信諾集團 (CI) 2006 Q4 法說會逐字稿

Good morning and welcome to the HealthSpring conference call to review its financial results for the fourth quarter and year ended December 31, 2006.

The financial results that were issued yesterday after the close of market trading. If you did not receive a copy of the press release, you may find a copy under the Investor Relations tab on the HealthSpring website, www.myhealthspring.com.

Before we begin, HealthSpring wishes to express that some statements made in this call will be forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995. Actual performance of the company may differ from that projected in such statements. Investors should refer to statements regularly filed by the company with the Securities and Exchange Commission for a discussion of those factors that could affect the company's operations and the forward-looking statements made in this call. The information being provided today is as of this date only and HealthSpring expressly disclaims any obligation to release publicly any updates or revisions to these forward-looking statements to reflect any changes and expectations.

In addition, certain non-GAAP financial measures may be covered in this presentation. These non-GAAP measures are reconciled to the most comparable GAAP measures in the press release filed with the SEC. At this time, I'll turn the call over there Mr. Herbert Fritch, Chairman, President and Chief Executive Officer of HealthSpring.

Please go ahead, sir.

Thank you, operator.

Welcome to HealthSpring's fourth quarter 2006 earnings call.

We are pleased to report a strong finish to our first year as a public company, and we are excited by the momentum we have going into 2007. We continue to show solid financial results in our core Medicare Advantage business, but the quarter was highlighted by better than expected results for our stand alone PDP product. We also experienced a steady increase in MA membership, with net growth of over 3600 members for the quarter in spite of being in lock-in period. In addition to these operating results, we continue to progress on our strategic initiatives that we believe will enhance our performance for 2007 and beyond.

We took full advantage of our new marketing campaign featuring Willie Mays as our spokesperson in both print and broad media. We also opened the prototype Living Well Health Center in Middle Tennessee in December. Moreover, we have set the stage to expand our paper quality program from about 8,000 lives to 24,000 to 25,000 lives in 2007 and have several more physician organizations ready to begin operations in 2007. In December, we announced the retirement of Jeff Rothenberger as our chief operating officer effective April 30, 2007. Though we are disappointed that Jeff will be leaving us, we sincerely appreciate his considerations to HealthSpring and wish him well in his future endeavors. In HealthSpring, when one door closes another opens. In December, we also welcome the newest member of our executive team, Jerry Coil, who will succeed Jeff as Chief Operating Officer. Jerry joins us from Health Net where he was president of the Behavioral Health subsidiary MHN. Jerry and I have known one another for over 30 years. While Jerry has big shoes to fill, I have always considered him one of the brightest people in managed care industry and he has already made positive contributions to our operations in the short time he's been with us.

On the membership front, we are encouraged by the second quarter of consistent growth during lock in. Although we benefited a little from hurricane exemptions in Mobile and Houston, we still saw net growth in all markets primarily through our total care product or dual eligible SNIP. The ability to grow during an extended lock in period will be even more critical this year. Our 2006 experience indicates an expectation of continued growth is reasonable.

It looks as though our January 1 MA only and MA-PD membership will end up at about 117,615, up about 2500 members from year end. We would expect to see about 40% of our 2007 growth in members during the first quarter and the remainder after April 1. Although we have continued to grow in all markets, the Houston market is becoming increasingly more competitive. Private fee for service plans continue to be our most formidable competitors. We did hear late last week that the most aggressive private fee for service plan in the Texas market had ceased enrolling new members. Our MLRs for the fourth quarter continue to be below 80% in spite of not seeing the usual seasonally favorable hospital admission rates during November and December. In spite of higher admission rates in November or December which we believe are attributable to an early flu season and absorbing the annual increase Medicare hospital payments in October, we still had acceptable MLRs, thus validating the effectiveness of our physician engagement and paper quality programs.

The quarter was highlighted by very favorable stand alone PDP results. Even taking into account the CMS risk corridors, the nature of the benefit design for auto assign dual eligibles drove substantial earnings for the quarter. Although we expect the margins of this product to decline with rates in 2007, we have grown membership in the PDP in our existing markets and as a result of our nationwide expansion by over 20% for 2007. We still expect this line of business to contribute substantially to earnings in 2007.

Our prototype Living Well Health Center began operations on December 4. We continue to be very enthusiastic about the positive impact these centers can have for members, physicians and HealthSpring. Early feedback from all constituents has been positive. We continue to gain experience in the day-to-day operations and refinement of this model. In this early stage of development, we have found it difficult to scale operations as rapidly as we would like and now looks as though we will be able to open two more centers in time for the 2008 open enrollment period versus our prior plans for four new centers.

During 2006, we expanded our paper quality program from one physician group to multiple groups in multiple markets with 12 primary care offices and 7500 members. We have continued to see very positive results. For example, our pilot program was approximately 7500 members, has seen significant increases in quality care measures with corresponding decreases in utilization trends and MLRs. Because of these results, we are expanding the program further in 2007 and we have targeted to have 24,000 to 25,000 members covered by these programs in the second half of 2007. With the continued success of the program, and this high level of engagement, we would hope to see a measurable impact on medical cost trend during the second half of 2007 and on into 2008.

Our physician engagement efforts have had a positive response in both Alabama and Tennessee. As we have experienced with our efforts in Texas, we would hope that both Alabama and Tennessee medical trends will be positively impacted in 2007. By the middle of 2007, the majority of our members in these markets should be with primary care physicians who are part of an organized entity actively working with us to improve quality and reduce the cost of care for our members.

As we enter 2007, our balance sheet is as strong as it's ever been with about $338 million in cash, including approximately $78.5 million in unencumbered cash. That number grows on a monthly basis. We also continue to have no debt outstanding.

One of the disappointments during 2006 was not being able to close an acquisition of another Medicare plan as part of the overall growth strategy for the company. The M&A pipeline continues to be robust and we remain focused on M&A as one means of growth in a lock-in environment. We are continually evaluating the most appropriate use of our capital to that end; if we are not able to enter into a significant transaction in the first half of 2007, we may look for other ways to deploy our cash and the best interest of stockholders.

I would also like to comment on the recent CMS publication of the 45-day advanced notice of proposed Medicare Advantage capitation rates in 2008. At this point, the preliminary rates appear to be in line with our expectations. Several of the factors used to determine the final rates have yet to be fully determined; however, we will not guess as to where rates will finally settle. As was the case with the 2007 rates, it does appear likely that the 2008 rates will lag medical cost trends. We believe this environment continues to favor plans like ours with a medical management focus. Even with any potential adjustments we may need to make in benefits going forward, the relative attractiveness of our Medicare Advantage plans, traditional Medicare should continue to be compelling.

In all, we believe steady growth in membership and revenue combined with our medical management model is the best way to achieve sustainable growth in earnings and generate the best returns for stockholders. Our model is less vulnerable to legislative changes and floor payments. Our approach to managed care is predicated on highly engaged networks actively managing medical costs. Consequently, we've avoided unmanaged products such as private fee for service where we believe the risk of adverse medical trends currently outweighs any near term benefits associated with membership and revenue growth.

With that, let me turn the call over to Kevin to give you the details on the financial metrics for the quarter and the year.

Thanks, Herb.

We were pleased to report fourth quarter net income available to common stockholders of $20.1 million or $0.35 per diluted share, an increase of $17 million from prior year fourth quarter. Significantly contributing to our fourth quarter results were one, a strong finish for our Part D stand alone product; two, a risk adjustment payment related to finalization of risk scores for fiscal 2005 received in the fourth quarter of 2006; and three, increases in our fee in investment income. With respect to net income available to common stockholders, results are not fully comparable to the prior year due to the inclusion of preferred dividends, transaction expenses associated with the recap and a significant amount of interest expense in prior year results.

However, results at the adjusted EBITDA line, which are fairly comparable year to year were up approximately 48% on an approximate 36% revenue increase, as the strong Part D stand alone results more than offset an increase in quarterly MLR.

Let me now spend a few minutes discussing each of our key financial metrics.

We finished the year with 115,132 Medicare Advantage members, approximately 95% of which were MA-PD members. Membership by market and the year to year growth rate was as follows:

In Tennessee, we finished the year with 46,261 members, which represented an 8.8% increase. Texas had 34,638 members, which was a 16.6% increase. Alabama had 27,307 members an 11.3% increase. Illinois, 6,284 members, a 50.8% increase, albeit off a smaller base. And Mississippi, 642 members, a 74% increase and again a small base. For a total of 115,132, a 13.7% increase.

Stand alone PDP membership was stable finishing the quarter at 88,753.

With respect to 2007 membership trends as Herb indicated, our records reflect 117,615 January effective with increases in all markets. Net member adds and the sequential growth of January 31 were at Tennessee, 992 for 2.1% sequential growth, Texas 345, 1% growth, Alabama 511, 1.9% growth, Illinois 584, 9.3% sequential growth and Mississippi 51 for 7.9% growth for a total of 2483 member adds in a 2.2% sequential growth.

As reflected in the member ads, selling efforts were robust during the first 45 days of open enrollment. As we expected, however, we also experienced a higher than normal level of disenrollments as members who found themselves locked in, in the first half of 2006 had their first opportunity to exit plans. We had approximately 9800 gross sales with the January 1 effective date with the corresponding disenrollment of approximately 7300. We have seen a slowing trend in January and February gross sales but disenrollment seems to have slowed fairly significantly as well. We are hopeful that we can add another 1,500 to 2,000 net members per month during the remainder of open enrollment and add approximately 1,000 net duals, age-ins and other eligibles during lock in. This latter number compares to approximately 1200 net adds per month during the 2006 lock-in period which was somewhat aided in some of our markets by Katrina exemptions. On the stand alone PDP, we picked up another 19,860 auto assign members on January 1, bringing membership to 108,613. As most of you are aware of we filed a National PDP Plan in 2007 and our bids were under the benchmarks in 29 of the 34 regions. Of our January 1 PDP membership, approximately 85% reside in our five current MA states.

We finished the year with just under 32,000 commercial members, most of which were domiciled in Tennessee. A number of these members were in groups which had chosen not to renew January 1. Consequently, our January 1 commercial membership was approximately 16,500 with 15,700 of these being in Tennessee. As we have previously discussed, our commercial business will continue to decline as a percentage of our total revenue. We would expect commercial premiums to represent less than 4% of total revenue in 2007.

Total revenue in the fourth quarter was $335.7 million, an increase of $89.6 million or 36.4% versus the prior year. The primary drivers of the year to year increase were incremental Part D premiums and in this context I'm using MA-PD and PDP of $45.5 million and an increase of 14.8% in MA member months combined with an approximate 6.2% increase in base MA rates.

Fee revenue was up $1.8 million or 35.5%, the majority of which relates to a management agreement with the Florida health plan that was terminated as of December 31, 2006. Investment income increased 264% due to significantly higher cash balances coupled with higher yields on these balances. Slightly offsetting these gains was a decline in the commercial revenue of $5.9 million or 18.4%, the decline was driven by a 23.7% drop in member months, which was partially offset by a 7% increase in commercial rates. Total MAP MPMs were $806.33 in the 2006 fourth quarter, an increase of $106.78 or 15.3% versus the prior year. Of this amount, $63.63 or 9.1% of the increase is due to the inclusion of the incremental MA-PD premiums. Again, that's adjusted for the risk corridor and the remaining $43.15 or 6.2% is due to increases in base MA rates, much of which is attributable to increased risk scores year to year.

Sequentially total revenue declined by $8.2 million or 2.4%. Contributing to the decline was a decline in the amount of the retrospective risk payments included in the 2006 fourth quarter by $9.7 million. The third quarter included $15.4 million related to 2006 whereas the fourth quarter included $5.7 million related to the final settlement of 2005 CMS payment. There were also sequential declines in commercial premiums of $3.7 million or 12.2% and in fee and other revenue of $1.6 million, the majority of which relates to the winding up of our management arrangement of the Florida health plan.

We recorded $2.3 million in the third quarter under this agreement versus $1.3 million in the fourth quarter. These declines were partially offset by a 2.7% increase in MA member months and incremental investment income of $700,000. Combined medical expense was $253.9 million, an increase of $65.7 million or 34.9% versus the prior year. With respect to the components in the relative metrics, MA medical expense was $218.7 million, an increase of $56 million, or 34.4% versus the prior year. On a PM PM basis, MA medical expenses were $641.99, an increase of $93.75 or 17.1% versus $548.24 in the prior year fourth quarter. $55.65 or 10.2% of this increase is due to the inclusion of drug costs associated with the MA-PD incremental premium. Adjusting for this, MA stand alone PM PM medical costs was $586.34 an increase of 7%.

MA MLR was 79.6%, an increase of 120 basis points versus 78.4% in the prior year fourth quarter. Of this increase, approximately 70 basis points are due to the inclusion of MA-PD costs in the current year; the remainder is due to medical trends slightly in excess of rate gains. Exclusive of the prescription drug component of MA-PD, year to year premiums were up 6.2% against the medical trend increase of 7%. On a year-to-date basis, we reported an MLR of 78.8% versus 78.4% in the prior year, an increase of 40 basis points. Of this increase, 60 basis points relates to the inclusion of MA-PD drug costs in 2006, partially offset by 20 basis point year to year improvement in core medical costs.

We acknowledge our 2006 MLR trends and metrics are somewhat confusing on a quarter to quarter as well as year-over-year basis due to the inclusion of MA-PD results in 2006 and the timing of retrospective risk payments. I encourage all listeners to visit our web site where we have posted under the Investor Relations link a non-GAAP supplemental disclosure schedule entitled "Medicare Advantage Results", which adjusts quarterly premiums in medical costs and recalculates MLRs on a with and without basis for these items.

PDP MLRs were 45.8% and were down significantly on a quarter to quarter basis due to the overall benefit design of this product. The quarter reflects the effects of more members moving into the coverage gaps and re-insurance corridors. On a year-to-date basis, the PDP MLR was 73.4%, reflecting actual experience significantly better than we had expected based on our original bids. The commercial MLR was 91.8%, essentially flat with that experienced in the third quarter. For the year, the commercial MLR was 89.8% reflecting an increase of 535 basis points versus the prior year. The annual increase results from medical trends of approximately 14% going against premium increases of about 7%.

Adjusted SG&A expenses were $48.5 million, an increase of $12.9 million or 36.3% versus the prior year. On a percent of revenue basis, adjusted SG&A expense was 14.5% in both periods. Contributing to the year to year dollar increase were five things. One, a significant increase in personnel costs associated with headcount additions. We finished 2006 with just under 1200 employees. Two, incremental expenses associated with the rollout and support of the new Part D program of about $2.8 million. Three, the inclusion of $1.8 million of FAS 123R costs in the fourth quarter of 2006. Four, incremental selling costs of $1.4 million and five, an incremental $2 million of non-personnel related corporate expenses primarily related to SOX compliance, legal and accounting conversion costs.

The legal expenses in the quarter primarily relate to the previously disclosed Alabama litigation. We've recently reached a tentative settlement in the substantial majority of the cases filed against our Alabama health plan. The terms and conditions of the settlement are confidential but the cases were settled at amounts within insurance coverage limits and supplemented by accruals the company made in 2006 related thereto.

Sequentially, adjusted SG&A expenses were up $10.7 million or 28.3%. Contributing to the sequential increase were approximately $4.5 million related to incremental sales commissions and marketing costs, approximately $2 million of increased corporate costs and incremental head count additions. We had forecasted an SG&A expense spend of $5 to $7 million in excess of third quarter levels. The excess above this amount primarily relates to accelerated hiring as well as corporate expense beyond forecasted levels. We finished the year with adjusted SG&A expenses at 12% of revenue which was in line with our internal target.

Before leaving SG&A, let me say that we expect SG&A to remain seasonally high in the first quarter of 2007 due primarily to open enrollment sales and marketing costs. We continue to set an internal target of 12% for these expenses in 2007. While a number of our corporate expenses will annualize in 2007, we are hopeful that we will see some operating leverage in the back half of the year.

Fourth quarter results are significantly impacted at the adjusted EBITDA line by the benefit design aspects of Part D, whereby the majority of your annual profits reside in the fourth quarter. As such, sequential and year-over-year comparisons at the adjusted EBITDA line are difficult. Through 2006, we have managed and accounted for our Part D business as an integral part of our Medicare business and as such have not allocated a discrete portion of corporate expenses nor any portion of investment income to Part D. Accordingly, we do not manage to or assign relative contributions from MA versus PDP.

Because I get the questions regularly, however, based on a reasonable set of assumptions, I estimate our PDP product finished the year with high teens EBITDA margins. This estimate would suggest that EBITDA contributed approximately that the PDP contributed approximately 13% to 15% of our $143.8 million in adjusted EBITDA for the year. Because of changes in PDP premium rates, we expect our comparable EBITDA margins for the PDP product to decline to a range of 6% to 10% in 2007.

Pretax margins were 9.1% for the fourth quarter and 9.5% for the full year. The fourth quarter effective tax rate was 34% and reflects further refinements of adjustments related to the 2005 consolidated federal tax return and state tax planning. Our annual effective tax rate was 35.1% versus the 35.5% projected at the end of the third quarter. As we have previously disclosed, we expect the tax rate in 2007 to be in the 36% to 37% range.

Looking at the balance sheet, we finished the quarter with $338.4 million in cash and cash equivalents, an increase of $71.4 million and $228.3 million for the quarter and year respectively. Unregulated cash at year end was $78.5 million of which $59.5 million represented cash at the parent. Days claims payable were 44 at year end, an increase of 4 versus the prior year. The majority of the increase is due to the inclusion of amounts payable for Part D claims to CMS and other health plans under the state to plan and plan to plan reconciliation processes. Operating cash flow for 2006 was 167.7 million or 2.1 times net income.

With respect to our 2007 guidance, we are reaffirming our previously released GAAP EPS guidance of $1.55 to $1.65. Key assumptions behind this guidance are MA membership of 130,000 to 135,000, that's leaving the year; PDP leaving the year membership of 100,000 to 110,000; revenue of $1.5 to $1.6 billion, MA MLRs at or below 80%; PDP MLRs of 85% to 90%; and we used weighted average shares of 57.6 million.

Operator, that concludes our prepared remarks. We can now open the line for questions.

Thank you.

[OPERATOR INSTRUCTIONS]

We'll go to Matthew Borsch of Goldman Sachs.

Yes. Hi. Good morning.

If you could elaborate a little more on the medical cost trend experience on the Medicare advantage side in the fourth quarter and, you know, to the extent that you're, you know, getting any glimpse of trend as we're now 45 days into 2007, if you could talk to that as well.

I think what we saw, Matt, for the most part in a normal year if you ever have that, we expect you get a blip in fourth quarter because we piggyback our hospital contracts on Medicare payments, and they increase on October 1 while revenue, of course, is flat for the year if you smooth out the risk adjusted payments. Usually, that's offset by pretty favorable admission rates in November and December as elective admissions tend to get deferred during the holiday seasons, and we didn't see that this year. We saw higher admission rates which in our minds indicated, at least in our Tennessee, Alabama and Texas markets, the onset of the flu we thought. So rates actually admission rates went up in November and December, which is a little unusual except for the flu. I think we typically expect high admission rates in January. We saw that, and things seem to have settled down a bit in the month to date in February.

Matt, if you went to that schedule on the web site, the fourth quarter gets a little skewed with the payment of the prior year risk payments in both of those quarters. But if you go to that schedule on the web site and footnote three, we do a with and without calculation for that arriving at an adjusted MLR of 80.9. If you do a similar calculation for the prior year risk payment, what you've got is the prior year Q3 to Q4 saw an 80 basis point increase and this year's was 130, and the incremental, we think, is associated with the higher than expected November/December.

Got it. And just on another topic, the competition that you're seeing in the Texas market, you know, I'm familiar with the competitor that's ceased marketing at this point, but are you seeing aggressive competition from others in addition to that, particularly on the private fee for service side in Texas?

Not on the private fee for service side. I mean, there's a lot of competitors, but none of them individually stand out as, you know, a particular competitive issue. When you add them all collectively, they amount to something. It is the one market where we have an MA competitor with slightly better benefits than us. And so I think in addition to the private fee for service, if the market where we have the strongest MA competitor from a benefit perspective.

Okay, thank you. I'm good.

We'll go next to Charles Boorady of Citigroup.

Good morning. My first question, you made a comment on '08 rates probably not keeping up with medical inflation. I wonder what you expect to see as a year-over-year growth in '08 in the Medicare Advantage per member month revenues that you receive including what you'd receive from the risk payments?

I think if you include what we get from risk scores and risk payments, we think we ought to roughly keep up with inflation again in '08. Most of that's coming from the risk side of things. From what's been announced so far, we think we're getting about 2% more than we got this year. And we feel good that it looks like we're going to end up, you know, getting 6 to 7% this year. That could still change a bit. They haven't announced anything. It looks slightly better than last year, I think.

This 6% to 7% is a per member month average year-over-year growth in '07?

Yes.

Versus '06. Including the risk payment?

Correct.

That's right.

Got it. And you think it could be better than that in '08 by two percentage points?

From what we know now, that would be our best guess.

I see. How much of that is from the risk-based payment and what assumption will you make in terms of any increases in your risk scores to get there.

You know, for us most of it comes from that. If it's 6 to 7, maybe 5 to 6. I think it's a combination of we are, you know, we've mentioned the increase many membership during lock-in coming from our dual eligible product. They do have higher risk scores and higher medical costs, so I think that's part of it. And part of it is just education efforts and work with the physician offices to capture codes more completely.

So this would include the effect of a mix shift towards more snips and other factors? If we looked at sort of a same customer basis growth in PM PM including the risk score, do you know roughly what that would look like? That would be the more relevant measure to compare it to and overall changing cost trend.

I don't know that we actually sat down and measured that. Probably a half a point left.

So you think it's still keeping up with cost trends then on a same member basis?

I would think so. I mean, the mix shift isn't dramatic. We're up maybe 2 percentage points or something and our percentage of dual eligibles year-over-year so it's not huge.

Okay. To your earlier point in your prepared remarks about rates not keeping up with inflation, that was just part of the story before taking risk adjusters into consideration, but all in, do you feel like this program is sustainable given the current payment mechanism and phasing out of the budget neutrality factor?

Yes, no. It would sure appear to be. You know, that assumes no significant changes legislatively that, you know, affect lower payments and all that kind of stuff.

Right.

Just from what's been announced so far, you know, the worst case for us might be, you know, a 1% degradation, something like that. That's worst case. Best case is probably a 1% improvement.

Got it. Thanks. Finally, the comments you made on admissions for I assume it was in-patient but I'm not sure for the fourth quarter. Do you know what to attribute the higher than normal admissions to? Did it have to do with the day of the week that the holidays fell on? It felt like people worked right through the holidays this year with the sort of industry-wide phenomena that could have related to something like that or was there a company-specific issue identified?

We've looked at it. We can't pinpoint a lot. We do think the states that we've got the majority of our membership in were some of the states that did get hit with early flu season. And I say that's the most likely case.

Do you have a breakdown of the components of the medical trend today sort of a unit price versus volume for the major components?

You know, I think the biggest unit price issue is hospital costs. Medicare's running 3 to 4%. Physician fees are pretty flat. So really, most of the rest of the trend would have to do with utilization and intensity and mix of services.

Understood.. Thanks. Just a final question on balance sheet and your generating cash. I know you were disappointed not close on the acquisition last year. Sometimes the best acquisitions are the ones you don't do. I'm just curious at what point do you start to think about deploying the cash for share repurchase as opposed to, you know, waiting for the next acquisition to come by. If you can comment on the pipeline opportunities that you see?

I mean, Charles, we're in active discussions with lots of folks. And the pipeline, you know, remains pretty full with respect to discussions. We have heard sort of anecdotally a lot of the comments and a lot of the folks you hear the comment that well, boy, we want to see what open enrollment looks like. We want to see what we look like after open enrollment. So we're hopeful that you get some loosening and some people wanting to move and do something in the late spring and early summer. If we don't see some movement by the middle of the year, then we'll start looking at other options in the back half.

Understood.. Okay, great. Thanks and congrats on the quarter.

Thanks.

We'll go next to Josh Raskin of Lehman Brothers.

First quick question, you guys didn't put it in the press release, but I know that yesterday you talked about 15% to 18% of full year EPS in the first quarter. Any change to that?

No, Josh.

Okay. Just wanted to make sure. Second on the flu season, I know you talked about this a couple of times about this point, but any evidence in January or even as we got into early February here of any abating or passing through the flu season. Anything to confirm that that's sort of moving on as typical? I think the CDC data is suggesting a pretty normal flu season.

I think we've started to see an abate of the admits in February.

Okay. That's helpful. And then just a strategic question, I guess.

As you look out at 2008, you mentioned that the rate increases are going to come in slightly below where you think your cost trends are going to be for a second year. You know, with further competition, you're certainly seeing that in '07 and maybe I'm being presumptuous for that to continue into 2008 as well. How do you think about that differential? Is something strategically, from your position, Herb, are you going to maintain margins into 2008 and maybe pare back some of the benefits or are you looking to continue to grow the product and even if it costs you on the margin side?

I think we focused on earnings and maintaining margin. I think, the way I look at these rate increases and look at the components of our increase, I think we've got a competitive advantage over either MA plans that don't have physicians engaged or certainly private fee for service plans that don't even have contract. I would hope that that competitively we may be able to maintain both benefits and margins where some of these other alternatives won't.

Okay. I think that makes sense.

The last question just on the 6.2% is what you reported on your base rate increase? Obviously that includes the risk adjusters. As you look into 2007, do you anticipate a similar level of improvement in terms of your coding capabilities, i.e. what your rates are going to look like versus, what the, the risk adjustment payment under CMS's methodology is?

Yes. I don't think we've seen much change in that.

In fact, the risk adjusted payments, the final true up for '05 that we got in the fourth quarter, one would expect should increase just because of it only applies to the risk component of the payment. It was for 2005 when risk was 50%, and in 2006, which is what we'll get in the fourth quarter of '07, the risk was 75% of your payment and we've got increased membership. So that component at least should go up.

Now one of the issues that CMS didn't address in their preliminary announcement was whether or not they're going to make an adjustment for coding intensity. That's certainly one of the factors that could change that.

Yes. I think they mentioned the studies, but it didn't sound like there was anything imminent.

Josh, in terms of we talked about the -- we fully expect to start accruing for risk payment.

Right.

For risk payments in '07. With respect to the methodology and how we're going about that and what we're talking to our auditors about is we're trying to accrue for the end year, the former not the latter part of that. That true up related to the prior year would still fall in the fourth quarter.

Oh, okay. So you'll still see a significant level of seasonality due to that single payment, though?

Correct.

All right, thanks.

We'll go next to Justin Lake of UBS Securities.

Thank you. Couple quick questions.

First, just on the membership numbers. Is that 117 number a, you know, is that a sales number through the end of January?

That's January 1 effective, Justin.

Okay.

You know, it's adjusted for things ha wouldn't get reflected until February payments come out with CMS and gets applied retroactively for both increases and enrollment and decreases.

Do you think that -- because C.M.S.'s February data shows you at that 117 number as February 1. I'm wondering if there's some disconnect or you think that 117 for February might be light.

Yes, we think that CMS number is a little light.

Okay. Any idea where you think you are for February 1?

We don't have all of the data for that yet.

Okay. On the reimbursement side, you talked about a 5 to 6% number, a lot of that coming from, you know, better risk adjustment payments. How much of that, Herb, is just the function of going from 75% to 100% risk adjustments?

You know, I think in our case, the waiting is probably worth a half a point or so.

Okay. So your risk scores are probably not too much above 1.0, on average?

No. I think, across the company, they are probably below 1.0, but the demographic scores are below 0.9.

Okay. So that difference is driving [both talking at once].

Still a bit there but it amounts to a fraction of a point.

Okay. The last question on this risk adjustment payment on the fourth quarter. I assume that gives you a higher run rate on your Medicare Advantage rates?

You know, this one really doesn't. [ All Talking At Once ] This is just a final true up for late claims and encounters that were submitted in '05 and doesn't affect your run rate.

It doesn't affect the run rate some.

No. Technically speaking, you will get a similar true up in '06 toward the end of '07. No one's really tried to accrue for that or account for it.

Okay. But you have a good idea it's going to be somewhat in the same range?

One would expect it'd be higher just based on the waiting you mentioned of how much your rate was based on risk. [ All Talking At Once ]

Doesn't that have to do with the change in your risk scores in '06?

I'm sorry?

Doesn't that have to do with the change in your risk scores in '06 as well, Herb? You can source out the change, year over year?

You know, this is pretty much, I think this is just a true up on those late claims that come in and counters that get submitted after they do because right now, they sweep payments for the third quarter adjustment at the end of March. So you've got two months of runout. I think ultimately you get another 2%, 3%, 4% of claims that come in after that. This is an adjustment. It's the same period of time; it just takes into account some additional and counter information.

Got it. That's helpful. Thanks, Herb.

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

Yeah, my first question deals with, you know, you indicated that, when at the Investor Day, that you introduced especially pharmacy product. I was wondering what kind of impact on trends that was having. And then you also, kind of more globally, threw out the potential of taking pharmacy in house, and I want to get an update on your thinking there as well.

Mike, I don't know what you are referring to in the specialty pharmacy products. We have going into '06, we did look at doing our own contracts with manufacturers directly. I think we've been thinking about whether we actually do our own network contracts with the pharmacies right now. Right now, we use Argus's network, and use Argus's participating clients.

How about, you know, more globally. You did indicate that there's a potential of maybe arbitrage on the price differential and contract rates by taking more of the functions in house.

Yes, I think that was really it. We haven't moved ahead on that, but that would be the issue of holding our own contracts with the pharmacies as opposed to using Argus's.

Okay. Thanks a lot.

We'll go next to Matt Perry of Wachovia securities.

Good morning. Just a couple more questions on risk scores.

I guess first do you feel like you're capturing all of the data you could capture to accurately reflect your risk scores? And then second, you know, as you kind of roll out this physician engagement model, would you expect risk scores to increase related to that?

You know, we certainly don't think we're capturing all of the data yet. One of the challenges we have in our model is, you know, we deal with literally thousands of primary care offices, many of whom have, you know, 25 to 50 of our patients. And irrespective of how engaged they are, we're not sure we can really change how they document and capture these codes. It's a gradual process. Certainly, the higher the level of engagement we think that all helps, and as we see that level go up in Alabama and Tennessee, we expect that's got to have some positive influence on that.

That's helpful. Separately on the PDP, your prior, you know, I think quarterly releases or your Qs, have talked about plan to plan reconciliation and receivables you've booked related to that. Can you just tell us where that stands? And how much is left to collect and what the time frame would be and what your confidence level would be in collecting it all?

Matt, that process, there was a very, very clearly defined process of what was called Phase 1 of that process, which related to the period where most of the volume and most of these issues came up being the start of the year through April 30. That process has been totally settled. We collected virtually everything and paid everything related to that process and that's behind us. We're now in what's called Phase 2 and State-to-plan. Phase 2 relates to the period after April 30. CMS has come out with some rules of how that works, and the State-to-Plan relates to payments to at the time states on the dual eligibles. The latter part, we think, that the exposure is much less significant. The dollars are much less significant and where we sit today is sort of the definition of what those amounts are is still trying to be worked through. To the extent they relate the State-to-plan, most of the items, as you run those payments through, most of it would go back through the risk corridor, so you get very little P&L exposure and relates to the geography of what we've got sitting up there today.

That flows into my last question. You do have, you know, that risk corridor payable on a balance sheet and then the funds health for the benefit of members, which boosted the '06 cash flow. When would we expect those payments to be made?

You're supposed to settle up under current rules in July.

Okay. So in theory, July '07 those balances you're carrying from '06 should go to zero?

You got one of them, yes. What should happen, Matt, if you go to the cash flow, the cash flow statement, we've actually split it, and we're running the risk corridor through operations because what brought the risk corridor would now flow through P&L. Then the funds held for the benefit which relates to LIS and the reinsurance is down in financing activities. Those two numbers are $28 million on the risk corridor and $62 million on funds held for the benefit. Where we don't assume a risk corridor in '07, then the 28 would just be a pure outflow. The 62 funds held for the benefit where you theoretically pay that out, you'd also be receiving more dollars in '07 related to the same amount. So it's not just a total outflow of that amount.

Okay great. That's helpful. That's all I had.

At this time, there are no further questions in the queue. Mr. Fritch, I'll turn the call back over to you for any additional remarks.

Thank you. I think that concludes our remarks, and we look forward to the next quarter call.

That concludes today's conference call. We thank you for your participation. You may disconnect at this time.