Centene Corp (CNC) 2012 Q3 法說會逐字稿

Good morning and welcome to the Centene third quarter 2012 earnings conference call.

All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation, there will be in opportunity to ask questions.

(Operator Instructions)

Please note, this event is being recorded.

I would now like to turn the conference over to Ed Kroll.

Please go ahead.

Thank you, Operator, and good morning, everyone.

I'm Ed Kroll, Senior Vice President Finance and Investor Relations for Centene Corporation.

Michael Neidorff, Chairman and Chief Executive Officer, and Bill Scheffel, Executive Vice President and Chief Financial Officer of Centene Corporation, will host this morning's call.

The call is expected to last approximately 45 minutes and may also be accessed through our website at Centene.com.

A replay will be available shortly after this call's completion also at Centene.com, or by dialing 877-344-7529 in the US and Canada, or from other countries, 412-317-0088.

The playback number for both dial-in, both relays is 10018806.

Any remarks that Centene may make about future expectations, plans, and prospects constitute forward-looking statements for purposes of the Safe Harbor Provision under the Private Securities Litigation Reform Act of 1995.

Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in Centene's Form 10-Q dated October 23, 2012, today, and other public SEC filings.

Centene anticipates that subsequent events and developments will cause its estimates to change.

While the Company may elect to update these forward-looking statements at some point in the future, we specifically disclaim any obligation to do so.

And, with that, I'd like to turn the call over to our Chairman and CEO, Michael Neidorff.

Michael?

Thank you, Ed.

Good morning, everyone, and thank you for joining Centene's third quarter earnings call.

This morning, I will provide an update on the issues discussed at our June investor day and on our second quarter earnings call.

I will then briefly discuss our quarterly results and certain macro issues before turning the call over to Bill for detailed financial results.

Let me begin with Kentucky.

Our focus has been and will continue to be, one, that our members receive the highest quality of care by the most cost-effective means.

Two, that our provider networks receive fair compensation.

Three, the plans meet statutory financial requirements.

And, finally, our shareholders receive a fair return on the capital deployed.

We are proud of the positive improvement in healthcare outcomes we achieved in Kentucky.

These include a 94% decrease in doctor shopping for narcotics, a 53% increase in hemoglobin A1c testing for diabetes, a 30% reduction in pharmacy costs, a 30% decrease in one-day hospital admissions, a 30% increase in well-child visits, a 23% reduction in hospital re-admissions, and a 17% decrease in medical surgery costs.

In our two decades working with states, this is the first time we have failed to achieve a partnership with the state.

We have experienced significantly higher-than-expected medical costs in Kentucky.

This is due to an unprecedented amount of retroactively assigned members.

Secondly, broad risk adjustment methodologies.

Thirdly, policies that are inconsistent with a successful managed Medicaid program.

And, finally, significant data booking issues.

We have tried to work with the state on these issues and while Kentucky has offered some changes, they were not enough to cover the higher-than-expected cost.

I might add that this is not only Centene's issues, it is our understanding based on statutory filings that the three plans combined lost just under $300 million in the first half of 2012.

We believe this raises serious concerns about sustainability of the program.

Our Kentucky experiences taught us to be cautious with [Sane City] using managed care for the first time.

Yesterday, we filed a lawsuit in Franklin Circuit Court against the Commonwealth of Kentucky seeking the territorial relief as a result of the Commonwealth's failure to completely and accurately disclose material information.

As expressed in our press release, we will use and exhaust all available administrative and legal remedies to ensure the review of our grievances with the state.

We believe we have a strong case, but will not comment further while these legal matters are pending.

Next, let's discuss Texas.

Our margin improvement plan for the Hidalgo expansion area is proceeding as expected, including the increased STAR+ PLUS business we took on in the last two months of the quarter.

Our HBR and Hidalgo is tracking in the mid 90% range.

Our medical management efforts have gained traction and we continue to move towards normalizing margins in Hidalgo in 2013.

We previously indicated that we expected a 3.7% statewide rate increase.

Due to member mix, we received 4% effective September 1.

Now, for an update on Celtic.

In June, we reported a high level of medical costs in our Celtic individual business.

Our corrective actions to improve performance included a new national network contract which took effect July 1. We are also putting in place targeted rate increases in the second half of 2012.

Our HBR has improved from over 100% in Q2 to the high 80% in Q3.

I would remind you that our hybrid Celtic business in Massachusetts is performing in line with expectations and is not experiencing the same margin pressures we have reported in the balance of the Celtic book.

Next, third quarter financials.

GAAP EPS for the third quarter was $0.07 per diluted share.

As you can see on page 1 of our press release, this is comprised of several components.

Earnings from operations, excluding Kentucky, are $0.78.

Third quarter loss in Kentucky operations is $0.31.

This resulted in an adjusted earnings of $0.47 which is in line with the forecast incorporated into our previous communicated annual guidance.

The other three items, the $0.69 Kentucky premium deficiency reserve, the $0.21 gain on sales of investments, and the state tax relief of $0.08.

Premium and service revenue growth were strong in the third quarter, increasing 75% year-over-year to $2.2 billion.

We ended the quarter with 2.5 million members representing an increase of 55% year-over-year.

This included a Medicaid membership increase of 63% to 1.9 million.

ABD membership increased of 126% to 76,900 lives.

Long-term care membership increased 66% to 7800 members.

Medicare membership increased 29% to 4000 members.

As you can see, we have continued to grow the growth of our high community membership which will be beneficial as more states move long-term care, ABD and due eligible recipients in the managed care program.

The third quarter HBR came in at 93.3% compared to 85% in the third quarter of 2011.

However, assuming the impact of the Kentucky operations, the HBR is 88.7%.

The 370 basis point year-over-year HBR increase is mainly due to new markets, including the Texas expansion as well as the Commonwealth of Missouri, Washington on July 1, and the phase-in of Louisiana beginning -- between February and June of 2012.

The Missouri and Washington launches are tracking in line with our expectations.

We expect relative stability in the Missouri membership going forward.

Washington should ramp up to over 50,000 lives by the end of 2012.

Now, a brief discussion of our rate offer.

Our composite rate increase for the first nine months of 2012 was approximately 2%.

While Georgia and Florida are yet to be determined, we believe the full-year 2012 rate increase will come in at 2%.

And now moving to a couple macro issues.

Our view of the election outcome and the effect on managed care have not changed.

Regardless of the election results and the fate of the ACA, we believe Centene is well positioned to maintain significant growth.

States continue to move recipients out of the fee-for-service and in to managed care.

We remain committed to helping states effectively manage their beneficiaries, health outcomes while reducing expenses.

The growth outlook remains more robust than ever with an approximate $45 billion pipeline through the end of 2013.

We expect our new Kansas brand to commence operations January 1, 2013 and New Hampshire to begin late in the first quarter of 2013.

We are pleased that Ohio selected Centene to serve Medicaid members in a dual eligible demonstration project.

This is set to commence in the second half of 2013 and is our first major dual eligible contract.

We continue to believe we are well positioned for future opportunities in this category.

Centene is preparing for the 2014 Medicaid expansion and continues to have conversations with states on future hybrid and exchange opportunities.

We look forward to our December 14, 2012 meeting in New York City when we will provide guidance for 2013.

I will now turn the call over to Bill who will provide further detail on the third quarter of 2012 financial results.

Bill.

Thank you, Michael, and good morning.

For the third quarter we have provided the detail of the components of our results in our press release and Michael has covered these at a high level in his comments.

I will address each of the items included in the press release table as I go through our financial results in more detail.

For the third quarter of 2012 premium and service revenues were $2.2 billion compared to $1.3 billion in 2011, an increase of 75% year over year.

The $950 million increase reflects the addition of four new states between years along with the Arizona and Texas expansions and the Ohio pharmacy carve-in in the fourth quarter last year.

Premium tax was approximately $200 million higher in the third quarter of this year compared to last year as one of our states paid us approximately $180 million during the quarter to immediately pass through to specified providers.

Our reported health benefits ratio was 93.3% for the third quarter.

Our HBR, excluding Kentucky, was 88.7% with Kentucky increasing the consolidated HBR by 460 basis points.

This was due to a third quarter HBR of approximately 115% in Kentucky before the premium deficiency reserve resulting in the operating loss of $0.31 per share and the recording of a $63 million premium deficiency reserve, or $0.69 a share.

As discussed in our release and in Michael's comments, we have taken actions to terminate the Kentucky contract effective in early July 2013.

Our premium deficiency reserve calculations assume that we will operate at approximately the same level between now and July 5, 2013, adjusted for expected changes in the program such as decreases in revenue from risk adjustment.

The premium deficiency reserve will be released over the next three quarters, including approximately one-third in the fourth quarter of 2012.

Looking at Texas, our largest market, we received a 4% overall rate increase effective September 1. And as we discussed at our investor day in June, we have been working to reduce the higher utilization levels seen in the March 1 expansion areas, particularly the Hidalgo service area.

For the third quarter, our HBR in the Hidalgo service area was in the mid 90s, and this includes the cost incurred in August and September from the members we added as a result of consumers switching plans due to dissatisfaction with their previous managed care organization.

At Celtic, we reported a lower HBR in the third quarter compared to the second quarter as a result of a change to a lower cost provider network and other actions.

We also have implemented or applied for a rate increase in a number of states.

In summary, we believe the actions we discussed during our investor day in June have been substantially implemented and coupled with the recording of the Kentucky premium deficiency reserve demonstrate that we are addressing the issues which have developed in 2012.

Sequentially, our HBR, excluding Kentucky, decreased from 91.1% in Q2 to 88.7% in Q3, a decrease of 240 basis points.

This reflects overall improvements in most of our operations, particularly in Texas and in Celtic between quarters, offset somewhat by an increase in Georgia's HBR related to an adjustment to account for changes in the third quarter and the state's handling of premium adjustments related to retroactive membership deletions.

Our general and administrative expense ratio was 8.2% for the third quarter compared to 11.3% in the third quarter last year and 8.2% in the second quarter of 2012.

The decrease in the G&A ratio between years reflects the additional leverage we have gained through our revenue increase along with lower performance-based compensation expense which lowers our G&A ratio in the third quarter by approximately 50 basis points.

Our investment and other income was $23.2 million in the third quarter this year compared to $2.7 million in last year's third quarter.

The increase is a result of two items which generated $0.21 of benefit in the third quarter.

First, we recorded a gain of $17.9 million related to a convertible note agreement which we entered into in 2008 with a third party to provide funds for investments in Medicaid and Medicare-related businesses.

During the third quarter we reached agreement to sell our interest in this investment for a specified amount.

The investment is secured by the underlying operating businesses.

The second item relates to a gain of $1.5 million we recorded in the third quarter from the liquidation of approximately $75 million of investments held by our Georgia Health Plan.

As discussed during the second quarter, we had receivables of $221 million at June 30 from the State of Georgia primarily as a result of the deferral of our capitation payments.

During the third quarter, we received additional capitation payments from the State of Georgia which reduced our receivables to approximately $100 million at September 30 which reflects one month of capitation payment along with receivables from the state for deliveries and other items.

Interest expense was $4.9 million in the third quarter compared to $4.6 million in the same quarter last year, reflecting higher average borrowings.

Our income tax line item reflects a benefit of $9.5 million for the third quarter of this year compared to expense of $18.5 million in Q3 of 2011.

We expect to have an effective tax rate of approximately 40% for 2012.

We have a pretax loss in Q2 and Q3, but an anticipated profit for the full year.

Additionally, the third quarter benefit -- benefited by approximately $4.6 million, or $0.08 a share from a clarification from one of our states which applied to several open tax years related to items included in the state income tax calculation.

Our earnings per diluted share was $0.07 for the third quarter compared to $0.55 in the same period last year.

Excluding the Kentucky operations and the investment gains and state tax benefit, our earnings per diluted share from operations was $0.78 for the quarter.

At September 30 we had cash, investments, and restricted deposits of $1.5 billion, including $36 million held by unregulated entities.

We've estimated our risk-base capital percentage, excluding Kentucky, to be in excess of 350% of the authorized control level at September 30.

For Kentucky, we expect to maintain the minimum required capital level.

Our total debt was $395 million, which included $40 million of borrowings under our revolver.

Our debt-to-capital ratio was 25% at September 30, excluding our nonrecourse mortgage note.

The medical claims liability totaled $919 million at quarter end, an increase of $311 million from December 31.

Our days and claims payable calculated without the expense and liability for the premium deficiency reserve was 42.8 days compared to 41.4 days at June 30.

Our cash flow from operations was $317 million for the third quarter.

The large increase this quarter reflects the decrease in the Georgia receivables and prepayment of approximately $120 million for fourth quarter capitation payments from other states.

For 2012 annual guidance we have updated our numbers as follows.

Premium and service revenues, $8.1 billion to $8.3 billion, diluted earnings per share on a GAAP basis, $0.56 to $0.66, consolidated health benefits ratio 90% to 91%.

General and administrative expense ratio 8.5% to 8.8%, and diluted shares outstanding 53.6 to 53.8 million shares.

Our EPS guidance reflects actual results for the first three quarters, including the impairment charge for Celtic of approximately $0.50 that we took in the second quarter.

And the third quarter items discussed this morning, including the $0.69 charge for the premium deficiency reserve and the $0.29 in benefits from the sales of investments and the state tax benefit, approximately one-third of the premium deficiency reserve is expected to reverse in the fourth quarter.

Compared to the guidance we gave during our second quarter call, operations other than Kentucky have performed slightly above expectations while Kentucky's results have deteriorated due to additional retroactive assignment of members and an unfavorable risk adjustment change beginning October 1. These items have been considered in calculating our premium deficiency reserve.

Our implied fourth quarter guidance for EPS is $0.70 to $0.80 per diluted share.

During the fourth quarter we expect to incur $0.12 to $0.15 for business expansion costs including start-up costs for Kansas which is slated to begin January 1. This compares to $0.07 per share for business expansion costs in Q3.

In addition, we anticipate incurring $0.04 of exit costs in Q4 for Kentucky related to severance and retention accruals.

Operator, you may now open the line for questions.

(Operator Instructions)

Peter Costa of Wells Fargo Securities.

Thanks, guys.

Thanks for all the detail on the call.

Can you go through a little bit of what's in that premium deficiency charge, just in terms of the overall size of it?

If, in the quarter, Kentucky cost you $0.31 and going forward you've only got $0.69 in the premium deficiency charge, why isn't it -- it's got to carry you for three quarters -- why isn't it a larger charge there at this point?

What's the improvement you're expecting to see?

Sure.

I think the main thing that happened is in the third quarter we continued to see a high level of retroactive assignment of members, and so we had unfavorable development in the third quarter which we had to accrue for from almost inception to date.

Even in September we continue to see members assigned to us from November of 2011.

So, what we did in calculating the premium deficiency reserve -- we utilized the HBR calculation that we've experienced through the life of the program to date, factoring out development from month or quarter to quarter, and then that HBR is actually slightly higher in our PDR calculation for now through the end of June 2013.

We know there's certain changes in the program that are occurring and we included those in there, but overall, we believe that the $0.69 that we've accrued for in our premium deficiency reserve reflects our best estimate of what the cost will be between now and July 5.

And then just a follow-up to that -- if I subtract the one-time items in this quarter away from your full-year GAAP guidance, your new GAAP guidance is on the lower side of the range that you gave before; which, from your conversation, sounds like the thing that underperformed here is Kentucky, and the Texas and Celtic business both improved a little bit.

So, why aren't we seeing a better improvement than in the fourth quarter, given that you now have the premium deficiency charge, than where we would have otherwise have been based on your full-year guidance?

Part of it I guess would be explained by the $0.04 of costs -- the exit costs from Kentucky.

And then, can you talk about those exit costs, and will they carry in to next year, and just go through that for me a little bit to help me with math?

Sure, let me see if I can cover all that.

First, I'll start with the exit costs.

In our 10 Q that was filed this morning there was a discussion of exit costs that will be incurred between October 1 and all of 2013.

These primarily relate to severance and retention accruals and lease termination costs.

Those costs are not included in the premium deficiency reserve calculation, but rather they are expensed in the period for which they occurred.

So, severance would generally be expensed in the period that you make those promises, which we would say is the fourth quarter of 2012; and retention bonuses would be expensed over the service period, which would be between now and the end of the June, July -- whenever people stay through.

So, those costs -- and the lease costs can't be expensed until you -- through using the facility and it's available for others.

So, those costs -- we've estimated, I think, $5 million to $7 million -- will be incurred between now and the end of 2013.

About half of that would be included in Q4.

With respect to business expansion costs, I think we said $0.12 to $0.15 in Q4.

A lot of that for Kansas, and that compares to $0.07 in Q3, so it's quite a bit higher in Q4.

I think you're right in the basic premise that Kentucky has performed worse than we included in our prior assumptions in our guidance numbers, and we've picked that up in our PDR calculation.

I think the $0.70 to $0.80 range for Q4, adjusted for the business expansion costs and the exit costs -- really, any differential in that is the Kentucky operations.

Okay, although the business expansion costs, you had given previous guidance of that being $0.20 to $0.22, I think, in the second half of the year.

You are little bit below that overall -- I guess because New Hampshire has been pushed out a little bit -- but it seems like that would have actually helped you in the fourth quarter?

Yes, it is, and I'm really thinking if we had $0.78 in Q3 from operations excluding the one-time and the Kentucky operations, compared to the $0.70 to $0.80 in Q4 -- if you adjust for the differential and business expansion costs and exit costs, and you pick up the fact that HBR is generally a little higher in Q4 than it is in Q3, that's how we come up with our estimate.

Okay.

And are you counting anything for legal costs in there in case the state sues you?

We have estimates for legal costs in our numbers, yes.

Okay.

Thank you.

Chris Rigg of Susquehanna.

Good morning.

Thanks a lot.

Just on the -- are you guys fairly confident that you can indeed contractually get out of Kentucky?

How can you help us feel a little bit better that this isn't going to end up in a long, drawn-out legal battle where you can't get out by mid-2013?

Chris, I'd like to talk more about it, but as I included in my script, we have now filed suit yesterday in the Circuit Court in Franklin County; and on that basis it's policy, practice, and wise to make no further comments.

Okay.

So then, changing gears -- when we think about your guys incentive compensation, at what margin prospectively do you start accruing comp for the management team?

And how does that equate to a net margin on a GAAP basis for the overall Company?

Well, we have several matrix that we look at it, and various compensation is evaluated and we have different programs -- long-term, short-term.

Your short-term is very much based on the EPS.

The elements of long-term -- one of them that we're using more and more in the future is total shareholder return compared to a peer group that will be identified in our next proxy statement.

So, there's a series of measures we use for different aspects of it.

So, in the case of the stock it is very much EPS.

In the case of our short-term, there is an EPS and margin aspect to it; and then long term is total shareholder return, the [elten].

Okay.

Just to -- in a more simplified way -- so, there is no incentive comp for the management team this year, at least at senior corporate level.

I guess in a normal year, what type, given your run rate now, how many basis points of margin pressure would the incentive comp have on overall margin?

I think maybe the simplest way to explain that is, you are correct.

In 2012 we've reduced our performance-based compensation.

We still have stock comp expense in there for RSUs and things like that, that have been granted that are not performance-based.

But for 2013 we would estimate 50 basis points of cost for performance-based compensation and we anticipate including those costs in our guidance, so we will provide in December when we are making that presentation in New York.

Just a further guidance issue.

If you go back to our discussion of compensation of the last proxy, half of the stock awarded is performance-based and that has been forfeited as a result of the outcome of Q2 and the year for the senior officers, as it should be.

Nobody's -- the previous year was a good year; we did well.

This year has been a difficult year for various reasons and we don't change the rules.

They are what they are.

Okay.

Great.

Thanks so much.

Ralph Giacobbe of Credit Suisse.

Thanks.

Good morning.

I understand you're going to give 2013 guidance shortly, but I think in previous calls you had talked about a 280 number being a relevant and decent jumping off point or starting point.

Does that change at all in terms of thought process with Kentucky out?

And then maybe just talk about the top line growth opportunities given new contracts in Kansas, the Ohio duals, and the annualized new business in 2012?

I think relative to the previous comments made, you all can get to the year-end run rates.

Bill has made it pretty clear what the guidance is.

That's what everybody based their last call on, so I'm not going to change that any.

And relative to the growth -- that is a subject for December 14, and I'm not going to speculate ahead of that because that's the purpose of that particular meeting.

Okay.

Fair enough.

You started new business in Washington and Missouri during 3Q.

Just help us in terms of how MLR is tracking there, and how your experience has been there so far?

Well, we gave you insight into membership, which is consistent, and the MLR we always book at a higher level, in the 90s as we've talked about historically, for the first two or three quarters of new business.

So, we've been consistent with that.

Nothing has changed there.

Yes, I think it's performing in line with our expectations for those two markets at this point.

Josh Raskin of Barclays.

Have you had any discussions with your current state partners around the situation in Kentucky?

And I would be curious to see any feedback and how you juxtapose that with your 20-year track record versus your nine-month track record in one specific state?

Yes, I will make only one comment.

We believe in good open discussions.

The states we operate in are really partners and work with us.

I think if you take Texas or any of them, they're good examples of how, where there are issues, we sit down at the table and are able to resolve it, not just for us, but for the industry.

So, that's why they have sustainable programs.

And clearly, when this was unfolding we had solid communications with our current states and those that we will be entering that we've already won contracts next year.

That has been received, they understand it, and they continue to work effectively with us.

They see it as purely a Kentucky issue.

Okay.

And I guess in terms of looking back at recent RFPs that you guys have been successful in, is there a part of that RFP response that you think you would have to address Kentucky had this happened earlier?

Doesn't sound like there's been any legal proceedings against you or anything like that, so I'm not sure where or why you'd have to bring it up, but is there any reason you think this could be included in future bids?

No.

We have no trouble discussing it.

It's very clear.

Anybody can get a copy of the complaints we filed yesterday and understand what the issues are.

And so I think I have no trouble with that.

It's very clear what has occurred there.

We had hoped that the state would have sat down with us and resolved it as every other state we've ever worked with has done; but beyond that, I don't want to get in to it, Josh, because of litigation.

That's fair.

Last question -- I don't know if Bill has this handy, but Mississippi and Louisiana -- especially Louisiana; decent sized state for you -- any impact from Hurricane Isaac in terms of volumes or impact there on your utilization this quarter?

Nothing noticeable.

Sarah James of Wedbush.

I wanted to think a little bit about start-up costs here.

As Josh has mentioned, you guys have been very successful.

You have won about six contracts starting in the second half of this year to 2013, and it's about $0.40 to $0.47 so far in start-up costs that have been mentioned in 2012.

I was wondering how much of that was in the quarter, and what do we know so far from contracts that you've already won where the start-up costs will continue on into early '13?

In my comments I said we incurred about $0.07 in Q3 for start-up costs and we talked, I think at the end of the second quarter, about $0.20 to $0.22 for the second half; so we're seeing $0.12 to $0.15 in Q4.

And most of that is for Kansas, which will start up January 1. There is a smaller level for New Hampshire, which starts later in 2013; and in 2013 we would expect to continue to have business expansion costs from the Ohio expansion and duals going on in addition to whatever else comes up.

So we will include a good estimate for business expansion costs for 2013 when we prepare our budget.

We can give you a lot more transparency.

Of course, Ohio -- the duals were already in that state, so that's important.

I think once again the time to talk about that in more detail is on the 14th.

Sure, I appreciate that.

I was just trying to get a clear picture of where the run rate is right now.

My other question is -- it looks like Ohio may have been pushed back again.

I think in the release you mentioned second half of '13.

Do you have a specific month then?

Can you speak to the reason that --

No, there is no specific time.

Jesse, anything you want to add?

Sarah, you're right -- there is some movement in the date with respect to that.

We mentioned second half for 2012, and obviously Ohio is on the front end of these duals demonstration programs working with both the state and at the CMS level.

So there's a lot to be done there, and that work's in process, but we can't be more specific than second half at this point.

I think it is positive.

We like it when states recognize they are not ready to go live at a given point in time, and they work with us on when the effective date should be.

That way it gets off to a good start.

Justin Lake of JPMorgan.

First, on the Kentucky exit -- your contract includes a fee to exit early, I believe.

Can you go over that from a potential cost perspective?

And whether you would expect to have to pay this fee if you are successful in court?

I think, as I just said, I really don't want to talk about it because of the court case.

I'm not going to preclude one way or the other something without going through the steps that are laid out in court.

I'm not going to give something away or presume something is not there.

It's not an appropriate discussion.

I wish I could talk more about it, but that case is filed.

Okay.

And then can you walk us through your capital needs for Kentucky in terms of exiting there?

Do you think that will be net cash positive if you walk away?

And then can you just give us an update on where you are from a capital perspective -- thinking out, let's say, toward the end of next year what your needs might be?

I think with respect to Kentucky we are committed to maintain the required capital levels in Kentucky through our exit, which would be July of 2013.

There will be some runoff that has to occur for several months.

Typically -- we have had this experience in a couple of states -- we will get our statutory capital back at the end of the period when we've paid down most of the claims and worked with particular Department of Insurance for purposes of paying back dividends.

I think with respect to our overall capital needs -- as we said, right now we are maintaining a 350% RBC level.

In the rest of our book of business we forecast out our requirements based on the large growth that we've had, and we continue to believe that we have available to us through both earnings and our credit lines, sufficient capital to meet our requirements in the near term.

Okay.

And the near term might be through the end of next year?

Yes, I think you look at it over the next few quarters, there are other RFPs coming up; so based on what is known today, it is different near term, that's fine.

That's a quarter or two.

As we add new business, then we look at it and we look at our debt capacity, because we obviously prefer debt, and we will continue to work with that basis in cash flow from our operations, which has thrown off decent cash.

So, I think to get beyond that, we may have more clarity in December, I would hope.

There are several RFPs pending.

So all that will influence it.

Trying to speculate beyond that gets precarious.

Okay.

Can I just ask one follow-up and I will jump off?

Thinking about the fourth quarter -- where you are now, versus what you were talking about after Q2.

In the second quarter, I think you had kind of blessed the $0.70 number, and that obviously included the Kentucky losses.

So if we assume that they were about $0.20 for the run rate and call that, the ex-Kentucky number would have been $0.90.

Right now you're guiding to a midpoint of about $0.75 and I know there is about $0.04 of headwind from the Kentucky exit, but that still leaves us about $0.10 short.

I'm just wondering if you can identify what that $0.10 was?

I think it relates back to Pete's question.

I just want to make sure I'm clear on it.

Is there some kind of higher tax rate?

Or is there any other kind of one-time item there?

Because you're talking about operations being better and yet it looks like there is something missing there.

I think most, if not all, the differential is related to Kentucky.

I think as we were preparing our calculations for the second half of 2012 when we made our presentation in June, there's an assumption that what was going to be happening in Kentucky during the course of the year, there would be certain improvements -- we were going to get a rate increase July 1 -- and so I think the basic issue is you are probably overestimating how much we had in the fourth quarter for the Kentucky loss.

So when you added $0.20 back to $0.70, I do not know that, that was a good starting point for a run rate.

Okay -- so it was probably closer to $0.10 than $0.20 in your mind?

I think that's more reasonable.

Okay, great, perfect; thanks a lot.

Scott Fidel of Deutsche Bank.

Thanks.

Just wanted to continue on that topic.

And just relative to the 4Q -- so should we basically assume that there will be around a $0.23 contribution from the beginning of the reversal of the premium deficiency accruals?

So if we take around one-third of what you accrued in the third quarter?

Yes.

I think that's a reasonable assumption and I think from our calculations that would, for the most part, cover Kentucky.

It may not cover the exit costs, which we talked about being $0.04 in Q4, but for the rest of the operations the reversal of the premium deficiency reserve in Q4 should cover the estimated operating loss in Kentucky.

Okay.

And then how should we think about days and claims payable in the fourth quarter, given that you will start to draw down some of that accrual?

Should we think about DCP coming down?

Or are there additional claims reserves that you'll be establishing that will offset that?

Well, the DCP number that we provided excluded the impact of the expense and the reserve for the PDR.

And so I don't know that, that number would change drastically.

It goes up a day or down a day in any quarter.

So I wouldn't expect to be any significant change from Kentucky being in there until next summer, if that causes any impact in the overall DCP number.

So I would expect it to stay in the same levels as we are, which is in the low 40s.

Okay.

Got it.

So, core DCP should be in the low 40s in the fourth quarter?

Yes.

Okay.

Then just separate topic.

Just interested in what, if anything, you guys have been hearing around the industry tax and how that will be addressed?

Or how -- either from the states or the federal government on any developments in terms of how they're thinking about building in the industry tax into Medicaid rates in 2014?

Our Washington office has had multiple conversations, both sides of the aisle, both houses.

They understand the issue.

I think there are a lot of issues.

If the ACA stands -- outcome of the election -- and you're not getting a lot of people committing one way or the other, but they clearly understand it.

There's a large group who have signed on to the necessary modifications, but we can talk more about it when we get through the election and Q1 of next year, because I think no matter what happens, both sides would agree that if ACA stands, a lot of changes need to be made to it to get it sustainable.

Okay.

And then just one last question.

Just on the ABD MLR, it looked like that continued to creep up to 97.3%.

Do you have what that is, excluding Kentucky?

And really just interested to hear, because obviously mix of business-wise, ABD will continue to grow, especially as we get into the dual.

So, just want to know what is putting the upward pressure on the ABD MLR.

Is that all Kentucky?

Or is that still some of the effect of Hidalgo?

Or are there any other markets as well that are pushing up the ABD MLR?

Thanks.

I think it's both.

Kentucky is in the overall number because there's quite a bit of SSI in there.

I think Hidalgo also increases the overall number compared to where we have in other states.

So those two items probably account for most of the differential.

Carl McDonald of Citigroup.

The open enrollment period in Kentucky just ended three days ago.

I'd be interested if you have any update on what your membership will look like in the fourth quarter.

If not, the membership that you've assumed in setting the premium deficiency reserve for fourth quarter and first half of next year?

I don't think we have insight at this point in time in terms of any real changes in the membership numbers as a result of open enrollment.

In our premium deficiency reserve calculations, we did not assume that there would be a significant decrease in membership between now and the end of June.

Anything is possible, but our calculations did not take that into account.

Okay.

Second question would be, just the thought process a quarter ago in not disclosing the $50 million premium deficiency reserve that you'd established in Kentucky.

I recognize it was just for the health plan business rather than consolidated Kentucky, but $50 million, a decent size number, also a pretty high-profile topic.

So, I just wanted to understand the thinking around that?

We have premium deficiency reserves for statutory purposes in several of our plans from time to time; and we've never really talked about what a statutory PDR calculation, what that implies because there's a number of things that go into that, that wash out in the consolidation.

So, we look at it always from a GAAP standpoint and that's what we disclose on.

So, if we have a premium deficiency reserve for GAAP purposes, we would disclose that.

This is really, I think, the first time we've had a GAAP premium deficiency reserve -- which was for Kentucky -- and we discussed this, I do believe, at the end of the second quarter.

We looked at that for purposes and at that point we presumed over the life of the contract we would still break even.

Obviously, the result in the third quarter worsened, and it didn't appear that there was going to be any improvement, and we have taken the actions that we have taken.

And as a result of that, we did our calculations again in the third quarter and recorded the amounts that we did at this time.

I think what's also important, Carl, is right up until the point in time we announced the PDR we were in discussions with the state on some changes to the program that had they agreed to would have completely turned around the way things are done, not just for us, but for everybody, to get that sustainable program.

So, as a result, there were some things we thought were particular to ourselves; but typically, once we saw that those were going nowhere, we very quickly calculated a PDR and got it out.

The $200 million in capital contributions that you're expecting to make in the fourth quarter -- is that just for new markets, or does that include capital that will go into Kentucky as well?

That would be for all markets.

Some of that is for Kentucky; a lot of it would be for Texas, where, given the significant growth in Texas as we increase our trailing 12-months revenue, that statutory requirement goes up every quarter.

And then to follow on Justin's question -- any sense at this point of how much of that $200 million will come from ongoing operations or existing cash, versus what we should expect from a debt increase in the fourth quarter?

Well, at this time we don't project out what our borrowings will be from quarter to quarter.

We do believe we will have a significant level of earnings in Q4 and that we would be able to have availability on the revolver to fund any differential there.

Well, with some cushion remaining, it's not a case of running the debt to the maximum.

So, we started it and we'll be in a strong balance sheet position at the end of the year is our forecast.

Okay, thank you.

Dave Windley of Jefferies & Co.

Michael, in your prepared remarks you made a brief comment relative to learnings from Kentucky and not --or being more wary about states moving populations into managed care first time.

I wondered if you could expound on how that influences your thoughts about pursuit of RFPs in the future.

Is it simply only states that are moving populations in for the first time?

Or what other learnings could you draw from this that might affect what you go after?

I have to be very careful here because I'm not representing my complaint publicly over a conference call.

But I think there are a couple things.

You want great assurance that the data they're giving you is complete and full and we typically have done that.

There is a standard of practice the way things have been done that has not been an issue up to this point in time.

And, as I indicated to you, this went very fast.

The RFP, I think, came out in May and they went live on November 1. And typically states would do it on a more extended basis, getting things right through discussions.

And I think I alluded to it before -- the fact that Ohio is where they've had managed care, they're in a new population, and they're extending the period over time to get some things right and have those discussions.

I think that's what you want to see.

You want to see people that are working and building sustainable programs versus having a program.

I don't want to go beyond that.

As I said, we're going to take the high road on this thing, and I'd much rather just leave it at that.

Okay.

So, apart from Kentucky, as you look at your business development efforts, do have thoughts that you need to expand that, bulk that up to handle the amount of the pipeline?

In other words, is there a process in capacity that you need to expand to be able to handle the expansive opportunities that are out there?

It was at no way, shape, or form a capacity issue on our part.

If you look at the number of states that we have entered, you look at how we've done two, three states at one time and more -- we've had no issues.

So, this is not a capacity; this is just a very particular issue for Kentucky.

Louisiana, Mississippi, Illinois -- I mean, all of the states that we've entered very successfully, to the state's satisfaction as well as ours.

Got it.

If I could ask one last followup on shift to Texas -- you've made some nice progress there.

Sounds like more than you expected.

Do you think that, that progress can continue?

Or are there any structural impediments that would cause that to plateau in the short term?

Well, we still -- we have a very strong team there.

We continue to meet with the state on issues when and if we identify them.

They are very interested in ensuring that the program continues to work, and that they recognize the need for the Company to be successful in doing that program.

So, I see no issues there.

I think we've said in our script that we anticipate it to continue to normalize going into '13.

Okay, thank you.

Brian Wright of Monness, Crespi, Hardt.

I just wanted to get -- so the $0.70 to $0.80 for the fourth quarter guidance includes $0.23 for the release of the premium deficiency from Kentucky.

That's a bit lower than your ex-Kentucky run rate in the second quarter.

You've spoken to $0.09 of it, I believe, in Kentucky run-off and higher Kansas G&A, but there is still a delta there.

How much of that delta is seasonal MLR higher in the fourth quarter versus a tax rate catch-up issue in the fourth, to get to the 40% for the full year?

I think, Brian, you said second quarter -- I don't know if you meant third quarter.

Actually, I meant third.

Sorry about that.

Good.

The issue that there is -- we say we had $0.31 of operating loss in Q3 and that was exacerbated by additional adverse development -- let's say from prior in the year -- as we continue to receive more retros coming from that.

So, I think what we're saying is we don't expect Q4 to be at the $0.31 run rate going forward.

More closely aligned to the $0.23, which reverses after the PDR.

And I think the differential -- we had planned for a lesser amount than that in Q4 when we were trying to reconcile the guidance numbers in total.

But we do believe the numbers that we are giving right now -- Q3 and Q4, the $0.78 that we have had for Q3 and then the $0.70 to $0.80 range for Q4 adjusted for business expansion costs and for the exit cost in Kentucky, and a little bit higher HBR in Q4 versus Q3 -- are the primary moving parts for the reconciliation.

Taxes really don't play much of a part in either quarter; they are about the same.

So, your view is that it is not a material difference run rate?

For which piece?

For the fourth.

I think third and fourth quarter are comparable in many respects when you adjust for just a few items.

Okay.

Thank you.

We have time for a couple more.

Scott Green of Bank of America Merrill Lynch.

On Kentucky -- I was just curious if you could tell us what the MLRs would have been in second quarter and then the third quarter if you reallocated the unfavorable development to the appropriate periods?

I'm not sure I have all of those, but I would say we ran 115% in Kentucky in Q3 and it probably would have been closer to 109% or 110% without the adverse development.

And that's all those numbers without a PDR.

Those are the before numbers.

Okay.

And I believe the statutory filing in the second quarter was 119%, but that assumed a little unfavorable development -- say, closer to 112%.

Is it safe to say that you got a little bit of improvement sequentially in Kentucky on a run rate basis?

I think it's dangerous to compare statutory numbers and GAAP numbers when you're picking up PDRs in one and not in the other.

So, I think I will leave it as I just explained.

Okay.

I guess I was not clear.

So, not referring to the stat filings, do you think the trend in Kentucky ex-favorable development improved sequentially?

They are about the same.

There's not much difference either way.

As we said, we're still getting retro adds going back to next November.

[Hard to tell] how many of those we are going to get next month.

We could give you a sense.

That's part of the issue.

That's one of the big issues.

Okay.

Separately -- in Texas, you said you had a mid 90s MLR.

Just hoping you could offer a bit more detail, since September 1 was the big rate increase that will help the MLR going forward.

Can you tell us maybe what the MLR was in the September period with the rate increase?

Was it lower than the average?

We'd much rather do it on a quarterly basis where we look at the prior period involvement on a quarterly basis.

So I think though it would be misleading to try and give one month.

Yes, I think in general we're just trying to show that with respect to Hidalgo it started March 1. We've had quite a few months to try to work on the utilization levels, but we also picked up a new membership in August and September.

We got a rate increase in September.

All of those things considered, we still operate in the mid-90s and our team is working very hard there to try to continue to bring down the utilization levels in that service area, which are still much higher than they are in the rest of the state and will continue to be a work in progress probably for several quarters.

We recognize that we took on 9,000 lives in the August and September of high-intensity and we're managing it down to that level.

That's important.

One more question.

Sure.

Can you elaborate on the Georgia revenue issue you called out?

Was that anything related to what Amerigroup talked about in the second quarter of last year with membership reconciliations?

And do you expect any sort of true-up from the state from this going forward?

It is a similar issue that all three MCOs have to deal with in the state of Georgia in terms of how the state processes membership, retroactive membership deletions primary from what they consider to be duplications, and it takes a while for them to process these.

We make accruals for this on a regular basis every month.

From time to time there is a true-up that might occur, which is particularly what happened in 2011; and then there is some adjustments in terms of how that impacts actuarial soundness and rates.

And so during the quarter Georgia made some adjustments in those amounts and we reflected that in the quarter.

It is routinely looked at every month.

One more.

Michael Baker of Raymond James.

I was wondering if you could give us some color on when the Ohio duals are coming -- what you're doing in advance of that as it relates to medical management outreach, particularly in light of what you've learned on other dual processes so far?

I think I will keep it somewhat limited.

We'll get what data we can and we will do it through our predictive models.

We'll use our system capability to examine what needs to be done, and we will work with the state and see what information we can get on the history of these people and just ensure that there is a solid -- the medical management people will work on a solid transition plan and ensure that they gain the benefits they should from managed care.

And the state's working very closely with us on that.

And are there any differences in how you're approaching your reserving assumptions in front of it, in light of what experience has been to date on the duals?

Well, we can't take reserves until we have the members.

Bill?

We try to reserve for the expected costs for each individual population; and this population we will continue to be looking at to determine what we think -- once we get rates and what expected HBR is, and we'll try to conservatively accrue that.

And normally we try to build margin up in the first six months of operations of a new area or segment of a population, so I'm sure that will be the case in Ohio.

Thanks.

We thank everyone, and we look forward to the December 14 guidance and the year-end call in February.

Thank you so much.

Have a good day, everybody.

The conference is now concluded.

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