 commercial HMO, Medicare/Medicaid members.
And we anticipate that we will keep about 75,000 of the indemnity and PPO and flex care members.
And that the -- the 250,000 of members generates probably $4, $500 million dollars in revenue, something like that.
And just looking out in terms of what our plans were for the profitability of this -- and incidentally, the profitability -- I mean the revenues I just cited include premium equivalents -- that the margins on this business are probably -- not probably -- they are lower than average of the remainder of the book.
Okay.
So, that's helpful.
And then just one quick question on the membership.
I think previously you guys have said that you thought maybe July enrollment would pick up a little bit.
I was wondering what maybe some of the impact was there with -- you know, is unemployment now coming in to impact the results there?
- Chairman, Chief Executive Officer
Well, yeah, I think -- we would say a couple things.
I wouldn't put too much credence on unemployment, although we see it as being an influence within group enrollment.
I would also say that from a practical standpoint, middle market sales, as we look out for the balance of the year, will likely not be quite as strong as we would have expected, so those are certainly at work on us.
As well as middle market retention, which as I said earlier, is about flat year-over-year.
And we probably expect that to continue.
Okay.
Thanks.
Operator
Thank you.
Our next question comes from Roberta Goodman of Merrill Lynch.
Thanks.
I actually have just a couple of number questions.
I was wondering of the portion of the book that is characterized as ASO and experience rated, how does that break down between ASO and experience rated?
- Chief Financial Officer, Execuitive Vice President
I'm not sure I have those numbers at my fingertips.
If I had to guess, I would say it's probably between 50 and 75% ASO, with the balance being experience rated.
So, 25 to 50 percent of the 80 or --
- Chief Financial Officer, Execuitive Vice President
Yeah, we can get -- Roberta, we can give you a better number than I just gave you.
But that's sort of order of magnitude.
Okay, and you referred to your cost trends, but I was wondering if you could share with us the premium trend and any impact of the benefit design changes you're seeing, and how you would expect that to look going into next year?
- Chief Financial Officer, Execuitive Vice President
Yeah, on the premium trends, the premium trends at this point before benefit buydowns are running in the high teens.
And the yields are running in the 15% neighborhood.
And that -- our expectation would be that at this point we don't see sort of any material changes in those patterns as we look out into -- look at medical costs.
Did you ask the medical costs question, as well, Roberta?
Well, you had said that the cost trend was 14%.
- Chief Financial Officer, Execuitive Vice President
Right.
Is that the expectation going out forward, or is there any change there?
- Chief Financial Officer, Execuitive Vice President
No, we expect the trend to be in the 13 to 14% range.
And at least at this point we don't see any factors that are likely to make any major changes in that, which is why I said that we would expect our rate increases and yields to continue at the kind of levels that we've seen.
Okay.
Great.
Thanks.
Operator
Thank you.
Our next question comes from Ed Kroll of S. G. Cowen.
Good morning.
Can you hear me?
- Chairman, Chief Executive Officer
Yes, we can, Ed.
Jim, thanks for the heads up on that guaranteed death benefit issue.
I just want to make sure I understand it.
So, you've got equity -- or I guess part of the assets that you're using to fund those guaranteed death benefits are in equities, and the weak equities environment?
- Chief Financial Officer, Execuitive Vice President
No, that's not quite the way I would say it.
What the product provides, Ed, is that -- a variable annuity death benefit product -- what it provides is that if a contract holder dies, when the market value of their asset is less than the specified value, we pay the difference.
And what I mean by that -- and specified value could change depending on what the contract holder.
But let me give you a simple example.
If the contract said that the specified value were the sum of the premiums, for example, that someone had put in $100 into the contract, and the market value because of the stock market decline was 90, and that the person died, then what the variable annuity death benefit does is it pays the difference between the 100 that he put into it and the 90 which was its value at the time of death.
With the stock market going down, the exposures associated with the market value versus the so-called specified value, in my example the sum of the premiums, widens.
And therefore, we have additional exposure, we have higher, if you will, death claims when the market goes down.
And the reserves are not held in equities.
The reserves are held in fixed income assets.
And so, the risk of the stock market is not with the reserves going down, but because of the larger exposures between the market value of a contract holder's assets and their quote, unquote, specified value.
Does that help?
I've got it.
So, the stock market, if you will, is just a bench mark to gauge the amount of your potential liabilities?
- Chief Financial Officer, Execuitive Vice President
That's correct.
Okay.
Thanks for that.
Second one, on the systems transformation, Ed, it sounds like you're on track, where you thought you were going to be, moving members onto the new platform.
Do you still anticipate you would be done completely by January '05?
- Chairman, Chief Executive Officer
A couple things, Ed.
First, we do think we're making progress.
And as I said, I think we feel very good about the migrations that occurred in July.
We've set '05 as the target.
Remember, we also said that we slowed down, a bit, the migrations this year to make sure we had this stabilized and so forth.
And so, the pace of migrations as we go forward will be dependent on our increasing confidence level with the system.
But yeah, I would say that in that -- in that time frame we expect to have the membership moved.
It could -- you know, that could -- the pace will pick up or decline depending upon whether we see additional issues or problems.
But right now the 6.2 or 3 million as of 1/1/03 is the next step, and we feel good about that.
Okay.
Thanks for that.
And then you -- several of your peers, I mean not just in our industry but in -- across all industries have gotten these SEC comment letters on their 2001 10-Ks.
I wonder if you got one of those, and if -- you know, is there anything material in there -- in their comments?
- Chief Financial Officer, Execuitive Vice President
Ed, this is Jim.
The last time we got a SEC comment letter was in the summer of 2001.
They raised no questions in that comment letter last summer about our accounting practices.
They did have some -- what I would call disclosure suggestions relative to how we describe premium equivalence, some comments about the disclosures relative to the deconsolidation of the Japanese Life operation.
They had some questions or some suggestions about how we presented earnings to fixed charges.
I think that was -- there might have been one other one, but I think that was the essence of it.
So it was more narrative description questions with no questions about accounting practices.
And that was a year ago.
We have not heard anything else since then.
Okay.
Thank you very much.
Operator
Thank you.
Our next question comes from Joseph France of Credit Suisse First Boston.
Thank you.
Jim, in your answer to Christine and Terry, if I understand it correctly, you said that the reason for the decline in experience related earnings -- experience rated business, was because of lower enrollment.
Is that correct?
- Chief Financial Officer, Execuitive Vice President
I answered the question -- maybe I didn't -- wasn't very explicit or clear about it.
The question had to do with, or at least I thought the question had to do with, why are the margins going down in experience rated, or said differently, why are the earnings flat?
And I cited four factors.
I'm not going to go over there to make sure -- let me come back to your question now.
What's your question again?
Well, I'm asking is it because of lower enrollment?
Is that why earnings were down as opposed to margins?
- Chief Financial Officer, Execuitive Vice President
The earnings were flat in the quarter in indemnity.
The margins were down, slightly.
And there are relative to the year-over-year changes, there are the four factors that I mentioned.
And that is, we have more experience rated business, which in the short-term -- more experienced rated sales in the short-term has a depressing effect.
We have lower volumes, which you picked up on.
We have a couple of underwriting issues in a couple cases.
And offsetting that was an improvement in the disability results.
Those are the factors at work on the earnings.
Okay.
When a client doesn't -- talking about your persistency in that regard -- when a client doesn't renew, is the basic problem rates?
They just don't like having to pick up the deficit and renew at a higher rate or?
- Chief Financial Officer, Execuitive Vice President
It could be a rate question.
It could be a service question.
Generally in those circumstances the lion's share would be rate questions.
Okay, how easy is it for them to leave?
Do they just not renew, and that's it?
- Chief Financial Officer, Execuitive Vice President
That's right.
They, well, you know, it's complicated.
They need to find a new carrier.
They need to go through the bidding process.
They need to have somebody who is willing to give them a -- if you will, a better deal.
They have to reenroll all of their employees and their dependants.
So, I mean, it's complicated.
I understand that.
I mean, but can they -- with respect to the relationship with you, can they just abandon it?
- Chief Financial Officer, Execuitive Vice President
That's correct.
Okay, thanks a lot.
Operator
Thank you.
Our next question comes from John Rex of Bear Sterns.
Good morning.
Two hopefully quick questions here.
Just -- I appreciate your explanation on kind of how this -- the reinsurance operations work, how these contracts work, but just want to follow up and make sure I understand correctly here.
My understanding is these are runoff operations.
And I didn't think anything had been sold -- or it doesn't seem like anything has been sold new here in some time.
So I'm trying to figure out kind of when these were sold versus what the market levels were back then.
I didn't think these were being sold kind of in the bubble times.
And maybe I'm misinterpreting how you said these contracts work.
- Chief Financial Officer, Execuitive Vice President
Just maybe a couple of things.
Relative to the discontinued nature of them, that is true.
We sold these -- we sold reinsurance on variable annuity death benefit contracts in the period 1995 through 1998.
However, the reason that they continue to generate premiums and has the potential for generating death benefit losses is the contracts that we put in place, the reinsurance contracts that we put in place were for the duration of the individual contracts.
So, while we did not take on new contracts after 1998, we continued to reinsure those death benefits for the participants that we wrote then.
So -- and typically customers keep their -- their annuities for some period of time.
And when you say didn't write during the bubble period, I would say that, just to expand a little bit on the explanation that I made relative to what the degree of our exposure is, there are a variety of measures to measure our exposure.
What I use the word specified value.
The example that I used is if the market value is less than the sum of the premiums.
Another -- some of the contracts have a provision in them that specifies that the -- I don't want to be redundant here -- that the specified value is the highest anniversary value.
So, in other words, if a contract's anniversary -- an individual contract's anniversary, if they continued to renew the case, their specified value will in fact go up with market highs and stay there.
That's very helpful.
And when you -- you took a charge, I think a reserve addition in 2000 for this of 84 million.
Was this a similar issue?
It seems a little different flavor.
- Chief Financial Officer, Execuitive Vice President
Yeah, we did, we evaluated based on the future stock market outlook and other factors like mortality.
Whether we thought we had the right kind of reserve balances, concluded at that point that we did not.
And of course, the market situation -- the stock market situation is significantly different today than it was in 2000.
And as I said in my prepared comments, we were satisfied with our reserve levels at the end of the year, at the end of the first quarter.
And with the significant change in the stock market, that's why we're looking at this and why we have said that, after reviewing it, it may have the potential to have a material effect on our financial condition.
That's very helpful.
And then just on the health segment, there have been, you know, at least a couple of specific accounts that received press attention, new accounts in terms of the renewal rate you're asking for, losses that have been cited in the press in terms of which you're recognizing on those accounts a fairly large magnitude, these are accounts that were new this year.
And I know you don't comment on specific accounts, so let's keep it away from that.
But just globally here, what contributed to kind of what appears be kind of a fairly large mispricing on these blocks -- on certain blocks of business that were signed in the last six months?
And what steps are you making -- taking to make sure that we don't -- we can't expect more of that as we look out to the new renewal year?
- Chairman, Chief Executive Officer
John, it's Ed.
You're right.
We don't comment on specific accounts.
Jim did comment when he explained the change in the indemnity margins that there were a couple of accounts where the underwriting was not adequate and so forth.
I would highlight that these are, in our view, aberrations.
I think we have a pretty strong track record of effective underwriting and pricing, and that's the case broadly for the book of business.
It doesn't mean that you don't occasionally make errors.
Clearly in a couple of cases we have.
We continue to review our underwriting guidelines and our control processes and strengthen them where we need to, and don't believe that this is indicative of a pattern at all.
All right.
Thank you.
Operator
Thank you.
Our final question comes from John Szabo of CIBC World Markets.
Good morning.
I was trying to follow up I think, on an earlier question regarding the HMO related operations, where you saw a pretty significant price increase -- I'm sorry, pretty significant revenue increase sequentially while your enrollment declined.
And if I'm doing the math right, it looked like about an 11% increase sequentially.
And you know, I guess, as I understand it, you really probably don't have an opportunity to reprice all of your book of business in the second quarter.
Was there some kind of catch up there or something unusual?
Maybe you could just expand a little bit on that?
- Chief Financial Officer, Execuitive Vice President
Yeah, I again don't have the statistics in front of me.
I think that the -- that the sequential increase -- I can't find what numbers you're looking at, because I don't think the sequential increase is as big as it is quoted as.
But I may be looking at the wrong thing.
All right.
Let me ask you this, do you know whether you put in more significant price increases in the second quarter than you had in the past or --
- Chief Financial Officer, Execuitive Vice President
Not particularly.
You know, I think the high teens number that I cited relative to before benefit buydown numbers may have moved up a little bit in the second quarter.
But I would not have expected it to have a particular material effect on sequential revenues.
I think what we need to do here is to make sure that we understand what data you're using, and we will follow up with the specifics.
Okay.
Fair enough.
Just a question on Loveless.
In the past when you've sold assets you've been fairly aggressive about buying back stock.
Is there any associated debt, like a mortgage or something like that, that would prevent you from using the proceeds of 235 million, you know, to use on share repurchase?
And can you give us maybe an idea of what the after tax proceeds may end up looking like there?
- Chief Financial Officer, Execuitive Vice President
There are like three or four questions embedded in the question.
I would -- relative to your first question or -- I'm not sure I have them in the right order.
There are no encumbrances on the -- on this.
And so, the cash proceeds are the cash proceeds.
Obviously there are always taxes and other assorted costs associated with it.
I'm not really prepared until we have a clearer view of that what the -- what we should say relative to the after tax gain, one thing.
And secondly, our views relative to stock repurchase, I would say what we always say, and that is, stock repurchase remains a potential use of capital.
I wouldn't -- we have not, nor will I project what our stock repurchase will do prospectively.
To the extent that we have additional cash from the Loveless sale, then we will deal with that as we always do.
I know that doesn't answer your question.
Okay.
Fair enough.
- Chief Financial Officer, Execuitive Vice President
We're not in a position to comment prospectively on uses of capital.
Okay, fair enough.
And just one last question on the annuity reinsurance.
Is it fair to say that -- you know, those annuity contracts turn over pretty frequently.
Is it fair to say that the longer you go, I guess the duration or the absolute amount of your liability or both, would go down due to turnover in those contracts?
In other words, if somebody flips from one annuity provider to another, where you don't have exposure, you would benefit?
- Chief Financial Officer, Execuitive Vice President
That would be accurate.
I would say that these tend to persist more than you might think.
Is that because of the guarantee, then?
In other words, if someone's deeply in the money on the guarantee, they're not going to flip?
- Chief Financial Officer, Execuitive Vice President
No, I think it's not mostly that.
What it mostly is, is these contracts are typically sold with surrender charges.
And the surrender charges again typically don't run off for seven years.
So, people don't like to pay surrender charges, which I think you can understand.
And generally there are tax benefits associated with them.
And by giving up the contract, you lose the tax benefits.
Now, it's true if you flip it into another provider, then you can retain the tax benefits.
It would be true that our exposures would decline because of people moving their contracts.
What is significantly more important about our exposures here has to do with the future of the stock market.
At what level is it going to settle?
Has it settled?
Is it going to go down?
Is it going going to go back up again?
That has a much more powerful effect, albeit I understand the effect of customers leaving.
But the stock market is the big impact here.
So, is it linear?
In other words, if we looked at the fact that you said you were comfortable with your reserves in the first quarter and the market's down let's call it 20% on average since then, that you would need a 20% increase in your reserves, or is it not quite that straightforward?
- Chief Financial Officer, Execuitive Vice President
No, it's not quite that straightforward.
And if you think about it, this is not linear.
For example, if somebody puts in $100 into their contract and the market value goes to 90, let's say, then our death death benefit exposure is $10.
If that person dies, we owe them $10.
If the market goes to 80, for example, the market value goes to 80, you'll notice that the death benefit exposure doubled, from 10 to 20.
So, it's not linear.
Okay.
- Chairman, Chief Executive Officer
It's also dependent upon the expectation for where the market goes over time, as well.
Right.
Okay.
Thank you.
- Vice President Investor Relations
At this point we'll bring the meet to go a close.
I want to thank everyone for participating in the call this morning.
Investor relations will be available to respond to additional questions shortly.
Operator
Ladies and gentlemen, this concludes CIGNA Corporation's second quarter 2002 results review.
A recording of this conference will be available for 11 business days following this call.
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Thank you for participating.
We will now disconnect.