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Operator
Ladies and gentlemen, thank you for standing by for CIGNA's third 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, during this conference, including the Q and 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, welcome to CIGNA corporation's financial results review meeting for the third quarter of 2002.
I'm Greg Deavens, Vice President of Investor Relations, and with me are Ed Hanway, CIGNA's Chairman and Chief Executive Officer, Jim Stewart, our Chief Financial Officer, and Pat Welch, the President of CIGNA HealthCare.
Ed will open the call and Pat will then provide additional insights on the actions we're taking to improve our healthcare operations.
Following Pat, Jim will review consolidated and segment financial results for the quarter, and discuss some other matters of interest.
Ed will then provide our financial outlook for full year 2002 and 2003.
After Ed's closing remarks, we will respond to questions.
In the interest of covering as many of your questions as possible, we will address some of the more commonly asked questions you've raised with us in the past week.
After responding to those commonly asked questions, we will use the remaining time to respond to additional questions you may have.
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 & Company outlines.
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 Ed.
- Chairman, President, Chief Executive Officer
Thanks, Greg.
Good morning.
As you know, we preannounced our results and discussed them with you earlier this week.
I want to focus my comments today on the issues in our healthcare business and what we are doing about them.
As Greg acknowledged, I've asked Pat Welch, the president of our healthcare business, to provide additional information on the actions we are taking to improve our results in that business which he will do in a few minutes.
After Pat's remarks, Jim's going to review our quarterly financial results, I will then comment on the outline for full year '02 and '03.
Now, as I've already stated on Monday's conference call, I view our results as unacceptable and clearly below our potential.
I also recognize that some investors and analysts are currently skeptical about our ability to deliver on our 2003 guidance.
This fact is reflected in our stock price.
Today's call is intended to give you greater clarity on what we are doing to address the challenges that we face.
We recognize that regaining your confidence must be based on improved operational and financial performance in our healthcare business, which we intend to achieve.
As we discussed, the shortfall in 2002 results and 2003 outlook rests in healthcare.
I would remind you that our other employee benefits businesses, are performing well with good additional opportunity.
The company remains profitable with reasonable margins, but clearly not at the levels we have historical achieved and that we are capable of.
We are addressing the situation and we fully intend to return to industry-leading margin levels.
To achieve these results, we are taking focussed actions and have put the right people in place to execute them.
I brought in Pat Welch, an experienced insurance executive, to lead the healthcare business and Pat has moved to identify and address and out of challenge that is that business faces.
In addition to Pat, we have also made significant changes in the senior leadership team in healthcare and we are taking actions in three areas, including service, underwriting execution, and expense levels.
The key actions are as follows: in service, we have changed leadership, added resources to improve our service levels, and we continue to improve the effectiveness of our transformation platforms.
In underwriting, we've made a leadership change here and will reinforce the processes and discipline that have served us very well historical.
In expenses, while service and technology spending will increase, we will achieve reductions in other areas as a result of our restructuring efforts.
As I noted on Monday, we did not execute well in the fundamentals, including service, transformation project management, spending, and underwriting.
We are moving aggressively to address our challenges and improve results and we intend to keep you fully informed of progress.
Now I'm going to ask Pat to further describe the actions that he and his team are taking to improve results.
Pat?
- President of CIGNA HealthCare
Thanks, Ed.
On the Monday call, I outlined our issues and actions.
Today, I want to provide more detail.
I addressed five areas: Organization, service, underwriting, medical management, and cost structure.
With regard to organization, we are realigning our organizational structure to more effectively address the unique needs of our customers and strengthen our position in the marketplace.
This will include a strong national account segment, a regional segment focussed on the middle market, and our specialty businesses.
A key component of our organizational realignment as Ed has stated before is leadership.
Since coming into this job this past summer, I've made a number of leadership changes.
I've built a new leadership team and I ticked those off on the Monday call, and they include a new chief financial officer, a new chief marketing officer, a new chief information officer, a new head of transformation, a new head of medical management and contracting, and a new head of service operations.
We have a strong leadership team with very good industry experience.
In the area of service, as you all know, we are investing significantly in technology, new processes and staffing to make what we believe are necessary improvements to our service platforms.
A major part of this endeavor is our transformation project, which will deliver enhanced customer service and improved productivity.
While transformation has clearly been a challenge, ultimately it is good for our business.
We have made changes in leadership and our focussed on improved project management and execution.
To date, customers like our new Internet and call technology.
There's faster resolution of issues when members call us, and with new support tools, our service representatives are able to resolve more issues in just a single call.
And our auto adjudication rates are in line with projected expectations and far improved over what our multiple legacy systems can deliver.
We learned from the difficult migrations of accounts on 1/1/02.
We implemented process changes and as a result, the mid-year migrations went well.
We expect the 1/1/03 migrations to go well also.
In the area of underwriting, we understand the fundamentals.
We've done this well in the past, we missed on the execution.
We've made some people changes within our organization to strengthen our underwriting function.
We are strengthening our front end monitoring, auditing, peer review and limits of authority processes.
With regard to medical management and contracting, we are taking significant steps to improve that area.
We have created a single organization that is focussed on overall medical management, including provider contracting and network management.
Our medical management model will deliver high-quality outcomes while managing medical cost.
That brings us to operating cost.
Given our membership level, which we are projecting to be down 4 to 5 percent on 1/1/03, and our need though ensure that our products will remain competitive, our cost structure is too high.
While maintaining our commitment to transformation, service quality and HIPA compliance, we will be reducing spending in all other areas.
The streamlined infrastructure will make us more competitive and serve as a solid foundation for profitable growth.
In summary, I believe that we have the right leadership, the right issues targeted, and we are moving aggressively to address them.
While I clearly recognize our challenges, I'm excited about our capabilities and am confident that the people in CIGNA HealthCare can and will deliver.
I look forward to discussing our progress with you in the future.
With that, I will turn it over to Jim for a review of CIGNA's third quarter operating results.
- Executive Vice President, Chief Finanacial Officer
Thanks, Pat.
I will describe our third quarter results, both in total, as well as by segment.
The result in, the remarks that I'm going to make relative to operating income and operating income per share, will exclude various charges and gains which are described in our press release and statistical supplement.
The results will also exclude realized investment result.
My comments will also include a review of the required reporting of our runoff reinsurance operations as a separate segment.
As an overview, operating income for the quarter was $208 million on a per share basis, that's $1.49 versus $1.91 in the third quarter of '01.
Moving to the segment results, starting with the employee healthcare, life and disability, the total results in this segment in the third quarter were $163 million versus $221 a year ago.
Within the total, I'll comment on the indemnity and HMO result.
The indemnity results for the quarter were $33 million, that's well below street estimates, and in the absolute quite poor.
The results reflect a number of factors we discussed these on the Monday conference call, but I will summarize them.
First, our expenses were higher than anticipated.
We have continued to incur higher operating costs in an effort to improve service levels.
Secondly, based on the third quarter review of cases in our indemnity business, we identified underwriting misjudgments and margin concessions that impacted third quarter results.
The review showed that in some cases we reduced margins on both renewals and new sales in order to retain existing members or to write new cases.
Also, for this book, we are required to make estimates in the early part of the year about future experience for indemnity cases.
In a number of situations, our detailed review showed that we needed to revise our estimates based on maturing claim experience.
These are the principal contributors to the both shortfall and year over year decline in our indemnity results.
In terms of covered lives in indemnity, they're flat versus as year ago and grew about 2 percent sequentially.
As we noted on Monday's call, we have made adjustments to the factors that we use in the indemnity lives estimation process.
These adjustments have no impact on the trends that one would see from period to period, or no particular impact, nor do the adjustments have any effect on either revenue or operating income.
From a revenue perspective, indemnity and indemnity premium equivalents were up 6 percent compared to the 2001 levels.
A few comments on experience rated.
We have had questions about the size of the experience rated book as well as the level of deficit balances for this book.
Relative to size, the experience rated business in 2001 represented about three and a half billion dollars of GAAP premiums, and we have seen many particular growth, our membership has been essentially flat with premiums being up year over year reflecting the cost trends.
Relative to the deficits on this business, the outstanding deficits will increase somewhat this year.
We had aggregate balances of about $250 million as we discussed on Monday, these do not enter our financial statements, but are memorandum accounts that represent the potential for future earnings.
We expect the balances of -- in the experience-rated the book, the deficit balances to increase this year by about $50 million, thereabouts.
We've also looked as another sort of piece of information, at the percentages of cases in deficit 2001 versus our estimates this year, and I would say that the percentage is they're essentially changed.
There's clearly work that we needs doing in this book of business as Pat referenced.
In the HMOs, or in the HMO portion of the segment, earnings were $133 million versus $124 a year ago.
This is close to our expectations, but short.
On a year over year basis, the earnings were up 7 percent, reflecting continued strong growth in our specialty healthcare businesses, and in improvement in the commercial HMO medical loss ratio.
Those two pieces of the HMO results were in line or better than expectations.
These results were partially offset by higher operating expenses in the ASO HMO business related to, primarily to, ongoing customer service initiatives.
Medical costs for commercial HMO business continued at trend in the 13 to 14 percent range, that's consistent with our expectations.
We currently expect medical cost trends to continue at about the current rate for 2003, in other words, we don't anticipate any major changes between 2002 and 2003 as it relates to medical trends.
Net premium yields have been in the 14 to 15 percent range this year and we also expect in 2003 similar kinds of patterns.
In the area of medical costs, I would say that in 2002 they have gone up as we expected from the 12 to 13 percent range to the 13 to 14 percent range, primarily driven by increases in inpatient.
The other physicians and pharmacy trends have been pretty flat and outpatient has actually come down somewhat from last year.
The commercial HMO medical loss ratio, as I cited the premium yields in medical trends have improved consistent with that, they improved 110 basis points from the third quarter of '01, and 30 basis points from the second quarter of '02.
Largely due to the effects of the premium increases.
In contrast to the underwriting issues in our experience rated book, the price execution in the commercial book has been sound.
In terms of total HMO medical membership, it was essentially flat compared to the third quarter of '01 and down slightly from the fourth quarter and the second quarter of '02 levels, and medical membership in the HMOs is about 7 million lives.
The enrollment trends reflect growth in our service managed care offerings, offset by attrition in the commercial HMO business.
HMO revenues including premiums and -- premiums and premium equivalents were up 17 percent year over year reflecting fee increases and higher medical costs for the ASO business, commercial HMO premium increases as well as strong specialty revenue growth growth.
As a reminder, the pending sale of Loveless Health Systems includes about 170,000 commercial HMO members as well as Medicare and Medicaid members, which when the sale is completed, will not be included in our membership numbers.
We will retain 75,000 medical members which are enrolled in our preferred provider organization as well as traditional medical indemnity and point of service plans.
We will also retain all specialty healthcare members associated with Loveless.
Moving on to the retirement business, the employee retirement benefits and investment services segment results were $57 million compared to $55 a year ago, and flat sequentially.
The year over year increase reflects business growth and a shift toward higher margin products, partially offset by the effect of the equity market declines on asset-based fees.
Ending assets under management from a year ago were up 3 percent while the average daily assets were down 4 percent.
Again, quarter over quarter -- year over year basis.
In the international life, health and employee benefits area, excluding the Japanese life operations which were fully divested in 2001, operating income was $8 million this quarter versus $2 in the third quarter of '01.
The increase in operating income is due to improved results in our life, accident and health operations as well as our international healthcare business.
The runoff reinsurance operations which include the remaining reinsurance operations, this business was previously reported in the other operation segment.
We are now required by GAAP to present these results separately.
This segment had operating losses excluding the nonrecurring charges for our variable annuity death benefit business in London and other -- an Unicover and other London exposures, putting those nonrecurring off to the side, the reinsurance operation had a loss of $16 million this quarter versus a loss of $2 million a year ago.
The increased loss reflects declining premiums in investment income and lower results in our remaining runoff reinsurance business, as well as higher expenses associated with arbitration proceedings.
Relative to the variable annuity death benefit exposure, our hedging program, which was put in place in late August, performed as expected.
The third quarter '02 market decline is measured by the S&P was about 17 percent, that required an increase in our liabilities for this product of about $300 million.
That was essentially offset by the hedge gains that are reported in other revenues which you can see and you can see the impact of the hedge in the income statements for this segment with the income from the hedge gains and other revenues of $300 million and the increase in liabilities, essentially the same increase in liabilities in the benefits line.
Moving on to other operations, includes amortized gain on the sale of individual life and annuity businesses, our runoff leverage corporate life insurance business and investment operations, the results are $18 million versus $15 million a year -- or in the third quarter of '01.
The increase reflects higher revenues and improved results in our investment operations.
For corporate, which includes unallocated investment income in parent company expenses, a loss of $22 million in this quarter, versus $19 a year ago, that was driven primarily by a decline in net investment income due to lower short term rates, as well as lower levels of invested assets at the parent company level.
We did talk a little bit on Monday about cash flow, I thought I would recap where we are there, recap our principal sources and uses of cash and our cash position for this year.
And when I'm talking about which, this is on a fuel year 2002 basis.
Starting with sources of cash, we expect to generate free cash flow at the parent company level net of shareholder dividends and interest payments of about $800 million.
This $800 million of free cash flow reflects dividends from the subsidiary companies of about $750 million, less shareholder dividends and interest payments of about $300, plus $200 million of proceeds for the pending Loveless sale, and $150 million of net positive cash flow from a variety of other items.
The -- as we disclosed in February, we started this year with cash available at the parent company level of $550 million, so when you add the $800 million of free cash flow of $800 to the beginning balance, you get sources of $1.350 billion.
Relative to uses, we intend to put funding in Connecticut General Life Insurance Company of about $900 million to fund, and we also intend to fund additional London requirements relative to the reinsurance charge of about $100.
So the $900, the $100, and the roughly $350 million of repurchase that we completed earlier in the year, adds up to a use of $1,350.billion.
Thus, our expectations for sources and uses are that the parent company will essentially -- at the parent company level, sources and uses will be in balance.
Said differently, the cash flow we started the year with and the free cash flow from operations that we have adequate internal funds to fund the obligations that we have.
Looking ahead, our expectations is that we will continue to generate free cash flow from operations, that being cash flow to the parent company, less shareholder dividends and interest payments, free cash flow at the parent company level of roughly $500 million a year, and that in 2003, we have debt maturities of $150, leaving net cash flow in the $350 million range.
On a related point, a question came up on Monday about the relationship between the parent company cash flows, which I just went through, and our expectations and the consolidated cash flows reflected in the financial statements.
I would note that the parent company cash flows basically follow a similar pattern to the consolidated GAAP cash flows over time, but for any particular specific period, they may differ due to a number of factors.
And with that recap of the numbers and statistics, I'll turn it back to Ed.
- Chairman, President, Chief Executive Officer
Thanks, Jim.
I now want to provide our outlook for the full year 2002 and 2003.
For full year 2002, we currently expect consolidated after-tax operating income, excluding nonrecurring items of $6.50 to $6.75 per share.
This is consistent with the outline we discussed Monday.
I would note that full-year outlook excludes nonrecurring items, including the previously announced fourth quarter restructuring charge.
Our after-tax earnings expectations for 2002 by segment are as follows: the employee healthcare life and disability segment, earnings will be $725 to $750 million, after the amortization of non-goodwill and tangibles.
Within this segment, HMO earnings of $470 to $480 million, and indemnity earnings of $270 to $280 million.
For the retirement business, the retirement business, we expect earnings in the $225 -- no, excuse me -- the $210 to $220 million range, excuse me, and for international, $25 to $30.
In the combination of the other operations and runoff reinsurance segments, we expect $40 to $45 million.
We expect the loss in corporate to be $100 to $105.
So in total, we expect full-year consolidated after-tax operating income of $915 million to $950 million, or $6.50 to $6.75 a share.
Let me go to 2003.
For 2003, we expect consolidated after-tax operating income of 625 to -- excuse me, $6.25 to $6.50 a share.
And by segment, in the employee healthcare life and disability area, total segment earnings of $675 to $725 million, after amortization of non-goodwill intangibles.
HMO of $425 to $455 million and indemnity of $265 to $285.
We expect the company's other segments in the aggregate to contribute approximately $200 million in earnings.
The pieces include $210 to $220 for the retirement business which reflects the impact of lower sales and persist tenancy due to ratings changes, $35 to $40 million for international, $40 to $45 million for the combination of other operations and runoff reinsurance segment, as the loss of to implicit.
So total, we expect col dated after tax operating income of $875 to $925 million, or $6.25 to $6.50 per share for the full year 2003.
To recap the actions being taken to improve results in our healthcare operations, our actions are focussed on, as I've said, service, underwriting and expenses.
We've installed a new management team within our healthcare business.
This team is experienced, has a proven track record and has my full confidence.
Pat discussed the initiatives to improve customer service.
These include a change in leadership, added resources to improve service levels, and continuing to improve the effectiveness of our transformation platforms.
We already noted we are strengthening underwriting leadership and improving our processes and discipline.
We are taking aggressive actions to reduce expenses in the healthcare operations.
In the near term, increased spending on service operations and technology, including HIPA compliance, will offset the benefit of these actions.
In longer term, expense levels will decline as we realize productivity improvements in our service operations.
We're going to continue to keep investors apprised of actions being taken and results achieved.
I strongly believe these actions will drive CIGNA's return to profitable growth while strengthening the company's competitive position in the healthcare industry over the long-term.
I want to emphasize as CIGNA remains a fundamentally sound company.
We've had a number of miscues as discussed.
We will improve our operating results and rebuild our capital position to their historically high levels through the actions that we have outlined today.
We recognize that to succeed and regain investors confidence, we must execute.
We know that what you are interested in is actions, not words, performance, not promises.
We totally agree and intend to deliver.
We'd now like to address several of the questions that you've raised over the past week and then after that, we will open up the line for additional questions.
Now, I think in terms of the top question that we have heard, which is not surprising, given our guidance change and the timing, is why didn't you know until the third quarter about the healthcare shortfall?
As we've noted, we conducted a detailed account level review of the healthcare experience rated book in the third quarter.
It clearly identified the extent of underwriting misjudgments and pricing concessions.
As the earnings on these books emerge over time, we are required to make estimates in the early part of the year about future experience for these cases.
In a number of situations, our detailed review showed that we had to revise our estimates based on maturing claim experience.
We've also recognized that service resource reductions earlier in the year were resulting in unacceptable service levels, and we've been adding service capacity and cost.
And we are also accelerating our HIPA spending.
These are the factors that led to us prerelease earnings last Friday.
Another question has been regarding the decline in earnings from '01 to '02.
If you take the midpoint of our '02 guidance range of $738 million, we have an earnings decline of about $140 million and people's reactions have been how can your earnings fall that fast and that far?
Well, the principal drivers here are first, we've got $100 million decline due to expenses in excess of membership growth.
And another is the $100 million decline that we talked about in indemnity split roughly evenly between misjudgments on a few large cases, and margin concessions.
These declines then are offset in part by earnings growth in commercial HMO, specialty, life and disability, which continue to perform well.
Now, another concern has been that, given the implied fourth quarter run rate, in other words, people have looked at our full-year forecast for '02, inferred the fourth quarter, looked at that growth rate, and as a result, were getting some skepticism about our ability to hit next year's estimates.
And I thought I'd have Jim just address this point.
- Executive Vice President, Chief Finanacial Officer
Yeah, just quickly, the run rate that is implied by the full-year guidance versus the nine months numbers would indicate that the healthcare number for the quarter would be around $130 million, when I say healthcare, I'm talking about the employee healthcare life and disability segment, which if annualized would indicate full-year earnings power of $520 million, yet we have indicated an '03 outline in the, sort of, $700 million range, and how do you go from $520 million to $700 million.
And the answer to that question is, there are three factors that cause the full-year '03 numbers to be improved over the fourth quarter run rate.
They are expenses, growth in a couple of areas in terms of operating income, as well as the elimination of underwriting misjudgments.
More specifically, as Pat mentioned, we are taking cost actions to reduce our expense levels so we would expect a full-year run rate and expenses to improve over the fourth quarter levels by about $100 million.
The other differences are split about 50/50, in other words, we expect to improve our results in the specialty life and disability and commercial HMO set between the fourth quarter and the full year '03 by about $50 million, and the last $50, roughly, is that the large case difficulties that we had in the experience rated block will mostly go away in '03.
- Chairman, President, Chief Executive Officer
Okay.
We've gotten another question relating to the '03 earnings guidance.
I want to spend a minute on.
We've outlined several actions that we're taking, we spent a lot of time on that, going through the areas that we're focussed on that will improve our situation, and yet '03's guidance is for earnings reduction.
If you take the midpoint of the the '03 guidance for healthcare of about $700 million, we're projecting roughly a $35 million decline year over year.
Now, that's about 5 percent, which is roughly consistent with our membership decline.
As you'd expect, there's several moving parts.
There's some pluses and minuses that largely offset.
One is about a $50 million improvement due to the actions that we are taking to address the few large indemnity cases that we mentioned.
And you also have improvements in the specialty commercial HMO life and disability businesses.
These improvements then are offset by increased spending for service in relation to our membership and HIPA.
So, while there are some moving pieces, we don't expect earnings growth in '03.
Given that there's no improvement, then, in '03, obviously, there's been lots of interest expressed in what our expectations are for '04.
And I want to be clear that we expect earnings growth in '04.
We have a sound foundation and while we've acknowledged that '03 is a rebuilding year, we believe that we have appropriate actions underway and the right people in place to execute against those actions effectively.
The area of particular focus, which we've talked about, include service, underwriting and expenses.
With the execution in those areas going into '04, we will be significantly better positioned in cost structure, in customer satisfaction, which clearly impacts sales and persistency, and in the effective management of the underwriting: As a result, as I said, we fully expect earnings growth in '04.
Now, another line of questioning has really struck to given the fact that our competitors are doing very, very well.
What's happened with us?
What's happened with our competitiveness?
I thought I would turn to Pat and have him provide his perspective on that.
- President of CIGNA HealthCare
Thanks, Ed.
Let me do it in two pieces, the first is related to the earnings.
Clearly our earnings are at a pattern with the competition.
But if we talk about our basic competitiveness, we are a very competitive company and we cannot forget the strengths of this organization.
CIGNA HealthCare has a great breadth of product and we have a full range of funding arrangements.
We are relatively -- there are relatively few players who can really provide the service to national multi-site accounts.
We have very high quality experienced people in the field and in the home office and we have a very strong commitment to clinical quality.
We have over 3,000 nurses and 150 doctors committed to quality outcomes for all of our members.
We've had a strong sales year and we have won much business.
And while we've talked about service, not all of our customers have experienced service slippage.
Many, many are very pleased with their relationship with CIGNA.
So from a market perspective, I think CIGNA HealthCare is very well positioned competitively.
- Chairman, President, Chief Executive Officer
I would echo that.
I think we've clearly recognized that while we've had some execution short falls, the core competencies of the organization should provide us with very very good market acceptance.
The other area that came up on the call on Monday, and we've gotten significant further follow up on, has to do with the pricing and underwriting posture as we go forward.
We've acknowledged short falls there in '02, and I want Pat to spend a minute on that as well.
- President of CIGNA HealthCare
Well, pricing and performance, while we've mentioned our challenges, the pricing and performance of our commercial HMO life and disability products are very strong.
And on the indemnity book, we've discussed the underwriting shortfalls which have been in contrast to our history.
We are strengthening our underwriting processes and procedures to ensure that misjudgments do not occur in the future.
With regard to underwriting concessions in response to competitive pressures, and service concerns, we're really addressing the root causes.
We're going very aggressively and improving our service.
And as we've said earlier, we are moving strongly to reduce cost to retain our product competitiveness.
The strong service and competitive products pressure for concessions is reduced.
And in any case, the pricing and underwriting discipline will be reestablished and confirmed throughout the organization.
- Chairman, President, Chief Executive Officer
Pat, there's one last area I'm going to ask you to comment on.
A number of folks have requested some insights relative to sales and persistency.
Clearly we've been challenged as we've acknowledged here on a couple of fronts relative to sales and persistency.
Our membership growth has not been acceptable.
Do you want to just spend a minute on that?
- President of CIGNA HealthCare
Yeah, I think clearly profitable growth is very important to this organization.
I think we focussed on some of our challenges, but profitable growth is still our goal.
I'll focus on four areas: The first is focus, the second is sales execution, third is service improvement, and the fourth is account management.
With regard to focus, we've talked about a realignment of our organization around three key customer segments.
The first is the national accounts where we are expanding the reach of our effective national account sales and customer service model.
The regional account segment is going to have a very clear focus on serving the middle market.
In the area of sales execution, we want to make sure that all of our people who are representing us in the field have a very clear understanding and can articulate CIGNA's strengths.
We have a very strong value proposition and we have a very good differentiated story.
We need to make sure that can we -- we get that out and we follow through on it.
With regard to the third point, service improvement, I think we've said an awful lot about the service improvement, but that's also extremely critical to our growth in new sales and retaining our existing customers.
And last but not least is placing a very high priority on account management.
- Chairman, President, Chief Executive Officer
Okay.
There's been one other area, and this will be the last one that I'll comment on, but there's been one other area that has received a fair amount of questioning, and had has to do with whether we are inclined to sell our spin off, our pension business.
And I just want to reiterate that the pension business has been and continues to be a good business for us.
It has strong margins, it has very, very good returns, it is a good fit with our overall employee benefits strategy, and we continue to see the opportunity to leverage the people, the customers, the infrastructure of that business with our other operations to generate attractive growth over time.
I'm going to close this and we're going to go to questions.
However, I want to acknowledge that there is certainly a sense or a broad-based question as to is CIGNA okay?
And I want to stress that, given our past results and the history that we've had, we have a very sound foundation.
We have some issues.
Hopefully we've not only acknowledged those issues, but been very straightforward relative to their impacts to us, and what we're doing about them.
Principal among them are expenses, underwriting and service.
We've identified aggressive actions in each, we put the right people in place to execute those actions, and while '03, as we've described it, is a rebuilding year, we are very confident that with the successful execution of the actions that we are taking, that we are going to return to being the solid, growing, profitable company with margins that are the best in the business, that is consistent with our past.
And with that, I'm going to turn the phone over to Greg.
Who will take your questions.
Operator
Ladies and gentlemen, at this time, if you do have a question, please press the one on your touch-tone phone and you will hear a tone, acknowledging your request.
If someone asks your question ahead of you, you can remove yourself from queue by pressing the pound key.
Also, if you are using a speakerphone, please pick up your hand set before pressing the buttons.
One moment, please, for the first question.
Our first question comes from John Rex of Bear Stearns.
Good morning.
I was wondering if you could provide a little color in your comment in the press release regarding the SEC inquiry, if they provided you with any detail of exactly what they're looking at and the scope?
- Vice President, Investor Relations
John, at this point, you know, interestingly, given the market reaction last Friday, I don't think that that action was unexpected.
I really don't have anything to add to what's in the earnings release, other than to restate, John, that we will fully cooperate with the SEC inquiry.
They didn't really provide any details exactly what they're looking at?
It seemed to be related to the stock price drop, is that what you're saying?
- Vice President, Investor Relations
Yes, John.
Then on membership, it appears that your 630 pro forma membership would be essentially flat with 930.
Is that correct?
- Vice President, Investor Relations
That's right.
And just kind of thinking the retention, I know there was one account that was, I think, in almost 200,000 members that you would have picked up in the third quarter.
If you could talk about what you saw in terms of retention issues in the third quarter, and exactly kind of where that was impacting you.
- Vice President, Investor Relations
The one account that you referenced is an indemnity account, and as you can see, I guess you can't see, if you do the sequential membership growth, you will note that indemnity life growth, there was, in fact, indemnity life growth in the third quarter, the numbers went up, and that there was the large case, and that's what was driving the increase.
I would say that in terms of sort of, if you will, sales and persistency aspects, we did see or have seen somewhat softer sales in the second half of this year.
The persistency is about at levels that we've seen in the first half of the year within the cases themselves, we have seen some drop off in what we call in-group growth, or in-group shrinkage.
I think that's predominately economically related.
Okay.
Good.
Last here, you talked about the review that you undertook in the third quarter to -- where you identified the issues.
Is there -- can you see any kind of changes you could make so that you could identify these issues earlier in the year?
Is this the soonest it can be done or is there something you can do to enhance reporting systems or feedback loops such that you would get this kind of message sooner?
- Chairman, President, Chief Executive Officer
John, it's Ed.
As Pat mentioned, we have a lot of activity underway in the underwriting area.
And the answer to your question is, yes, we can make significant improvements there, both in process and how we manage that book of business.
These are things, John, that we have done in the past very well.
We've, I believe, acknowledged a couple times, this experience rate of book of business is one that's been very profitable, continues to be profitable, simply not at the levels that we've seen.
We know how to fix this business.
Okay.
- Vice President, Investor Relations
I would just add under that, John, that you mentioned the word "feedback loop" and I think the feedback loop you mentioned is one of the areas that we intend to strengthen between -- particularly in the area of underwriting and make sure those feedback loops are appropriately responsive to the underwriting actions which have been taken.
Will you be providing us with restated quarterly membership numbers for '01?
- Vice President, Investor Relations
Yes.
Okay.
We'll get some kind of table, we can request that?
- Vice President, Investor Relations
That's correct.
Great, thank you.
Operator
Our next question comes from Matt Swanson of ICOMP.
Yes, good morning.
One question, it seems that the technology initiatives in the service are related, and it's been rumored or reported that the company's had to make payments to some of its customers for service short falls.
I was wondering whether the company would be willing to identify the -- let's say the three or four key service metrics that trigger those payments and what are the absolute numbers attached to those metrics and how we might -- excuse me, better monitor those going forward?
My second question relates to the cash flow, and it sounds like the cash figures, as you will end the year in 2003, will be close to a billion dollars.
I just wanted to get some confirmation of that.
And also, ask you where the pension deficit charge sits within all that.
Thank you.
- Vice President, Investor Relations
The -- in terms of the key service metrics, there are a variety of them, not to go into too much detail, but having to do with the claim measures, accuracy and timeliness, our response times relative to calls for average speed of answer and abandonment rates and things like that.
We have with some customers, service guarantees that relate to that.
I would say historical given the rather tight metrics that we have, we don't get all of them right for all of the customers all the time.
The amount of payments that are associated with that are reasonably limited and have not not -- have not changed materially.
I would say that the important thing isn't the dollars on the performance guarantees, which are -- which aren't a big deal, but rather it's customer retention and customer satisfaction.
Our goal is not to avoid financial payments per se, of course we'd like to do that, but rather improve our customer service.
And as Pat talked about, we have a variety of initiatives that are directed at all of the metrics and we intend to improve it, along with the technology linkage that you mentioned, and that is to improve our -- in various areas, our transformation platforms.
On the cash flow question, the math that I went through, maybe I misspoke.
We would intend to end with, if you will, free parent company cash at the end of the year of about zero.
Said differently, what we said was, or what I tried to say, maybe not effectively, was that sources and uses of cash in 2002 are in balance with each other, that the sources including the original 1/1 cash position and the free cash flow at the parent company level, are about equal to the uses.
So that's what I meant to say.
On the pension question, the pension question is a GAAP requirement relative to the minimum pension liability.
It is unrelated to any funding and unrelated to the cash flows.
More specifically, we have not been funding the pension plan because of its -- because of its status.
That's not unusual.
Most companies recently have not been funding defined benefit pension plans.
The cash requirements of the pension fund in 2003, are about $75 million.
And that would by included in our operating company cash flows.
Can I come back to you on the technology question?
Is it the company's intention to, again, list the three or four key metrics on a quarterly basis and say, okay, this is where we are and this is where we expect to be so that from an outsider's perspective, looking in, we can assess the progress that you're making on that front?
Because again, it seems to be related to the service issues and your ability to grow your membership.
- Vice President, Investor Relations
I think that's fair.
It is clear that it's a very important project for us, as Pat has noted and we will be creating a set of milestones that will allow not only you, but others who have interest in understanding the progress that we're making.
We will be doing that.
Operator
Our next question comes from Terri Shu.
Going back to the service problem, since it seems to be the root of all the issues.
I had earlier thought that part of the service problem was just in transitioning the membership to the new platform.
But it sounds like it's much more an ongoing service problem.
Is it because your auto adjudication rate is so well below some of the -- your competition for big accounts, for instance?
And that, does that not by definition mean that you are going to have more errors and it's going to cost more money to make sure that errors are at a lower level in order to maintain standards?
Am I understanding that problem correctly or not correctly?
I'm not sure.
- Chairman, President, Chief Executive Officer
Terry, it's Ed.
Let me start.
First of all, the -- yes, we have some service issues that are broader than simply transformation, although in some respects, they're transformation-related.
They are not a function of lower auto adjudication rates.
Because on our legacy platforms, we've had reasonable service on our legacy platforms historically with those lower levels of auto adjudication.
So that's not something that - a stumbling block that until you get it up, that you're going to be will go -- lagging, that's not it?
- Chairman, President, Chief Executive Officer
No, Terry, it's not.
What is it then?
I'm not exactly sure.
Because the service problem sort of always in the background, you hear about it, but how did it kind of blossom into this situation where you had much greater customer dissatisfaction?
Is it comparative versus your competition or is it something faltered because you were distracted from transformation?
Which one is it?
- President of CIGNA HealthCare
Terry, this is Pat.
Let me take a crack at that.
I think in your first question, you did have the essence of it.
When we did the migrations of those large accounts on 1/1/02, there were -- I don't know what the right noun is -- glitches.
We did have challenges as we migrated those large accounts.
And when you have that kind of challenge, it results in a much higher level of phone activity.
So at the time, we thought we were appropriately staffed for that.
The phone call volume went very high, therefore, the service levels dropped off.
We worked through in the first quarter cleaning up those migrations, and then, as I said at one time, thinking that we were getting the productivity, we then reduced staffing around the end of the first quarter or so.
The productivity didn't materialize.
So now you are --
All right.
- President of CIGNA HealthCare
Understaffed.
Okay.
- President of CIGNA HealthCare
And we got behind there, Terry, when you're understaffed in your service centers-
Fair enough.
Because it's absolutely critical to understand how systemic it is, because as you said, that's the issue.
If people think that there's some very serious problem, then that's why there's not the belief that you can turn it around.
That's why I press on that point.
The other point is that when you talk about cost takeouts, in the face of all these challenges, on the surface, it seems contradictory.
How can you improve service, as you said, while taking out cost?
Now, where exactly are these large dollars coming out from, as you said, $100 million of savings.
Where exactly can you take that out?
- President of CIGNA HealthCare
What we're doing, I guess maybe I'll focus on three areas.
The -- when we went to this, as we were going to this segment focus, we are being able to take out some redundancies.
I think you've been around this organization quite a while and you know that we have tended to have some redundancies in our operation.
So we are going to a much clearer focus on the segments.
Secondly, we are really this unified medical management organization focussing on outcomes and deploying of our clinical resources independent of product or independent of organizational structure, we are really optimistic that we are going to have higher quality outcomes and we're going to be able to reduce our cost in that area as well.
And then the other area is the -- basically, the corporate or the divisional infrastructure.
So we are reducing staffing levels and consolidating a lot of our functions that we had disbursed around the field.
We are very mindful of maintaining the quality of service, completing the transformation activities, and complying with HIPA.
But there are opportunities to cut costs elsewhere.
Let me put it another way.
How visible of these cost savings?
If you're taking out head count, if you're removing redundancies and such, are they kind of risky forecasts as we look out into 2003?
The reason why the market is discounting earnings, not of $6.50, but of probably $3, $4, no one believes the earnings, is because people are not paying attention to either your service turnaround or your ability to cut costs in part, because that's a meaningful component of the run rate recovery.
How visible, how much assured do you believe are these cost savings, are -- or is there a risk around it?
- President of CIGNA HealthCare
I think that if I were to say that going through as much change as we are trying to drive the change here, that it is totally without execution risk, I'd probably be being gullible.
There's obviously, when you make this level of change and try to realign your organization and try to streamline the decision-making, there is execution risk.
Our goal is to make sure that we do it with as -- as invisible to our clients as possible.
Our goal is to improve the relationship with our clients and CIGNA, and that what we're trying to do is streamline and clean up our internal processes.
But there's obviously execution risk and they were very highly focussed on that .
Right, right.
I understand.
That's why I asked how visible are the savings.
Do you know, by removing X number of functions, you're saving X dollars, that kind of thing, is it done that way?
- President of CIGNA HealthCare
Yes, we have, we're in the process of this, and we have it really department by department, the number of dollars we think our going to be coming out.
Then finally, let me go back to that one question that bothered me, which is regarding pricing.
And I relayed just the question I had posed to you earlier.
And I guess I got a little worried, the idea that you needed to grow your membership perhaps at the - by reducing margins.
I assume that you, going forward, the much higher priority is persistency and pricing right and restoring margins.
That -- that's the first priority before even thinking about growing.
Am I right there?
- President of CIGNA HealthCare
Yes.
Because that worried me.
And that was before the discovery that you had underpriced this year's book.
- Chairman, President, Chief Executive Officer
Terry, that's right.
That's the priority.
I think it very clear that there are a number of issues here that will all contribute to ongoing -- our ongoing competitiveness, that is getting the costs right, getting the underwriting right.
The priority here is let's get the book of business priced right and get back -
Right.
You're not going to give you -- up margins anymore, I assume, just to keep an account necessarily, because first you have to get to the root cause.
Am I understanding that right?
- President of CIGNA HealthCare
That's right, Terry.
We're going to address root causes.
I would like to just make one more point here on this reduction of cost.
This is kind of the first time that we have been talking about this, and it's been in relationship to our reduced guidance.
We have started down this path about two months ago.
This was in reaction to an understanding that we have -- we had to streamline our operation to streamline our decision-making and to make our products more competitive.
And this is something that we have been kind of lining up and we've been talking about it internally, is our need to realign, get clear focus and lower cost.
I press on this pricing thing, because I do believe I heard you correctly in one instance that you had said that you would like to see CIGNA be a bit more aggressive.
Am I not right?
- President of CIGNA HealthCare
Aggressiveness is aggressiveness in terms of demonstrating the active says differentiation from point of sale.
You did also say on pricing that perhaps that you don't have to necessarily have the exact margin or something like that.
- President of CIGNA HealthCare
I'm not sure exactly what you're speaking to, but I think when I talk about aggressiveness, I talk about differentiating CIGNA and not being forced into a commoditization of the product.
Fair enough.
Thank you very much.
Operator
Our next question comes from James Averil of Wellington. [pause]
Our next question comes from Albert Coperstino of Columbia Management.
One moment for our question.
It appears there are no further questions.
Ladies and gentlemen, this concludes CIGNA's third quarter 2002 results review.
A recording of this conference will be available for 10 business days following this call.
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Thank you for participating, we will now disconnect.