信諾集團 (CI) 2004 Q4 法說會逐字稿

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  • Operator

  • Ladies and gentlemen, thank you for standing by for CIGNA's fourth quarter 2004 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.

  • If you should require assistance during the call please press star 0 on your touch-tone phone.

  • As a reminder, ladies and gentlemen, this conference, including the Q and A session, is being recorded.

  • We will begin by turning the conference over to Mr. Tim McGarrity.

  • Please go ahead, Mr. McGarrity.

  • - Investor Relations

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

  • I'm Tim McGarrity of CIGNA's Investor Relations department.

  • With me this morning are Ed Hanway, CIGNA's Chairman and Chief Executive Officer;

  • Mike Bell, CIGNA's Chief Financial Officer;

  • David Cordani, Senior Vice President of CIGNA HealthCare; and Jon Rubin, CIGNA HealthCare's Financial Officer.

  • Before we get into the main part of our call, Mike Bell will provide an overview of the actions we have taken regarding stock option expensing and the adoption of statement of Financial Accounting Standard, or FAS 123, share-based accounting.

  • Mike?

  • - CFO

  • Thanks, Tim.

  • Good morning, everyone.

  • In a few minutes we'll discuss our fourth quarter results.

  • And by way of overview, the quarter was strong and demonstrated continued progress in CIGNA HealthCare.

  • But before reviewing the quarter, I'll discuss 2 items related to share-based compensation.

  • First, I'll review our implementation of the new accounting standard, FAS 123; then I'll discuss a change in prior accounting related to certain stock option grants.

  • I would note that neither changes has any economic impact.

  • The first change is to implement the new accounting standard, which requires expensing of stock options.

  • In our fourth quarter reporting, we have implemented the standard and are restating prior reporting periods on that basis.

  • Since we have disclosed the impact of expensing options in our footnotes for sometime now, we do not view the impact of its implementation as new information.

  • When we file our 10-K for 2004 all reporting periods will reflect the new standard.

  • As a result, implementing now affords direct comparability of current and historical results.

  • Second, as part of our review of executive compensation programs and during the year-end closing process, we determined that certain stock option grants required variable accounting rather than the fixed accounting methodology which we had put in place in the mid-1990s.

  • This relates to an accounting interpretation under the old stock option accounting rules.

  • Upon review, we concluded that it would be prudent and appropriate for to us restate our financials under the old basis.

  • I would note that this accounting change has no economic impact and is a moot point under the new stock option accounting standard.

  • These accounting changes are summarized in Exhibit 3 of our press release and will be reflected in amended SEC filings which we expect to file later this month.

  • With that I'll hand it back to Tim.

  • - Investor Relations

  • Thanks, Mike.

  • For the remainder of this call we will review CIGNA's financial results for fourth quarter of 2004 and discuss our outlook for 2005.

  • First, Ed Hanway will discuss the highlights of 2004.

  • Mike will then discuss CIGNA's fourth quarter and full year 2004 financial results.

  • Mike will also provide CIGNA's financial outlook for first quarter and full year 2005.

  • David Cordani will then discuss our medical membership results and actions CIGNA is taking to grow membership.

  • Ed will conclude with a brief discussion of CIGNA's strategy and 2005 priorities.

  • We will then open the lines for your questions.

  • As noted in our earnings release, 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 investments results and special items, which may include unusual charges and gains as the principal measure of performance for our operating segment.

  • This measure is most directly comparable to the GAAP measure income from continuing operations.

  • Please see note 3 of today's press release which is posted in the Investor Relations section of CIGNA.com for a discussion of these matters.

  • In reporting fourth quarter financial results CIGNA made certain format changes to the earnings release and quarterly statistical supplement.

  • These changes included the elimination of the HMO and indemnity distinction for HealthCare segment earnings, revenue, and membership.

  • Also, in Exhibit 7 of the statistical supplement, we added an expanded analysis of HealthCare revenue.

  • We also modified Exhibit 8 to provide medical membership by funding arrangement.

  • We ask that you save detailed questions related to the new reporting format for after the call, as they may not be of interest to the broad audience on this call.

  • Before turning it over to Ed, there are a few special items that I would like to cover pertaining to our fourth quarter results.

  • First, I would note that CIGNA's earnings release details 4 special items which are excluded from income from continuing operations before realized investment results and special items.

  • The first special item is an after-tax gain of $141 million related to the accelerated recognition of a portion of the deferred gain on the sale of CIGNA's retirement benefit business.

  • The second special item is an after-tax gain of $28 million related to a federal tax settlement that occurred during the quarter.

  • The third special item is a net after-tax charge of $16 million related to the modified coinsurance arrangement resulting from the sale of CIGNA's retirement benefits business; and the fourth item is an after-tax gain of $12 million related to the sale of CIGNA's asset management subsidiary, TimesSquare, that closed during the fourth quarter.

  • These items will be discussed in further detail in CIGNA's report on Form 10-K, which we plan to file with the SEC in late February or early March.

  • In our remarks today, we'll be making some forward-looking comments.

  • We would remind you that there are risk factors that could cause actual results to differ materially from our current expectations.

  • These risk factors are discussed in Form 8-K, filed this morning with the Securities and Exchange Commission.

  • With that I will turn it over to Ed.

  • Ed?

  • - Chairman and CEO

  • Thanks, Tim.

  • Good morning, everyone.

  • I'm going to start the call today with an overview of the key highlights from 2004, and overall 2004 was a year of significant accomplishment for us.

  • We materially strengthened operating fundamentals for our HealthCare business, delivering substantial value to our customers and improvement in our earnings.

  • We also continued the strong pattern of earnings and revenue growth in our disability and life and international businesses.

  • And we have focused the Company on health and related benefits by completing the divestiture of the retirement business.

  • Our stronger market position and improved execution has clearly established the foundation for future growth.

  • Full-year 2004 earnings, excluding realized investment results and special items, were slightly over a billion dollars, a 36 percent increase over 2003.

  • Major driver of the improved earnings growth was very strong execution in our HealthCare business.

  • For example, the actions we took in medical management drove continued improvement in medical cost trend, providing a significant benefit to our customers and to CIGNA's earnings.

  • Improved performance in our HealthCare facilitation centers drove lower in-patient utilization, which actually declined 3 percent in 2004, and our recontracting efforts further lowered medical cost trends in 2004.

  • Last year our customers also benefited from a very strong service experience.

  • All metrics were strong with first call resolutions exceeding 90 percent, and customer satisfaction rates on our new platforms are now at 95 percent.

  • Consistent with prior expectations, we now have close to 90 percent of our membership on our in-state technology platforms.

  • Overall in 2004 we delivered very strong customer service.

  • In 2004 we also introduced the new and unique Signature suite of products, which includes our CIGNA Choice Funds consumer-directed option.

  • We have received strong positive feedback from producers and customers.

  • This product suite positions us well for future sales and improved customer retention.

  • We also maintained strong pricing and underwriting discipline during 2004 in the face of a very competitive marketplace.

  • Strong execution on our expense reduction initiatives helped us exceed our target of reducing HealthCare SG&A expenses by 300 million in 2004.

  • Now, all of these factors contributed to improved margins and a high quality book of business which is reflected in our HealthCare segment's earnings of 791 million in 2004.

  • On the membership front, as projected, our medical membership declined 16 percent for the full-year 2004, and between 8 to 9 percent in January 2005.

  • We continue to expect membership to be stable for the remainder of 2005, and we see very positive signs, particularly in middle market retention, sales pipeline, and close ratios.

  • Our other core businesses have continued to perform very well in 2004.

  • Our disability and life business posted full-year '04 earnings of 183 million.

  • That's a 19 percent increase over 2003.

  • These operations continue to deliver top quartile margins through strong fundamental execution and very disciplined pricing and underwriting.

  • Our products and service delivery in this business are competitively very strong.

  • We've added new sales and marketing talent and are achieving solid growth, particularly in the middle market segment.

  • Our international operations earned 76 million in 2004, a 52 percent increase over 2003.

  • Our expatriate benefits business continues to grow and provide strong results, and this business now covers over 170,000 members worldwide.

  • International life, accident, and health operations also posted strong earnings growth.

  • Overall, 2004 was a year of significant accomplishments, as CIGNA strengthened fundamentals and delivered strong earnings improvement in our healthcare operations while continuing to profitably grow our other benefits businesses.

  • Now, turning to the fourth quarter of '04 for just a moment, this quarter represented yet another milestone in our turnaround with our sixth consecutive quarter of meeting or exceeding our earnings expectations.

  • Again, this result was driven by strong execution in our HealthCare business and good contributions from our disability and life and international businesses.

  • So while we feel very good about 2004 results, we are committed to further progress in 2005, and firmly establishing CIGNA as a leader in the health benefit industry.

  • In my closing remarks, I will discuss our strategy for 2005 and beyond, which is to further differentiate CIGNA as a company with very competitive medical costs, superior clinical quality, and a leadership position in product innovation.

  • Our focus on enabling true consumerism and effective utilization of clinical information positions us well to deliver on this strategy.

  • Now let me turn it over to Mike for details on the fourth quarter as well as our 2005 outlook.

  • Mike?

  • - CFO

  • Thanks, Ed.

  • I'll now review CIGNA's fourth quarter and full-year 2004 results, also discuss our outlook for 2005.

  • As Tim noted, our fourth quarter results reflect several special items.

  • These matters are discussed in our earnings release and will also be addressed in our 10-K.

  • In my review of consolidated and segment results, I'll comment on income from continuing operations before realized investment results and special items.

  • The results I discuss will include the impact of implementing the new accounting standard for stock options.

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

  • Overall, our fourth quarter and full-year earnings were significantly higher than in 2003.

  • These results were driven by strong earnings growth in our healthcare, disability and life, and international businesses.

  • Specifically, our fourth quarter earnings were 323 million, or $2.41 a share; compared to 224 million, or $1.59 a share in 2003.

  • Our full-year earnings were 1.04 billion dollars, or $7.55 a share; compared to 764 million or $5.44 in 2003.

  • I'll now review each of the segment results beginning with healthcare.

  • Healthcare earnings in the fourth quarter of 2004 were 230 million, compared to 150 million in the fourth quarter of '03.

  • Full-year healthcare earnings of 791 million were significantly higher than our full-year 2003 results of 451 million.

  • This strong year-over-year earnings growth primarily reflected improved experience-rated and commercial HMO results, driven by lower medical cost trends, favorable prior year development, and strong underwriting execution.

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

  • Favorable prior year claim development for the full year was approximately $106 million after tax.

  • Full-year 2004 operating expenses declined by approximately 10 percent, driven by strong execution of our expense reduction initiatives.

  • Premiums and fees for the segment declined 12 percent in the fourth quarter and for the full year due to a 16 percent decline in membership, partly offset by price increases.

  • The 16 percent decline was consistent with our prior estimates.

  • I'll now provide an update on medical cost trends and premium yields.

  • To afford better insight into medical trends across our full range of product offerings, we will provide trade information for our total book of business.

  • This view is now particularly useful given that the industry has blurred the lines between what the market has traditionally called HMO and PPO products.

  • Full-year medical cost trend for our total book of business was approximately 8 percent.

  • The trend for our commercial HMO block, which now represents 9 percent of our total membership, was approximately 11 percent.

  • This result was 100 basis points better than the full-year estimate which we had previously communicated.

  • Full-year premium yields were approximately 12 percent for commercial HMO; and as a result, our full-year commercial HMO medical loss ratio improved relative to 2003.

  • Excluding prior-year claim development, the full-year commercial HMO medical loss ratio in 2004 was in the low 84 percent range.

  • Our experience rated margins increased significantly in 2004.

  • Strong underwriting and medical cost results drove fewer new account-level deficits as well as higher levels of deficit recovery.

  • As a result, earnings on our experience-rated book improved significantly relative to 2003.

  • Overall, our healthcare results were stronger than in 2003, reflecting continued improvement in medical cost management and in pricing and underwriting results.

  • Now I'll review the results for our other segments.

  • Fourth quarter earnings for the disability and life segment were $54 million, compared with 39 million in the fourth quarter of '03.

  • Full-year 2004 earnings of 183 million were 19 percent higher than the 2003 result of 154 million.

  • Our disability and life earnings growth reflected solid revenue results and strong underwriting performance.

  • Our competitively superior profit margins are driven by strong execution in disability management, pricing and underwriting, and operating expense management.

  • I would note that fourth quarter earnings included very favorable mortality experience in our group life book.

  • While we expect group life results to remain strong, we do not expect this level of mortality to continue.

  • In 2004, our revenue growth reflected solid sales results and strong persistency.

  • We continue to see stronger growth, particularly in the middle market segment.

  • Turning now to the international segment, 2004 results demonstrated another year of strong earnings growth.

  • Fourth quarter '04 earnings were 18 million compared to 14 million in '03.

  • Full-year 2004 earnings were 76 million versus 50 million in 2003, and this 52 percent increase reflected strong revenue growth and profit margins in our life, accident, and health, and expatriate benefits businesses.

  • In aggregate, the remaining operations included runoff retirement, runoff reinsurance, other operations and corporate generated 21 million of earnings in the fourth quarter.

  • The runoff retirement segment earnings for the quarter primarily reflect the amortized sale gain, which was $15 million.

  • The accelerated portion of the sale gain due to contract novations was 141 million in the fourth quarter, and this was broken out as a special item in our reporting.

  • Fourth quarter earnings in the other operations included approximately $40 million of favorable impact from reserve changes for our leverage corporate-owned life insurance book.

  • We do not expect this level of earnings to recur in 2005.

  • Fourth quarter results in corporate included 9 million of stock option expense, resulting from our implementation of the new accounting standard.

  • Now, before providing our outlook for 2005, I'll comment briefly on our capital position.

  • Our parent company capital position continues to be strong.

  • Our subsidiaries remain well capitalized and are able to support their operations.

  • At the end of the fourth quarter, cash at the parent company was $1.5 billion.

  • We ended the quarter with a leverage ratio of approximately 21 percent, which is at the low end of our target range.

  • During fourth quarter, we continued our share repurchase program and repurchased 2.7 million shares of our stock for approximately $200 million.

  • In January of 2005, we repurchased an additional 590,000 shares for $48 million.

  • We have approximately 830 million of remaining repurchase authority at this time, which includes an additional 500 million authorized by our board of directors last week.

  • I'll now comment briefly on the outlook for our capital position for 2005.

  • Consistent with prior quarters, we do not forecast the amount or pace of share repurchase, and, therefore, my comments will exclude the impact of any potential repurchase activity.

  • For the full year 2005, we expect our sources of cash at the parent company to materially exceed uses.

  • Specifically, we currently expect dividends from our subsidiaries to be in the range of 700 to $800 million.

  • We expect interest on corporate debt and other net capital uses to be approximately 100 million.

  • As a result, we expect to maintain a strong and flexible capital position through 2005.

  • I'll now review the earnings outlook for the full year and for first quarter of 2005.

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

  • The outlook I provide will include the impact of implementing the new accounting standard for stock options.

  • On this basis, we estimate full-year 2005 consolidated earnings to be in the range of 745 to $815 million.

  • Now, to allow comparison with the estimates that we've discussed previously, I would note that we estimate the full-year 2005 impact of expensing options to be in the range of 20 to $25 million after tax.

  • Therefore, on a comparable basis, our updated range of 745 to $815 million for full-year 2005 estimated earnings is approximately 15 million higher than the estimated range we provided in early December and 25 million higher than the estimates we communicated on our November call.

  • Our estimate for full-year healthcare earnings is in the range of 520 to $580 million, which is 25 million higher than the estimates we communicated in November.

  • With respect to the healthcare outlook, I would remind you that our 2004 full-year earnings included 106 million of favorable prior year claim development.

  • Excluding the prior year development, there are 3 main factors causing earnings to decline in 2005.

  • First, our reduced membership levels, including the full-year impact of the membership decline in 2004, will contribute to lower earnings.

  • As Ed indicated, our outlook continues to be the first quarter membership will be down 8 to 9 percent from year-end 2004, and will then stabilize for the remainder of the year.

  • Second, while we expect 2005 margins in our experience-rated book to be strong, they will likely be modestly lower than last year, reflecting the high absolute level of margins that the book earned in 2004.

  • Third, relative to operating expenses, we expect to achieve further reductions in 2005, although the reductions will not completely offset the decline in membership.

  • We are currently evaluating our expense plans for 2005 in light of the stronger-than-expected 2004 results and the opportunity to further strengthen our market position.

  • As part of the review, we continue to evaluate opportunities to increase our investments in market facing capabilities which would support our initiatives to improve membership.

  • Taking into account all these factors, our outlook for full-year 2005 healthcare earnings is a range of 520 to $580 million.

  • With respect to medical costs, I would note that we currently expect full-year 2005 medical cost trends for our total book of business to be between 7.5 and 8.5 percent.

  • I would also note that while the details of our 2005 expense actions are not final at this point, we are considering restructuring actions that will most likely result in severance charges in 2005.

  • This is consistent with our discussion in third quarter.

  • We currently do not expect such charges to exceed $50 million after tax, and we would record them as special items.

  • Turning now to the balance of our reporting segments.

  • We expect our other businesses to contribute approximately 225 to 235 million of earnings for the full year.

  • This reflects our expectations of continued strong earnings from our disability and life, and international businesses.

  • This outlook includes approximately 20 million in amortized gain on the sale of the retirement business.

  • It also includes 20 to 25 million of after-tax stock option expense in corporate.

  • Putting together all the pieces, our consolidated outlook for full year 2005 is a range of 745 to $815 million.

  • Our full year earnings per share will be affected by the amount and pace of share repurchase during the year.

  • As we have stated, we do not predict the amount or pace of repurchase and our EPS estimates do not reflect the impact of any further repurchase activity.

  • On this basis, our estimate of full-year 2005 earnings per share is a range of $5.55 to $6.05.

  • Turning now to the first quarter of 2005, we currently expect income before realized investment results and special items of 180 to $210 million.

  • First quarter healthcare earnings are estimated to be in a range of 130 to $150 million.

  • We expect the balance of our reporting segments to contribute approximately 50 to $60 million of earnings, including 7 to 8 million of after-tax stock option expense.

  • Putting together the pieces, we estimate that our consolidated first quarter earnings, excluding realized investments results and any special items, will be in a range of 180 to $210 million.

  • Excluding the impact of future share repurchase, our estimate of first quarter 2005 earnings per share is a range of $1.35 to $1.55.

  • So to conclude, our fourth quarter results were strong.

  • Our year-over-year earnings increase was driven by strong execution in healthcare and by continued strong results in our other businesses.

  • With that I'll turn to David, who is going to provide additional commentary on the membership outlook.

  • David?

  • - SVP of CIGNA HealthCare

  • Thanks, Mike, and good morning.

  • As Ed noted, our healthcare results for 2004 reflected improved operating fundamentals which significantly strengthened our competitive position.

  • This includes a competitive medical cost structure; strong, consistent customer service; and a significantly enhanced product portfolio.

  • I'll focus my remarks this morning on an outlook of our medical membership, the key actions we have been implementing to improve results, and the emerging trends that are driving our membership result and outlook.

  • I'll also provide an update on our significantly enhanced product portfolio and provide examples of how these products differentiate us in the marketplace.

  • Relative to membership results, as Ed indicated, our medical membership declined for 2004 was in line with our previous projection.

  • For January of 2005, the total membership decline consistent with our projections is in the 8 to 9 percent range.

  • As for the components of the January 1st result, the regional segment decline is approximately 5 percent, which is at the better end of the range I previously provided.

  • I would highlight the significant year-over-year improvement here from minus 18 percent for the regional segment in 2004 to the minus 5 percent result for January 1st.

  • As for national accounts, membership declined approximately 11 percent.

  • Again, at the better end of the range I previously communicated.

  • Now let me highlight some of the specifics for each segment, starting with the regional segment.

  • First, I would remind you that we have consistently said that the regional results would improve prior to the national account segment; and as for the components, we expected retention rates to improve first, followed by pipeline, and then close ratio.

  • The important point to note is that the continued improvement in the regional segment results confirms the strength of our value proposition and our outlook for a stable membership base throughout the remainder of 2005.

  • Now let me provide you with an update on some of the key metrics and leading indicators that support our outlook for the regional segment.

  • Since mid-2004 we consistently experienced improved retention and sales results; and for January 1st, I'm pleased to report that we continued to see this improvement.

  • Specifically, our retention rates improved 900 basis points from 75 percent in January of 2004 to 84 percent in January of 2005.

  • Second, as I noted in November, we expected to see a significant increase in our sales pipeline for our regional segment.

  • The actual increase was 50 percent versus the same time last year.

  • I believe this is an excellent indicator of the market's emerging view of the strength of our product offerings.

  • Finally, we're also having more success at winning new cases.

  • Specifically, our close ratios have increased by 30 percent versus the same time last year.

  • Again, we have experienced a significant year-over-year improvement for this book starting with the most important measure, retention of existing customers.

  • Let me re-emphasize, though, we expect to achieve further meaningful improvements for this book throughout 2005 by stabilizing membership and positioning for growth in 2006.

  • I'll now move to national accounts.

  • As we've discussed on prior calls, approximately 85 percent of the membership renews on January 1st of any given year.

  • And as you know, this business has a long lead time for decision making; and in 2004 the consulting and employer community did not fully recognize our progress on fundamentals nor the depth and quality of our new product offerings in time for the 2005 buying decisions.

  • In a moment I'll discuss the actions we are taking to ensure the consultants and employers are fully aware of our value proposition.

  • As for results, retention rates for national accounts as of January 1st were 84 percent.

  • While this is a modest improvement over January of 2004, over time we do expect retention levels to return to our historical rates, in the low 90 percent range.

  • And while we did secure new business and expand current relationships, the rate was clearly below our historical levels and not reflective of our current capabilities.

  • Again, our membership results for January 1st at minus 11 percent were modestly better than the midpoint of the range I shared with you in November.

  • Moving on to priorities.

  • Going forward, our priorities are to continue the positive momentum we have built in the regional segment and position national account segment for a much improved result for January of 2006.

  • To do so, we are focused on 2 critical areas.

  • The first is product and solution capabilities.

  • Here, we must ensure that our capabilities meet employer and members' needs better than our competitors.

  • The second area of focus is to improve sales and distribution effectiveness.

  • To achieve this, we are focused on clearly demonstrating our capabilities and the effectiveness of our products, strengthening the depth and skills of our sales and sales management team, and strengthening producer relationships.

  • Let me comment on each area.

  • First, relative to our product portfolio.

  • Last quarter I discussed our industry-leading Signature product suite that enables customers to tailor benefit plan solutions using a modular approach.

  • As you may recall, customers may select the benefit design, medical management, funding, and network options to create their health solution of choice.

  • I also discussed the CIGNA Choice Fund, our consumer directed portfolio of solutions.

  • This comprehensive suite of products and tools enables employers to provide employees with programs, information, and health coaching to better understand their healthcare product choices and to engage them as true owners of their health benefits.

  • This is a suite of capabilities that truly enables consumerism.

  • By way of differentiation, our CIGNA Choice Fund provides a number of funds that allows employers to incent targeted behaviors for their members.

  • Examples include a wellness preventative care fund, and a prescription drug fund.

  • The goal here is to ensure that members are balancing wellness and maintenance care while saving for unexpected events.

  • The second point of differentiation is our award-winning member support tools.

  • A consumer directed product newsletter recently ranked CIGNA's support tools number one.

  • Consumer directed plans can only be effective with the right engagement and navigation support.

  • A third example of differentiation for CIGNA is that our HSA has a fully integrated seamless claim experience between the provider, CIGNA, and JP Morgan, our banking partner.

  • As for results, we had a full launch of this product on July 1st of 2004; and as of January 2005, we already have about 100,000 members on our new consumer-directed health plan.

  • The second product I will highlight is our Health Advisor.

  • This product delivers personalized one-on-one coaching and support for members.

  • We view the Health Advisor program as a key ingredient to assist members in navigating the healthcare system.

  • Key points of differentiation for our Health Advisor program include the fact that we staff our program with nurses, not call support staff as some of our competitors do; and secondly, our nurses are enabled by a single integrated care management system that allows them to understand a member's full clinical situation and available programs.

  • The combination of these 2 components is unique in the marketplace.

  • As for results, we already have 700,000 members and counting on this product.

  • The third product-related enhancement that I'll comment on focuses on customer reporting and clinical insights.

  • We've taken a different approach than many in our industry.

  • Instead of focusing on managing and delivering basic raw data, we've developed robust reporting and insights for employer and producer business partners.

  • Specifically, we have developed and are now delivering reports, analytics, and recommended actions to assist our customers in improving health, productivity, and cost outcomes.

  • Our client management, underwriting, and clinical management teams leverage this array of information and insight capabilities to help employers modify benefit designs, contributions strategies, clinical programs, and communication and member engagement strategies.

  • In short, we have built some powerful capabilities and customer and producer receptivity has been very positive.

  • I'll now turn to a brief update on the actions we're driving to improve sales and distribution effectiveness.

  • Again, the key areas of focus are demonstrating the capabilities and competitiveness of our products to effectively meet customers' needs, strengthening the depth and skills of our sales force and sales management team, and strengthening producer relationships.

  • Relative to demonstrating capabilities, we have substantially enriched our sales story and customer presentations to include specific demonstrations of our care management programs and processes.

  • Additionally, we now have many of the proof points that customers and producers need to make truly informed decisions.

  • For example, versus key competitors, CIGNA customers experience a 5 percent lower in-patient utilization rate, driven by 4 percent better clinical quality as measured by NCQA.

  • Relative to our sales force and sales leadership team, now with new leadership in place in all key roles we are focused on improving overall sales execution.

  • This includes aggressively expanding the depth and breadth of sales training, embracing the problem solver mentality with producers and employers to design and implement the right solution suite for each employer, and significantly enhancing sales tools to demonstrate our value proposition.

  • Finally, on the producer front, we are working to more effectively partner with producers to solve employers' cost, health quality, and productivity challenges.

  • This includes aggressively leveraging the use of our clinical insight and employer reporting capabilities to demonstrate our value delivery and enable key producers.

  • These actions, coupled with our new product portfolio and the strength of our member care management results gives me the confidence that we have the right actions in place to grow membership over the long run.

  • In closing, we fully understand the challenges that we face in growing our membership, especially in light of this very competitive marketplace.

  • However, I would emphasize we are seeing positive signs regarding membership levels including the improving regional trends, which are, again, higher retention levels, a 900 basis point improvement year-over-year; a stronger pipeline up 50 percent year-over-year; and a better close ratio, up 30 percent year-over-year.

  • We are focused on stabilizing membership results for the remainder of 2005 and positioning CIGNA for growth in 2006.

  • I am confident we are taking the appropriate actions and I know our organization, especially the sales and distribution teams, have the passion, ownership and sense of urgency to meet these membership goals.

  • With that I'll turn it back over to Ed.

  • - Chairman and CEO

  • Thanks, David.

  • Before I get into CIGNA's strategy and 2005 priorities, I think it's important to reiterate just a few of David's key points.

  • First, membership growth is clearly our top priority and we continue to see very positive indicators on this front.

  • We have significantly strengthened our sales and distribution team at all levels.

  • Just as important, the broker and consultant community is now acknowledging CIGNA's competitive medical cost and innovative products as well as our strong overall value proposition.

  • I remain quite confident in the actions David has outlined and in our outlook for a stable membership base after the first quarter of 2005.

  • Let me spend a few minutes discussing CIGNA's strategy and specific priorities for 2005.

  • We believe that our success in the health benefits industry will be defined by delivering superior health and wellness solutions for both employers and consumers.

  • We will achieve this by creating a competitive cost advantage, delivering superior clinical outcomes, driving product innovation, being a partner of choice for employers and producers, and creating a winning environment for our people.

  • Let me comment just briefly on each of these strategic imperatives.

  • Creating a cost advantage requires top quality hospital and provider networks that provide service at competitive rates, medical management that is value-based and is supported by outstanding healthcare professionals, and maintaining an efficient operating cost structure.

  • To build an advantage in medical costs, we are continuing our hospital recontracting efforts to improve our unit cost structure, and as Mike discussed, this has already had a meaningful impact on 2004 medical cost trend.

  • Our medical management model is delivering the industry's highest quality scores, while ensuring members get the right care at the right time and in the right setting.

  • We will continue to selectively establish strategic network alliances, Tufts in the Boston area is just one example, which will further enhance our network and medical cost structure in key regions.

  • We have introduced the CIGNA care networks, which focus on both quality and efficiency measures.

  • Specifically, we are targeting up to 19 types of specialists who represent the highest quality providers.

  • Our CIGNA care networks can reduce overall medical costs up to 4 to 5 percent.

  • And finally we continue to reduce SG&A costs through strict expense management.

  • We believe CIGNA is already a leader in delivering superior clinical quality, and this fact is independently confirmed by our leading NCQA health plan ratings, and our continued superior HEDIS effectiveness of care scores.

  • We are further strengthening our clinical quality leadership position through integrating clinical programs and health benefits, providing industry-leading disease management programs including our new obesity and depression programs, and leveraging the largest clinical team in the industry which includes our nurse-based health advisor program.

  • Our strategy also includes driving product innovation.

  • As David discussed, the Signature suite of products includes the CIGNA care networks, the Health Advisor program and CIGNA Choice Fund.

  • Our innovative consumer directed option that really empowers employees to take ownership of their health management.

  • We will also be a partner of choice for both producers and employers, and here we are focused on leveraging our robust information, analytics, and insights to enable employers as well as producers to address the healthcare cost and productivity challenges that they face.

  • And finally, and very importantly, we will promote an environment within CIGNA itself that prepares our people to succeed, gives them the tools they need to succeed, and then rewards them appropriately for that success.

  • A successful execution on these 5 strategic imperatives will determine CIGNA's future success.

  • Now with these strategic imperatives as a backdrop, CIGNA's primary focus for 2005 is to stabilize healthcare membership.

  • And we'll do so through continued strong execution of the fundamentals, ongoing investment as well as innovation in our product and service capability, and aggressive sales and account management actions which ensure the CIGNA value proposition is understood by both customers and brokers and consultants.

  • In closing, 2004 was a year of significant accomplishments for CIGNA, as we strengthened operating fundamentals for our healthcare business, delivering value to customers and improvement in earnings for our shareholders.

  • We continued the strong pattern of sales and earnings growth in our disability and life and international businesses.

  • We improved financial flexibility with a singular focus on our healthcare and related benefits businesses.

  • Today, we are well-positioned to compete in the marketplace in each of our businesses.

  • We are confident in our ability to execute our plans, achieve our near-term goals and profitably grow our business in the future.

  • This concludes our prepared remarks.

  • At this time, we'd be more than pleased to take your questions.

  • Operator

  • [Operator Instructions].

  • Matthew Borsch, Goldman Sachs.

  • - Analyst

  • Thank you.

  • Good morning.

  • I wanted to ask a question as you look forward to stabilizing enrollment on 2 components.

  • One, your commercial HMO business where you had the majority of the decline in the fourth quarter and what you see looking ahead in 2005 for that business.

  • And then also, as you get into the 2006 national account selling season, there's been some discussion that the RFP activity may be significantly higher for 2006.

  • I'm wondering if you're seeing any early signs of that and what you think that might mean.

  • - CFO

  • Matthew, it's Mike.

  • I'll take the first part of your question, then I'll ask David if he wants to add on to it, and also talk about the national account 2006 cycle.

  • In terms of your specific question on commercial HMO, it's our view that the market has been moving away from the lock-in commercial HMO product and moving more towards open access-type products.

  • We saw that in 2004.

  • We've seen early signs that that's continued for 1/1/05, and I'd expect that we'll see that continuing trend throughout 2005, which, again, means that the commercial HMO metrics that we've talked to you about in the past will be less meaningful and what will be more meaningful will be aggregate trends.

  • David, you want to add anything?

  • - SVP of CIGNA HealthCare

  • Yes.

  • Picking up on that and moving over to the RFP, Matthew.

  • It's David.

  • I'll remind you that the -- for example, the product suite we launched, the Signature product suite, consciously de-couples points of the product position, so you have the ability to have a guaranteed cost product that's not necessarily a CHMO product, so we're more focused on enabling guarantee cost funding over a broad range of products, whether they're HMO, point of service, or open access.

  • And as Mike said, you'll see a continued blurring there.

  • Relative to the RFP activity, it's early in the season but early signs are positive that there will be some good uptick in the RFP activity.

  • Early read of the RFPs, as you might expect, are looking for total cost solutions, a lot of energy around the CDHP capabilities, because employers are either looking to aggressively implement or begin to implement CDHP capabilities, and finally we're seeing in the early read of the RFPs that are coming through a lot of focus and energy around clinical quality programs which plays nicely to our capabilities.

  • So early read positive, momentum building right now in the cycle.

  • - Analyst

  • Okay.

  • Great.

  • And just one quick follow up. [Technical difficulties] development in the fourth quarter, how much was that?

  • - CFO

  • Matthew, it's Mike.

  • Related to prior year claim development it was minimal, approximately a million dollars after tax.

  • It is the case that the earlier quarters of 2004 and, therefore, full-year 2004, emerged to be stronger than we had expected.

  • And that stronger earnings power is the primary reason that we increased our 2005 estimates as we did by 25 million after tax.

  • Specifically, we estimate the underlying run rate of earnings for healthcare for fourth quarter would be approximately 160 million after tax, as compared to the 230 that we reported.

  • - Analyst

  • Fantastic.

  • Thank you.

  • Operator

  • Thank you, Mr. Borsch.

  • Josh Raskin, Lehman Brothers.

  • - Analyst

  • Thanks.

  • Good morning.

  • Quick question, just a quick follow-up, the healthcare run rate of 160 sounds like you're excluding obviously 80 million, and then should we also think about the additional 40 million on the COLI as sort of favorable development in the quarter that is not consistent with what would you think as a run rate?

  • - CFO

  • Josh, it's Mike.

  • The -- I think it's actually 70 in healthcare.

  • It would be the difference between 230 and 160.

  • You're absolutely right, I would exclude the approximately 40 million from leverage COLI from the run rate as well.

  • I also, just for completeness, I would not bank on CIGNA group insurance making 54 million a quarter throughout 2005.

  • The group life mortality results there were very strong.

  • And while we'd expect them to continue to be strong I wouldn't expect them to be that strong.

  • - Analyst

  • Right.

  • No, that's fair.

  • And then just a quick question on the transformation project still on schedule for a January '06 completion.

  • I just -- one, is the first question.

  • And two, as you look into '06, what sort of cost savings are you expecting with the sort of shut down of the legacy systems, and if you could just give us a sense of how the systems are running now.

  • Are they running concurrently or have you been able to shut down any of the old systems to this point?

  • - CFO

  • Josh, it's Mike.

  • The transformation continues to be on track.

  • We now have approximately 90 percent of our members on the new -- the new in-state platforms and the remainder will be completed in first quarter of '06, is our expectation at this point.

  • I'd remind you that the benefits from transformation are actually twofold.

  • You talked about the efficiency, which is certainly one; but it also gives us stronger market facing capabilities as well, which is -- which is useful.

  • In terms of your other part of your question on dimensioning the productivity gains, in 2005, we're not going to get a lot of benefit because we have yet to shut down any of the legacy claim systems.

  • So we still have the 14 claim systems up and running.

  • Now, we would expect in late 2006 to begin to shut those down.

  • We'll still get benefit in 2006 from the fact that our auto adjudication rates will be much higher.

  • The auto adjudication rates were in the high 40s last year.

  • We'd expect they'd be in the high 60s, approaching 70 percent in 2006.

  • And we've also got higher productivity on the new in-state systems which will also help.

  • But we'd expect those benefits to accelerate over time, and we'll get sort of the first piece of the dividend, if you will, in 2006.

  • Ed, you want to add anything?

  • - Chairman and CEO

  • Mike, no, I think you covered all the key points.

  • I think it's important to recognize that we are on schedule, that we are seeing the benefits and importantly to reinforce something Mike said, both the efficiency gains, but also the flexibility that those new platforms give us relative to the product design and relative to information support, particularly in the clinical area.

  • So transformation continues to be on track, and as we move through '06, we will start to increasingly see the benefits of being able to shut off that old legacy platform.

  • - Analyst

  • Is there any way to quantify dollar amounts towards the end of '06 or even as you look into a run rate for '07 for cost saves?

  • - CFO

  • Josh, it's Mike.

  • I'd prefer not to put a specific number at this point on 2006 and 2007.

  • Just to repeat there, what we've talked about on prior calls, we do expect the long-term benefits of completing transformation will be in the neighborhood of 200 to 250 million of annual pretax operating expense savings, and between stabilizing and then ultimately growing our membership, and also capturing the full benefits of completing transformation, we would expect to increase our earnings per member and our overall margins.

  • - Analyst

  • Okay.

  • Thanks.

  • Operator

  • Thank you, Mr. Raskin.

  • Doug Simpson, Merrill Lynch.

  • - Analyst

  • Good morning, everybody.

  • Just a couple questions on the balance sheet.

  • Apologize if you touched on this earlier, but looks like the reinsurance recoverables came in quite a bit and the contract holder deposit funds dropped by a little north of 6 billion.

  • Just wondered if you could walk us through what was going on on the balance sheet?

  • - CFO

  • Doug, it's Mike.

  • The changes in the balances that you're referencing relates to the contract novations for the retirement business that we sold to Prudential.

  • So, when we sold the retirement business to Pru, we used reinsurance as a means of completing that transaction.

  • Over time, the Pru retirement customers changed their contract to get off of, in this case, Connecticut General Life Insurance Company paper, and on directly to Pru paper.

  • So, therefore, the reinsurance in effect unwinds over time, which is a good thing terms of making our balance sheet more compact.

  • - Analyst

  • Okay.

  • Should that continue for the next couple of quarters?

  • - CFO

  • We would expect that that will continue through 2005; and ultimately, we would expect the vast bulk of the Pru customers to be directly on Pru paper.

  • - Analyst

  • And then on the -- if I take the sum of future policy benefits and healthcare claims payable looks like it was 11.5 billion at end of Q3 and closer to about 10 billion at year end?

  • - CFO

  • Yes, Doug.

  • Here's what it suggests.

  • The -- we did improve our financial disclosures here at fourth quarter.

  • What I'd suggest is for Tim to walk you through those details off line.

  • - Analyst

  • Okay.

  • - CFO

  • There are a number of moving parts there, and it would just be -- I'd suggest that that would be more efficient, and obviously I'd be happy to join that call if you'd like.

  • - Analyst

  • Okay.

  • And then maybe just one question on the cash flow, just thinking about the seasonality of it and if membership starts to come back this spring, would you expect -- how should we think about cash flow progression?

  • - CFO

  • Well, I assume you're referring to GAAP cash flow?

  • - Analyst

  • Yes.

  • - CFO

  • As I've talked about on prior calls, I would suggest that you not over weight that amount, and we've made it a consistent practice not to project GAAP cash flow going forward since there's so many moving parts that influence that number in any given quarter.

  • I think the more meaningful cash flow item to look at -- or cash flow metric to look at, is the parent company metrics that I referenced in my prepared remarks.

  • - Analyst

  • Okay.

  • Thanks.

  • Operator

  • Thank you, Mr. Simpson.

  • Charles Boorady, Smith Barney.

  • - Analyst

  • Good morning.

  • First question, could you give us the components of medical trend in the quarter, as well as your thoughts for '05?

  • And if you can give us pricing versus volume for each component, that would be great.

  • - CFO

  • Charles, it's Mike.

  • I'll ask Jon to cover the trend piece first, then I'll come back on the pricing piece.

  • - Financial Officer of CIGNA HealthCare

  • Hi, Charles.

  • As Mike mentioned in his prepared remarks, for our total book of business full year 2004 medical trend was approximately 8 percent.

  • Turning to the components, the 8 percent is broken down as follows.

  • Inpatient 8 to 9 percent.

  • Outpatient 9 to 10 percent, professional 6 percent, and pharmacy 7 percent.

  • And if I look at 2005, as Mike also mentioned, we currently expect medical cost trends to be between 7.5 and 8.5 percent and the components for the projection are broken down as inpatient in the range of 5 to 7 percent, outpatient approximately 9 to 11 percent, professional around 5 to 7 percent, and pharmacy in the range of 8 to 10 percent.

  • - Analyst

  • And I assume the '04 numbers exclude the prior period development -- well, it's a full year, and most of the prior period development in the fourth quarter sounds like was for the year.

  • - Financial Officer of CIGNA HealthCare

  • That's correct, Charles, that's on an operating basis, so the 2004 numbers exclude the prior year claim development.

  • - Analyst

  • And as a follow-up, can you discuss some of the reasons for keep the billion and a half free cash and equivalents at the parent and what some of your plans are for use of that, as well as if you could walk through for us expectations of any dividends to the parent that you expect throughout '05.

  • - CFO

  • Charles, first, in terms of our overall capital management strategy, it is unchanged from what we've discussed previously.

  • So we've discussed previously the 3 components being, number one, maintaining financial flexibility at the parent by holding at least $500 million of cash.

  • Second, maintaining our leverage ratio in the 20 to 30 percent range, and then third, after we have sufficient capital to maintain our financial strength ratings and support the growth of our businesses we'll use the excess for share repurchase.

  • So the capital management strategy has not changed.

  • Now, again, consistent with our historical practice, I'd prefer not to comment or try to predict for you the future amount or pace of repurchase.

  • Now, back to your other question on the subsidiary dividends, we do expect a subsidiary dividends in 2005 will range in the 700 to 800 kind of range, which if you think about our -- the midpoint of our GAAP earnings of 780, gives you a sense of the drivers.

  • And relative to the uses of that 700 to 800, the net uses will be approximately 100 million, and that's mainly paying interest to our parent company debt holders.

  • We also repurchased 50 million of stock in January, so it gives you, from a 1.5 billion starting point it indicates that we've got approximately $2.1 billion of expected resources through the remainder of 2005.

  • - Analyst

  • Just to clarify, so the amount that you earn will be pretty close to the amount that you'll be able to dividend up to the parent, which suggests that you won't be increasing the amount of reserves in the subs?

  • Is that normal on an ongoing basis, or is there something unusual about '05 that allows you to dividend more than you ordinarily would be as a percent of your reported GAAP earnings?

  • - CFO

  • In a nutshell what you're describing, Charles, is generally right.

  • I would remind you that we postponed $100 million of dividends from Connecticut General Life Insurance Company from fourth quarter to January and that's something that we talked about on the prior call.

  • It relates to tax planning.

  • Other than that, the real drivers are, you can think about the GAAP earnings, you could add back in the parent company interest, you could back out the non statutory earnings and dividends.

  • Power from the subsidiaries is driven by statutory accounting rather than GAAP accounting, and what you'd have left would be the amount available for dividends and to support growth, and obviously our growth rates in 2005 are not yet to the point where we would like them to be.

  • Although they're improving.

  • - Analyst

  • So the ongoing number would you say -- assuming you don't grow or shrink '05 as a sort of run rate number would be sort of in the 600 to 700 range if we exclude the 100 that you postponed from '04?

  • - CFO

  • Yes, that's a fair characterization at this point in time, Charles.

  • - Analyst

  • Great.

  • Thanks.

  • Operator

  • Thank you, Mr. Boorady.

  • Patrick Hojlo, Credit Suisse First Boston.

  • - Analyst

  • Thanks.

  • Good morning, guys.

  • Could you give -- give us what you expect now, at least for the commercial HMO if not for the combined risk bood in terms of yield for 2005?

  • - CFO

  • Sure, Patrick.

  • It's Mike.

  • We expect revenue yields for commercial HMO to trail medical costs by approximately 50 basis points.

  • So we'd expect the medical loss ratio to increase by approximately 50 basis points on an operating basis, 2005 versus 2004.

  • As we talked about on the third quarter call, we do expect overall commercial HMO margins to be approximately flat 2005 versus 2004, since we expect the expense ratio to improve by approximately 50 basis points.

  • Now, early estimates here for January 1, 2005, would suggest that revenue yields for commercial HMO will be in the neighborhood of 9 to 9.5 percent, again, on a per member per month basis for those accounts that renewed.

  • The overall number for the -- for the year I would expect to be in approximately that range.

  • I mean, it depends upon the mix of business and so while it's an estimate that's in line with our full-year expectation.

  • - Analyst

  • For the entire -- for the entire risk book?

  • - CFO

  • For the entire commercial HMO book.

  • - Chairman and CEO

  • I would remind you, Patrick, as well that what Mike just commented on represents now, I guess, about 9 percent of our membership; so one of the things we need to keep in mind is the impact of that book, given the current mix, is significantly reduced from what it's been historically.

  • - Analyst

  • Sure. [Inaudible] I'm wondering are you going to perhaps start giving yield for the rest of your books and start giving cost trends now?

  • - CFO

  • Patrick, we are looking at that.

  • We are certainly committed to continuing to improve our financial disclosures and that's one of the items that we're reviewing.

  • - Analyst

  • And just to clarify, when you say yield will trail cost trends, you mean it will be a little bit higher than cost trends?

  • - CFO

  • I literally meant trailed cost trends.

  • We would expect the commercial HMO medical cost increase in 2005 to be somewhat higher than the overall business.

  • - Analyst

  • Got it.

  • Sorry.

  • I was confused on the HMO stats and the overall stats.

  • Now I'm following you.

  • One last question.

  • Just I'm wondering when you back out the prior period development from 1Q through 3Q '04, what did cost trends look like for the year?

  • Did they, in fact, decelerate?

  • - CFO

  • Jon, do you want to provide any color there?

  • - Financial Officer of CIGNA HealthCare

  • Yes.

  • If you look, Patrick, at the year-over-year improvement on cost trend, our total trend improved from approximately 11.5 percent in 2003 to the 8 percent that we mentioned earlier for 2004.

  • So that's a 350-basis-point improvement in aggregate.

  • And on balance, we're very pleased with the continued strong medical management results which are creating meaningful benefits both to CIGNA and to our customers.

  • - Analyst

  • Great.

  • Thanks, guys.

  • Operator

  • Thank you, Mr. Hojlo.

  • Joe France, Banc of America Securities.

  • - Analyst

  • Thank you, Mike.

  • I just wanted to review your enrollment expectations for the balance of the year.

  • If I understand you're looking for it to be flat, and yet you've lost a million lives or so since September, and in 2004 you lost about a half a million lives in the last three-quarters of the year.

  • Especially since, as I understand, there's a pickup in RFP activity.

  • - CFO

  • Joe, I'm not sure -- was there a specific question there?

  • - Analyst

  • Yes.

  • I'm just trying to understand how you can be looking for flat enrollment from this level, given the changes over the last -- well, the last 9 months of last year.

  • What's different this year that would enable you to be flat instead of continue losing business?

  • - SVP of CIGNA HealthCare

  • Joe, it's David.

  • Let me start and maybe go to what I think the heart of your question is.

  • If you look at our book of business, as I mentioned in my prepared remarks, for the national account segment 85 percent of that segment renews on January 1st.

  • For the regional segment, comparator measures, about -- approximately 60 percent of that book renews on January 1st so there's a meaningful amount of opportunity.

  • If you look at 2004, as I mentioned in my prepared remarks, we begin to generate some momentum each month starting with July going forward in terms of increasing pipeline, improving retention rates and improving the overall results for the regional segment and as we stepped into January, we had the minus 5 percent.

  • Specifically looking throughout 2005, we expect to stabilize the membership result by continuing to improve the middle market, or the regional segment results; so we expect stable retention rates and improving pipeline and an improving close ratio there in line with what we've seen over the last 7 months or so, and consistent year-over-year performance of the national account book for that 15 percent or so that renews.

  • That would be the pattern that would generate a flattish performance for February through December of this up and coming year, with our heavy focus for national accounts on 1/1/2006.

  • Joe -- I'm sorry, Ed.

  • Go ahead.

  • - Chairman and CEO

  • Joe, I was just going to add that what David just suggested is very consistent with what -- the pattern that we are seeing, have seen through the second half of '04, saw for 1/1/05, and now continue to see.

  • So we are continuing to see upticks in the retention rate.

  • The opportunities we are getting, as a practical matter, are up very significantly, and the close ratios have begun to improve as well.

  • So if you look -- just look at the trend we've experienced over the last 6 months.

  • It's very, very -- it supports the flat membership projection that we have for the balance of the year.

  • The other thing I would note when you look at the second half of last year is you have one large municipal account in the fourth quarter that has a distorting impact on that second half of the year.

  • So we feel pretty confident about the flat membership post-January in '05.

  • - CFO

  • Joe, it's Mike.

  • The other piece I would add is that if you think back to the past 2 or 3 quarters that we've talked about this, we've been very consistent in describing to you that we expect, first, the middle market results to improve, followed by national accounts, because of the longer sales cycle, and in addition for persistency rates to improve first before new business sales, and that's exactly the trend that David and Ed just described.

  • - Analyst

  • Thank you all.

  • Operator

  • Thank you, Mr. France.

  • Carl McDonald, CIBC.

  • - Analyst

  • Thank you.

  • Could you give us a sense for where the favorable development in 2004 is coming from?

  • Is there any particular component or geography that you'd cite?

  • - CFO

  • Carl, it's Mike.

  • There's not a specific area in terms of geography.

  • In terms of the components, Jon, you want to provide a little color there?

  • - Financial Officer of CIGNA HealthCare

  • Well, I would just say in terms of the major drivers, it's split equally between utilization improvements driven by continued good performance on -- in patient day management and unit cost improvements that's primarily the result of the early phases of our facility recontracting efforts, both on an inpatient and outpatient.

  • - Analyst

  • And on your hospital contracts today, what percentage of your hospital contracts would you say are based on percentage of billed charges versus more fixed base costs?

  • - SVP of CIGNA HealthCare

  • Carl, it's David.

  • We've typically not disclosed the percentage of our contracts per diem versus percent of billed charges or otherwise.

  • We have said that our preferable reimbursement structures are more fixed reimbursement structures, and it's important to note, as you know, with the contracting environment, it's important to make sure the total contracting arrangement is understood so the per diems, the carve-outs, and the overall reimbursement structure.

  • I would remind you that as we've talked about our recontracting initiatives, as we've gone at recontracting the top hospital facilities that make up 60 percent of our total facility costs we're looking at both the economic terms and the administrative or structural terms of the contracts and working to improve both the economics as well as administrative terms, and in that we might be seeking to improve, if you will, percent off billed charges or the carve-out arrangements but we've not explicitly quantified the percentages.

  • - Analyst

  • Okay.

  • Can you give us any sense on the more per diem arrangements, where the outlier thresholds are today versus where you think you can get them?

  • - SVP of CIGNA HealthCare

  • Carl to clarify, when you said the outlier arrangements?

  • Are you going specifically at stop loss?

  • - Analyst

  • I'm sorry, meaning when -- on most of the per diem arrangement there will be some sort of threshold point at which point you'd be making additional payments.

  • - SVP of CIGNA HealthCare

  • Typically, the industry, I think, classifies that as stop loss.

  • There's first dollar and second dollar stop loss.

  • I would tell you they're highly varied geographically and by facility.

  • Our preference is not to have stop loss.

  • If you do have stop loss, it's second dollar stop loss, not first dollar stop loss, but I would tell you it's highly varied geographically.

  • And again, part of our recontracting initiatives are to either remove stop loss provisions or move first dollar stop loss to second dollar stop loss provisions and focus on the discount post stop loss trigger, so the industry's given this a lot of attention as are we and again stop loss is not all in one bucket.

  • There's first dollar and second dollar stop loss.

  • Operator

  • Anything further, Mr. McDonald?

  • - Analyst

  • No, thank you very much.

  • Operator

  • Christine Arnold, Morgan Stanley.

  • - Analyst

  • Good morning.

  • My first question relates to the bridge between '04 versus '05 in healthcare.

  • You said declining enrollment, experience rate and margin changes and operating expenses kind of account for some of the difference in the run rate year-over-year.

  • Could you quantify the impact of those 3 changes?

  • And then could you also talk -- thank you for disclosing the experienced rate of detail, about how to think about modeling that in terms of kind of the SG&A load versus the MLR versus your at risk product?

  • Thanks.

  • - CFO

  • It's Mike.

  • First in terms of the first piece of your question, the roll forward of the 2004 earnings to 2005, I suggest first that the way you think about it is 2004 earnings came in significantly higher than we had expected and had estimated; and as a result, we've increased our 2005 estimates by 25 million after tax.

  • So what that says is we are not counting on all of the 2004 favorability carrying over to 2005.

  • Now, in terms of your specific question on the breakdown, as I said in my prepared remarks, there are three main components of the year-over year decrease.

  • The first is the membership.

  • Again, that's approximately half of the year-over-year decline, excluding the prior year development, so let me just requote the numbers here.

  • We reported earnings for healthcare of 791 million in 2004.

  • If you back out the 106 of prior year development, you get 685.

  • The 685 compares to the midpoint of our 2005 estimates of 550.

  • About half of that decline from 685 to 550 relates to the lost membership.

  • The 8 to 9 percent membership decline that we expect in 2005 and the carry-over impact of the 2004 membership decline.

  • The other 2 key drivers here are higher operating expenses per member, and a modest decline in the experience rated margins.

  • Specifically, what we currently have built into our earnings model is a 3 to 5 percent reduction in dollar terms to our operating expenses for healthcare on a year-over-year basis.

  • Obviously, the 3 to 5 percent is lower than the 8 to 9 percent membership decline, and this is an area where we're still evaluating our options.

  • I'd also, just as background, remind that our 2004 operating expenses was a very strong result.

  • In fact, we accelerate some expense reductions that we originally planned for 2005 into 2004.

  • But the point is that the operating expenses on a per member basis are increasing 2005 versus 2004, and that's putting pressure on earnings per member.

  • And then the third key contributor which is worth about 20 million after tax is a modest reduction in the experience-rated margins.

  • We did have a significant increase in experience-rated earnings in 2004.

  • Excluding prior year development, the experience-rated earnings were up about 60 million versus 2003, and obviously all that is good news.

  • In 2005, though, we've got a smaller percentage of our customers that have deficits, thanks to the strong 2004 medical cost results, and while we expect that our experience-rated results will still be strong, it will contribute to a lower level of deficit recovery in 2005.

  • And again in round numbers, that's worth approximately 20 million after tax.

  • In terms of the last piece of your question on how to best think about the experience-rated earnings, I would suggest that you think about it in terms of all-in earnings compared to an annual revenue base for that business of approximately $4 billion.

  • The $4 billion is a combination of annual medical premiums and also the premium equivalents for the minimum premium contracts.

  • So you can think about it as 60 million after tax improvement '03 going to '04 on $4 billion of revenue and revenue equivalents, and then a -- approximately a $20 million year-over-year decline '04 going to '05.

  • - Analyst

  • That's all real helpful.

  • Thanks.

  • Operator

  • Thank you, Ms. Arnold.

  • John Rex, Bear Stearns.

  • - Analyst

  • Just want to clarify on the cost trend guidance of 7.5 to 8.5 percent, is that specifically for risk products?

  • And I would include experience-rated there, or is that for a trend you expect across all business?

  • Sometimes you have talked to ASO trend also, so I'm just trying to clarify what that is and then how that -- if that compares -- if that's apples to apples with 8 percent in '04, and then think about premium yield on the all-in risk book, instead of just the commercial HMO risk book, since it is a small piece.

  • - CFO

  • John, it's Mike.

  • I'll start and I'll ask Jon Rubin if he wants to add to it.

  • First, the trend expectation that we have for 2005 in the 7.5 to 8.5 percent range is apples to apples and comparable to the 8 percent aggregate medical cost trend that we saw for the entire book of business, the 10 million members, in 2004.

  • Now, specifically for the risk book, we would expect that the full guaranteed cost book, including commercial HMO, would have a somewhat higher trend in 2005 than the overall aggregate trend.

  • - Analyst

  • Okay.

  • And how -- you cannot -- can you really not think about the experience rate?

  • Can you book that way also?

  • - CFO

  • I would expect that the experience-rated trend would be more in line with the aggregate trend of 7.5 to 8.5 percent, because the experience-rated book is a mix of traditional HMO kinds of arrangements as well as open access products, and, therefore, I would think about experience-rated in line with the aggregate trends that we talked about.

  • - Analyst

  • Okay.

  • Operator

  • Thank you, Mr. Rex --

  • - Analyst

  • -- sorry, I have another question.

  • In terms of inpatient trend, your biggest decline there in terms of what you're talking about last year was inpatient, I think you were talking last quarter about expecting inpatient trend of 9 percent in '05, comparing to the 5 to 7 you're looking for.

  • Is that primarily just better contracts?

  • - CFO

  • Jon?

  • - Financial Officer of CIGNA HealthCare

  • Yeah, I'd say it's actually 2 things, John.

  • It's both continued progress on our facility recontracting, as well as improved utilization as we introduce our more effective clinical programs to our open access product portfolio.

  • - Analyst

  • Okay.

  • And then I wonder if you could talk just for a moment about your assessment of the Medicare opportunity for '06?

  • What kind of things you're looking at and your initial take on the regulations in terms of what products you might want to participate in?

  • - SVP of CIGNA HealthCare

  • Hey, John, it's David.

  • I'll start there.

  • As you know, some of the final regs just came out on -- a couple thousand pages on January 23rd or so.

  • As we look at the seniors opportunity more broadly, there's at a minimum 5 major categories of opportunity.

  • One's Medicare advantage.

  • Second's a pharmacy play with pharmacy part D. Third is clinical services.

  • Fourth are administrative services, and then fifth are products designed specifically for the 55- to 64-year-old group, which is the fastest growing subsegment, by the way.

  • Currently we have plays that are active in 4 of these 5 categories of opportunity, and we're evaluating each of the five categories as we sit here today for either further expansion or in the one category we're not playing entry going into '06 and beyond.

  • So overall some attractive opportunities here.

  • A lot of movement, lot of specificity being defined.

  • The regions are obviously laid out, but the regs are finalized.

  • And again, I would stress that we have plays in 4 of these 5 categories that are active right now, and expect to continue to be active in at least those 4 areas.

  • I'll turn it to Ed for other comments.

  • - Chairman and CEO

  • Yes, David.

  • Just one addition.

  • John, as you know, we've always been, or certainly for the last several years, not been particularly active in the Medicare Advantage area, with one exception.

  • We continue to do that business in Phoenix and will.

  • I think that's the area that we will look at the hardest and with the most critical eye in terms of some of the uncertainty that continues to exist there, relative to reimbursement rates and so forth.

  • But to reinforce a comment that David made, the other 3 or 4 areas we do have activities underway, we are active with proposals, and we do see some reasonably good opportunity in those areas that have more predictable revenue streams and we think more predictable earnings potential for us.

  • So while we'll look at all of them, I would continue to express some degree of skepticism relative to a massive entry by us into Medicare Advantage.

  • That's not likely to occur.

  • - Analyst

  • Great.

  • Thank you.

  • Operator

  • Scott Fidel, JP Morgan.

  • - Analyst

  • Hi, thanks, good morning.

  • First question just has to do with your disease management initiatives.

  • And just wondering if there's any way that you can quantify the benefit that those have had in terms of, I guess, lowering medical cost trend or in terms of dollars saved.

  • Then also as you're trying to look for growth again potentially in '06 with the consultants, how much of a factor your DM initiatives have been in talking with consultants?

  • - SVP of CIGNA HealthCare

  • Scott, it's David.

  • I'll start.

  • First off, as I think you know, we've recently launched some additional programs including obesity, depression program, and certain impact or additional conditions.

  • Broadly stated, these programs assist our medical management team and model in terms of defraying or dampening medical cost trend.

  • Broadly speaking, the total suite of our medical capabilities, our modular medical program and our disease management program, can dampen medical costs for a payer in the 4 to 8 percent range.

  • Specific to disease management programs, though, the normal purchasing process around the disease management programs typically have ROIs that are attributed to the exact program, and the ROIs, Scott, on any individual program are in the 2 to 1 to 3 to 1 range, depending upon an employer's exact experience and what we're able to contribute back.

  • As it relates to market activity around these programs, I would say quite high.

  • A lot of degree of activism, especially as the information flow enables consultants and employers to directly attribute cost savings and quality improvement to these programs.

  • And lastly, I would say we're very excited about the 3 new programs that we've launched, taking a leading position in the marketplace right now by integrating behavior health, pharmacy, and medical to deal with the obesity impact conditions and depression programs.

  • - Analyst

  • Okay.

  • - Chairman and CEO

  • The only thing I would add is the programs as David said by themselves stand alone have quite attractive ROIs.

  • I think the real power for us and what we're seeing real interest in in the marketplace is when you combine those programs which we think are leading edge, you combine those with the flexibility we can provide relative to medical management and the degree of medical management and the Health Advisor that David mentioned earlier.

  • When you combine those 2 or 3 different capabilities, what you get is a very robust approach to total health within an employer's population.

  • And that can have a significant difference and impact as it relates to cost trends.

  • - Analyst

  • Okay.

  • That's helpful.

  • And then just a second question, just on the runoff reinsurance business which it looks like the losses did come in a little bit in the fourth quarter from the third quarter.

  • Can you just give us some guidance on how we should think about modeling that line for '05?

  • - CFO

  • Scott, it's Mike.

  • Yeah, as you know, our reinsurance business has been in runoff for awhile.

  • You are right that in fourth quarter as we conducted our normal reserve review we did determine that one of our reinsurers, somebody that we've reinsured business to, has experienced a deterioration in their credit conditions, so as a result we strengthened reserves against reinsurance recoverables to -- of an amount approximately $25 million after tax.

  • In terms of the modeling going forward, first thing I would say is there's obviously still a fair amount of uncertainty in this business.

  • We do believe that our current reserve balances are appropriate, but we acknowledge the uncertainty.

  • In normal run rate without any adverse development, the normal run rate would be in the 5 to $10 million after tax per quarter, although obviously the last couple of quarters we've had the adverse development.

  • - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Thank you, Mr. Fidel.

  • Eric Veiel, Wachovia Securities.

  • - Analyst

  • Yes.

  • Just real quickly, can you explain the significant difference in the cost trend at the commercial HMO expectations, which I think would be 9.5 to 10 if we add 50 bips to your premium expectations, versus the consolidated book?

  • Is it just mix?

  • Is it geography?

  • Is there something else there?

  • - Financial Officer of CIGNA HealthCare

  • Yes, Eric.

  • It's Jon Rubin.

  • Our commercial HMO trend is approximately -- call it 2 points higher than our aggregate trend.

  • First, there is a greater impact of geographic and demographic mix changes on the CHMO book.

  • And also, our aggregate book trends include our open access product trends, which have benefited in 2 areas.

  • First, as I mentioned earlier, from the extension of our most effective clinical management program to this product line; and second, while our recontracting efforts have benefited all product lines including our CHMO product, the greatest impact has been from our strengthening the competitiveness of our lead open access product.

  • - Analyst

  • Okay.

  • That's helpful.

  • And then second, can you just walk through the correlation between the $100 million sequential reduction in the medical payables line down to, I think, 1.594 billion from the third quarter number and how to reconcile that with the prior period development favorable in the quarter of, I guess, about 6 -- 70 million?

  • - CFO

  • Eric, it's Mike.

  • I'd be happy to.

  • First, you reference some of the numbers that we talked about earlier but just to recap them for everybody's benefit, we do estimate that the underlying run rate for healthcare in fourth quarter in terms of earnings was approximately 160 million after tax versus the 230 that we -- that we've reported.

  • So we had approximately 70 million, most of that is favorable development related to prior quarters earlier this year.

  • If you look at the quarter-over-quarter change in the net medical reserves, at third quarter it was 1.2 billion, at year end it's 1.1 billion.

  • It's actually -- specifically, if you carry it out further digits it's a $95 million decline in the reserves.

  • That's essentially the combination of a 2 percent sequential decline in our membership and the reserve releases that I just referenced, related to the emerging favorable experience from earlier in the year.

  • So if you take 70 million, take the bulk -- 70 million, and that's after tax, take the bulk of that, gross it up to pretax it's essentially about 100 million, it's about the quarter-over-quarter change.

  • - Analyst

  • Okay.

  • That's what I thought.

  • Thank you.

  • - CFO

  • And, Eric, incidentally you will see -- we are providing additional detail in the 10-K.

  • You'll see the reserve rolled forward and I would expect that when you look at that you'll conclude that the quality of our earnings is strong.

  • - Analyst

  • And also sort of on historicals, Mike, will we get some supplemental information that helps us match the helpful historical enrollment data with something a little bit more detailed, like what was in page 7 of the sup, or --?

  • - CFO

  • Eric we're working on that detail as speak, and I would expect to continue to enhance those disclosures throughout 2005.

  • - Analyst

  • Okay.

  • Thanks.

  • Operator

  • Sara James, UBS.

  • - Analyst

  • This is Bill McKeever with UBS.

  • On the pharmacy component you had that increasing from 7 percent in '04 to 8 to 10 percent on in '05.

  • Just wondering what your thoughts were there for acceleration of pharmacy trend?

  • - Financial Officer of CIGNA HealthCare

  • Yes, this is John Ruben.

  • Really the 2004 trend came in favorable and is below historical levels, so while it is up in 2005, the range of 8 to 10 percent is still good historically.

  • If I could point to one item that's going up it would be the specialty pharmaceuticals which is an industry trend that we're all dealing with.

  • - Analyst

  • Okay.

  • And then on the -- the HSA product of the 100,000 new lives, where are those coming from?

  • Are they previously uninsured, or are they coming from other accounts?

  • Do you have any insight into where the lives are coming from?

  • - SVP of CIGNA HealthCare

  • Bill, it's David.

  • The 100,000 is a combination of HSA and HRA, so our new suite in terms of both product offerings.

  • The lives are, generally speaking, national segment in regional segment, so they, generally speaking, do not pick up what would be defined as uninsured lives.

  • I do think that on a go forward basis as that product portfolio gets further penetrated down throughout the small segment, we're going to have a good opportunity to pick up some lives that are working individuals that are currently uninsured as small segment employers begin to roll out consumer directed capability and opportunities to their members.

  • But today, it's middle market and national account business.

  • - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Ed Kroll, SG Cowen.

  • - Analyst

  • Good morning.

  • One more question on the yields.

  • In -- back in '04 you said the all-in cost trend was 8 percent, I believe.

  • What was the all-in yield number for the full year '04?

  • - CFO

  • It's Mike.

  • It's difficult to calculate a meaningful all-in yield number, because we have ASO customers where, literally, they're paying for all their claims and all we're getting is fee increases which would be a smaller number in the low-single digits.

  • For commercial HMO and experience-rated, I can give you numbers there.

  • For commercial HMO the overall revenue yield for full year '04 was 12 percent.

  • For experience-rated it was a little north of that, approximately 13 percent.

  • - Analyst

  • Okay.

  • Thanks for that.

  • And then two other quick ones.

  • Can you tell us what the GAAP cash flow was for Q4 and also the actual share count at 12/31, and if you'll give it to us, through today?

  • Net of all your repurchase?

  • - CFO

  • Ed, the GAAP cash flow for fourth quarter was positive 245 million.

  • Again, please remember all the caveats that I've given you and please don't overweight the GAAP cash flow particularly in one quarter, but it was 245 to answer your question.

  • And in terms of the exact stock count, it's approximately 133 million given our repurchase to date.

  • - Analyst

  • So that's through the current repurchases you've done?

  • - CFO

  • Correct.

  • - Analyst

  • Okay.

  • Thank you.

  • Operator

  • Thank you, Mr. Kroll.

  • Ladies and gentlemen, this concludes CIGNA's fourth quarter 2004 results review.

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

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

  • You may access the recorded conference by dialing 888-203-1112, or 719-457-0820.

  • Passcode for both numbers for replay is 878231.

  • Thank you for participating.

  • We will now disconnect.