信諾集團 (CI) 2004 Q2 法說會逐字稿

Thank you ladies and gentlemen, and thank you for standing by for CIGNA's second quarter 2004 results review.

At this time all callers are in a listen-only mode.

We will conduct a question and answer session late during the conference and will review procedures on how to enter queue to ask questions at that time.

If you should require assistance during the call, please press star, zero, on your touch-tone phone.

As a reminder, ladies and gentlemen, this conference, including the question and answer session, is being recorded.

We'll begin by turning the conference over to Mr. Greg Deavens.

Please go ahead, Mr. Deavens.

Good morning, everyone, and thank you for joining today's call.

I am Greg Deavens, Vice President of Investor Relations and with me this morning are Ed Hanway, CIGNA's Chairman and Chief Executive Officer, Mike Bell, CIGNA's Chief Financial Officer, and David Cordani, Senior Vice President of CIGNA Healthcare.

David will participate in the Q&A portion of today's call.

The purpose of this call is to review CIGNA's financial results for the second quarter of 2004 and to discuss our outlook for full year and third quarter 2004.

CIGNA uses certain financial measures which are not determined in accordance with generally accepted accounting principles, or GAAP, when describing its financial results.

Specifically, we use income from continuing operations before realized investment results and special items, which would include unusual charges and gains as the principal measure of performance for our operating segments.

This measure is most directly comparable to the GAAP measure, income from continuing operation.

Please see note two of today's press release, which is posted in the Investor Relations section of CIGNA.com for a discussion of these matters.

I would note that there were no special items reported in the second quarter of 2004.

There are, however, a few housekeeping items that I would like to cover pertaining to our second quarter results and other recent activities.

As previously disclosed, CIGNA completed the sale of its retirement benefits business on April 1, 2004.

The sale was structured primarily as a reinsurance agreement.

The total ultimate gain on sale was approximately $800 million.

Realized investment results in the second quarter of 2004 include $259 million of gain related to this sale.

The remainder of the gain on sale has been deferred and is being amortized over future periods at the rate that earnings from the sold business would have been expected to emerge.

In addition the sale resulted in a number of changes to CIGNA's balance sheet, reflecting, among other things, the recognition of a reinsurance recoverable asset of approximately $15.6 billion.

In conjunction with the sale of the retirement benefits business and the realignment of leadership responsibilities for certain case management operations, we have changed our segment reporting.

We describe the segment reporting changes in a press release issued two weeks ago and again in today's press release.

Pro forma historical analyses reflecting our current segment reporting are available in the Investor Relations section of CIGNA.com.

During the second quarter of 2004, CIGNA completed its annual update of planned participant data for its qualified pension plan.

The update resulted in an after-tax charge to equity of $39 million in the quarter.

Further disclosures regarding the charge for pension obligations, the sale of the retirement benefits business, and the segment reporting changes, will be included in our second quarter report on Form 10(Q), which we plan to file with the Securities and Exchange Commission later today.

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 Ed.

Thanks, Greg.

Good morning, everyone.

Today we are pleased to report our second quarter income from continuing operations before realized investment results and special items of $1.75 per share.

I am going to provide an update on our strategy and an overview of our earnings for the quarter.

After my remarks, Mike Bell is going to provide details on the second quarter, as well as commentary on CIGNA's capital position and expense reduction initiatives.

Mike will also provide our earnings outlook for the full year and third quarter of 2004.

Our earnings for the quarter are up over 50% from the second quarter of 2003.

This improvement was driven by a substantial increase in Healthcare earnings, as well as strong earnings growth in the Disability and Life and International operations.

I want to stress that each of our ongoing businesses are performing very well.

Before I go through the highlights for the quarter, I want to spend a few minutes on our progress to date in executing on our strategy and our improvement efforts in the Healthcare business.

As you know, we completed the sale of our retirement benefits business on April 1.

We are now a focused healthcare and related benefits company.

We have very strong capabilities and solid market position in medical and specialty healthcare, disability, life, accident and expatriate benefits.

Our top priority is to profitably grow each of these operations.

And to do so, we are working aggressively to differentiate our offerings in the marketplace in five ways.

First, establishing a meaningful medical and administrative cost advantage.

Second, achieving superior clinical outcomes for our members.

Third, marketing our unique integrated product clinical information and service capability.

Fourth, continuing to deliver sustained competitive service results.

Fifth, strengthening our customer and consultant partnerships.

Our suite of product and service solutions enable employers to offer innovative benefit options to their employees at competitive costs and with superior clinical quality results.

We have made very good progress in strengthening our value proposition and executing on the fundamentals, including medical management, service and operational efficiency.

Our progress in these areas is driving our significantly improved earnings.

We also have a new suite of products, called the Signature Suite, which includes the industry's best consumer-directed health plan.

Leveraging these capabilities, we are now focused on improving membership in what admittedly is a fairly challenging pricing environment.

As I've noted, we have improved and continue to strengthen the fundamentals of our business, including underwriting, medical management, expense management and service.

Membership levels have been a lagging indicator for us.

Our medical membership through the end of the second quarter is down 13% on a year to date basis.

Despite the decline, we are beginning to see some favorable trends.

First, July 1 retention of existing business improved meaningfully versus the first half of 2004.

July 1 membership level is consistent with our expectations, at a decline of about 1.5%.

That would put us at 14.5% at the end of July year to date.

Also, our flow of new business opportunities is improving.

Basically, we are getting more at bat.

Our close ratios, while improved, continue to be below our historical levels.

This is in part reflective of our disciplined approach to underwriting in a fairly challenging, competitive pricing environment.

For the full year, we expect our membership to be down approximately 17%.

It is too early to the predict 2005 membership, but given market pressure and our determination to maintain appropriate underwriting discipline, we expect that we will experience some additional downward pressure on membership in 2005.

Let me stress that we are pleased with the improving fundamentals of our business and believe that they establish a very solid foundation for us to improve our membership results.

In my closing remarks I will provide additional details on our healthcare improvement initiatives, including actions to address improved membership.

Regarding our other businesses, our market position and results in the disability and life and international businesses are quite strong in the absolute and competitively, reflecting effective execution of our strategy.

Now let me comment on the second quarter results.

As I noted earlier, second quarter 2004 earnings increased significantly from the second quarter of 2003.

These results primarily reflect higher healthcare segment earnings and strong results from our disability and life and international businesses.

Second quarter healthcare earnings were primarily driven by good execution of the fundamentals in our medical business.

Overall I continue to feel good about the results we are achieving, particularly in the areas of medical management, service and operating expenses, and the resulting improvement in earnings.

And I would note that as we seek to improve membership results, we maintain committed to maintaining appropriate pricing and underwriting discipline.

Our disability and life segment posted a very strong second quarter.

The earnings here reflect competitively strong results, particularly in our disability business.

We are profitably growing this business, with a particular emphasis on the middle market.

Our international operations also had a very strong quarter, driven by continued growth in our life, accident and health businesses.

We also continue to profitably expand our expatriate benefits business.

Also through the sale of the retirement benefits business, we have strengthened our capital position.

Overall, results for the quarter were strong.

We feel good about our improved earnings and we are intensely focused on efforts to improve membership.

As I said, I'll talk about these efforts in a few minutes.

But first, I am going to turn it over to Mike for a review of the second quarter results and our earnings outlook.

Mike?

Thanks, Ed.

Good morning, everyone.

In my remarks today, I'll review CIGNA's second quarter 2004 earnings.

I'll also provide some observations on our capital position and expense reduction activities.

Afterwards I'll discuss our earnings outlook for the full year and for third quarter.

As Greg noted, our second quarter results reflect changes to our reporting segments.

That includes significant realized investment gains.

These matters are discussed in our earnings release and our second quarter 10(Q), which we plan to file later today.

In my discussion of consolidated and segment results, I will comment on income from continuing operations before realized investment results and special items.

This is also the basis on which I'll provide our earnings outlook.

On this basis, our second quarter earnings were $246 million, or $1.75 per share.

This strong improvement, relative to the second quarter of 2003, was driven by improved healthcare earnings and continued strong results in our disability and life and international businesses.

Turning to the segment results, healthcare earnings for the second quarter of 2004 were $175 million, as compared to $69 million in the second quarter of last year and $180 million in first quarter of this year.

The year-over-year improvement reflects strong underwriting execution, significant favorable prior-year claim development, solid specialty healthcare earnings and lower operating expenses, partly offset by lower membership.

The commercial HMO medical off ratio was 81% for the second quarter, versus 90.7% in the second quarter of '03.

The improvement reflects the impact of better utilization rates and the impact of favorable prior-year claim development.

Favorable prior year claim development in the quarter was $50 million after tax.

This includes $24 million related to our commercial HMO business, $18 million in our indemnity business and $8 million related to our specialty healthcare operations.

This favorable development reflects strong medical cost management over the last 12 months.

Operating expenses for our healthcare segment declined 8% from the same quarter last year, as we continue to effectively execute our expense reduction initiatives.

Specifically operating expenses declined from $866 million in the second quarter of last year to $799 million in second quarter of 2004.

This improvement was in line with our expectations.

Premiums and fees for the segment declined 13% relative to second quarter of '03, with the impact of lower membership partly offset by the impact of price increases.

Now, relative to the components of the healthcare segment results, I'll discuss HMO and then indemnity.

HMO earnings include results from our health plans and from our specialty healthcare businesses.

HMO earnings in the quarter totaled $149 million versus $66 million in the second quarter of '03 and $141 million in the first quarter of this year.

The year-over-year increase primarily reflects lower operating expenses, favorable prior-year claim development and strong results in our specialty businesses.

These factors were partly offset by the effect of lower membership.

Now, with respect to medical cost trends and premium yields, for our HMO business in total, which includes both ASO and commercial HMO, we expect full-year medical cost trend to be approximately 11.5%.

Now, as a point of information, we calculate trend by taking per member medical costs in the current period and comparing them to per member medical costs in the same period for the previous year.

The only adjustment we make is for prior year claim development.

As a result our trends numbers include components of medical costs that some competitors may exclude from their trend calculation.

For example, we include changes in mix and severity, the impact of new technologies and procedures, and the cost of specialty pharmaceuticals.

On this basis, our ASO HMO business, which represents the majority of our HMO membership, we expect full year trend to be approximately 11%.

We expect commercial HMO full year medical trend to be between 12% and 13%.

And this is relative to a 2003 starting point that is better than we had previously estimated, due to the favorable prior-year claim development in the past two quarters.

The estimated ASO trend reflects a net pharmacy trend which is lower than for commercial HMO.

This is due to a higher level of ASO benefit buy-downs.

The commercial HMO business is experiencing higher trend leverage, due to a greater proportion of fixed co-pays.

HMO inpatient utilization for the first half of this year was lower than in the first half of last year.

Favorable utilization continues to reflect the positive results of our medical management initiatives.

Now, relative to premium yield we expect that yield for our commercial HMO business will be approximately consistent with medical trend for the full year.

Specifically, we expect our full-year commercial HMO net premium yield to be in the 12% to 13% range.

Now, turning to indemnity.

Second quarter indemnity results were $26 million, compared to $3 million for the second quarter of '03 and $39 million for the first quarter of this year.

The year-over-year increase reflects improved underwriting and medical cost results in the experience rated and guarantee cost businesses, partially offset by the impact of lower membership.

The sequential decline in indemnity earnings, mainly reflects lower fees on the run-out of cancelled business and the impact of lower membership.

Moving on now to the other segments.

Earnings for the Disability and Life segment were $48 million, an increase of 23% over the second quarter of '03 and 20% over the first quarter of this year.

Results reflect favorable mortality experience and lower expenses in group life insurance, and continued strong disability results.

Premiums and fees increased 9% over the second quarter of '03, reflecting solid sales results and strong persistency.

Turning now to our International segment.

Earnings were $20 million versus $11 million last year and $15 million for the first quarter this year.

The year-over-year and sequential increases primarily reflect higher earnings in our Life, Accident and Health business.

Premiums and fees increased 22% versus the second quarter of '03, primarily driven by growth in the life, accident and health, and expatriate benefits businesses.

Moving on now to the run-off Retirement segment.

Second quarter 2004 earnings of $29 million, reflected $22 million in amortization of deferred gain and $7 million of other sale impacts.

These amounts are in addition to the gain on sale recognized in our realized investment gains for the quarter.

Going forward, this segment will include the amortized gain on the sale of our Retirement business and any run-off expenses.

The remaining operations including run-off reinsurance, other operations and corporate, generated an aggregate loss of $26 million.

Within this amount, corporate results included approximately $5 million after tax in overhead, that was previously allocated to the retirement business.

Corporate results also include $5 million of after tax costs related to debt retirement.

Before providing our 2004 outlook, I'll comment briefly on our capital position and priorities, as well as actions we are taking to reduce our expense structure.

Starting with capital management.

Overall, our parent company capital position remains strong and our subsidiaries are also well capitalized.

Our priorities for the use of capital continue to be, first, maintaining at least $500 million in cash at the parent company group through the end of the year.

Second, maintaining our leverage ratio near the midpoint of our targeted 20% to 30% range.

And third, after providing capital needed to support growth and maintain appropriate financial strength ratings, using excess capital to repurchase our stock.

As we have discussed before, stock repurchase depends on market conditions and other uses of capital.

We are well-positioned relative to each of these priorities.

At the end of second quarter, cash and short term investments at the parent company group amounted to $1.5 billion.

We ended the quarter with a leverage ratio of 23% , which is below the midpoint of our target range.

Our subsidiaries are well capitalized and are able to support current business levels.

We re-initiated our share repurchase program in April and repurchased approximately 4.2 million shares of our stock on the open market for $284 million during the second quarter.

In July, we repurchased an additional 830,000 shares for $56 million.

We have approximately 730 million of remaining repurchase authority at this time.

This amount includes an additional 500 million in authority approved by our Board of Directors last week.

I'd also note that we retired approximately $76 million in long-term debt during the second quarter.

We paid an aggregate premium of $7 million to retire these bonds.

Overall, our capital position is very strong and adequate to support the needs of our businesses.

Let's move on to the expense actions.

Consistent with our previous discussions, we continue to drive expense initiatives, which we expect to yield approximately a $300 million year-over-year reduction in healthcare operating expenses in 2004.

For the first half of this year, healthcare operating expenses were $149 million or 9% lower than in the first half of 2003.

I would like to emphasize that our expense reduction initiatives are not a one-time exercise.

We will continue to pursue opportunities to improve productivity and reduce operating expenses in order to improve our competitive position.

Turning now to the outlook for full year 2004.

Consistent with our normal practice, I will provide estimates of income from continuing operations before realized investment results and special items.

Realized investment results in 2004 include amounts related to the sale of our retirement benefits business.

Relative to the outlook for healthcare, I will start by observing that our pricing and underwriting is strong.

We are making good progress in improving healthcare's fundamentals, including medical management, expenses and service.

The pricing environment continues to be challenging, particularly in the middle market, where we have seen episodes of very competitive pricing.

Want to stress that we intend to maintain appropriate underwriting discipline.

With respect to membership, as Ed mentioned, our outlook for year end 2004 is for membership to be approximately 17% below year-end 2003.

June 30 membership was 13% below last year end.

We estimate that membership declined an additional 1.5% in July.

Taking into account uncertainties relative to the pricing environment, and the fact that a number of national accounts are currently in the decision-making process, it is premature to provide specific membership projections for 2005.

Directionally, we expect some continued downward pressure on membership next year.

Turning to the earnings outlook for Healthcare.

We've increased our full year earnings outlook for the healthcare segment to be between $580 and $610 million.

This increase reflects the favorable prior-year claim development in the second quarter.

When we discussed the outlook in our first quarter call, we estimated that our healthcare earnings for the second through fourth quarters would be, on average, in line with our first quarter run rate of $125 million.

The $125 million included $5 million in earnings for the the disability and worker's comp case management services, which are now reported in the Disability and Life segment.

Thus, our first quarter run rate and the average quarterly expectation for the balance of the year, which we discussed in April, was $120 million on our new reporting basis.

Now, looking at second quarter earnings, excluding the $50 million in prior-year claim development, our underlying second quarter run rate was $125 million.

This is in the middle of the estimated range which we provided in April, taking into account the reporting change.

Our outlook for Healthcare earnings in the balance of the year is consistent with our April estimates.

Specifically, the midpoint of our full-year outlook implies earnings of $240 million in the balance of the year, or on average, $120 million per quarter.

As to the distribution of the $240 million between third quarter and fourth quarter, we expect third quarter to be somewhat higher and fourth quarter to be somewhat lower.

This pattern reflects the impact of increased investments, which we intend to make in product and service capabilities, and the impact of lower fourth quarter membership.

So, to recap, our full year healthcare earnings outlook is consistent with our April estimates, taking into account favorable prior-year claim development in the second quarter.

Turning now to the balance of our reporting segments.

We would expect our other businesses to contribute approximately $255 million to $265 million of earnings in 2004.

This updated range is higher than our previous estimated range and reflects higher earnings expectations for our disability and life and international businesses, both of which are performing well.

We also expect somewhat higher amortized gains in the runoff retirement segment.

So, putting together all the pieces, our consolidated outlook for full year 2004 is between $835 million and $875 million.

Our earnings per share for the year will be impacted by the amount and pace of share repurchase.

As we've said before, we plan to take a measured approach to share repurchase.

And, consistent with our past practice, we do not predict the pace of repurchase and our EPS estimates do not reflect the impact of any future repurchase.

And on this basis, our estimate of full year earnings per share is a range of $5.95 to $6.25.

Turning to the third quarter of 2004.

We expect our healthcare segment to generate between 120 million and 130 million in earnings in the third quarter.

Consistent with my comments about the quarterly earnings patterns assumed in our full-year outlook.

Relative to our other reporting segments, we expect that, in total, they will contribute between $55 million and $65 million in the third quarter.

In summing the pieces, our consolidated outlook for 2004 is to be between $175 million and $195 million in earnings.

Excluding the impact of any additional share repurchase in the third quarter, our estimate of earnings per share for the quarter is a range of $1.25 to $1.40.

For the recap, our second quarter results were strong.

The year-over-year increase was driven by solid execution in healthcare, including medical management results and operating expense reductions, and by continued strong results in our other businesses.

Our full-year outlook has increased as a result of favorable prior-year claim development in healthcare, as well as higher earnings expectations for our other businesses.

With that, I will turn it back to Ed.

Thanks, Mike.

Let me now offer a few additional observations on our results for the quarter, as well as additional perspectives on our healthcare improvement efforts, including actions designed to improve membership results.

Results for the quarter were very strong, as we've said, for all of our employee benefits businesses.

As Mike indicated, our balance sheet and capital position are solid.

Our core healthcare results were strong for the fourth consecutive quarter, demonstrating the significant progress we are making in executing on the fundamentals of this business.

We continue to expect additional improvement in medical cost management, operating expense productivity and ultimately, in membership growth.

Let me spend a few minutes on the status of our improvement efforts.

As we've noted previously, improvement efforts in our healthcare operations are focused on four key areas.

These include reducing medical cost trend, delivering quality service, reducing operating expenses and improving membership results.

We've made very good progress in a number of these areas.

Let me review progress in each, starting with medical costs.

Our second quarter results showed continued progress in this area.

Our efforts to improve medical costs are focused both on improving utilization trends and slowing the pace of unit cost increases.

Our medical management model continues to drive improved utilization results, while delivering superior quality outcomes.

As Mike noted, inpatient utilization declined during the first half of 2004, and this follows solid improvement in the second half of 2003.

Importantly we are achieving the improvements in utilization at the same time we are leading our major competitors on quality indicators.

Specifically, CIGNA ranks highest of its primary competitors in eight of nine key HEDIS effectiveness of care measures.

In addition, 100 percent of our health plans are NCQA rated, with over 70% receiving the highest possible rating of excellent.

Also, NCQA recently gave one of our behavioral healthcare centers a perfect score.

NCQA cited major strength as "effective integration of depression prevention into disease management programs, a novel open access program promoting positive enrollee and provider relations, and a strong and unique network of crisis stabilization experts."

These results represent important validation of our competitively strong clinical management, quality and integration capability.

Turning to unit costs, we continue to make progress on our unit medical cost initiatives as well.

As we've previously indicated, we are working to renegotiate contracts with our 250 largest hospital systems.

We continue to expect that we will renegotiate 50% of these contracts in 2004 and the remainder in 2005.

Our re-contracting efforts are contributing to a moderation in medical cost trend.

We continue to expect that our re-contracting efforts will contribute 100 basis points to our expected year-over-year decline in the fully insured commercial HMO trend.

In addition to renegotiating existing contracts, our contracting staff has been working to expand our physician networks in certain geographic markets.

As one example, we've added approximately 3500 physicians to our network in the greater New York area At the same time, our contract standardization efforts are helping us to continue to improve service levels and shorten the cycle of time for paying claims.

Our second area of focus is service.

Our member service metrics across the board are fully competitive and continue to improve.

These improvement are driven by strong execution, as well as our new, more efficient service and technology platforms.

We now have approximately 70% of our medical members on these new platforms.

Our July conversions of members to the new platforms went well, marking eight consecutive quarters of successful migration of customers to our new, more efficient service infrastructure.

We expect our service levels to continue to improve as we complete the migration of members to the new platform and drive further productivity and administrative efficiency.

With respect to administration-- or, administrative expenses, Mike highlighted the results we are seeing from our expense reduction initiative.

We continue to make good progress on this front and, as previously noted, we have made the drive for continuous productivity improvement an ongoing part of our business.

As we complete the target reduction efforts for 2004, we are also looking to identify further actions for 2005 and beyond.

As we have previously indicated, our expense reduction actions allow to us make significant investments in our product portfolio, service and technology capabilities, as well as our sales resources during the second half of 2004.

These investments are important to further improve our value proposition.

Moving on to membership.

As I said in my opening remarks, we have made significant improvements in the fundamentals of our business in the areas of medical cost trends, service and administrative expenses.

These improvements are an essential foundation for us to improve membership.

That said, medical membership remains the final step in our successful turnaround.

As noted, we now expect membership to be down approximately 17% for the full year 2004.

Improving membership is now the primary focus area of our healthcare turnaround.

The key to improved membership is, first and foremost, strong execution of the fundamentals of our business, medical cost management, service delivery and administrative costs.

As I've noted, we've made solid progress in these areas and I believe we have a very competitive value proposition for both existing customers and new customers.

And we've also had some encouraging signs, particularly the July 1 renewal period.

As I noted, our July retention rates improved meaningfully, in the mid-80% range for our regional segment.

We also saw an increased flow of new business opportunities, as we had expected.

Our close ratios on this business are not yet as strong as we want, and the market environment has some impact on close ratios, obviously.

In addition we are working to more effectively demonstrate our very strong capabilities to customers and intermediaries, as a means of improving our close ratio.

All in all, we are encouraged by the July 1 middle market experience, while recognizing there is much more to do to achieve acceptable growth rates.

It's too early to project 2005 membership levels, as we are in the midst of the 01/01/05 decision making cycle for national accounts and we are in the very early stages of middle-market selling.

While we are working hard to increase new sales, we will not sacrifice appropriate underwriting or pricing discipline to do so.

And, given the current market conditions, as we said, we expect to experience some additional downward pressure on membership in '05.

We are pleased with the improved fundamentals in our business.

They reflect solid execution of our turnaround plans and have materially improved the margins of our book of business.

We've established a very solid foundation which we will supplement with further investment in our sales, product and service capabilities to improve our membership position.

In our sales organization, we are redeploying and adding resources to our sales, client management and marketing units.

We've expanded our customer and producer communications and we have enhanced our sales training program.

On the product front, we've introduced a very innovative suite of products for January 1 of '05.

The Signature product suite provides employers with strong, cost-effective options in the areas of medical management intensity, health adviser services, network options, funding alternatives and consumer-directed plans.

Our consumer-directed plan, called CIGNA Choice Fund, is being well received in the marketplace.

Our partnerships on this plan with Yahoo and J.P.

Morgan position CIGNA to provide one of the market's premiere consumer-directed products.

In aggregate, we firmly believe all of these actions will improve our membership results.

Now to turn our attention back to the quarter, our results for the quarter reflect a continued improvement in the healthcare business and strong profitable growth in our disability and life and international businesses.

Our outlook for the remainder of 2004 reflects continued solid execution of our improvement initiatives, partially offset by the impact of lower membership.

Our capabilities and financial position remain strong.

We remain confident that our improving fundamentals and our investments in expanded sales resources, products and services, will ultimately drive profitable growth.

This concludes our prepared remarks, and at this time we'd be happy to take your questions.

(Operator instructions) And one moment please, for our first question.

We'll go first to Josh Raskin with Lehman Brothers.

Hi, thanks.

Good morning.

Could you just review the cost trend expectations that, Mike, that you were running through, if there's any changes in those expectations, maybe by product, even, versus what we saw three months ago?

Sure, Josh, it's Mike.

Relative to the full year outlook for 2004, we continue to expect our ASO- HMO book of business to have a year-over -year medical cost trend in aggregate of 11%.

The commercial HMO trend that we are now projecting is in the 12-13% range.

That's higher than what we had talked about at first quarter.

Now, some of that relates to the fact that we now have a better baseline, a better starting point, if you will, in terms of full year 2003 to start off of.

So, that's a portion of it.

The other portion, relative to what we talked about at first quarter, is that we are now expecting a somewhat higher pharmacy trend for commercial HMO.

Those are the major drivers.

And you went through the reasons for the RS.

What was the expected trend on the commercial HMO?

Was that the 11-12 last quarter?

Last quarter-- for pharmacy in particular or for overall?

For overall commercial HMO.

Overall, for commercial HMO we had been expecting 11% and now we are expecting 12 -13%, again , a combination of the revised starting point and some higher other trends that we've talked about.

Okay, and then just one follow-up question.

The favorable mortality, it wasn't necessarily a trend that had been seen by others in that line of business.

Just wondering, is there anything that caused the deviation from industry, and is this a temporary blip or should we expect continued strength in the Disability and Life segment because of this?

Well, first off, to answer the last part of your question, we do expect continued strength in our group insurance operations, and in our Disability and Life business in particular.

I wouldn't necessarily take the second quarter and extrapolate it for the second half of the year.

But if you look at the combination of the first and second quarter, we do expect a continued good pattern of group insurance earnings for the second half of the year.

On the mortality results themselves, obviously, we have been focused on that business for a couple of years.

I'll tell you, mortality tends to bounce around, even in a book the size of ours.

So I wouldn't get overly carried away with one particular quarter or one particular comparison versus competition.

Okay.

So you're still expecting-- your guidance is based on a more normalized number?

Yes, that's correct.

Okay, and then just -- I'm sorry, the last follow up on the first question that I had asked.

How do we think about favorable prior-period reserve development, despite an expectation of higher costs now, versus what we were seeing three months ago in the commercial HMO book?

Well, the way I would suggest that you think about the favorable prior-year claim development is that we obviously made estimates around the 2003 medical cost level.

As experience has emerged, it's emerged at a better rate relative to those estimates.

So, as a result with the benefit of hindsight, our medical management results improved at a faster clip in 2003 than we had originally estimated.

Now that doesn't materially change-- or, in and of itself, it doesn't change our point estimates for how 2004 claims are running.

That's based more on the fundamentals of medical management and the provider contracts that we have.

Got it.

So the 2Q $50 million all related to '03 and before?

That is correct, Josh.

Okay.

Got it.

Thanks.

Thank you, Mr. Raskin.

We'll go next to Matthew Borsch with Goldman Sachs.

Hi.

My first question is on the healthcare earnings.

And I'm just trying to look at the run rate for fourth quarter.

It looks like it's about, as you alluded to, about $5 million lower than you previously said to expect.

I'm trying to understand how much of that relates to the lower membership and how much of it relates to the investments that you talked about making in the fourth quarter?

Obviously, from our standpoint, I realize it's too early for guidance on 2005.

But if we are looking at that as a run rate and then you're expecting some continued downward pressure on enrollment in 2005, that might lead some of to us look at a lower healthcare earnings number going into next year.

Matthew, it's Mike.

First, you're absolutely right.

It is premature to talk about earnings estimates for 2005.

The implied range for fourth quarter, which, if you do the arithmetic for healthcare, is $105 million to $125 million earnings.

The width of that range, that $20 million range, connotes the fact that there are several moving parts in there.

For example, medical costs are obviously a moving part.

As you alluded to, we are consciously making investments in product development in particular.

And also, as you correctly alluded to, the membership outlook is also a moving target for us.

Again, we will obviously have a clearer view on fourth quarter by the time we get to reporting third quarter results in 90 days.

But I would suggest it would be inappropriate to take the fourth quarter number and annualize it as a starting point in 2005, given the moving parts that I talked about.

Okay.

And is the second question-- on the enrollment front, how do you-- there seems a little inconsistency, at least from my standpoint, in the observation you made about the July retention coming in perhaps better you expected, and yet seeing perhaps continued downward pressure in 2005.

I'm just trying to sort of square those two observations.

Matthew, it's Ed.

I think the way I would answer that is to say, first, we are very encouraged by what we saw in July, and I think that's reflective of all the actions we've been taking through the first half of the year.

I think the comment relative to next year is purely around the market environment.

And recognizing that, we are not going to change our philosophy, relative to the pricing and underwriting discipline we think is so important here.

We do expect retention rates to be better.

But the flow of new business and the close ratios on that business are a little bit difficult to predict right now, because we don't know exactly what the market environment's going to look like over the next, let's say four or five months.

So that's really why we are making that statement.

Got it.

I'll get back in queue.

Thank you.

And, Matthew, just one other thing on Mike's response relative to the fourth quarter.

We have to remember when we do the comparisons to what we have provided previously, you have to make the adjustments for the disability business transferred out there to get an apples-to-apples basis.

Right, that's why I said $5 million, not $10 million.

Okay, good.

Thank you, Mr. Borsch.

We'll go next to Charles Boorady with Smith Barney.

Yes, good morning.

And Ed, I'm encouraged to hear about continued pricing for margin instead of market share gains.

And in that regard, can you share with us what you see as a target level of profit margin percent for the Healthcare business?

In other words, the 5.8%.

Where do you see that going, ultimately, once the turn around is quote, unquote, "complete?"

And maybe you'll share with us where it has been, apples-to-apples, with your new method of reporting?

Well, Charles, I think, first of all, the 5.8 or 5.9 in the second quarter, I don't think that's as high as we have seen previously in our history.

But it obviously reflects a significant improvement that has been growing over the last several quarters.

We are, as you suggested, very committed to maintaining a price for margin.

We think that's most appropriate to ensure that the quality of the book of business we have is strong.

As we've said before, we believe over time we should be able to generate margins in this business that look more like what we saw historically and that's clearly the objective we have.

How quickly we return to that, I think is difficult to predict right now because the marketplace is quite challenging.

What is that historical number, just given there's a new break-out in terms of spiking out the disability, for example?

And so was-- is 10% or 7% what's roughly that historical number that we should think about?

What I would suggest that you think about is our overall healthcare earnings per member, and compare that to both what we have had historically as well as what our competitors make.

I think that's a more relevant measure, given the mix of business, than profit margin.

On that basis we will end up this year, we expect at this point, approximately $60 a member.

If do you that same calculation on our competitors, the best in class competitors are obviously higher.

And we would expect to improve our results over time, particularly as we get through the transformation work and get our operating expense productivity back to where it should be.

Understood.

But my follow up, just kind of related on the hospital re-contracting and cutting the 100 basis points from the trend, can you explain where that 100 bips would come from in terms of-- is it on the price or utilization side, or is it cutting out some high-cost hospitals from your network, et cetera?

Charles, it's David.

Talking about the100 basis points coming out, it's 100 basis points on unit cost, year over year.

We talk about the 250 facilities, it's hospital systems, so it's just shy of 900 hospitals.

And as we go through the renegotiations, it's specifically seeking to decrease the rate of growth of the unit cost reimbursement, both inpatient and outpatient.

As you know, when you are renegotiating with facilities, you are renegotiating both inpatient and outpatient unit costs.

So it's unit cost specific, and as we go through that, facility re-contracting.

Okay, terrific.

Did anything keep you from buying back more stock in the quarter in terms of quiet periods since the sale was complete of the retirement business?

And should we use your quarterly share buy-back as a reasonable basis for projecting your buybacks going forward?

Charles, as I reinforced in my prepared remarks, our capital management strategy is unchanged.

And consistent with our historical practice, we don't comment on the share repurchase program and certainly don't predict the future amount and pace of repurchase.

Okay.

Thanks.

Thank you, Mr. Boorady.

We'll go next to Patrick Hojlo with Credit Suisse First Boston.

Good morning, guys.

A question for you on the run-off of the retirement business.

You actually report a number for earnings in that business that is a lot higher than I was looking for this quarter, and I believe other than you guiding for, from where you were looking, from $0- $5 million from earnings from that segment this quarter.

You got more like 29.

It looks like you have some acceleration in the amortization of the gain.

Can you explain that and explain also why you expect that to continue, which I believe you referenced in in your prepared remarks?

Yeah, Patrick, it's Mike.

It is the case that the overall gain on the sale of the retirement business is higher than what we had previously estimated.

I cannot emphasize enough, the accounting for this transaction is very complicated and there are a lot of moving parts.

But the overall gain is higher.

The gain that we took immediately on April 1 was higher and the deferred gain recognition is, as you noted, is also higher.

For the balance of the year, what I would suggest that you think about is, for the second half of the year, we are expecting an amortized gain in aggregate of about $30 million after tax.

And that would be higher in third quarter than fourth quarter.

So call it high teens would be our expectation in third quarter and low teens in fourth quarter.

But a couple of other things I'd emphasize.

One is, there are a lot of moving parts here, so I would expect there will continue to be fluctuations in the pieces.

The other point I would reemphasize is that it does not change at all the economics of the deal.

The economics are consistent with what we've talked about in the past.

And the $20 million to $25 million of residual overhead is running off as expected?

The residual overhead that ends up being allocated to corporate is a little better than we had expected, meaning the earnings drag there is a little lower than we expected.

We had a $5 million after-tax impact in second quarter.

We would expect that to improve over the course of the year and then disappear once we get into 2005.

So just to make sure I have it right, you were guiding for $0 to $5 million profit in the segment this quarter, and instead you got $30 million, right?

Because of the acceleration of the amortization?

That's a portion of it.

I would also say that, remind you that the $5 million of residual overhead is in corporate, not in the runoff retirement segment.

So, if you wanted to mentally put that $5 million back to the $29 million, you'd want to make that comparison versus the 0 to 5 that I talked about last quarter.

Okay.

Fair enough.

Hospital utilization, I don't think you gave that yet, it was negative 5% last quarter.

What was it this quarter and what's your guidance?

Let's see.

The hospital utilization for first quarter ending up emerging to -4 rather than -5.

We had estimated -5 and it ended up being -4.

For second quarter for commercial HMO, it ended up being -3.

Or, at least that's what we estimate at this point, and we would expect for the remainder of the year to be pretty close to -3.

So we would expect for the full year 2004 inpatient days to be 3% lower per member for our commercial HMO book versus last year.

Okay, and just to confirm, once again on the first question, your raised guidance at this point is entirely due to the prior trade development in the healthcare business and the incremental earnings from the runoff retirement business.

Is that fair?

That's not quite fair.

The group insurance and international results are a little better as well.

Okay.

Fair enough.

Thanks, guys.

Thank you, Mr. Holjo.

We'll go next to Joe France with Banc of America Securities.

Thanks.

I just wanted to verify in your prepared remarks, when you talk about enrollment, it appears that you're saying that you lost about 110,000 lives in July and that you are looking for losses totaling about half a million lives in the second half of the year.

Is that correct.

I think, generally speaking, that's about right.

We said about 150 basis points further drop for July 1 and we said that would take us to about 14.5, I think, or so, and we said 17 for the full year.

Joe, it's Mike.

So that would mean August through December would be down 2.5% which is about, call it 250,000.

Okay.

And that assumes 80% retention the rest of the year?

No, it's more precise than that.

We obviously have factored in, for example, the loss of a significant state account.

We are assuming that loss effective October 1.

The persistency for the-- for August through December includes that known cancellation.

We've also got more small cases that typically renew in that period, which have lower persistency.

So, again, it would it not be in the 80s for that period.

Okay.

Just one related question, then.

What percentage of the business renews in July and what percentage in total renews in the second half of the year?

Let's see.

In the second half of the year, 25% of our overall book renews, and that's split about half and half, July versus August through December.

Thanks, Mike.

Thank you, Mr. France.

We'll go next to Christine Arnold with Morgan Stanley.

Hi.

My first question relates to cost trends.

You had been expecting 11% trend.

Now you're thinking it's 12% to 13%, and part of that was the movement in last year's trend, which, in retrospect, because the favorable development was positive.

What was your 2003 medical cost trend in retrospect versus what you thought it was?

Christine, it's Mike.

To the nearest integer, the 2003 trend was 14 rather than 15, which is what we had originally estimated.

Okay.

So that's a point and then that will get you from 11 to 12, and you are saying, 11 to 12 to 13.

So the rest of that is drug?

We expect that the-- for commercial HMO, the pharmacy trends to be a little higher and also higher inpatient costs.

Those are the two reasons we are in the 12-13% range.

Is that that inpatient utilization or is it the re-contracting that's causing the inpatient a little bit higher than you previously expected?

I will start and ask David if he wants to add.

It is driven by higher unit costs, as compared to what we had expected.

I would not blame that or attribute that, though, on the re-contracting effort.

David, you want to add some additional color?

Christine, the expansion on that would be for the small portion that drives the total cost trend, as you identified, it's really the mix in utilization resulting in higher cost per day.

As we, for example, as we've indicated as we worked to remove one day stays, inappropriate one day stays from the system, those are lower average cost per day.

The resulting days have a higher average cost per day.

Secondly, we have some geographic or utilization mix shift.

So average cost per day driving up the unit cost piece of the equation.

Okay.

And you said you're seeing price competition in mid market.

Are you seeing price competition on the self-insured book?

I am trying to get a sense for your guidance that '05 enrollment might be down.

You know, kind of where?

Is it experience rated, fully insured, self insured?

Yeah, Christine.

I think that-- I don't think we can be as explicit as which particular product.

I can answer your question, though.

I think the marketplace is generally reasonably competitive.

I would say episodically, you see more aggressive competition.

I wouldn't say it is blanket, across-the-board, every-market, every-product.

But what you will see is some markets being more competitive than others, and then you will see episodically some competitors being much more competitive.

Not necessarily consistently, but when they choose to be.

My last question is the retirement gain.

It looks like it is going to be bigger, the amortized gain on a quarterly basis, than you previously expected.

What happens to that gain, roughly speaking going into '05?

Does it remain stable, does it fall a lot?

Christine, it's Mike.

I would expect that the amortized gain will be lower in '05 versus the comments I gave Patrick a minute ago in terms of thinking about it as low teens in fourth quarter.

So I would expect it to be lower than the low teen rate extrapolated into '05.

Thank you.

Thank you, Ms. Arnold.

We'll go next to Doug Simpson with Merrill Lynch.

Hi, good morning, everyone.

Are the Q1 and Q2 cash-flow statements comparable or is there any impact there from the Pru sale?

I would say yes and yes.

Doug, it's Mike.

Yes, there are impacts from the Pru sale and, yes, they are comparable.

Okay.

It's-- you know, we talked about this in the first quarter, you have this-- I guess now the number is 954 for the proceeds from the sale to the securities behind the pension policy holder stuff.

If you pull that out it looks like year to date cash is about 309, adjusted for that.

So if the math is correct, it looks like operating cash flow in the quarter was about $18 million.

Is that right?

Doug, that is correct.

Now I would emphasize, to give you context here, our parent company cash-flow and liquidity is by a wide margin the more meaningful metric, particularly given our business mix and structure as a company, and that obviously continues to be very strong.

As I've said before in prior conference calls, I would really urge you not to overweight the GAAP cash-flow number.

There are a lot of moving parts in there that impact that number, and I will give you a particular example.

We have cash being paid out now that relate to earnings charges that were accrued in prior years.

So while you are right in terms of your arithmetic on the 18, just to give an example, we had a $70 million cash outflow in the quarter, related to the previously announced settlement of the provider class action litigation.

The majority of that 70 being amounts paid to attorneys.

So again there are a number of bouncing-around items that get picked up in that 18.

Just looking down the line items here, the one that jumps out is the insurances liabilities coming down by roughly 700 million.

I would suspect that as your membership is declining and you are paying our claims for prior periods for lapsed members, is there any way that you can characterize what the hit was from that type of activity?

Just directionally, how do you see, is there a reason to expect a sharp rebound in the gap reported operating cash-flow in the near term?

It's Mike, a couple things.

First as is consistent with our historical practice we don't project the future changes in GAAP cash-flow.

But in terms to give you some thoughts on how you might want to think about it, included in our press release is the reserve balance change for our insured healthcare coverage.

You can see in the press release that our reserve balance for that portion of our business declined from 1.88 billion, to 1.56 billion.

Now both numbers are on a consistent reserve methodology basis.

We also have communicated to you, We had earnings impact from the prior year claim development if you combine first and second quarter $80 million after tax.

So call that 120 pretax.

If you take that piece out you can see that our reserves versus year end declined by 11%.

If you compare that with the fact that for example our commercial HMO membership is down 23% and our overall membership is down 13, you can get a sense for the pattern.

The punch line is, there are a lot of moving parts here.

We especially spiked out for you specifically.

The prior year claim development and as a result we would hope that those moving parts that you would conclude the same thing that we have which is our earnings are of high quality.

Okay.

That's great.

Thanks.

Thank you Mr. Simpson.

Next, John Rex, Bear Stearns.

Good morning.

Could you just take us through specifically each of the four components of cost trends that you did last quarter so we can see how they move more specifically?

Sure, John.

David, you want to do that?

I will walk through the trends and similarly walk through the break out utilizations in unit costs.

Two caveats.

One is, I am commenting on our full risk book of business because we wanted to follow up on ASO book of business and I would note that right now that book is about 10% of our total membership, to put it into context, but we used that as the indicator.

For that book, our inpatient trend for the full year we expect to be at 12%.

Is that compared to the 8 to 9% last quarter that you talked about?

That's correct.

The out-patient trend we expect it to be 13 to 14%.

Consistent Professional, 10 percent, consistent.

Pharmacy, 18%, up from the 15% we talked about prior quarter.

And professional up, the range was 9 to 10 last quarter so just pushing at the higher ends of the range?

A slight uptick in the professional, specifically we have a little utilization pressure there but 50 basis points still at the high-end of that range.

The major drivers are inpatient and the pharmacy component.

As we made reference before, a big part of the driver in terms of the prior versus the current 11 to 12 to 13% is the restatement of the baseline.

I would also add, to remind you of context here, you can see in our said supplement, we've a 31% year-over-year decline in our CHMO membership.

So please recognize that given the magnitude of that change there is a lot of volatility in our mix.

So the trend numbers that David alluded to that we are expecting for the full year are based on PMPM measures.

I would just not suggest that you overweight the year over year trends given all the moving parts.

Okay.

And then could you take me through the utilization of pricing impact for each one.

Sure, for inpatient it's all unit cost which is consistent with the prior conversation.

Out-patient, 50/50, so split about equally between unit and utilization, professional, 75% of it's utilization, 25% is unit cost.

Pharmacy, about a third of it is utilization with two-thirds of it being unit cost.

That's a change from the last conversation.

The last conversation I had indicated that 25% of it was utilization, 75% unit cost.

That's where we see some of the pressure on the pharmacy side.

Okay.

Great.

If you were to take your commercial risk NCR and adjust the 1Q and 2Q for the prior year reserve developments, would it look essentially flat sequentially?

I mean close to flat sequentially?

It's Mike, reasonably close.

On a year to date basis, stripping out the favorable prior year claim development, it would be about 86% on an operating basis as compared to the 82.6% on a reported basis.

For the full year 2004, we do expect that will improve on an operating basis for the full year we would expect about 85.5%, which is consistent with what 2003 would be after pushing the favorable prior claim development back there.

Now, the reported basis for 2004 we would be expect it to be something in the high 83's. because of the favorable prior year development that has already occurred, but we would expect it to be flat at the end of the day ex the favorable prior year claim development.

In last quarter I think there was 11 million favorable in HMO, was any of that due to specialty, you didn't break out, that did you last quarter versus this year's quarter.

It was all commercial HMO.

What drove that in the specialty segment this quarter, which area?

Behavioral health operations in particular, and it's the same phenomena that we experienced in our healthcare business.

Okay.

Are you anticipating going forward is we would now expect the magnitude of these reserve development to come down significantly?

Obviously from prior year you should be done with that I would assume at this point?

First off we have not changed our reserving methodology.

Nevertheless I would be very surprised if we continued to have the same high level of favorable prior year development back to 2003 given that at this point, 2003 is largely complete at this point.

At this point would you put it 85% complete?

Or higher or lower.

I would guess higher but I don't honestly have that number right at my fingertips.

Great.

Thank you Mr. Rex.

Next, Ed Kroll with SG Cowen.

Good morning.

First, on the, just following up on that cash discussion before, did I hear you right that cash at the parent or free cash if you will at June 30 was 1.5 billion?

That's correct, Ed, cash and short term investments.

So excess resources at the parent company level that are not needed at the sublevel.

Okay.

Unencumbered.

Unencumbered.

Thanks.

What do you think ex buy back, take that out of the equation what do you think happens to that 1.5 billion between June 30 and December 31?

Sure, Ed.

There are obviously a lot of moving parts here but at this point we would expect that subsidiary dividend of between July 1 and year end would be in the neighborhood of 250 to 300 million.

So call it high two hundreds.

We would expect to pay approximately 50 million in dividends to our shareholders and interest to our bondholders in that same period, July 1 through December 31 and we would expect other uses at this point to net to approximately 50 million.

So we would expect to have between, call it 1.6 and 1.7 billion in resources directly available to the parent, which obviously is a significant amount of financial flexibility.

Yeah, I would agree with that.

So recognizing that you don't guide to anticipated buy back or bake that into your earnings guidance, certainly you have the financial wherewithal to execute a more aggressive buy back in the rest of this year than you did in the second quarter.

Thank you for your observation, Ed.

I would still say that as in the past we are not going to project the amount and pace of future repurchase.

Okay.

Thanks for that.

I guess my other question has to do with expense control and it sounds like you are on track for this year's target, the 300 million.

Can you give us, and it sounds like based on your comments, Ed's and the others, that there's an additional opportunity and I'm just wondering if you could in any way size that for us what you might be able to achieve in '05 and beyond, in any fashion would you choose just to give us some sense of how much more leverage there would be, in particular if once you stop, once you would stabilize your membership base.

Ed, I will start and I will invite Mike to add anything he'd like.

I am not going to try to dimension that economically for '05.

I think it's premature for that.

I think what I would say is that, consistent with my prepared remarks, as we've executed against the plans we have in place for '04, we continue to look for opportunities to continue to drive some of that efficiency through the organization.

In addition as we put more, as we complete putting the business on to the new platform, we get the productivity enhancement they provide us as well and also as we acknowledged on other calls we get the benefit of, as we turn those systems off, we get the benefit of that because clearly we are running some redundant costs today in terms of maintaining both the old legacy platforms as well as the new platforms.

We have, we believe good opportunities to continue to drive the efficiency in the organization.

Not easy but I think we are focused on it and I think we've executed through this year very well, Mike, do you want to add?

The only other piece I would add is just to remind everybody that we have consciously protected our service organization and protected our market facing areas with the expense reductions that we've done this far.

If I think about the components of our year over year expense reductions that will add up to 300 million, over half of those expense reductions are coming from the staff areas including the reconfiguration of the company operating model and market facing areas other than reducing variable expenses to reflect the membership decline we've really protected those areas.

So as Ed mentioned there are opportunities further down the line particularly with the productivity improvements once we get through transformation and also the shut down of the legacy systems that Ed mentioned.

Not to mention the fact we know on a PMPM basis, the market facing areas are a higher level than what they've been the last couple years.

Thanks for that, for those answers.

Just to follow up, the redundancies that you mentioned on the systems, have you started to unwind the legacy systems at all or is that, is all of that redundancy still on the come?

Well at this point we have certainly done a lot of the foundation building to figure out how exactly we are going to do this but we have not, we've literally not unplugged any of our significant claim systems at this point.

So those savings are yet to come.

Right.

Thank you.

Thank you Mr. Kroll, We will go next to Scott Fidel with J.P. Morgan.

Hi, thanks, good morning.

Just wondering if you could touch a little bit on some of the regional variation that you might be seeing right now in your performance, particularly relating to the earnings and then also some of the membership attrition.

Also specifically I was wondering if you might just touch on three of your primary markets, the New York market, Texas and California.

Thanks.

Scott, this is David, I'll start.

Consistent with our prior comments we had indicated that if there was geographic concentration at all, number one, we had some challenges within parts of the west and parts of the southwest.

That picks up a little bit of your Texas comment specifically as relates to membership growth.

Secondly we had indicated that we have consistently seen some more pronounced pricing pressure or competitive pricing pressure in the tri-state region and tri-state marketplace and that's been pretty consistent.

As you'd expect our membership performance based on those comments is a little more muted in those regions of the country, specifically the west and parts of the southwest, Texas, and then the pricing pressures made the sledding a little more difficult in the tri-state reasons over the past full year business cycle.

Just can you add color on California as well?

California would be included in my comments of the west.

California is a pretty diverse and broad marketplace so southern tip versus LA proper versus northern California, a different profile but we would put California in the category of having some membership pressure, a little bit worse than the rest of our book of business.

So when I make the West comment, that and southwest Texas would be two examples.

Just a follow-up question, just in terms of on the renewals, what you are seeing in terms of employer interest on benefit buy down levels, are you seeing still as you're getting into your '05 negotiations, similar levels of buy downs or are you seeing signs that some of that momentum in buy downs might be mitigating a little bit at this point?

Yeah, I will start and turn it back to Ed.

Relative to the buy down levels you are, our ASO book, specifically within the national account portfolio, we've been pretty aggressive and proactive positioning continuing around management buy down.

And specifically, I'd indicate good planful thinking over a several year management movement, buy down is even too broad of a phrase, so benefit strategies over a two, three-year horizon, for example as we seek to bring in consumer and consuming directed products.

So one, real aggressive, very proactive

In a multi-year view in terms of benefit buy-down.

As you come down the middle market segment and upper ends of the small segment the marketplace continues to be pretty aggressive in terms of its use of benefit buy downs, as well as it's considerations of alternatives.

For example in the case of pharmacy, if the co-pay, three-tier co-pay opportunities have run their course, now there's some receptivity to converting to co-insurance plans, additionally there's some interest in terms of looking at consumer directed .

So generally speaking, good receptivity, a little different in the national account multi-year planning, appropriate prudent multi-year planning in terms of benefit buy downs is how I would characterize it.

So it's safe to assume that the higher RX trend that you're talking about, doesn't really have to do with just less buy down at this point, just more other factors?

The higher pharmacy trend that Mike made reference to was pronounced in our full risk block of business, that 10% of our portfolio that is full risk, which as you'd expect is more middle market and small segment.

For our ASO block of business, our pharmacy trends actually performed quite well and that's an area where we actually saw progress with in preactivity from the employers in terms of continuing to drive benefit buy down or benefit lien ins, ultimately generating a little bit better cost share with their employees on the pharmacy plan.

Okay.

Great.

Thank you.

Thank you Mr. Fidel.

Eric Veiel with Wachovia Securities.

Mike, why, if I just calculate this math real quick, why did the indemnity business on a sequential basis, membership looked like it was down 3.4% but premium and fees were down by about 6.7%?

Eric, I'll have to follow up with you with the detail on the specifics there.

I'm sure it has to do with the mix of business fully insured versus ASO.

And the pieces. but why don't we follow up with that offline

Alright.

I'll call you.

Thank you Mr. Veiel.

We'll go next to Michael Baker with Raymond James.

Two quick housekeeping items.

What are your thoughts with respect to the blended tax rate for '04?

And where did the debt premium flow through on the income statement?

Michael, it's Mike.

Take them in reverse order.

First on the debt premium that shows up in corporate, it had an after tax impact of, a hit of $5 million in second quarter earnings.

The tax rate I would not expect, I don't have a specific number for you, I would not expect it to be materially different than what we've seen in the past.

Thank you.

We'll take our final question for the day from John Szabo with CIBC World Markets.

Thanks, good morning.

I had a question I guess last week, Express Scripts mentioned that it was a subcontractor to CIGNA on the account that apparently is a focus of this lawsuit that's going to be filed today.

Are you going to be a party to that lawsuit and is there any potential liability there?

John, it's Ed.

Regarding the dispute with express Scripps and the New York AGs office, two of our subsidiaries along with Express Scripps did receive notice of proposed litigation.

It's a little early to know exactly what our engagement is going to be here.

Express Scripps is the PBM for the entire Empire plan.

We are the insurer and reinsurer but the way the contracts are structured they are a subcontractor of us.

We believe that the dispute revolves around Express Scripps administration of the PBM plan and not with our role as the insurer/reinsurer.

So that's where we fit it today.

Did you have any role in setting the particular formulary or preferred drug list for that account?

We function as the insurer here for the program and the program is administered by Express Scripps.

Okay.

So you would not expect then to be the target then of this lawsuit?

No.

We believe that the allegations here relate to Express Scripps administration of the program.

In fact, that's what I think was documented this morning in an article that I saw.

All right.

Okay.

Thank you.

Thank you, ladies and gentlemen.

This concludes CIGNA's second quarter 2004 results review.

CIGNA Investor Relations will be available to respond to additional questions shortly.

A recording of this conference call will be available for ten business days following this call.

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Thank you for participating.

We will now disconnect.