信諾集團 (CI) 2009 Q4 法說會逐字稿

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  • Operator

  • Good morning, and welcome to the HealthSpring conference calls to review its financial results for the fourth quarter and year-end December 31, 2009.

  • The financial results were issued before the opening of market trading today.

  • 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 at www.HealthSpring.com.

  • Before we begin, HealthSpring wishes to caution that some statements made in this call will be forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

  • Actual results may differ materially from those in the forward-looking statements.

  • Investors should refer to statements filed by the Company with the Securities and Exchange Commission for a discussion of those factors that could affect the Company's financial results and the forward-looking statements made in this call.

  • The information being provided today is as of this date only.

  • HealthSpring expressly disclaims any obligation to update these forward-looking statements as a result of new information, further events or developments, except as required by law.

  • In addition, certain non-GAAP financial measures will be covered in this presentation.

  • These non-GAAP measures are reconciled to the most comparable GAAP measures in the press release or on the Company's website.

  • Please note today's call is being recorded.

  • At this time, I will turn the call over to Mr.

  • Herbert Fritch, Chairman and Chief Executive Officer of HealthSpring.

  • Please go ahead, sir.

  • Herbert Fritch - Chairman, CEO

  • Thank you, operator.

  • Welcome to our 2009 fourth-quarter and year-end conference call.

  • We are pleased to report another good quarter and a close to what we think was a very strong 2009.

  • Our total revenue net income for the year were over $2.6 billion and $133 million, respectively.

  • This represents an increase of 22% and 12% over 2008.

  • We began the year with an earnings per share guidance range of $2 to $2.20, raised it two times during the year, and today, we are reporting EPS at $2.41, which is above our most recent guidance of $2.30 to $2.40.

  • I would like to spend some time discussing the many things that went right in 2009 and a few that went wrong and how this positions us well for 2010 and beyond.

  • This time last year, we were talking about issues in our stand-alone prescription drug plan in Florida markets.

  • In both respects, those parts of our business deserve the come-back award for 2009.

  • Perhaps our biggest disappointment in 2008 was significantly lower margins in our stand-alone PDP business.

  • At that time, we reported an MLR of 89.6% for fiscal 2008.

  • With several years of operating on a national basis in this product, however, we now believe our business has achieved a level of stability to allow for more predictable results.

  • We are extremely pleased with our 2009 Part D performance and are reporting today an MLR for the year of 83.3%.

  • Tighter bids and a more efficient process for member data exchange were significant drivers of our 2009 improvement.

  • Moving to 2010, we believe that our ability to bid accurately for these products continues to improve and our guidance contemplates MLRs and operating margins in line with our bid amounts.

  • We have made the strategic decision to reduce our PDP target margin in 2010 somewhat to stay below selected regional benchmarks.

  • It appears that this decision was a wise one, as we have picked up approximately 75,000 new PDP beneficiaries in the first part of 2010.

  • Changes in the bid calculations implemented in 2010 have also reduced the potential for large shifts in membership going forward.

  • Despite MLR guidance of 85.5% to 86.5%, which is higher than we experienced in 2009, we expect the profit contribution from this line of business to increase in the aggregate in 2010 due to the increased PDP membership.

  • Another focus in 2009 was improving the results of our Florida health plan.

  • The medical trends in inpatient utilization metrics in 2008 in Florida were significantly higher than they were in prior years.

  • Planned recontracting efforts with hospitals completed during the second half of 2008 proved to be fruitful.

  • In addition, the expansion of the number of facilities, hours of operation and scope of services at Leon Medical Centers is having a positive effect on both the medical trends and the enrollment levels for the health plan.

  • Moving into 2010, we certainly are not expecting the same sort of outperformance in Florida that we saw in 2009, as the year-over-year improvement in medical trends from recontracting cannot be replicated in 2010.

  • However, we continue to believe that the enhanced clinical capabilities of Leon Medical Centers will have a positive impact on membership and medical trends going forward.

  • Other positive developments in 2009 include a strong performance in our Texas and Alabama markets.

  • While we continue to face increased outpatient medical costs in all of our markets, year-over-year improvement in inpatient admissions helped these plans deliver results exceeding our initial expectations.

  • One significant negative development in 2009 was the underperformance of our Tennessee plan.

  • Coming into the year, we had high expectations for Tennessee after the success of their IPA development network tiering efforts in 2008.

  • However, it appears that Tennessee experienced both higher inpatient procedure costs and increased outpatient expenses in 2009.

  • To address these issues, their leadership has been focused on medical management initiatives centered on clinical interventions at the member level by HealthSpring nurses and other staff members.

  • We are also working more closely with our physician partners to address the sources of higher costs and have renegotiated our IPA contracts to create even stronger incentives to drive down medical trends.

  • It is our belief that these trends will have a positive impact on the Tennessee plan's MLR.

  • On a positive note, the membership growth in Tennessee in 2009 and thus far in 2010 has been the best of any of our markets.

  • We believe that this has been driven by the level of engagement achieved within several key primary care groups in the market, creating significant network advantages.

  • In general, we are optimistic about our future prospects in Tennessee.

  • Concerning developments in Washington, we now believe the comprehensive healthcare reform may no longer be a near-term possibility.

  • While we may have at least another year before a legislative reduction in Medicare Advantage rates becomes a reality, we continue to believe that Medicare Advantage rates will be cut at some point in the future to help pay for other policy initiatives.

  • We developed our business model and thrived when Medicare Advantage rates were at parity with fee for service, and we believe we are well-positioned should they return to parity.

  • Tightly-managed coordinated care models like ours should be able to provide better benefits than our competitors and certainly better than fee-for-service Medicare in most markets.

  • In the near term, we are focused on whether a single or multi-year physician fee schedule fix will be implemented before the end of March, thus impacting 2011 rates.

  • Before I pass the call over to Karey, I want to briefly discuss a few pieces of our guidance for 2010.

  • MA membership growth of 3% to 6% is below our historical experience due to the negative impact of product changes we made for 2010 in select geographies, coupled with the benefit cuts that we had to make in light of the declining reimbursement environment.

  • The product changes include tiering of networks in Texas and the elimination of several of our chronic care SNP products.

  • We are also forecasting an increase in our MA-PD MLR from 81% in 2009 to a range of 81.5% to 82% in 2010.

  • This is caused by forecasted medical cost trends net of benefit reductions being somewhat higher than we expected in our 2010 bid assumptions.

  • Offsetting this MLR erosion is an expected increase in our interest income and in our fee income, which is tied to the overall increase in membership and total premiums.

  • We have made a concerted effort these past few years to increase our IPA management business, both in terms of the number of IPAs and product design efforts to drive membership into the IPAs.

  • These efforts have been successful enough to make this line of business a significant contributor to our financial results.

  • It also positions us well should accountable care organizations become a meaningful alternative in future legislation or if employers return to tighter network models as a way to address rapidly increasing premiums or higher deductibles in their employee benefit offerings.

  • We hope that our clinical initiatives will drive further improvement in our medical trends, but for now, we are not building it into our guidance.

  • Finally, we continue to believe that we are well-positioned to capitalize on potential acquisition opportunities created by both the current rate environment and healthcare reform.

  • To that end, we continue to evaluate our capital structure, including our borrowing capacity, and review alternatives providing us with greater flexibility to react quickly should the opportunity arise.

  • With that, I would like to turn the call over to Karey.

  • Karey Witty - EVP, CFO

  • Thank you, Herb, and good morning, everyone.

  • We were very pleased with our performance for the quarter and the year, including our reported quarterly net income of $38.8 million, or $0.68 per share, an increase of 33% compared to 2008 fourth-quarter EPS of $0.51.

  • Moving to the specifics, we reported 189,241 Medicare Advantage members at the end of the fourth quarter, reflecting year-over-year growth of 17%.

  • Growth during the lock-in period of 2009 was significantly better than we expected.

  • During the fourth quarter, we added approximately 2600 new members.

  • As was highlighted in our earnings release, our February 2010 plan payment report reflected MA membership of 193,320, representing growth of 2% from year-end.

  • This should serve as a good proxy for our January 2010 membership.

  • PDP membership at year-end of 313,045 increased 11% over 2008, and our PDP membership for the February 2010 report is 387,442, reflecting 2010 growth of 24% so far.

  • Total revenue in the fourth quarter was $677.6 million, an increase of $136.8 million, or 25%, versus the prior-year fourth quarter.

  • Medicare Advantage revenue was up 24%, or $114.4 million, to $586.5 million.

  • The primary drivers of this increase were an increase in member months and MA premiums PMPM.

  • For the three months, MA premiums PMPM increased 6% year-over-year to $1037.

  • For the year, MA premiums PMPM were $1050, an increase of 5% year-over-year.

  • PDP premiums were $76.5 million in the fourth quarter of 2009, an increase of $20.1 million, or 36%, versus the fourth quarter of 2008.

  • For the full year, PDP premiums PMPM were $91, an increase of 10% over 2008.

  • Keep in mind that quarter-to-quarter and year-to-year percentage changes in PDP PMPMs are significantly affected by risk corridor adjustments.

  • Fee revenue for the quarter increased $4.6 million as compared to the fourth quarter of last year.

  • The increase was primarily the result of higher membership in IPAs.

  • Investment income was down 75% to $800,000 in the quarter due to the significant decrease in investment yields.

  • Total medical expense in the quarter was $522.5 million, an increase of $106.6 million, or 26%, versus the prior year's quarter.

  • With respect to the components and the relative metrics, MA medical expense was $475.4 million, an increase of $103.1 million, or 28%, versus the comparable prior-year quarter.

  • MA medical expenses PMPM were up 9% over 2008 to $841.

  • For the full year, MA medical expenses PMPM were $851, an increase of 8% year-over-year.

  • The MA MLR was 81.1% for the current quarter versus the prior year's 78.9%.

  • The increase year-over-year was primarily the result of higher inpatient costs in our Tennessee market and higher outpatient costs in all markets, offset by previously mentioned improvements in the Florida plan's MLR.

  • For the year, the MA MLR was 81% as compared to 78.3% in 2008.

  • The drivers of this increase are similar to those mentioned for the fourth quarter.

  • PDP MLR in the 2009 fourth quarter decreased to 60.7% versus the year ago 75.8%.

  • For the year, the PDP MLR was 83.3% versus 89.6% in 2008, driven primarily by increases in PMPM revenue.

  • We were quite pleased with the profit contribution from our PDP business in calendar year 2009, driven by the significant increase in membership, coupled with the lower MLR.

  • SG&A expenses for the quarter were $79.4 million, an increase of $10.6 million, or 15%, versus the prior year.

  • The increase year-over-year was primarily the result of additional personnel costs associated with membership increases and increases in other administrative costs.

  • SG&A expense decreased 100 basis points to 11.7% as a percent of total revenue in the 2009 fourth quarter compared to 12.7% in the fourth quarter of 2008.

  • Sequentially, SG&A costs increased $13.6 million.

  • The primary drivers of this increase were marketing and related expenses, including advertising, printing and postage costs, as well as other administrative expenses.

  • Let me reiterate that we expect SG&A to remain seasonally weighted to the first and fourth quarters as a result of marketing and commission costs.

  • For the year, SG&A of $279.8 million represented 10.5% of revenue.

  • This reflects a decline of 75 basis points from 2008 as we continue to be focused on driving operating efficiencies in all aspects of our business.

  • The annual decrease as a percentage of revenue resulted primarily from improvements in our operating model and revenue increases.

  • We are pleased that our team was able to significantly outperform their SG&A targets in 2009.

  • Moving to items below the line, the depreciation and amortization expense in the 2009 fourth quarter was $7.8 million.

  • For the year, depreciation and amortization increased $2.2 million in 2009 as a result of increases in amortization of intangible assets related to the Valley Baptist Health Plan acquisition and additional depreciation expense on capital expenditures.

  • Interest expense in the 2009 fourth quarter was $3.6 million, a decrease of $1 million from the 2008 fourth quarter.

  • For the year, interest expense decreased by $3.5 million.

  • Both the quarterly and annual declines were a result of lower average debt balances and reduced interest rates in 2009.

  • Our weighted-average effective interest rate for the quarter was 4.6% compared with 5.5% in 2008.

  • The Company's effective income tax rate for the three months ended December 31, 2009 was 39.7% compared with 36.1% for the three months ended December 31, 2008.

  • The annual effective income tax rate for 2009 was 36.4%.

  • The rate increase in the 2009 fourth quarter compared with the 2008 fourth quarter was a result of a greater concentration of the Company's profitability in entities taxed at a higher state tax rate and the reversal of tax benefits on cancelled stock compensation awards for certain executives retiring in 2009.

  • Building these changes into our tax rate going forward, we expect our 2010 tax rate to be between 36.5% and 37%.

  • Moving to the bottom line, net income in the 2009 fourth quarter was $38.8 million, or $0.68 per diluted share.

  • This represents increases of 37% and 33%, respectively, over the fourth quarter of 2008.

  • For the year, net income was $133.6 million, or $2.41 per diluted share, reflecting increases of 12% and 14%, respectively, over 2008.

  • Included in our 2009 result is $0.04 of EPS associated with prior-year retroactive risk settlements recorded during the first half of 2009.

  • The corresponding amount in 2008 was $0.24.

  • Moving to the balance sheet and cash flow, our balance sheet at December 31, 2009 reflected cash and cash equivalents of $439.4 million.

  • Unregulated cash was $106.4 million.

  • Days in claims payable were 35 days at the end of 2009, unchanged from the sequential third quarter.

  • Total debt outstanding was $237 million at year-end 2009.

  • During the quarter, we also released from escrow approximately 2.0 million shares (sic -- see press release) to the former shareholders of Leon Medical Centers Health Plans, following the opening of two additional LMC facilities.

  • These shares are now reflected in our issued and outstanding shares on the balance sheet, as well as included in our basic and diluted share count for the quarter.

  • We recorded $34.7 million of additional goodwill during the fourth quarter associated with this issuance.

  • In 2009, cash flow from operations increased $8 million to $170 million, or 1.3 times net income, compared to $162 million or 1.4 times net income in 2008.

  • Moving to 2010 guidance, we expect earnings per share to be between $2.25 and $2.50.

  • Major components of this guidance include MA membership of 195,000 to 200,000, an increase of 3% to 6% versus 2009; PDP membership of 410,000 to 420,000, an increase of 31% to 34% over 2009; total revenue of $2.85 billion to $2.95 billion, representing growth of 7% to 11% versus 2009; and MA-PD premium PMPM decline of approximately 2.5%; a PDP premium PMPM increase of 1.5%; an increase in management and other fee revenue of 20% to 25%.

  • As to interest income, we have implemented a new investment strategy in 2010 and expect to redeploy a substantial portion of our cash from money market funds to high-quality fixed income assets.

  • We expect this change should increase the average yield on our portfolio without taking on significant additional risk.

  • MA-PD MLR of 81.5% to 82%, PDP MLR of 85.5% to 86.5%.

  • The PDP MLR in 2010 should continue to follow our historical seasonal pattern of improvement throughout the year.

  • SG&A as a percentage of total revenue at or below 10.5%; a 2010 tax rate of 36.5% to 37%; and average shares outstanding of 57.8 million in 2010.

  • This share count assumes no share repurchase and includes the additional 2.7 million shares issued to the former shareholders of Leon Medical Centers Health Plans.

  • All things being equal, this increased share count is $0.09 dilutive to our 2010 EPS.

  • Before we take questions, I want to invite all of you to our 2010 Investor Day, which will be held in New York City on Friday, March 26.

  • A release will be going out later with all of the specifics, but we look forward to seeing you there.

  • Operator, that concludes our prepared remarks, and we can now open the call to questions.

  • Operator

  • (Operator Instructions) Michael Baker, Raymond James.

  • Michael Baker - Analyst

  • Karey, I was wondering if you could give us a sense of the CapEx plans for 2010, and also any plans with respect to additional LivingWell Centers.

  • Karey Witty - EVP, CFO

  • I would say at this time it is not in our current thinking, in our short-term thinking, that we would be building additional LivingWell facilities.

  • That said, on the CapEx side, our expectations for 2010 would not be materially different.

  • We do have some IT initiatives that we will be working on over the next 12 to 24 months that you will see us utilizing some additional CapEx dollars.

  • But for 2010, we are not expecting anything wildly out of the norm with what you've seen historically.

  • Michael Baker - Analyst

  • I was wondering if you could provide an update on the coding audits, whether there has been any pickup around those in terms of activity.

  • Herbert Fritch - Chairman, CEO

  • Really, I don't know about pickup in activity.

  • They are proceeding on with the audits.

  • I think the big question in everybody's mind in the industry is clarification on what, if any, extrapolation they will make to full-year revenues.

  • And it was -- I mean, of recent developments, it was noted that the President's budget asked for legislative clarification of their authority to extrapolate.

  • But so far, nothing has come out specifically regarding that.

  • Michael Baker - Analyst

  • And then finally, Herb, I was wondering if you could just comment on your thoughts as it relates to M&A.

  • Obviously, the Florida acquisition played out very well.

  • I know that reform kind of comes and goes, so I was just wondering in context your updated thoughts along those lines.

  • Herbert Fritch - Chairman, CEO

  • I think we continue to think in this environment that there will be M&A opportunities.

  • We continue to think it is a preferred way to expand geographies, rather than de novo expansions.

  • So we are continuing to explore the options out there.

  • Michael Baker - Analyst

  • Thanks a lot.

  • Operator

  • Charles Boorady, Citi.

  • Charles Boorady - Analyst

  • The first question is just generally, as you look at the components of your 2010 guidance, what are some of the key risks that we should be thinking about in terms of any major provider contracts up for renewal, any coding audits?

  • And just being that we've passed the major Jan.

  • 1 enrollment period, can you describe for us what you've been able to do so far?

  • I know only a month has passed, but to look at prescription trends or other keys telltales of whether the selection of new enrollees that you've gotten is one that presents risk or upside potential to your guidance.

  • Herbert Fritch - Chairman, CEO

  • Boy, let me see if I can remember all those.

  • I don't think that I'm aware of any really major provider contract issues.

  • We have the usual hospital renewals during the year, but I don't know that anything stands out as a particular risk from a renewal standpoint.

  • In terms of coding, I think we've talked about that.

  • We do have an audit going on of our Tennessee plan, I think for 2008.

  • But it really remains to be seen.

  • The big question is this extrapolation issue and how and whether they will take the results and extrapolate.

  • And there have been no word out of CMS in that regard right now.

  • Part D trends, I think it is just too early to say.

  • We don't -- I'm certainly not aware of anything negative at this point, but as far as I can tell, everything seems on track, but it is awfully early in the year yet.

  • Charles Boorady - Analyst

  • Yes.

  • And in terms of MA, though, are you able to look at the prescribing habits of your new MA lives and get a sense for whether you were adversely selected against or got the risk pool that you expected?

  • Is there any risk of a surprise?

  • Herbert Fritch - Chairman, CEO

  • Given that all our business is this auto-assigned, dual-eligible business, we don't feel like there is much risk of adverse selection inherent in that as there would be in the voluntary PDP business.

  • And as far as we can tell, I don't think we've seen any signs of anything.

  • Charles Boorady - Analyst

  • Okay, great.

  • And then just longer-term, if I could ask you a final question.

  • Should we expect your Medicare Advantage loss ratio to tick up a little bit every year over the coming few years, based on the -- and I know that reimbursement system is subject to change -- but given the system that we presently have, is it reasonable to assume that the loss ratio ticks up each year for the next few years as med costs seem to be going up more than the reimbursement is?

  • Herbert Fritch - Chairman, CEO

  • I think our goal has consistently been to hold margins flat.

  • We did see some -- we realized some reduction in our SG&A, and that allowed us to up the MLR a little bit and still hold margins about level.

  • But I think we will continue to try and hold the MLR as flat as we can, and that will be our strategy in the bid process.

  • It is certainly more challenging if rates are coming down.

  • But nonetheless, we are going to try and hold it as flat as we can going forward.

  • Charles Boorady - Analyst

  • Great.

  • Thanks.

  • Operator

  • Joshua Raskin, Barclays Capital.

  • Joshua Raskin - Analyst

  • Herb, maybe any preliminary expectations for 2011 rates?

  • You know, we will get the 45-day notice in a week or so; just curious what you guys are expecting.

  • Herbert Fritch - Chairman, CEO

  • Josh, I think the big variable we are focused on, as I mentioned, is this SGR fix.

  • I think there is a scenario where if they can get this thing fixed at least through 2011, we could have a positive if we don't get a negative legislative change.

  • And that is looking more and more unlikely, that we will get it in time to impact '11 rates.

  • But we really don't know.

  • I mean, that is the key variable.

  • It could be as much as a 4.0 positive if they do get it fixed through 2011, and don't pay for it with reductions in MA rates.

  • But it just remains to be seen.

  • Joshua Raskin - Analyst

  • Okay.

  • And obviously, status quo would have sort of a two-month error correction for '10, then a similar sort of dropoff back in '11.

  • So it would be -- I assume no doc fix at all before the April deadline would be slightly negative.

  • Herbert Fritch - Chairman, CEO

  • Yes, slightly negative, maybe level.

  • I did see something in -- I think it was a Senate bill that they talked about another three-month fix on top of the two-month fix (multiple speakers), which might turn it slightly positive from slightly negative, but not a major change.

  • Joshua Raskin - Analyst

  • Got it.

  • And then as you think about your January and I guess you've got your February enrollment date as well, any way to parse out how much of that is coming from seniors that were previously enrolled in private fee-for-service plans?

  • Or are you getting a sense of any of that shift that occurred this year?

  • Herbert Fritch - Chairman, CEO

  • I don't think we've had a chance to analyze the details yet to get any read on that.

  • So I haven't received any word one way or another.

  • I imagine some component of it is a shift over, but we haven't been able to quantify that.

  • Joshua Raskin - Analyst

  • Let me ask a different question then maybe.

  • Karey, you had mentioned IPA management revenues continued to -- sort of to grow.

  • Were there any one-time items in that fourth quarter, or is the fee revenue that you guys reported of about $13 million, is that a good run rate now?

  • Karey Witty - EVP, CFO

  • Yes, that is a pretty good run rate, Josh.

  • We just looked at it in totality, guiding it up 20% to 25% growth in 2010 over 2009.

  • So -- with the point being, I think it is probably something that we've been quietly growing as a Company and felt, for various reasons, that it was (inaudible) to call that out and call that to your attention.

  • Joshua Raskin - Analyst

  • Okay.

  • Thanks, guys.

  • Operator

  • Scott Fidel, Deutsche Bank.

  • Scott Fidel - Analyst

  • Could you just talk about what you're building into 2010 PMPM yields for risk adjuster impacts?

  • Would that be primarily what gets us from the down 4% to 5% CMS rates to the down 2.5% in your guidance, or is that more just your market-specific rates relative to the national?

  • Herbert Fritch - Chairman, CEO

  • No, I think that's accurate.

  • I think that is kind of the coding offset, primarily.

  • Scott Fidel - Analyst

  • Okay, so we should think about coding as like 2% sort of a build-in to your rates?

  • Herbert Fritch - Chairman, CEO

  • Yes, that's the way it looks.

  • Scott Fidel - Analyst

  • Okay.

  • Then just on the SNP membership that you exited for '09 that you won't have in 2010, how much membership was that?

  • Herbert Fritch - Chairman, CEO

  • I don't know if I've got the specific number on that.

  • We might have to get back to you with that.

  • I don't think I have anything off the top of my head.

  • Scott Fidel - Analyst

  • Okay.

  • It's very small though, right?

  • Herbert Fritch - Chairman, CEO

  • It is small, right.

  • Scott Fidel - Analyst

  • Okay.

  • Then just one last question.

  • Do you have an update for D&A expense guidance for 2010?

  • And then on operating cash flow, should we expect a similar relationship to net income, around 1.3 times, for 2010?

  • Karey Witty - EVP, CFO

  • Cash flow, I would say yes to that, Scott.

  • And depreciation and amortization, again, with no wild exceptions to CapEx during 2010 planned, I would expect kind of similar D&A rates.

  • Scott Fidel - Analyst

  • Okay.

  • Thank you.

  • Operator

  • (Operator Instructions) Daryn Miller, Goldman Sachs.

  • Daryn Miller - Analyst

  • Herb, a question.

  • You indicated that you have reduced your target margin on the PDP business.

  • I was wondering where do you expect that margin to come in and how much of the reduction is -- did you guys forecast?

  • And then as we look forward, is that lower margin what you're looking or would you expect the margin to come back up?

  • Herbert Fritch - Chairman, CEO

  • You know, I think generally, we've tried to normalize the PDP margin with our MA margin, make it all pretty close.

  • It just -- the higher MLR recognizes that our SG&A expense associated with the PDP is lower than on the MA business.

  • But we felt that was a reasonable way to approach it, and that resulted in us targeting about a couple points higher MLR targets.

  • Daryn Miller - Analyst

  • But the actual margin is going to come in lower?

  • Herbert Fritch - Chairman, CEO

  • Well, lower than we experienced this year, but comparable, we think, with targeted margins on our MA business.

  • Daryn Miller - Analyst

  • So is the 2010 margin what we should think about long term?

  • Herbert Fritch - Chairman, CEO

  • Yes.

  • Daryn Miller - Analyst

  • Okay.

  • And one question just on priorities of use of cash.

  • What is your target debt level?

  • And then how do you think about potential M&A as we look forward the next couple years, where we could see a challenging rate environment?

  • When do you think you guys hit the most opportunistic point as far as plans in trouble and looking to sell?

  • Karey Witty - EVP, CFO

  • I would say from a debt level, one could argue that we are underlevered.

  • We certainly have capacity from a leverage ratio standpoint.

  • And as a matter of timing, there is no magic catalyst necessarily.

  • Certainly, with seemingly some clarity on reform, might that free up some opportunities?

  • We certainly think so.

  • So our goal is just to position us when those opportunities avail, and take advantage of them as we can.

  • Daryn Miller - Analyst

  • What would be the peak kind of debt level you guys could take on?

  • Karey Witty - EVP, CFO

  • I would say probably two times leverage.

  • Daryn Miller - Analyst

  • Great.

  • Thank you.

  • Operator

  • Matt Perry, Wells Fargo.

  • Matt Perry - Analyst

  • Herb, wanted to make sure I understood a comment that you made in your prepared remarks.

  • I thought you said that the medical cost trends that you are expecting for Medicare Advantage in 2008 are now higher than what you had expected when you submitted bids.

  • Can you clarify that for me, make sure I am understanding it?

  • Herbert Fritch - Chairman, CEO

  • No, I think these outpatient trends that we've talked about have been a little more persistent.

  • We are putting actions in place to try and modify them.

  • But at least right now, we are taking a little more conservative position on their impact relative to the MLR in 2010.

  • Matt Perry - Analyst

  • Okay.

  • Because I guess if I look at your 2009 guidance for MA MLR as it has progressed through the year, you had been thinking 81.5, and you ended the year closer to 81.0.

  • But is there some kind of offsetting factor that happened in 2009 that kind of offset those higher trends that you are talking about for 2010, that won't recur in 2010?

  • Herbert Fritch - Chairman, CEO

  • Well, actually, I think the reduced loss ratio may actually be more of a result of higher-than-expected revenues than they were lower-than-expected medical expenses.

  • And at least right now, we are not changing our outlook in terms of revenue levels for '10.

  • Matt Perry - Analyst

  • Okay, thanks.

  • Operator

  • Thomas Carroll, Stifel Nicolaus.

  • Thomas Carroll - Analyst

  • Could you comment just briefly on your expectations for the sequence in quarterly EPS in 2010?

  • Is it going to be roughly the same as it was in 2009?

  • And then secondly, I was wondering if you could just comment on the large sequential decline in your PDP medical loss ratio from third quarter to fourth quarter.

  • And I guess I don't know if it will be quite as steep in 2010; maybe just some comments on that.

  • Thanks.

  • Karey Witty - EVP, CFO

  • Tom, I would say certainly the PDP loss ratio, as we indicated in our prepared remarks, you do see that drop sequentially.

  • I think you would see the same phenomenon in years past, that Q4 is always our strongest quarter from a PDP standpoint, as the members enter the -- more of the membership enter the doughnut hole.

  • So that is really the loss ratio on the PDP product in Q1 is extremely high, and in Q4 is substantially lower.

  • And those are drivers of the overall loss ratio.

  • So hopefully, that is how you're modeling the PDP side.

  • The MA side, I would say no thinking for 2010 outside of the norm from seasonalities within our business.

  • Thomas Carroll - Analyst

  • We definitely expect to see a big drop 4Q, even third quarter a bit.

  • But it seemed like we went -- prior years, we've dropped 10 percentage points, 5 percentage points, and we are just seeing a much more sizable decrease.

  • So are you suggesting I should be modeling fourth quarter in the 60% range?

  • It just seems like the magnitude is bigger.

  • Karey Witty - EVP, CFO

  • (multiple speakers) yes, yes.

  • Herbert Fritch - Chairman, CEO

  • (Multiple speakers) recognizing our target MLR is up a little bit, but nonetheless, I think we think the quarterly pattern should be reflective more of what we saw in '09 than what we saw in '08.

  • Thomas Carroll - Analyst

  • So new plan designs for 2010, the change in PDP is going to potentially put up an MLR in the 60% range, 4Q 2010?

  • That's fair to assume?

  • Herbert Fritch - Chairman, CEO

  • I think so.

  • A little higher than what we had this year, but it will still be in the 60% range.

  • Thomas Carroll - Analyst

  • Excellent.

  • Thank you.

  • Operator

  • Mr.

  • Fritch, there are no further questions at this time, so I will turn the call back to you for closing remarks.

  • Herbert Fritch - Chairman, CEO

  • Thank you, operator.

  • We appreciate your interest and attendance on the call.

  • Look forward to hopefully seeing you at our Investor Day in New York in March or on the next call.

  • Thanks.

  • Operator

  • That does conclude today's call.

  • You may now disconnect.