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Operator
Ladies and gentlemen, thank you for standing by for CIGNA's third quarter 2006 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 the queue to ask questions at that time. [OPERATOR INSTRUCTIONS] As a reminder, ladies and gentlemen, this conference, including the Q&A session, is being recorded.
We'll begin by turning the conference over to Mr. Ted Detrick.
Please go ahead, Mr. Detrick.
Ted Detrick - VP of IR
Good morning, everyone.
And thank you for joining today's call.
I am Ted Detrick, Vice President of Investor Relations, and with me this morning are Ed Hanway, CIGNA's Chairman and CEO;
Mike Bell, CIGNA's Chief Financial Officer;
David Cordani, President of CIGNA HealthCare; and Jon Rubin, CIGNA HealthCare's Financial Officer.
In our remarks today, Ed Hanway will begin by discussing highlights of CIGNA's third quarter results.
He will also make some comments regarding our growth prospects for 2007.
Mike Bell will then review the financial details of the quarter and provide the financial outlook for both full year 2006 and 2007.
David Cordani will discuss our medical membership results and outlook and will also make remarks about CIGNA HealthCare's improving competitive position and value proposition, as it relates to both consumerism and health advocacy.
Ed will then conclude our prepared remarks by commenting on our long-term prospects to profitably grow our HealthCare business.
At that point, we'll open the lines for your questions.
Now it's 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 the term labeled adjusted income from operations, which is income from continuing operations before realized investment results and special items, with special items being unusual charges or gains, as the principal measure of performance for CIGNA in our operating segment.
The reconciliation of adjusted income from operations to income from continuing operations, which is the most directly comparable GAAP measure, is contained in today's earnings release, which is posted in the Investor Relations section of CIGNA.com.
Now in our remarks today, we will be making some forward-looking comments.
We would remind you there are risk factors that could cause actual results to differ materially from our current expectations.
Those risk factors are discussed in today's earnings release, which was filed this morning on form 8-K with the Securities and Exchange Commission.
Now before turning the call over to Ed, there are a few items that I will cover pertaining to our disclosures.
This quarter, we updated the presentation of the guaranteed cost medical loss ratio in the quarterly statistical supplement.
This updated presentation more accurately reflects the net medical cost for our guaranteed cost customers by excluding certain inner-company specialty costs, specifically pharmacy and behavioral costs, that have been previously included in reporting those ratios.
We have made available our updated ratios for the four quarters of 2005 and the first two quarters of 2006 as an exhibit to the third quarter supplement.
In addition, we have expanded our guaranteed cost medical loss ratio disclosures to provide this information on two basis, that is both including and excluding the results of our voluntary benefits business, which we obtained through the acquisition of Star HRG in July of 2006.
We have also provided other disclosures concerning our acquired voluntary benefits business.
Specifically, we are separately reporting the premiums, other operating expenses and membership of this business in this statistical supplement.
We hope you will find these disclosure enhancements beneficial and we remain committed to look for additional ways to further improve the transparency of our financial reporting in the future.
On one last note, I do want to remind you that CIGNA will be hosting its annual Investor Day in New York City at the Grand Hyatt Hotel on November 17th.
If you have not yet registered for this conference, please do so, as space is limited.
There will also be a Webcast of this event on CIGNA's Web site.
Further details will be available shortly.
We hope you will be able to join us for that event.
With that, I'll turn it over to Ed.
Ed Hanway - Chairman, CEO
Thanks, Ted.
Good morning, everyone.
As Ted noted, I'm going to start today's call with a few brief comments on our third quarter results and I'm then going to discuss the highlights of our 2007 outlook.
Mike will then provide more details on the third quarter and our 2006 and 2007 outlook.
And then David will comment on how we are differentiating ourselves in the marketplace, which is resulting in a leadership position in the area of consumerism and health advocacy, and thereby positioning us to achieve our expected membership growth goals in 2006 and 2007.
In my closing remarks, I will provide my perspective on the ongoing opportunity to profitably grow our HealthCare business.
Overall, our third quarter results were better than our expectations, resulting from good earnings contributions from all three of our health and related benefits businesses.
The earnings reflect strong HealthCare and International results and continued solid results in Group, Disability and Life.
Third quarter adjusted income from operations was $268 million or $2.48 per share, well ahead of our expectations.
Our HealthCare earnings, excluding prior year development, were at the high end of our expected range.
HealthCare results in the quarter reflected effective operating expense management and better than expected guaranteed cost results due to strong pricing execution.
We continue to manage medical costs very effectively, which benefits both our customers and us, as indicated by our full-year medical cost trend outlook of approximately 7%.
We also continue to make solid progress toward reducing HealthCare operating expenses while continuing to make significant investments in consumerism and other important initiatives.
Good progress in the area of customer retention and new sales have positioned us to achieve our full-year 2006 goal of organically growing our medical membership by 1 to 2%.
In addition, our results for 2007 National Accounts business have been very successful, which David will discuss in a moment.
Overall, we remain confident in our full-year HealthCare earnings and membership outlook.
Our Group and International businesses continue to deliver strong, profitable growth.
Our Group Insurance business reported earnings of $58 million, with solid revenue growth and an after-tax margin that remains industry-leading.
Our International business reported strong earnings of $31 million on 23% growth in premium and fees.
This is the 12th straight quarter of double-digit earnings growth in International.
Both our Group and International operations have strong market positions with good growth opportunities.
We also continue to be active with share repurchase.
Year-to-date through October, we have repurchased about $2.4 billion of our stock and we currently have $820 million of stock repurchase authority available.
Now regarding our 2007 outlook, we expect our full-year 2007 medical membership to grow 4 to 6% and we expect approximately 3% of this growth will be achieved on January 1.
As Mike will describe, we expect HealthCare earnings, excluding prior year development, to grow by double digits in 2007.
This membership and earnings growth validates our strengthening market position, which we have achieved through significantly improved business fundamentals and strategically focusing on our differentiated capabilities related to consumerism.
We also expect continued good growth in our Group and International businesses.
Overall, our third quarter HealthCare and consolidated results are strong and we believe we are well-positioned to achieve our full-year earnings and membership goals.
And we are very pleased with our prospects for membership and earnings growth across all of our Health and related benefits businesses in 2007.
Now I'm going to turn it over to Mike, who will cover the specifics of the third quarter results and our outlook for 2006 and 2007.
Mike?
Mike Bell - CFO
Thanks, Ed.
Good morning, everyone.
In my remarks today, I'll review CIGNA's third quarter results, and also discuss our outlook for the balance of 2006 and for full year 2007.
In my review of consolidated and segment results, I'll comment on adjusted income from operations, this is income from continuing operations excluding realized investment results and special items.
This is also the basis on which I'll provide our earnings outlook.
Our third quarter earnings were $268 million or $2.48 a share, compared to $251 million or $1.94 per share in the third quarter of 2005.
The quarter's consolidated results reflected strong HealthCare and International results and were better than we had previously estimated.
Now I'll review the segment results, starting with HealthCare.
Third quarter HealthCare earnings were $177 million.
This result included favorable prior-year claim development of $11 million after-tax.
Excluding the prior-year claim development, HealthCare earnings were at the upper end of our expected range.
HealthCare earnings in the quarter reflected effective operating expense management and better than expected guaranteed cost results, primarily due to strong pricing execution.
The year-to-date guaranteed cost medical loss ratio on the updated basis, and excluding prior-year claim development and the results of our recently acquired voluntary benefits business, was 86.4%.
This was improved relative to the June year-to-date MLR of 86.7%.
The improvement primarily reflected strong execution of our pricing actions and continued effective medical cost management.
We expect guaranteed cost results to continue to improve in the fourth quarter, resulting in a full-year 2006 MLR of approximately 86%.
And I'll discuss this further when I cover the outlook.
Medical membership grew 1.5% on an organic basis in the quarter and increased 3% in total, including the Star HRG acquisition.
We continue to expect full year 2006 organic membership growth of 1 to 2% in addition to the benefit of Star.
Relative to operating expenses, year-to-date results demonstrate good progress in improving productivity.
Our stat supplement breaks out the impacts of our various growth initiatives and transformation amortization.
Excluding these items, our operating expenses for the first three quarters of year declined $83 million or 4% relative to 2005.
This result reflects continued progress in our efforts to improve productivity, including additional gains at our service operations.
On the same basis, we expect the year-over-year reduction in operating expenses for full year 2006 to be in excess of $100 million.
HealthCare premiums and fees in the third quarter were up 11% year-over-year, excluding the loss of the New York State prescription drug program discussed previously.
The increase primarily reflected higher guaranteed cost medical membership and rate increases.
To recap our HealthCare earnings; excluding prior year claim development, we're at the upper end of our expected range, primarily reflecting effective operating expense management and better than expected guaranteed cost results, primarily due to successful execution of our pricing actions.
Now to discuss the results of our other segments.
Group, Disability and Life earnings in third quarter were $58 million.
These results included a $12 million after-tax net favorable impact from reserve reviews.
Excluding the impact of the reserve reviews, earnings reflected continued strong Disability management results and less favorable mortality experience in the life and accident product lines.
Our profit margins in this business continue to be top quartile.
Our International business generated earnings of $31 million in the quarter.
This result reflected strong topline growth and margins in both the expatriate benefits and life, accident and health businesses.
Our Group Insurance and International businesses continue to be important contributors to our results.
Our remaining operations including run-off retirement, run-off reinsurance, other operations and corporate, had combined earnings of $2 million for the quarter.
Now I'll comment briefly on our capital position and our 2006 capital outlook.
Our parent company capital position continues to be strong and our subsidiaries remain well-capitalized.
At the end of the third quarter, cash and short-term investments at the parent were approximately $350 million.
During the third quarter, we continued our share repurchase program and repurchased approximately 8.4 million shares of our stock for $931 million.
Through October 13th, we repurchased an additional 1.8 million shares for $213 million, bringing our year-to-date 2006 share repurchase activity to 22.6 million shares for $2.4 billion.
We currently have approximately $820 million of repurchase authority, which includes an additional $500 million authorized by our Board of Directors last week.
Our capital management priorities remain consistent with our prior communications.
We intend to continue to effectively deploy capital for the benefit of our shareholders.
Our first priority is to maintain appropriate liquidity at the parent company and to ensure that our subsidiaries remain adequately capitalized to support growth and to maintain and improve their credit ratings.
Relative to parent company liquidity, we consider an appropriate target to be approximately $250 million.
Our second priority for excess capital is to consider acquisition opportunities.
We routinely review a range of acquisition opportunities that will enhance our strategic position and meet our return on investment goals.
Acquisitions to date in 2006 include Star HRG and a smaller transaction in Arizona.
We do not know when or if we would find additional opportunities that would meet our criteria, and absent these items, our priority would be to buyback our stock.
Looking ahead, our full-year 2006 outlook for the parent company is better than we had previously estimated.
We now expect to receive subsidiary dividends of $1.7 billion for the full year.
This is $400 million higher than our previous expectation of $1.3 billion, reflecting the strength of our subsidiary's capital positions.
We received approximately $1.5 billion in subsidiary dividends through September 30th, and at this point, expect approximately $200 million in the fourth quarter.
We expect other net uses of parent company cash to be approximately $200 million for the balance of the year.
This includes October's repurchase and the cash outflow for the Star acquisition, but excludes any additional share repurchase or M&A activity, as well as any potential debt issuance.
Finally, with respect to leverage; we're comfortable operating at our current level or slightly higher.
So in summary, we continue to have a strong capital position and good financial flexibility.
Now I'll review the earnings outlook for the full year 2006.
Our updated estimate of consolidated adjusted income from operations for full year 2006 is a range of $995 million to $1.035 billion.
The midpoint of this range is $25 million higher than the estimate we provided in August.
The increase reflects the favorable third quarter results, including the prior year claim development in HealthCare.
I'll now discuss the components.
For the full year 2006, we continue to expect organic membership growth of 1 to 2%, in addition to the benefit of the Star acquisition.
We expect full year medical cost trend for our total book to be approximately 7%.
We expect the guaranteed cost MLR to be approximately 86% for the full year, due to effective medical cost management and strong pricing actions.
Relative to Medicare Part D, we expect full-year results to be near breakeven, compared to a year-to-date after-tax loss of $7 million.
So all-in, our estimate for full year 2006 HealthCare earnings is a range of $635 to $665 million.
The midpoint of this range is $10 million higher than the estimate we provided last quarter to reflect third quarter prior year claim developments.
It assumes no additional prior year development in the balance of the year.
Turning now to our other reporting segments.
We expect our remaining operations to contribute approximately $360 to $370 million of earnings in the 2006.
This is $15 million higher than our previous estimate, reflecting strong third quarter results.
Putting together all of the pieces, we estimate that our full year 2006 consolidated adjusted income from operations will be in a range of $995 million to $1.035 billion.
This estimate does not include a potential fourth quarter charge associated with cost reduction initiatives to further improve our expense position for 2007.
Our consolidated earnings will be affected by any share repurchase that occurs in the balance of the year.
We do not predict the amount or pace of repurchase and our estimate for earnings and EPS do not reflect the impact of any further repurchase activity.
On this basis, our current estimate of full year 2006 EPS is a range of $8.85 to $9.15 a share.
Compared to the estimated range of $8.30 to $8.80, which we provided last quarter, our current estimate reflects the benefit of share repurchase through October and the increase in our outlook for total earnings.
Turning now to the full year 2007 outlook.
We currently expect consolidated adjusted income from operations in a range of $1 billion to $1.06 billion.
I'll discuss the components, starting with HealthCare.
First, as Ed indicated, we currently expect that our medical membership will increase by approximately 3% on January 1st, and 4 to 6% for the full year 2007.
We currently expect medical cost trends for our total book-of-business to be in the range of 6.5 to 7.5%.
We expect guaranteed cost pricing to exceed trend and the guaranteed cost MLR, excluding prior-year development in the voluntary benefits business, to be approximately 84%.
Our estimate for full year 2007 HealthCare earnings is a range of $665 to $715 million.
In comparing our estimated 2007 HealthCare results to 2006, it's important to remember that 2006 year-to-date earnings include $43 million of favorable prior-year claim development, while our 2007 estimate assumes zero prior-year development.
A useful way to understand the 2007 HealthCare outlook is to start with the midpoint of our full year 2006 earnings estimate for HealthCare, which is $650 million.
Subtracting our year-to-date favorable prior year development gives a starting point of $607 million.
The $690 million midpoint of our 2007 range represents growth of 14% from this space.
The expected earnings growth of 14% in 2007 primarily reflects two key drivers.
First, we expect guaranteed cost pricing actions in excess of medical cost trend to improve the medical loss ratio by 200 basis points and to contribute approximately $50 to $55 million in after-tax earnings growth.
Second, we expect to realize a 2% year-over-year improvement in operating expenses per member.
We expect this to contribute $50 million pre-tax or $30 to $35 million after-tax in increased earnings.
There are also some other puts and takes.
For example, we expect a benefit from membership growth.
On the other hand, we expect experience rated results to be lower than the strong results in 2006.
Overall, the improved guaranteed cost MLR and lower per member operating expenses are the two main drivers of 2007 earnings growth.
I would also note that we've raised our expectations for productivity improvements in our service and technology organizations.
Our current estimate of total productivity savings in 2007 and beyond is in the range of $200 to $250 million.
This compares to our previous estimate of $200 million.
Given that we expect to achieve savings of $50 million next year, we now expect savings of $150 to $200 million after 2007.
We expect to achieve these productivity improvements while continuing to deliver strong customer service and will provide additional detail at our upcoming Investor Day.
Turning now to the balance of our segments, we expect our remaining operations to contribute approximately $335 to $345 million of earnings in 2007.
We expect our Group, Disability and Life and International businesses to continue to grow revenue while maintaining strong margins.
Specifically, we expect mid-single digit earnings growth in Group and mid-teens growth in International.
Earnings for the balance of our operations, which include run-off businesses and parent company, are expected to be lower year-over-year.
Parent company losses will likely be higher in 2007, due mainly to the absence of the favorable expense in tax items that we experienced in 2006.
Putting together all the pieces; we estimate that our full-year 2007 consolidated adjusted income from operations will be in a range of $1 billion to $1.06 billion.
Our consolidated earnings will be affected by any share repurchase that occurs in future periods.
As I mentioned before, we do not predict the amount or pace of repurchase and our estimates for earnings and EPS do not reflect the impact of any further repurchase activity.
On this basis, our estimate of full year EPS for 2007 is a range of $9.50 to $10.10 per share.
This estimate reflects strong earnings growth in HealthCare, as well as the benefit of our aggressive share repurchase program in 2006.
In 2007, we expect to maintain continued strong dividend paying ability in our subsidiaries.
I would also note that we continue to have ongoing dialogue with the rating agencies, and believe that upgrades to our current ratings are achievable, based on our outlook.
We'll provide more specifics relative to our 2007 capital management expectations in February.
So to recap, our consolidated third quarter earnings were above our expectations, reflecting favorable results in HealthCare and International.
Our 2007 earnings estimates reflect a attractive growth in HealthCare and continued good performance in our Group and International businesses.
With that, I'll turn it over to David.
David?
David Cordani - President, CIGNA HealthCare
Thanks, Mike.
And good morning, everyone.
As both Mike and Ed indicated, CIGNA HealthCare is on target to meet our growth and earnings goals for 2006.
But more importantly, we are well-positioned to continue to grow profitably in 2007.
This is a direct result of the disciplined execution of our consumer-focused business strategy.
Today, I'll focus my remarks in three areas.
First, expected membership growth for 2006 and 2007; second, the drivers of our success; and third, some exciting results we are seeing as we execute our consumerism strategy.
Now to my first topic.
Our medical membership increased from 9 million at mid-year to 9.3 million at the end of September, including the members gained through the acquisition of Star HRG.
Excluding Star HRG, our membership grew 1.5% sequentially.
So we are on track to meet our expectation of 1 to 2% organic growth for the full year.
Including the Star HRG membership, our full year 2006 projected growth is 3 to 4%.
Growth of consumer-directed members, specifically HSA and HRA, or fund-based plans, is particularly strong.
A the end of September, our total consumer-directed health plan membership exceeded 250,000, up substantially from year end 2005.
Our growth rate is better than the projected industry growth rate here.
I'll now provide some additional insights on our results by segment.
Results in national account memberships continue to be in-line with our expectations, driven by strong retention on our existing book.
Year results have improved year-over-year by 500 basis points, from 86% in 2005 to 91%.
Growth in our regional segment was 6.5% through September, which is in-line with our expectations, and continues to build on the momentum we have highlighted in prior calls.
We are on track to achieve 9% growth for the full year, which is a very strong result.
For full year 2007, we expect medical membership growth of 4 to 6%.
Through January 2007, we're projecting overall membership growth of approximately 3%.
We anticipate that our January National Accounts membership will be up approximately 3%, driven by year-over-year improvement in our retention rate, which will improve from 91% in 2006 to the mid-90s in 2007 and a significant increase in new business sales.
Here, our sales pipeline is up approximately 70%, driven by a 30% increase in our RFP volume and increases in average case size.
Our close ratio has also improved.
Suffice it to say, we are pleased with this performance and we are very proud of our National Accounts team.
In the regional segment, our outlook is for membership to grow approximately 3% in January.
Fueled by new business sales and a projected 200 basis point improvement in case persistency.
Our pipeline of new members is up approximately 20%, reflecting increases in both RFPs and average case size.
This positive momentum is a direct result of executing our business strategy to broaden our strike zones, both in terms of geography and buyer segment.
With regard to consumer-directed membership growth, we're projecting our membership to double in January, and to grow to approximately 650,000 by year end.
This is 2.5 times the 2006 growth rate.
I'd also note that CIGNA's growth rate in this area is expected to outpace the industry, which is predicted to double.
With good reason, we are pleased with the trajectory we're on.
Profitable growth is being driven by all three key levers.
First, improved retention, followed by improved pipeline, and improved close rates.
And we're taking share from the largest organizations in the industry, as well as second tier players.
Importantly, though, our growth outlook for 2007 is complemented by the equally positive expectation for double-digit earnings growth that Mike just reviewed.
I'll now turn to my second topic for today, the drivers of our success.
Essentially, our success is a direct result of the disciplined execution of our customer-focused strategy.
I'll briefly highlight three aspects.
First, operating fundamentals; second, health advocacy; and third, information transparency.
The second and third topics are both key components of a successful consumerism strategy.
We've made good progress in our operating fundamentals which include pricing, network, service, and cost efficiency.
For example, with respect to our pricing and renewal strategy for the guaranteed cost business; we're getting the rate increases we need, while maintaining persistency at expected levels.
This tells us that while the pricing environment is very competitive, the value of our capabilities continue to be recognized in the market.
Relative to provider networks, we continue to make enhancements to complement the expansion initiatives we've discussed previously, including our alliances with [inaudible] health plan, health partners and health alliance plans.
In addition, we recently formed an alliance with MVP HealthCare to offer, on a national basis, a suite of open access and PPO products to mid-sized and large companies.
These relationships have clearly improved the competitiveness of our network in key growth geographies.
Turning to service, CIGNA HealthCare remains the first and only national carrier to be recognized for excellence under the J.D.
Power and Associates Certified Call Center Program.
This program recognizes us for providing an outstanding customer service experience to our members.
It provides a powerful example of how we're taking service from a market entry requirement to a competitive differentiator.
Final operating fundamentals I'll comment on is cost efficiency.
We continue to closely examine our cost structure and take steps to ensure cost efficient operations across the enterprise.
Where it is appropriate, we use key partners and third party vendors to expedite strategic development or to handle non-core tasks.
Our recent agreement with IBM is a good example of securing a strategic partner who will enhance our ability to deliver cost-effective solutions to employers and members.
The second element of our strategy that I will comment on is health advocacy.
At CIGNA, we believe passionately that we have a significant role and responsibility to help guide members to effective, high-quality care at the right time and in the right setting.
This philosophy guides our industry-leading wellness initiatives, health coaching programs, disease management and intensive case management programs.
According to this year's quality compass, the national average for CIGNA across all effectiveness of care measures, improved another 3%.
I would note that our overall results far exceed the results of other national carriers.
In fact, we're so committed to the benefit of measurement in support of health advocacy, that we became the first national health plan to voluntarily submit information to NCQA to help establish benchmarking for quality performance among PPO plans.
Our commitment to quality extends across all aspects of our business.
For example, CIGNA Behavioral Health, a critical part of our consumerism formula, was recently recognized for operating the industry's best employee assistance program for the second year in a row.
We're also working diligently to extend the reach of our health and wellness programs to more members.
For example, Cure Allies, which we launched late last year, offers benefit plans sponsors and their employees, a proactive approach to health and wellness, regardless of their medical plan or provider network.
We also announced the network of our CIGNA Cure Network, with specialists in 58 markets across the country.
Participating specialists receive our Cure Network designation based on their performance on select quality and efficiency measures.
Another clear illustration or our committment to health advocacy lies in our award-winning approach to disease management.
In addition to our existing suite, we recently added disease management programs for weight management and depression to our portfolio.
And early next year, we'll add oncology management to the portfolio, to help prevent development of cancer, facilitate early diagnosis and provide personal case management for those undergoing cancer treatment.
And we'll also introduce our Healthy Pregnancies, Healthy Babies program, which aims to minimize potential complications and premature birth.
It's important to note that our new generation of disease management programs are proprietary in nature.
Here we utilize and leverage the full range of skills and capabilities resident in our expert staff to design and structure these programs.
As you can see, each of these examples highlights the personalized support for members in our approach to health advocacy.
I'll now turn to the third aspect that our strategy is driving, specifically, information transparency.
The fact is, CIGNA is a leader in the industry in providing tools to promote quality and cost transparency, all designed to help the consumer make more informed health care decisions.
Recently, for example, we added two new capabilities to help members.
The first compares average quality and cost for outpatient services and high-tech radiology, including CT scans and MRIs.
The second compares specialists, quality and cost performance by leveraging NCQA measures and converting them to easy to use star-based ranking systems.
Our commitment to transparency has not stopped at the medical service alone.
In fact, we continue to expand our tools that consumers can use to manage their dental care.
Our dental treatment tool and dental plan cost estimators are helping members today to be more informed and effective consumers.
Before I turn it to my third and final topic, I do want to take a minute to highlight the recent and exciting news regarding the CIGNA HealthePass We clearly understand that to be a leader in consumerism, we have to partner with providers to help ease their administrative burden.
In fact, our announcement of the CIGNA HealthePass yesterday, is a groundbreaking program and set of capabilities will help providers as well as members.
Through HealthePass, providers receive assurance of member payment, a shortened revenue cycle, and reduced administrative costs.
At the same time, members enjoy clarity around their payment obligation and convenient access to multiple funds via a single integrated card.
This brings me to the final area I want to discuss with you today; the results that our consumerism and health advocacy are delivering.
Our leadership in consumerism is clearly paying off.
Not just in our own growth, but more importantly, in the activation of consumers and improved health and cost results.
Early findings from our twelve-month study, which will be published on November 8, indicate that CIGNA members increasingly are engaged in managing their own health, compared to the level of engagement recorded only two years ago.
Let me share a few highlights of our findings.
For member and CIGNA consumer-directed plans, medical costs were 16% lower than costs in traditional plans, excluding the impact of cost-sharing changes.
Yet consumer-directed members continue to receive the recommended care that reflects best practices and in many cases, are more active with preventative care.
For example, consumer-directed members increased the use of medications that treat chronic conditions and their day supply of generic medication increased by 9%.
We'll discuss these and other proof points more fully at our Investor Day.
So to recap my consumerism and health advocacy comments;
CIGNA is succeeding in the consumer-driven marketplace today.
Why?
Because we continue to meet the highest clinical standards of excellence.
We continue to provide accessible transparent information about health care quality and cost that members use to make sound decisions.
And we continue to leverage our capabilities to active member health advocates, acting as trusted advisers equipped to guide consumers through the complex health care delivery system.
CIGNA is fully prepared and extremely well-positioned to perform this role.
We are already doing so today and our results demonstrate that.
To wrap up my remarks; we believe 2007 will be a very strong year for CIGNA HealthCare on all fronts.
Our value proposition is playing well in the market.
And we expect to realize 4 to 6% membership growth with double-digit earnings growth in 2007.
We have made significant progress in strengthening the foundation and differentiators for our business.
And our consumerism and health advocacy capabilities are generating attractive results for members and employers.
I look forward to reviewing these actions and results in more detail with you, live, at our next Investor's Day.
And with that, I'll turn it back to Ed.
Ed Hanway - Chairman, CEO
Thanks, David.
I want to reemphasize a couple of David's points.
First, we are winning business from our competitors, based on our increasingly differentiated product and service capabilities.
And second, the advances that we have made in consumerism and health advocacy have positioned us as a recognized industry leader.
These points, combined with continued solid execution of the fundamentals, give us confidence in our ability to profitably grow our business in 2007 and beyond.
Before we respond to your questions, I want to share with you a few thoughts on our longer-term growth strategy.
Our strategy focuses on the following major areas.
First, our primary focus for growth will remain the employer-sponsored health care arena.
We are demonstrating the ability to take market share from competitors and we see significant, continuing opportunities for growth.
We expect to realize meaningful improvement in our National Accounts business for 2007, based on account wins for January 1st and positive signs for the remainder of 2007.
In addition, we will look to further expand our National Accounts business with existing HealthCare customers, by selling them more of our broad array of specialty health care products and services, including our award-winning disease management and health advocacy programs.
We expect our regional market segment overall to continue to achieve attractive growth in 2007 and importantly, we expect to grow in each of our geographic regions.
We plan to expand our presence in the small employer, [inaudible] in government markets; each of which is seeing good growth today.
We are also actively developing health care solutions to address the senior population, with a particular emphasis on the fastest-growing segment, which is the 55 to 64 age cohort.
Within that group, we have successfully focused on providing products and services to the employer-sponsored non-Medicare eligible seniors.
And as we've noted previously, we are also revealing how and when to expand our activity in the Medicare markets.
We have completed our acquisition of Star HRG, a leading provider of low-cost health plans for hourly and part-time workers, which extends our line of health care offerings into the individual and voluntary markets.
We're also developing new capabilities to address the emerging needs of other voluntary health coverages that complement our strong employer group position.
Finally, we will also continue to grow and invest in our Group and International businesses, while maintaining their competitively strong margins.
These businesses will continue to make strong contributions to our earnings growth.
In summary, I believe that our opportunities for profitable growth are significant and will be achieved through solid execution of the fundamentals and continued product and service innovation and expansion.
In closing, our third quarter HealthCare and consolidated results were strong and exceeded our expectations.
Overall, we remain confident in our ability to effectively execute on our 2006 priorities to achieve our full-year earnings and membership goals.
And we expect to continue this momentum and generate strong membership and earnings growth in 2007.
CIGNA today is very well-positioned.
And we continue to make the investments in product and service capabilities, as well as people, to strengthen that position for 2007 and beyond.
We have several new and ongoing growth opportunities that will enable us to achieve our longer-term growth goals.
We'll provide a more detailed review of these goals and our road map to achieve them at our Investor Day in November.
This concludes our prepared remarks.
And now we'd be glad to take your questions.
Operator
Thank you, sir. [OPERATOR INSTRUCTIONS] We go first to Matthew Borsch of Goldman Sachs.
Matthew Borsch - Analyst
Thank you, good morning.
My first question is, when you're looking at the outlook for -- if I heard it correctly -- 3% growth in the National Accounts book, what would you cite as the single most important factor in the turnaround from what you'd experienced in prior years to this 3% growth, in terms of CIGNA's capabilities?
David Cordani - President, CIGNA HealthCare
Matthew, it's David.
Good morning.
Trying to pin it on a single factor is challenging.
But if I had to boil it down to a single factor, it has to do with the product and program capabilities that we have today -- that we've worked hard over the last couple of years to put in place.
So what that comes down to is having a very broad suite of consumerism and health advocacy capabilities that are playing well with the National Accounts employers as they're trying to make decisions and looking at, essentially, their multi-year buy.
And looking forward and determining who they want to partner with over the next three, four, five years, to put in place a set of employer solutions that bring in more and more member engagement capabilities.
If I had to boil it down to one, I would say it's that suite of capabilities that we've worked hard to build over the past couple of years and will continue to enhance.
But it's a suite of solutions that employers are seeing that make sense for them not only for 2007, but to continue to grow with them in '08, '09, et cetera.
Matthew Borsch - Analyst
As a follow-up question, do you have any -- I realize it's quite early, at this point -- but do you have any sense for whether 2008 is likely to be a year for account switching that might be potentially bigger than 2007, as you take the temperature of employers and you look at the pattern of annual renewal dates?
David Cordani - President, CIGNA HealthCare
Matthew, your question is to National Account employers, specifically?
Matthew Borsch - Analyst
Both, really.
David Cordani - President, CIGNA HealthCare
Relative to 2008, if there's any indication, it would be more directional toward where the National Account employers are.
As we sit here today, we're already at the early -- early cycle of 2008 selling just beginning, in terms of the RFP process.
I wouldn't suggest that we expect or see anything today that would suggest a sea change in the movement.
Rather, with the National Account employers, we expect to see further of their consolidation of their number of carriers and strengthening of their consumerism health advocacy programs.
So an extension of what we saw in 2007, which was a reasonably active marketplace.
Matthew Borsch - Analyst
If I could sneak one more question in.
On the small group side of the business, could you try to reconcile your pursuit of growth there with what appear to be anecdotal indications?
And I think, actually, you've referred to some of these yourselves -- of aggressive price competition in that business segment.
And also, how you think -- is that going to have a structural impact on your guidance for 200 basis points improvement in the MCR?
David Cordani - President, CIGNA HealthCare
Matthew, it's David.
I'll start with that one.
First, for us, we define small group and small employer as employers with 200 and fewer employees.
So we're not defining it today, as we talk to you, as under 50 or otherwise.
So it's employer groups, 200 and fewer employees.
Today for CIGNA HealthCare, that makes up an overall small percentage of our absolute number of members -- to the nearest couple hundred thousand, about 0.5 million members of made up in that category.
We see great growth opportunity going forward.
But I submit to you that that should not be a wild, large driver of the MLR improvement that we expect to see.
We've focused our growth initiatives in small segments in a finite number of geographies, five or six.
And again, we've seen more progress in the 51 to 200 space in 2006.
And we expect to extend that into 2007, as we continue to grow that segment further.
Matthew Borsch - Analyst
Thank you.
Operator
Thank you, Mr. Borsch.
We take our next question from Scott Fidel with Deutsche Bank.
Scott Fidel - Analyst
Morning.
First question, Mike, can you walk us through the sources and uses of cash expected for '07?
Then also, what the dividends expected from the [inaudible] for next year?
Mike Bell - CFO
Good morning, Scott.
In terms of 2007, I would like to hold off at this point, Scott, in terms of specific 2007 projections.
Reason is that we're about to have the wrap up of our discussions with the rating agencies here in November.
And the main open question that we still have to sort out with them is the CG Life surplus for next year.
It's at approximately $2.3 billion at the end of September and we believe there is still some additional excess surplus that can be extracted in 2007.
On the other hand, probably not the same level that we extracted in 2006.
And basically, I just would like to review our reasoning with them first, since it is important for us to obtain a rating upgrade.
I would rather not commit to a specific number until I'm confident that our views are in line with theirs.
Scott Fidel - Analyst
Okay.
As a follow-up, just relative to the CDHP growth guidance; if you could talk about how you expect that to trend out between risk products and ASO products?
I know so far, most of the growth has been in ASO, do you expect that to continue into next year?
David Cordani - President, CIGNA HealthCare
Good morning, it's David.
Relative to the CDHP growth guidance, which again we're very excited about, we would expect 2007 to have a similar pattern to our overall block of business.
The majority of the CDHP growth will be ASO-related, as we see the majority of our growth in 2007 being ASO-related.
As we get further and further traction, for example, as we drive into the small segment, as we -- my comment in the prior question, we'll see more guaranteed costs begin to bleed in.
But early adopters in CDHP tend to be the National Account employers, that's all ASO, and really the low end of small segment on guaranteed costs HSA, which we historically have inflated.
So to recap; '07, more ASO versus guaranteed costs with some opportunity to grow the guaranteed cost CDHP, as we go forward.
Scott Fidel - Analyst
And if I could slip one more in, as well.
Magellan recently announced that they're going to enter a radiology contract with you where you're going to outsource some of the radiology services to them.
Could you just talk about the expected cost savings and rationale behind that?
And how that might change your medical risk profile?
Jon Rubin - FO, CIGNA HealthCare
Scott, this is Jon.
Relative to high-tech imaging, more broadly, the industry is continuing to experience significant increases in utilization for these services such as MRI, CAT Scans and other such procedures.
To address this, we're driving a number of mitigating actions, including recently bidding our high-tech imaging between several national imaging vendors with the objective of creating a comprehensive program.
Our specific goals include both improving unit costs and advancing program quality and patient safety.
As an important initial result, we recently issued a non-binding letter of intent to award NIA, part of Magellan, with 12 states which equate to about three million members.
And highlights of this agreement include anticipated unit cost savings to CIGNA and our customers, with an increased amount of risk assumed by our vendor partner.
But also, a more an enhanced network and broader geographic coverage, a more effective medical management and pre-certification process, implementation of web-based tools for member and provider self-service and integration of the program with CIGNA's consumerism and cost and quality transparency initiative.
Finally, while we're very pleased with the progress to date, key next steps still include; continuing that bidding process, further enhancing our medical management [steerage], education and network access initiatives, and evaluating potential program expansion to other areas, such as nuclear and CT cardiology, as well as to potentially low-tech imaging.
Scott Fidel - Analyst
Okay, thanks.
Operator
Thank you, Mr. Fidel.
We go next to Doug Simpson with Merrill Lynch.
Doug Simpson - Analyst
Good morning, everyone.
Was just wondering -- Mike, maybe if you could just chat through.
On the MLR, if you exclude the prior period, it looks like it went, sequentially, from to 87 down to 85.7.
I think those are the comparable numbers.
So a downtick of about 130 basis points.
Could you walk us through what was really -- what was driving that improvement?
Mike Bell - CFO
Sure, Doug.
First, your numbers are, in fact, accurate.
And the main driver is really the path that we've talked about on the last couple of calls.
Specifically, that we've been targeting and we've been securing rate increases for the third quarter as well as the fourth quarter renewals, in excess of the expected medical cost trend.
And at the same time, our persistency has been running somewhat better than the 75% assumption that we've been modeling.
In addition to that, as I think I talked about last quarter, the profitability profile for the renewing accounts that has been better than for those accounts that have canceled.
And so, in terms of the MLR improvement in third quarter that you're noting, we got the benefit of the price increase, as well as some medical cost deceleration that we believe is being, at least somewhat, driven by the better profitability profile.
And we really expect that same kind of trend to continue into fourth quarter.
And therefore, we expect the MLR for the second half of the year on this book of business to be running in the low 85s, which we think will position us effectively to achieve the 84% in 2007.
Doug Simpson - Analyst
And then on the claim's payable, just on the balance sheet, it looked like it was relatively stable.
What are you thinking about growth in that line item in Q4 and then for all of '07?
Mike Bell - CFO
I'd rather not give you, Doug, a real specific projection there, because it does tend to bounce around.
On the other hand, if you decipher the main three components of the year-to-date roll forward, the drop -- in the press release that noted from $800 to $750, rounded.
Prior-year development is a big driver of that, the $66 million [defit] of prior-year development.
We also had net run-out on the year-to-date prescription drug program that canceled on 12/31/05.
There's no impact on earnings, but we paid out $69 million of claims there.
If you adjust out for those two things, the balance is actually up $66 million.
Which really reflects the combination of medical cost trend and increased guaranteed cost membership, which more than offset the claim processing improvements and the drop in the ER membership.
I would rather not give you a specific number, because of other payouts.
But I think you would conclude, that in all likelihood, the reserves will probably inch up because I wouldn't expect the same level of prior-year development and the -- at least at this point, the majority of the prescription drug program has been paid out.
Doug Simpson - Analyst
Okay.
Just one data question.
On the -- just given the change in the way you breakout the reporting, just on an apples-to-apples basis, could you give us the -- I think if you include the specialty [inaudible] and the behavioral, you ran at 87.3 then 87.9; what -- just on an apples-to-apples -- what would that have been in Q3?
Mike Bell - CFO
I'm sorry, in Q3 -- ?
Doug Simpson - Analyst
The 85.7, if you had -- on kind of the old basis, as previously reported, what would the comparable number have been?
Mike Bell - CFO
Let's see.
It would have been adjusted up by about -- call it, 60 or 70 basis points, ballpark.
Doug Simpson - Analyst
Okay.
Thank you.
Operator
Thank you, Mr. Simpson. we go next to John Rex with Bear Stearns.
John Rex - Analyst
Good morning.
Wondering first if you could give us some thoughts on the average ASO fee that you're seeing in relation on the '07 National Account business that's coming on in early years?
What I'm getting at -- should we expect a blended fee basis -- PMPM basis that is stable with what we've seen in '06 rising or falling?
Mike Bell - CFO
John, it's Mike.
In terms of -- let me talk first about overall fees and then I'll talk about the National Account fees.
In terms of overall fee yields for ASO business, we expect that they will be approximately flat in 2007 versus 2006 on a PMPM basis, which is a similar pattern that we saw 2006 versus 2005.
Now I would emphasize, that is just the fees per member.
So beyond the fees, we obviously strive to get increased revenue for specialty penetration, disease management, behavioral, pharmacy, et cetera.
But, again, that is not picked up in that fee number.
So I'm trying to answer just your fee piece.
In terms of the breakdown of that, approximately flat between National Account and regional.
I expect that in the final analysis, National will likely be down a little bit, probably averaging 1 to 2% negative yield.
And I would expect regional to be up by a comparable amount on an all-in basis.
John Rex - Analyst
Okay, on an all-in basis.
So does that mean that on the new business, that it's on average, a meaningfully lower fee PMPM -- that is driving that overall?
Or does that just mean the whole book is shifting down a little bit?
Mike Bell - CFO
I think it's fair to say, John, that the new business tends to drag that down.
On the other hand, the fact that -- as I look as customers that we have over a long period of time, there's more of an opportunity to sell additional services, including increased specialty penetration over a longer period of time.
I think it really is the nature of the game there.
John Rex - Analyst
Okay.
And then, also, you've talked about pursuing Medicare business, perhaps more -- doing more thereover time.
How do you think about getting into that over time?
And what would be the timeframe we should think about to do more there?
Ed Hanway - Chairman, CEO
John, I don't think we've -- we haven't been specific with that.
Our strategy has continued to be, let's make sure we can take care of our employer customers first, let's make sure that we have the kind of capabilities required there.
The Part D capabilities that we have built, as David has said a couple of times, is very much directed to ensuring we could meet the needs of our employer customers first ,and then become more active in individual.
We will -- we are looking at further expansion into the Medicare space.
We haven't concluded yet exactly what that looks like or how rapidly it could occur.
But I think it's safe to assume, as I've said to you in the past, that as we think of a couple, two three years from now, we'll be more active in that space than we have been.
John Rex - Analyst
And could you just kick out for us the component cost trends, how they changed relative last Q since the overall trends followed?
I just wanted to see what was driving it.
Jon Rubin - FO, CIGNA HealthCare
It's Jon.
In terms of the relationship to our previous '06 outlook communicated second quarter, if you look at the midpoint, we've improved our estimate by about 25 basis points.
And this is primarily attributable to an improvement in our trend projection for our lead self-funded and experience-rated product, which is a non-HMO product.
And it specifically reflects continued progress on our in-patient recontracting initiatives, as well as further penetration of our most effective clinical programs to these customers.
And the component, turns in-patient, outpatient MDRX?
Not a lot of change overall, since what we talked about last quarter.
So in-patient and out-patient would each be in the -- call it 7 to 9% range.
And professional and pharmacy would be kind of in the mid to high single digits.
John Rex - Analyst
Okay.
And I shouldn't take that just when you say you characterize them as mid-single last quarter -- are you saying there was a change in those?
Or are you just saying -- that was really, they were mid high single last quarter?
Jon Rubin - FO, CIGNA HealthCare
Pretty consistent with what we talked about last quarter.
Doug Simpson - Analyst
Perfect, thank you.
Operator
Thank you, Mr. Rex.
We go next to Carl McDonald with CIBC.
Carl McDonald - Analyst
First question, I just want to try and rectify the overall enrollment guidance with the assumption that the guaranteed cost medical loss ratio improves in 2007.
So maybe you could look at that and break it down between the ASO book versus the risk business?
Or potentially, it's just a mix shift from the low 80s medical loss ratio, second half of this year, down to 84 next year.
Mike Bell - CFO
Carl, it's Mike.
First, in terms of the membership outlook for 2007, we do expect the vast majority of that growth in 2007 to be in the ASO product line.
So call it 80 to 85% of the membership growth to be in ASO, and with the remainder in guaranteed cost and experience-rated.
In terms of your question on reconciling that with the improved MLR that we're looking to secure; so far, based on our visibility into the January 1, 2007 renewals, we feel like it's going well and that it's consistent with the experience that we've seen in the second half of this year.
At this point, we've secured renewal rate increases on a little over half of our renewing members at the kinds of rates, at the kinds of yields that we're targeting.
So obviously ,that still means that there's still more membership left in play.
But the early signs are that the persistency will likely end up in the 70 to 80% range, which is what we're targeting in terms of the overall enrollment.
David Cordani - President, CIGNA HealthCare
Carl, it's David.
I would add to it, just back to put it context -- you need to remember that our guaranteed cost book of business is 10% of the portfolio today.
If you sensitivity test that, if we had a 5 or 10% worst performance than what one might anticipate, you're talking about 50,000 to 100,000 members against the book of business, so 0.5 point to a full point.
Conversely, the reconciliation you're asking for, in terms of how you could drive the growth is, we've meaningfully improved the foundation that I tried to highlight in a couple of areas.
Our medical cost proposition is much more effective.
We've expanded our strike zone, both geographically into markets where we've not had a great market proposition before and in buyer segments.
They had profiled, for example, [inaudible] or the traction we're seeing in small section or government.
It's a combination of a variety of things.
But I would just ask you to keep in mind that the guaranteed cost block of business is 10% today.
Carl McDonald - Analyst
Okay.
And the second question is just on the operating expenses.
If you could walk us through the major drivers of the $100 million reduction year-over-year in operating expenses?
And then also, maybe, provide a little bit more color on that cost reduction initiative you mentioned that had might impact the fourth quarter.
Would that be head count reductions, facilities consolidation?
Just some more detail around that.
Mike Bell - CFO
Sure.
Carl, in 2006 -- the expense reduction that you're referencing, I assume, is '06 versus '05?
Carl McDonald - Analyst
Correct, yes.
Mike Bell - CFO
In 2006 -- the main driver of the expense reduction in 2006 versus 2005 has been improved productivity in our service operations.
And this really goes back to what we've talked about for the last couple of years.
We made significant investments in technology as part of the transformation project four or five years ago.
We now have 99% of our membership moved on to the two in-state platforms.
The good news there is that other adjudication rates continue to improve, productivity rates continue to improve.
Overall processing quality has continued to improve.
And as a result, we've been able to get additional productivity benefits there.
We've also looked -- beyond the service organization, we've looked at non-market facing capabilities or -- non-market facing departments across CIGNA HealthCare and have also looked to reduce expenses there.
And that's really the main driver of the '06 success.
In terms of 2007, as I talked about in my prepared comments, at this point, we do expect to reduce operating expenses per member by approximately 2% next year.
We're still working out the specific details department by department, but at this point, we believe it's achievable.
And the main driver will be a continuation of what I just talked about for 2006.
In terms of the fourth quarter potential charge, what I was referencing there is that the fourth quarter earnings estimates that are embedded in the full year '06 estimates that I provided, exclude potential special items.
And that includes a potential charge for cost reduction.
Again, we're still evaluating our options.
If we had a charge, I'd expect it to be in the $25 to $50 million range after-tax.
And I would expect to it contribute to 2007 productivity improvement.
And very importantly, also enable us to increase our investments in technology, which would be important to our continued success in membership beyond that.
But really too early -- we're still finalizing those details.
And I would prefer to wait until February to give you specific detail there.
Carl McDonald - Analyst
Great, thank you.
Operator
Thank you, Mr. McDonald.
We go next to Christine Arnold with Morgan Stanley.
Christine Arnold - Analyst
Good morning.
A couple questions here.
Experience-rated earnings down in '07?
How much and why?
You showed enrollment growth this quarter, do you expect that to continue?
Mike Bell - CFO
Christine, it's Mike.
First -- let me answer your second question first.
In terms of enrollment for experience-rated, we expect that, for the full-year 2007 -- we expect some experience-rated membership growth.
Likely -- at this point, we're modeling in the 1 to 2% range for the full year.
For 1/1, I would expect it to be closer to flat.
This would be through the balance of 2007 as opposed to on 1/1/07.
In terms of your question on the experience-rated earnings; at this point, we are modeling approximately two points of lower margin in 2006 on approximately $2 billion of annual GAAP revenue.
So approximately $40 million year-over-year decline.
I would point out the margins there are still very strong on an absolute basis, but we think that 2007 will be a more normal level of earnings, as we've talked about before.
Remember that the 2005 and 2006 experience-rated earnings have been very strong.
And we've been able to secure price increases of approximately 9% -- medical cost for that book is running in the 6 to 6.5% range.
So as a result, we've moved a lot of pieces that had been in deficit into surplus.
And we now have 70% of that book of business in surplus.
There's less opportunity for deficit recovery in the future that contributes to earnings.
We also had -- just to complete the picture -- we also had a decline in membership in 2005 and 2006 for this book, which gave us the near-term benefit of increased canceled gains.
On the other hand, we don't expect that same level of benefit in 2007, because we do expect to grow our full-year membership.
Overall, still strong results on an absolute basis, just not as strong as what we experienced in '05 and '06.
Christine Arnold - Analyst
Right.
And then I have a conceptual question.
If trends are coming in lower than you thought and today are lower than, perhaps, you had thought first half of the year; for business renewing now for second quarter -- or whatever you're seeing right now, are you relaxing your premium yield stance?
And do you anticipate that you will be relaxing your premium yield stance, given what you're seeing in trends for 2Q to 4Q '07?
Mike Bell - CFO
Christine, first the fact that medical cost trend continues to decelerate is reflected in the MLR estimates I gave you for full year 2006 and 2007.
We are picking up the benefit of that in the improved MLR for 2007.
And in terms of how that affects specific accounts, remember we don't price --particularly guaranteed cost accounts -- we don't price them on an all across the board, one size fits all type of approach.
Instead, it's very targeted, geography to geography.
It's very targeted based on the experience of those particular accounts.
But I would say as a general rule, I think your point is right, that for accounts that were priced earlier in the process, we were counting on more medical cost trend than what we're counting on currently.
And therefore, there might be some marginally lower yields for, say second quarter 2007 accounts.
But remember, as Jon Rubin pointed out, the trends are only 25 basis points less than what we had talked about before.
So it's relatively small in the scheme of things.
Christine Arnold - Analyst
Thanks.
Ed Hanway - Chairman, CEO
Christine, the only thing I would add is, Mike mentioned earlier that we are seeing retention rates that are a little bit better.
And the business we are retaining actually has a good profit profile associated with it.
So I think we are executing this pretty effectively and keeping the better business.
So that has an impact on that loss ratio, as well.
Christine Arnold - Analyst
Great.
Thanks for clarifying.
Operator
Thank you, Ms. Arnold.
We go next to Josh Raskin with Lehman Brothers.
Josh Raskin - Analyst
Hi, thanks.
Good morning.
My question around the health advocacy programs that you were talking about, the disease management wellness programs, the EAP on behavioral health, et cetera.
How much of that is insourced, done on your own?
Versus how much of that is outsourced?
And what's the strategy, going forward, around some of those programs?
David Cordani - President, CIGNA HealthCare
Josh, good morning.
It's David.
I'll address that.
The health advocacy strategy -- maybe to round out a few of the capabilities that we would put into that category; the licensed health coaches, health advisers, lifestyle management programs that exist, disease management programs, EAP, et cetera.
Simply stated, the vast majority of that fulfillment is insourced -- to use your term -- today.
There's about half a dozen disease management programs; more of the mature, historic disease management programs that are done in partnership with us and a key vendor.
But the vast majority of the other programs are fully functioning as CIGNA HealthCare activities.
And we've got great leverage opportunities across our behavior health operation, our Cure Allies operation, our case managers today.
The strategy going forward is, we see tremendous opportunity to leverage our clinicians.
And I would remind you that today we employee about 3,000 clinicians on staff, well more per member than anybody else in the industry.
So primarily insourced, in your terminology.
And expect that the majority of work on a go-forward basis will be to lever our proprietary capabilities and expand those.
Josh Raskin - Analyst
Got it, that's perfect.
That's helpful.
I think Mike alluded to a potential ratings upgrade, based on your projections and where you think you can get to with the ratings agencies.
Could you just remind us, what would the impact be, from an interest expense line?
And is that included in your '07 outlook?
Mike Bell - CFO
Josh, it's Mike.
First, just to be clear, I'll let the rating agencies draw their own conclusions.
It's simply our opinion that, given that we're on positive outlook from both Moodys and S&P, that this continued favorable news for 2007, we believe, positions us well.
Just to be clear.
In terms of your question on the impact on our interest expense for 2007, I would not expect that to have a material impact.
We are looking at, as I noted in my prepared comments, we are looking at potential debt issuance.
On the other hand, one notch for the kind of money that we're talking about is just not worth very much.
So it would be -- it would certainly be relative rounding error and kind of embedded in the overall contingency of the earnings outlook.
Josh Raskin - Analyst
That's helpful.
And last question, back on the membership.
It sounds like expectations around 650,000 full year consumer-directed -- broadly speaking, consumer-directed membership, and then 4 to 6% total.
So suggesting that the non consumer-directed membership probably down a little bit.
Just want to make sure I've got the math right there.
And two, if you could help us out.
Is it fair to say they'll be disproportionate non consumer-directed health plan membership in the regional business?
There's a higher percentage of the large National Accounts in the consumer products?
Mike Bell - CFO
Josh, it's Mike.
First, I would not think of it as consumer-directed members being up, and non consumer-directed members being down.
I don't think that's a very effective way to think about it.
I think you want to think about it is, is that we're expecting, ballpark, to add organically, approximately 500,000 members next year.
Included in that -- included in some of those additional members, as well as upselling to existing members, would be growth in CDHP.
But I wouldn't try to think of it as CDHP versus non CDHP members.
David, do you want to add?
David Cordani - President, CIGNA HealthCare
And to add on to that the -- you need to consider that when we're giving you the breakout of the CDHP membership, part of that is new business sales, and part of that is conversions of existing members that are carrying across into those capabilities.
And by way of a little color, there; for our January National Account new business sales, greater than 50% of our new relationships there were CDHP, meaning specifically HRA or HSA.
Playing back off of Mike's comments, it's not that one's going down and one's going up.
The conversion of existing business into CDHP, which is on strategy for us, as well as selling new CDHP programs, is a part of what you see unfolding.
Ed Hanway - Chairman, CEO
The only thing I would add is, I think to -- you have to keep in mind, as well, Josh, that the importance of CDHP to us today and the relationships we build is not just the membership it builds today.
Because, particularly in some of the larger programs, you're getting these programs put in place.
Penetration is not that high.
Our expectation, clearly, over the next several years is, as employers move to favor those programs more directly in their own reimbursement methodologies, we'll see growth there that is greater than we may see in some of the other lines.
Josh Raskin - Analyst
That's helpful.
I was missing the conversions.
That's very helpful.
Thanks.
Operator
Thank you, Mr. Raskin.
We go next to Charles Boorady with Citigroup.
Charles Boorady - Analyst
Thanks, good morning.
I'm curious if you can give us more specifics on the fees charged for new business versus your existing book, excluding the cross-selling opportunity?
Mike Bell - CFO
Charles, it's Mike.
I'd prefer not to go into that level of detail at this point.
Again, I think the main points are that overall, we expect ASO yields, excluding the additional revenue that we get from specialty coverages, to be approximately flat in '07.
And that -- that means that new business will tend to drag that number down, just by virtue of the traditional profile of new business.
And that over time, we expect to be able to get better premium yields as well as additional specialty penetration.
I think that's really the most important headline.
Charles Boorady - Analyst
And on the fee-based business, specifically, does the same apply?
Or are you just referring to the premium?
Mike Bell - CFO
I'm sorry, I was referring to the fee-based business.
Charles Boorady - Analyst
Okay, that's what I thought you said.
But premiums -- I got a little confused.
So if I look at your any new business being signed, I can sort of impute a cut in the average fee per member month, to come up with a blended yield that's flat next year versus this year?
And you're not telling us what that cut is, but I can basically impute it.
Am I interrupting that right?
Your entire book, your yield will be flat on the fee, which implies a cut on the new business that would offset any increase in the existing book?
Mike Bell - CFO
Yes, I think that's fair, Charles.
I would point out, this is not exactly a new phenomenon.
We've seen this -- that kind of trend, in terms of new business versus renewals, for several years.
David Cordani - President, CIGNA HealthCare
And Charles, it's David.
To reinforce components of the strategy, our objective with ASO relationships is specifically and explicitly to sell additional products and programs to those employers.
We look at that opportunity when we write new business or retain business.
And as Mike said, in many cases, those opportunities don't all present themselves on the first year.
You might sell one specialty program year one, with the exception of selling an two additional programs, either during the year or in the next renewal cycle.
Charles Boorady - Analyst
I understand, the pile-on strategy, as you've called it in the past.
I guess if we just look excluding that cross-selling opportunity, is the yield still flat?
Mike Bell - CFO
Yes.
Ed Hanway - Chairman, CEO
That's what Mike referred to, yes.
Charles Boorady - Analyst
Okay.
Can I ask what the contribution to the health segment was in the quarter for the earnings from the Star acquisition?
Mike Bell - CFO
Charles, Star was approximately break even in the quarter.
Charles Boorady - Analyst
On an overall basis, including what it cost to buy it?
Or just to the health plan segment?
Mike Bell - CFO
Just to the health plan segment.
Charles Boorady - Analyst
Got you.
Okay.
Do you have a comment on your long-term view -- it seems like you've invested a lot to improve your service levels that's drawing in new customers, at the same time your admin costs are coming down, because you're more efficient.
Do you think you're back to the -- what was, historically, a long-term 10% expectation for annual earnings growth?
Can you share with us your thoughts on that?
What your expectations would be for average growth, longer term, beyond '07?
Mike Bell - CFO
Sure, Charles, it's Mike.
First of all, we have not changed our view that we've talked about before.
Which is, if we can execute effectively for the medium term, we really expect that EPS could grow in excess of 10%.
We're not ready to give you a new set of specific numbers.
This is a topic that we're going to talk about at the Investor Day -- but it's really the combination of things we've talked about before.
We expect with market share gains like we're going to have in 2007, to be able to drive high single digit revenue growth.
And if you add to that, segment expansions and expanded margins, and you recognize the fact that our return on equity is greater than our growth rate, which means that we would expect to drive significant free cash flow that we'd either plow back into repurchase or M&A; you do the arithmetic and you get to an EPS growth rate in excess of 10%.
More to come on the Investor Day.
Ed, you want to add?
Ed Hanway - Chairman, CEO
Yes.
Not on the numbers, necessarily.
But I think in terms of where you're going with our core fundamental capabilities, Charles, we have invested very heavily in that infrastructure.
We are seeing the benefits of that, as Mike has noted, and our expectations for the longer-term benefits continue to increase.
As we noted earlier today, the '07 to '10 time frame, we're now expecting to see greater productivity improvement than we had talked about before.
We continue to invest in that infrastructure, both to provide better capability to, particularly consumers, but also to become more efficient.
I think we'll talk a little bit more about the specifics behind that at the Investor Day.
But we clearly believe that the platform we are on today is very efficient and getting more so.
Charles Boorady - Analyst
Thank you.
Operator
Thank you, Mr. Boorady.
We go next to Bill Georges with JP Morgan.
Bill Georges - Analyst
Hi, good morning.
In the prepared remarks, you mentioned two things about membership a couple of times.
I think the first was that you continue to take share from other MCOs.
And the other thing was broadening the strike zone, geographically, to drive profitable business.
I'm wondering if you can indicate who have you been stealing share from?
Or perhaps, if you don't want to give that detail, in what geographies have you been stealing share?
And what geographies are more appealing from a medical cost perspective?
David Cordani - President, CIGNA HealthCare
Morning, Bill, it's Dave.
I'll address your question.
I'm not going to go through individual competitors, in terms of who we're taking share from.
But suffice to say, with our objective of 4 to 6% membership growth and 3% organic growth on 1/1, we've had some success in the marketplace.
In the regional segment, geographically, the best way to describe it is we expect to see improved results in all of our regions.
We run about six regions out of the country.
And each of the regions will show improvement.
And each of the regions will show some contribution towards growth.
That's a broad tablesetting comment.
Secondly, if you think about the strategic alliances we've secured over the past two years, you can look at four specific geographies, where we've gone into very competitive network value proposition opportunities.
And the third comment I would make is -- Ed highlighted in his prepared remarks -- is when we talk about expanding the strike zone, in some cases it's buyer segment, so with [Haf Hartley] or government, like cities and counties, would be an example of a buyer segment outside of the -- if you will -- traditional commercial employers.
Good opportunity broadly based across the countries.
We're expanding our strike zone geographically, aided by, not solely, but aided by the alliances.
And then targeting some buyer segments where we think our value proposition works rather nicely.
Bill Georges - Analyst
That's helpful, thanks.
Can you also, maybe, give us an idea of to what extent the service fee guarantees play a role in the new business that you're writing?
And maybe how does that compare to your existing ASO business?
David Cordani - President, CIGNA HealthCare
Bill, it's David again.
Relative to service fee guarantees -- service fee guarantees have been a part of the business for quite some time.
What we see is some modification, in terms of the structure of those guarantees.
So for example, employers might be asking -- large employers might be asking to move a percentage of the guarantee from traditional members -- measures, such as ASAs or average handle time, to more forward-looking measures, where we're working to partner to get members more activated.
So one and done call measurement as opposed to ASA and putting some dollars against that.
But the aggregate pool of dollars relative to service hasn't changed dramatically, nor is the phenomenon of guaranteeing some aspect of your fees against certain service performance levels.
That has not changed dramatically, either.
Ed Hanway - Chairman, CEO
Bill, just to add one thing to the service fee comment.
I think it's important to note -- we clearly have to be competitive from a fee standpoint today.
But the business we're winning, particularly in the larger markets, is not really driven by the fees.
You have to be competitive.
But I think it's safe to say that what we're seeing today is employers much more focused on, how do you engage my employees, how do you affect appropriate behavior change with my employees, in terms of their own health status?
And our ability to demonstrate capabilities in that area is what's really helping us in the marketplace.
As David said, the service fee structure itself really hasn't changed materially, other than some of the measures have changed.
I think what is changing is the basis of competition and the capabilities you have to have to be successful.
Bill Georges - Analyst
Okay.
If I could ask just one last quick one; the new MLR guidance of 86%, does that compare on an apples-to-apples basis to last quarter, which I believe was 87%?
Mike Bell - CFO
Not -- Bill, it's Mike.
Not exactly.
The -- with the pro forma adjustment that Ted referenced in his prepared remarks, you would want to add approximately 60 basis points to the 86 to put it back on the old basis.
So, it would still be -- call it 40 basis points better, but not 100 basis points better.
Bill Georges - Analyst
Okay, got you.
Thanks very much.
Operator
Thank you, Mr. Georges.
We go next to Ed Kroll with Cowen and Company.
Ed Kroll - Analyst
Yes, good morning.
Most of my questions have been answered.
And I just have -- on the enrollments, under the guaranteed cost line in the stat supplement, what -- can you remind us what's in that other category?
Mike Bell - CFO
Sure, Ed, it's Mike.
Embedded in that category is the non HMO guaranteed cost business.
So this would include our care-to-cost open access business, the guaranteed cost PPO business, a little bit of indemnity remains there.
So it's the non commercial HMO guaranteed cost business.
Ed Kroll - Analyst
Got it, okay.
Thank you.
Operator
Thank you, Mr. Kroll.
We take our final question from Joe France with Banc of America Securities.
Joe France - Analyst
Thanks.
Just a housekeeping question.
The business that you have in Tucson that generated -- I forgot the number -- $45 million revenue in the quarter; that's reinsurance, which, I assume means it's contributing very little to earnings, currently?
Is that expected to earn more money next year?
Mike Bell - CFO
Joe, it's Mike.
Yes, you're correct on both fronts.
It is, essentially, breakeven today and we expect it to earn money and actually roll to our paper in 2007 -- so show up in the membership, as well.
Joe France - Analyst
You expect the full 54,000 lives to, basically, stay?
Mike Bell - CFO
Well, I wouldn't necessarily project 100% persistency, although we would like David to be able to accomplish that.
But the -- certainly, the vast bulk of those members to renew on our paper.
Joe France - Analyst
Fine.
And then, finally, the Part D business, where you have expanded virtually into -- and diversely all the regions, now.
The contribution next year -- what is the earnings contribution expected to be for Part D in 2007?
Mike Bell - CFO
Joe, at this point, we have modeled $5 million of earnings contribution in 2007.
Joe France - Analyst
Thanks.
Operator
We take a final question from Justin Lake with UBS.
Justin Lake - Analyst
Thanks.
Just a couple quickies.
First, in regards to the MLR that you discussed, is there any impact there from the acquisition in Arizona for Star?
I know you pulled out a couple of the Star businesses, I just want to make sure that that's an apples-to-apples number, sequentially, with the acquisition.
Mike Bell - CFO
Justin, it's Mike.
Yes, the -- we have pulled out the Star HRG.
And in fact, in you look at page eight in the stat supplement, you can see it with and without Star.
But the numbers that I talked about in my prepared remarks exclude Star.
First in terms -- and then second, in terms of the membership in Arizona.
The membership there in Arizona has a loss ratio inline with the overall book.
So the fact that we add that membership over the course of 2007 would not be expected to impact the medical loss ratio.
Justin Lake - Analyst
That's helpful.
And when you -- I was -- on your HealthCare P&L, you list life and other non-medical.
The revenue is down pretty significantly, but if I kind of offset that with other benefits, it actually looked like it was a big contributor in the quarter.
Do you have any color on that?
Mike Bell - CFO
Sure.
Justin, included in that line item is the old experience-rated disability and life business that has frequently, through time, often been bundled with the medical coverage in an overall experience-rated arrangement.
So I would not get hung up, in terms of the various pieces.
We work hard to try to get as clean a cut as possible between the medical piece and the non-medical piece.
But it is, at times it involves a fair amount of judgement.
If you look at -- your specific comment around, did it contribute significantly to earnings; if you look at it on a year-to-date basis, it is roughly inline with 2005.
So, for example, if you look at the other benefit expenses on page six; yes, they are down $103 million year-over-year.
Which is consistent with the fact that this business is running off.
And then that is reasonably comparable to the drop in the premiums for that line of business on page seven, of -- excuse me, of $99 million year-over-year.
So from an overall P&L standpoint, it's roughly flat year-to-year.
Justin Lake - Analyst
Okay, well what about -- it looks like it drops significantly in the third quarter, is what I was asking.
Was that -- was it a contributor?
I mean, I realize year-over-year it wasn't very -- it didn't look like it was very profitable in the first and second quarters.
But it looked like it was very profitable in the third versus it was more rateable across the quarters in 2005.
Mike Bell - CFO
Yes.
It has bounced around quarter-to-quarter.
And, again, there has also been some play between the medical piece of experience-rated, along with the non-medical piece.
So I would really urge you not to get hung up in those pieces.
And instead, look at the piece in aggregate over the period.
Justin Lake - Analyst
Okay.
So it was not a significant contributor to the quarter?
Mike Bell - CFO
The better way to think about it, Justin, is that experience-rated earnings in the quarter were down $6 million in third quarter versus second quarter.
And I think that's more important than the individual pieces that you're looking at.
Justin Lake - Analyst
Okay.
Thank you.
Operator
That concludes our question-and-answer session for today.
I would like to turn the call back over to senior management for any additional closing comments.
That concludes today's conference call.
If you would like to access the replay for today's call, it will be available at 719-457-0820 or 888-203-1112, starting at 11:30 Central Time today running through midnight on the 15th.
Thank you for your participation.
You may now disconnect.