Centene Corp (CNC) 2017 Q3 法說會逐字稿

Good day, and welcome to the Centene Corporation 2017 Third Quarter Financial Results Conference Call.

(Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Ed Kroll, Senior Vice President, Investor Relations and Finance.

Please go ahead.

Thank you, Steve, and good morning, everyone.

Thank you for joining us on our 2017 Third Quarter Earnings Results Conference Call.

Michael Neidorff, Chairman and Chief Executive Officer; and Jeff Schwaneke, Executive Vice President and Chief Financial Officer of Centene, will host this morning's call, which can also be accessed through our website at centene.com.

A replay will be available shortly after the call's completion, also at centene.com or by dialing (877) 344-7529 in the U.S. and Canada or in other countries by dialing (412) 317-0088.

The playback code for both dial-ins is 10111720.

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 most recently filed Form 10-Q dated today, October 24, 2017, the Form 10-K dated February 21, 2017, 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.

The call will also refer to certain non-GAAP measures.

A reconciliation of these measures with the most directly comparable GAAP measures can be found in our third quarter 2017 press release, which is available on our website at centene.com under the Investor section.

Finally, reminder that our next investor day will be on Friday, December 15, 2017, as always, in New York City.

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 2017 earnings call.

During the course of this call, we will discuss our third quarter financial results and provide updates on Centene's markets and products.

In addition, we will provide commentary around the ongoing health care discussions in Washington as well as discuss Centene's recently announced acquisition of Fidelis Care.

I would like to begin with the health care regulatory landscape.

After several repeal and replace efforts in Washington failed, we fully recognize the possibility that cost-sharing reductions, CSRs, might not continue to be funded, and as such, planned accordingly.

We filed 2018 rates in all our exchange markets, assuming there would be no CSR payments.

And they have now been approved in all markets.

I would like to note there seems to be a misunderstanding regarding the applications of CSRs.

They are not a profit contributor.

Instead, they are intended to cover the out-of-pocket health care cost for the country's most vulnerable populations.

The CSR pass-throughs are reconciled annually, and any overage is paid back to CMS.

I would like to remind everyone, in 2015, the Supreme Court ruled the ACA advanced premium tax credits legal.

These credits cannot be removed via executive order.

It is important to note, contrary to the administration's desired impact of reducing insurance premium cost, the defunding of the CSRs will cause the federal government to spend more money to hire funding of premium tax credit.

In fact, the Congressional Budget Office recently estimated the defunding of CSRs would increase federal spending by almost $200 billion over a 10-year period, or $20 billion per year.

Note, the federal government currently spends approximately $7 billion annually on CSR payments.

Equally important, we are putting in place a system to track the incremental premiums being charged.

In doing so, we know what refunds would be required if the decision is reversed by the courts or the Congress.

The process has a long way to play out.

Injunctions have been filed and legal actions taken on multiple fronts.

I want to emphasize the importance of vulnerable populations having access to high-quality affordable health care.

Centene will continue to work with members of both parties on stabilizing the marketplace and improving the health care delivery system.

We also believe important social change should be a bipartisan effort.

In the meantime, it is business as usual for Centene.

We make decisions based on the facts in front of us at any given time.

We will continue to focus on fundamentals, as evidenced by another strong quarterly financial performance.

Next, I will discuss the acquisition of Fidelis.

On September 12, we signed a definitive agreement, under which Fidelis Care will become Centene's health brand in New York City.

Fidelis Care is a not-for-profit, diversified leader in government-sponsored programs across the state of New York.

New York is the second largest managed care state.

By adding Fidelis Care, Centene will have a leadership position in the 4 largest managed care states: California, Florida, New York and Texas.

Under the terms of the agreement, we will acquire substantially all of the assets of Fidelis Care for approximately $3.75 billion.

New York law allows for the acquisition of assets of a not-for-profit rather than the conversion to a for-profit entity.

This facilitates our ability to complete the transaction.

This deal is positive from both a strategic and financial standpoint.

We expect it to create significant value for Centene shareholders and both companies' stakeholders.

Fidelis Care is quite complementary to Centene.

The company takes a local approach towards providing high-quality, affordable health care to low-income, vulnerable population.

The company is ranked #1 in state-sponsored programs in the state of New York.

It is the fastest growing New York Medicaid and managed long-term care plan as well as the second fastest growing New York Medicare Advantage plan.

It is the only plan that operate Medicaid-ship and managed long-term care plans in all 62 counties in the state.

At June 30, 2017, Fidelis Care served over 1.6 million beneficiaries.

And for the first 6 months ended June 30, 2017, Fidelis Care's revenue was $4.8 billion.

Through the incorporation of our data analytics tools, case management and award-winning clinical management programs, we will be able to further build upon and enhance the existing capabilities of Fidelis.

We expect the transaction to be immediately accretive to GAAP EPS.

We anticipate high single-digit percentage accretion to adjusted EPS in the first 12 months following the close and low to mid-teens percentage accretion to adjusted EPS in the second full year following the close.

We also anticipate generating approximately $25 million in pretax synergies in the first 12 months following the close and $100 million in pretax net run synergies.

These synergies will primarily be attributable through the use of our medical management programs and specialty services.

We expect Fidelis Care to add approximately $500 million of 2018 adjusted EBITDA, including net synergies.

On October 2, it was announced that Centene was granted early termination of the waiting period under Hart-Scott-Rodino.

We are moving through the process for approval from regulatory agencies in New York.

The initial integration planning process is underway and is going extremely well.

In fact, it is ahead of where we were at this time after the announcement of the Health Net acquisition.

We expect the transaction to close in the first quarter of 2018.

New York will mark Centene's 29th state of operation.

Now onto third quarter financials.

We are pleased to report a strong third quarter marked by solid top and bottom line growth.

Membership at quarter end was 12.3 million individuals, representing an increase of approximately 875,000 recipients or 8% compared to the third quarter of 2016.

Total revenues increased approximately 10% year-over-year to $11.9 billion.

The HBR increased 100 basis points year-over-year and 170 basis points sequentially to 88%.

These increases are primarily due to new and expanded health plans, which initially operate at a higher HBR, and an increase in higher acuity members.

Additionally, rate reduction for California Medicaid expansion also contributed to the uptick in HBR.

Last week, we reported third quarter adjusted diluted earnings per share of $1.35.

This compares to $1.12 reported in the same period last year, and represents a year-over-year increase of approximately 21%.

Jeff will provide further financial details, including updated 2017 guidance.

A quick comment on medical cost.

We continue to see, as well as anticipate, overall stable medical cost trends, consistent with our expectations in the low single digit.

Moving onto markets and product updates.

First, we'll discuss recent Medicaid activity.

Nevada.

On July 1, we began providing health care services to Medicaid beneficiaries enrolled in Nevada's Medicaid -- managed care program.

The contract launched as expected.

At September 30, we served approximately 17,000 beneficiaries in the state.

We expect continued growth for the balance of the year.

Illinois.

In August, our Illinois subsidiary, IlliniCare, was awarded a statewide contract for the Medicaid managed care program.

This contract now includes needy children.

Centene is currently contracted to provide health care services in the state's Medicaid and dual eligible population in 12 counties.

The new contract expands our footprint to all 102 counties in the state.

It is expected to commence on January 1, 2018.

Pennsylvania.

The Pennsylvania long-term care contract remains on track to commence on January 1, 2018.

Pennsylvania HealthChoices TANF award continues to be subject to protest.

We anticipate the award will not meet the initial expectation of a January 1, 2018, start date.

Next, Centurion.

In August, Centurion successfully re-procured its contract in Tennessee.

At September 30, Centurion provided health care services for over 22,000 inmates in this state.

A new contract is expected to commence in the first quarter of 2018.

Centurion currently operates in 7 states, providing correctional health care services to 158,000 individuals as of September 30.

Now onto Medicare.

At quarter end, we served approximately 330,000 Medicare and dual-eligible beneficiaries.

As I have previously stated, we are applying a test-and-learn approach to our first year of Medicare Advantage expansion in 4 Centene Medicaid states.

We are pleased with the operating performance of our Medicare Advantage for (inaudible), thus far, in 2017.

We have supplied -- or applied the insights we had gained, thus far, this year to Centene's 2018 Medicare Advantage and D-SNP plans.

Next year, we will be offering plans in 8 new Centene Medicaid states.

These plans will be launched under our national Medicare Advantage brand name Allwell and are all eligible for a premium bonus under our 4-star parent rating in 2018.

The annual enrollment process began on October 15.

We were pleased with the competitive position of our products and engagement of the brokerage meeting with [Ralwell].

While it is still early, the initial metrics for 2018 membership will -- are in line with our expectations.

Upon the close of the Fidelis Care deal, we will also be serving Medicare Advantage members in New York.

We were disappointed by CMS' recent downgrade of our 4-star parent grading to 3.5 for 2019, and are currently in the process of appeal.

This downgrade was the result of a 2015 program audit related to one of Health Net of California's MA plan.

Health Net in California's underlying performance reflects a 4-star rating performance.

However, CMS lowered its single measure, BAPP, beneficiary access and performance problems, due to the civil monetary penalty associated with the planned audit in 2015.

This causes decline in the overall score to 3.5 stars.

The overall quality results improved on a year-over-year basis.

However, this improvement was insufficient to compensate to the lower BAPP measure.

It is important to note that this is a short-term issue.

We will still be receiving the 5% bonus payments in 2018.

The penalty related to the 2015 program audit will only impact the 2019 bonus year and will not have a continuing impact on the star ratings in future years.

As I said earlier, we are in the process of appealing.

We are also evaluating additional options at this time to mitigate the effect of the loss of a 4-star parent rating for the 2019 year

Over the long term, we continue to expect our Medicare Advantage products to drive over 20% of our annual growth rate.

Next on the Health Insurance Marketplace.

At September 30, we served approximately 1 million exchange members.

This represents a sequential decline of approximately 60,000 beneficiaries due to normal attrition and is in line with our expectations.

The key demographics of these members, including age, gender, financial assistance and mental care, remain consistent.

Over 90% are subsidy eligible and over 90% are enrolled in silver-tier plans.

Our exchange business continues to perform well in 2017.

As I said in my earlier remarks, it is business as usual.

We remain focused on providing high-quality, affordable health care to low-income individuals.

In addition to expanding our footprint in 6 existing Centene markets next year, we are adding 3 new exchange states in 2018: Kansas; Missouri; and Nevada.

Open enrollment starts November 1. Jeff's guidance includes incremental marketing and other outreach efforts to offset the federal government's cuts.

Upon the close of Fidelis Care, we will also be offering an exchange product in New York.

Shifting gears to our rate outlook.

We continue to expect 2017 net composite Medicaid rate adjustment of 0% to 1%, consistent with the past few years.

In summary, third quarter results offer continued evidence of Centene's financial strength and operating capabilities.

While we will give full 2018 financial guidance at our December Investor Day, it is important to recognize the operating momentum we have going into 2018.

Centene has been and continues to be a good company.

We will continue to execute on our growth strategy, as evidenced by recent announcement of the Fidelis Care acquisition, and as previously discussed, the Illinois and Missouri expansion, which are already in our numbers.

Centene's entry into the state of New York is consistent with our strategy to continue to be the national leader in government-sponsored health care.

Regarding health care policy, there will continue to be headline volatility.

It is important to differentiate between this and the actual results we are delivering.

As I have said many times before, this process is complicated and will take quite some time to play out.

It is also important to remember Centene is that we have a solid track record of demonstrating our capacity and capability to navigate industry changes to the benefit of our members, customers and shareholders.

As a reminder, our next investor day is on December 15 in New York City.

We look forward to seeing you there.

We thank you for your interest in Centene.

Jeff will now provide further detail on our third quarter financial results.

Thank you, Michael, and good morning.

Earlier this morning, we reported strong third quarter 2017 results with both top and bottom line growth.

Total revenues were $11.9 billion, an increase of 10% over the third quarter of 2016, and GAAP diluted EPS was $1.16.

Adjusted diluted earnings per share was $1.35 this quarter compared to $1.12 last year, representing 21% year-over-year growth.

As a reminder, adjusted diluted earnings per share excludes the amortization of the acquired intangible assets and acquisition-related expenses.

Additionally, for the third quarter 2017, adjusted diluted EPS excludes additional expense of $0.03 per diluted share associated with the Penn Treaty guarantee assessment.

During the third quarter, we received updated information from the California Guarantee Association regarding our share of the assessment.

Let me provide some of the performance highlights for the quarter.

Total revenues grew by $1.1 billion year-over-year, primarily as a result of growth in the Health Insurance Marketplace business, the expansion of the Missouri contract in May of 2017, a full quarter of business expansions in Texas and the start-up of our Nebraska health plan on January 1, 2017.

This growth was partially offset by the 1-year moratorium of the health insurer fee, lower membership in the commercial business in California as a result of improvement actions taken last year and lower revenue in Georgia, driven by the addition of a fourth competitor in July 2017.

Moving on to HBR.

Our health benefits ratio was 88% in the third quarter this year compared to 87% in last year's third quarter and 86.3% in the second quarter.

The increase year-over-year is primarily driven by new or expanded markets, which initially operated a higher HBR and increase in higher equity membership year-over-year and a premium rate reduction in our Medicaid expansion business in California effective July 2017.

Sequentially, the 170 basis point increase from the second quarter is primarily attributable to the favorable risk adjustment in our marketplace business recorded in the second quarter of 2017, the California Medicaid expansion premium rate reduction previously mentioned and normal seasonality of the business.

Turning to our 2017 marketplace business.

For the third quarter and 9 months ended, the marketplace business continues to perform in line with expectations.

We have provided disclosure on our press release and other filings this morning with respect to the CSRs for 2017.

If the federal government does not pay the CSRs in the fourth quarter, we expect the lack of those payments could reduce our diluted earnings per share for the fourth quarter and full year 2017 by $0.07 to $0.12 per diluted share.

This estimate primarily represents states where we are projecting receivable positions on CSRs by the end of the year.

For the majority of our states, we have received CSR payments through the third quarter that represent our full year CSR expectations and, as a result, do not believe we have exposure associated with those states.

As there are still a lot to play out with respect to CSRs in the fourth quarter, including court cases and potential legislative actions, we have not included the defunding of CSRs in our updated guidance announced today.

Moving on.

Our adjusted selling, general and administrative expense ratio was 8.9% in the third quarter this year compared to 9.1% last year and 9.3% in the second quarter of 2017.

The decrease in the ratio, as compared to the prior year, is primarily due to the leveraging of expenses over a higher revenue base.

The decrease sequentially is a result of higher incentive compensation expense recorded in the second quarter as a result of higher earnings.

Additionally, during the quarter, we incurred $0.12 of business expansion cost.

Due to the open enrollment period for both the Medicare marketplace business, we expect the fourth quarter adjusted SG&A ratio to be an excess of 10.5%.

Interest expense was $65 million in the third quarter compared to $57 million in the third quarter of 2016 and $62 million in the second quarter of 2017.

The increase year-over-year is due to the increase in senior notes over 2016.

Our effective income tax rate was 38.3% in the third quarter of 2017.

The lower tax rate compared to the prior year is due to the one-year moratorium of the health insurer fee.

Now onto the balance sheet.

Cash and investments totaled $9.9 billion at quarter end, including $308 million held by unregulated subsidiaries.

Our risk-based capital percentage for NAIC filers continues to be in excess of 350% of the authorized control level.

Debt on September 30 was $4.7 billion, including $150 million of borrowings on our revolving credit facility.

Our debt-to-capital ratio was 41.2%, excluding our nonrecourse mortgage note compared to 43.7% at last year-end and 42.1% at the end of the second quarter 2017.

We are pleased with the continued deleveraging of the company and continue to focus on returning our debt-to-capital ratio to the mid to high 30% range.

Our medical claims liability totaled $4.3 billion at September 30 and represents 42 days in claims payable compared to 40 days last quarter.

The increase in days in claims payable is due to the timing of payments at quarter end and the impact of new business.

Cash flow provided by operations was $97 million in the third quarter.

Operating cash flows for the third quarter were affected by the 2016 marketplace risk adjustment payment of $437 million paid during the quarter.

Next, I would like to provide an update on the Fidelis transaction.

As Michael mentioned, we have received early termination of the waiting period under the Hart-Scott-Rodino Act and continue to work on the remaining regulatory approvals.

We continue to believe the transaction will close in the first quarter and plan to fund the transaction with approximately $2.3 billion of equity and $1.6 billion of debt.

The timing of the financing is subject to market conditions.

Lastly, turning to guidance.

We have increased our annual total revenue guidance for the performance in the third quarter and additional revenue of approximately $700 million that is expected in the fourth quarter from pass-through payments, primarily in California.

We do not anticipate the same level of these pass-through payments in 2018, as the state is contemplating changing the process for these types of payments.

We have adjusted our GAAP and diluted earnings per share guidance for several items, including: the performance for the third quarter 2017; an increase in merger-related cost from $0.02 to $0.03 per diluted share to $0.07 to $0.09 per diluted share, reflecting additional cost associated with the Fidelis transaction we expect to incur in 2017; and an increase in business expansion cost from $0.42 to $0.47 to $0.46 to $0.51 associated with additional marketing and membership outreach efforts as a result of the decrease in spending on these programs at the federal level.

The midpoint of our adjusted diluted earnings per share guidance has been increased based on the strong third quarter performance, partially offset by the increase in business expansion cost noted previously.

In summary, our updated full year 2017 guidance is as follows: total revenues between $47.4 billion and $48.2 billion; an HBR ratio of 87% to 87.4%; SG&A expense ratio of 9.4% to 9.8%; adjusted SG&A expense ratio of 9.3% to 9.7%; GAAP earnings per share of $4.04 to $4.18; adjusted diluted earnings per share of $4.86 to $5.04; an effective tax rate between 39% and 41%; and diluted shares outstanding between 176.3 million and 177.3 million shares.

While there is a lot of noise in the market, we continue to focus on the fundamentals in the business, and we are pleased with the third quarter results.

The strong third quarter results provide operating momentum heading into 2018.

That concludes my remarks.

And operator, you may now open the line for questions.

(Operator Instructions) And our first question comes from Kevin Fischbeck with Bank of America Merrill Lynch.

Just wanted to follow up on, I guess, maybe that last point about the revenue guidance, including the pass-through payments for California.

I just want to make sure that, that number is basically kind of a 0 margin revenue adjustment.

Just trying to think if there's a headwind from that for next year.

No, no.

It's -- it'd be in a premium tax revenue and premium tax expense in a pass-through line, so it's a 0.

Okay.

Great.

And then as far as the commentary around the star ratings, it sounds like you're thinking that basically, one way or another, either through an appeal or to mitigation efforts, you would not expect there to be a star's headwind in 2019.

Is that the right way to think about it?

That's -- I think that's what we're looking at.

We do anticipate the appeal.

I think there's some good reasons to appeal.

And at the end, there are ways to mitigate the impact to the finance.

Do you want to add to that, Jesse?

No, Kevin.

I think there's sort of recent precedent with respect to contract migrations and related activities from other plans.

And we -- the legacy Health Net organization has experience in that within California.

So we're familiar with that approach.

And I think, Mike, as you said, by the combination of the appeal process and other mitigation activities, which we can control, we think that this is a manageable risk for 2019.

Kevin, what's important, too, we're launching the new plans in 2018.

The expansion areas will not be impacted in the first year.

Okay.

Great.

And just maybe last question.

As far as the exchanges go, it sounds like you're saying that you do not expect the CSRs to be a headwind at all to 2018 profit target.

Is that right?

That's right.

I think you have the premium adjustment tax.

And so I think that we will offset it.

And we'll have the same plan as the CSRs.

Our next question comes from Sarah James with Piper Jaffray.

I wanted to go a little bit deeper on the exchange performance.

So initially, when you set margins for '17, it was 150 basis points conservatism or about $0.20 EPS.

Then you outperformed about $0.16 in the first half and took the remaining $0.04 out of guidance for conservatism buffers.

So it sounded like you were back to expecting a 5% margin for '17.

Am I thinking about that right?

If -- are you still expecting 5%?

And how did 3Q exchange performance compared to those expectations?

Yes.

This is Jeff.

First, on the third quarter, you have to realize there is some seasonality in the exchange business.

So the profit is more, I would say, front-end loaded because of the design of the products more towards a commercial-type product.

And I think your math is correct on the conservatism -- original conservatism.

So yes, I think our expectations for the performance of the year that it's going to be at the high end of the range.

Got it.

And can you walk us through some of the headwinds and tailwinds you expect to impact sequential progression of the fourth quarter MOR?

Specifically, I'm thinking about potential for hurricanes or flood-related issues to change seasonal progression or asthma in Texas, the heightened flu season that we've seen in the Southern hemisphere, how you guys approached flu expectation this year.

And I guess, if there's any offset for medical management or some high-acuity contracts that you're making changes and that could be a positive influence in the fourth quarter.

I'll start off.

As it relates to floods and hurricanes tell us when and where they're going to hit and I can start to take a guess and it's still be a guess because look at what happened in Florida and elsewhere, minimal impact.

But for the flu, we were -- we are anticipating normal flu season.

That says that we'll work the necessary expense for the normal flu season.

If it's milder or lighter, we'll be in a better position to give you insights on that in the fourth quarter earnings.

So it's a -- it's kind of business as usual.

We see a -- we have to plan on a more normalized fourth quarter doctors' contingencies and (inaudible) what kind of deal as we always have at that point in time.

I'm not sure if that helps, but I'm trying.

No, that's helpful.

And just any good guys on the fourth quarter as we think through MOR.

So you had flagged in the third quarter pressure on MOR from some of the new high-acuity contracts.

So as we think through your medical management process, is there any good guys coming on these new contracts?

Jeff, you want to...

Yes.

I mean, I will tell you that the medical management process is a continuous process.

It's going on all the time.

The only thing I would say is that if you kind of look at the seasonality of the business, if you kind of look at last year's HBRs, I think November tends to be a pretty good month for us and it just depends on how the calendar falls.

But there is some seasonality to the business between the quarters, and that's what I would point to.

Our next question comes from Chris Rigg with Deutsche Bank.

We're just hoping to get a clarification on the way you guys are thinking about the CSR impact.

Did I understand you correctly that in states where you're currently in a payable position, all things being equal, even if you're in a payable position at the end of the day, you'll keep that money?

Or is that not what you tried to imply?

No.

I think what I -- you're right.

We are in a -- I mean, if you look at our filings, we are in a net payable position.

And I think what you have to understand is that the regulations provide for an annual reconciliation.

So what we're saying is that in the majority of our states, our payable position as of the end of the third quarter is large enough that we don't really need any CSR payments in those states for the rest of the year.

So only in states where we are projecting a receivable position would we have exposure.

And that's what the $0.07 to $0.12 represents.

Great.

And then just a follow-up on one of the prior questions with regard to the fourth quarter.

It looks, when we back into it, about flattish to maybe even down a little bit sequentially.

And I heard your comments about November.

But is the seasonality mostly in the Medicaid business and you do expect the health insurance exchange enrollees to see a spike-up in the fourth quarter?

Just want to better understand how you think about the MCR in Q4.

Yes, yes.

Again, I think I'd pointed to last year as far as a relative comparison on the HBR.

I think if you look at last year, we did have a lower HBR in the fourth quarter than we did in the third quarter.

So there is seasonality there, and that would be business outside of the exchange.

Because the exchange, the fourth quarter is the highest MLR of the year.

Our next question comes from Lance Wilkes with Sanford Bernstein.

Yes, a couple of questions on medical cost trend and pricing.

Could you just walk through for the traditional Medicaid programs, for the higher acuity programs and public exchange?

What are you seeing as far as medical cost trending utilization specifically?

Well, I mean, are you specifically talking about what's priced in?

I mean, there's a big difference in pricing on the Medicaid and LTSS side.

I mean, those are primarily price by the states using historical cost data versus the exchange business, which is more of a premium bid and more prospective.

So there's a differential there.

And I would say, consistent with what we've said in the past, it's low single-digit cost trends on the Medicaid side and a little bit higher in the exchange side.

It's more of a commercial product.

Got you.

And where I was going with it is on the higher acuity side, especially with the newer contracts, are you seeing kind of higher-than-expected utilization or -- relative to obviously the premiums?

And is that consistent with your expectations?

And how long does it normally take for that utilization to kind of come back into line with maybe a more seasoned book of business?

Yes.

Two things just to make clear.

And generally, in higher acuity businesses, they do -- they are rated at a higher MLR.

So when we talk about the impact on the consolidated MLR, it's really a mix issue.

Meaning if we have more higher acuity business, it's underwritten into the low 90s versus more exchange business, which is a lot lower in HBR.

I would say a lot of the programs that you enter into initially have continuity of care periods where we are not allowed to effectively apply all of our medical management procedures.

Those can range from 3 months to 6 months.

And then after that we were able to apply our full tools.

But nothing outside of what we have experienced in the past.

Yes.

I think when you look at it, we've always said we book a higher MLR until you get the actual experience.

And then two, we've always said plan on 3, 4 quarters for normalization.

And that's just a general rule that one should follow when looking at that.

Sure.

And just last one.

What was the impact of the California Medicaid expansion rate reduction relative to the overall change in HBR kind of year-over-year?

So we mentioned -- I think we mentioned 100 -- well year-over-year, I'll just do sequential.

From Q2 to Q3, there's 170 basis points.

I would say between the risk adjustment recorded in Q2 and the rate decrease in California, that's about half of that movement.

The rest is really seasonality in the business.

Our next question comes from Matt Borsch with BMO Capital Markets.

Just on the -- I'm sorry.

Can you hear me?

Yes.

Yes.

I'm sorry.

On the exchanges, I realized that your member mix has stayed pretty stable at about 9% receiving subsidies.

Can you just drill down a little bit into that in the sense of do you have any numbers that you can share about what percentage of those are below 250% of the federal poverty level or anything like that relative to how much subsidy they're getting?

I don't know if we have that specific available.

But we've kind of said that it's consistently at the 90% of our population do receive subsidies.

It runs the gamut but it's probably a pretty normalized curve.

I guess what I'm getting at is I'm wondering, clearly, you've had a pretty targeted approach with targeted mostly the by-product of the way that you build your network so that it sort of a near-Medicaid population.

But is that going to change as you go into 2018, and we have fewer health plan offerings relative to what Centene's got out there?

And then if it does change obviously, there's the risk that partially subsidized or unsubsidized members maybe heavily skewed to those who need immediate care?

I do think so, Matt.

I mean, when I think about Maricopa County last year where we took over the whole county and it stayed pretty consistent.

So we've seen no sign where you see a change because of the change in proprietors available.

And -- so I don't think so -- at least, we've not historically seen any of that and that we have no indications at this point.

And sorry, I just have one more sort of granular question.

If you directionally, can you tell us, in Maricopa, did you see then a higher percentage of unsubsidized in that population if you can measure that as a result of being the only carrier left in that county?

No.

If there was any, it was negligible and not really -- wouldn't be a comment, Matt.

Okay, okay, let me just ask one more, if I could, on a different -- just -- can you tell us just directionally, what sort of headwinds and tailwinds you're expecting at this point going into 2018?

Well, we're going to give full guidance on December 18.

So you'll have a good sense of the population mix at that point, much better sense.

With the growth we're anticipating and Fidelis coming in hopefully, the first quarter as planned, I think you can expect us to just to continue the kind of momentum you've seen from us historically.

Our next question comes from Peter Costa with Wells Fargo Securities.

I was hoping you could go back to the MLR question for a minute and then talk about the part of the MLR change that was mix-related when we look year-over-year.

So there was 100 basis point increase year-over-year?

So how much was mix-related versus how much was the rate cut?

Yes.

I mean, I'm not going to quantify those 2 for you, Pete.

So I mean, 100 basis points is on a year-over-year basis.

So I'm not going to bifurcate those is what I'd say.

Okay.

And then the second question, if you don't mind since I got nothing on the first one.

Can you explain how the Maryland Physicians involve contract affected service revenues and cost of services and SG&A in the quarter.

And if that wasn't part of the change in terms of the lower cost of services, can you explain why cost of services were so much lower this quarter?

Yes.

On the cost of services side, specifically, we saw favorable performance in the fed services contract, Behavioral Health.

And also, you mentioned the startup of the Maryland contract, which -- those carry higher operating margins and also the performance of our home health business.

On the federal services side, there were some performance incentives under the current contract, which played out very well and the performance of the shared savings programs in the home health business were good as well.

So you wouldn't expect that to continue into the fourth quarter?

I would probably put it more on an annual basis, for example, on the home health business, those are really annual reconciliations.

So I would say in the fourth quarter, probably not to that magnitude, but on an annual basis, I would say, it's all-inclusive.

Our next question comes from Steve Halper with Cantor Fitzgerald.

So when you think about the impact of the CSRs, assuming they're not paid next year, is it -- and recognizing that you put out rates for 2018 reflecting potential nonpayment.

Are you able to sort of understand what happens from a demand side?

Asked another way, what do you think membership -- what do you think the membership trend is for 2018 given the substantial increase in premiums?

Well, I think it's business as usual.

Jesse will add here in a minute, but from the perspective of the end-user, it is on a business receiving rates and receiving subsidies and there will be no change visible to them.

Jeff, anything you want to add.

Yes.

There are a couple of things.

One, so with respect to our population, in particular, obviously, we already have a targeted subsidized population, and we've got a book of 1 million people across the country.

So one of the things we're very focused on is continuity of coverage for those individuals and consistency in our planned design for retention purposes.

So we're very focused on that on a year-over-year basis.

So we think any kind of movement, if you will, in our end would be mitigated based on the combination of those things.

But we've done a lot of scenarios as you would expect with respect to 2018 and we're comfortable saying that at this point, we view 2018 as a growth year for marketplace, and we maintain our ability to operate within our targeted profit margins.

Our next question comes from Dave Windley from Jefferies.

I wanted to shift to Fidelis.

What low-hanging fruit in light of the fact that you're looking at medical cost specifically for your synergy achievement.

Where are the low-hanging fruit items there?

And how long should we expect it to take for you to roll out your case management and clinical management programs into Fidelis?

Well, I think when you look at it, it covers the gamut of our TruCare and other programs into the integration process now.

They're analyzing what they can use in establishing priorities for implementing it and we have to look at the interface with the TriZetto program, it's those kinds of things you're looking at.

And I think we indicated in the second full year, you'll see a low double-digit accretion plummet and most of that is medical management.

So we see it -- it's a very successful opportunity.

Okay.

And shifting follow-up then on a different topic.

In California, you highlighted already a couple of times that you took some rate actions to improve margin in the commercial book.

It looks like if I extract the growth in individual from your commercial numbers, it looks like membership is down a 116,000 members year-over-year.

I guess, I'd be curious about your views on the efficacy of the actions that you took.

Have they brought margin to your expected level?

Is there still upside room going forward and would you expect there to be still some membership sensitivity there?

As you take those actions.

Yes.

This is Jeff.

What I would say is that, yes, they have -- those actions have been effective, specifically on the small group side.

Those actions have been very effective.

It's probably operating where we would expect it to operate.

On the large group side, there's probably more opportunity for margin expansion.

But really, what we've done is kind of reestablish the baseline of membership, and then we're going to try to grow from there.

So I think that's what's most important.

And you're right on the decline.

It's about right in the ballpark there in numbers.

Our next question comes from Christine Arnold with Cowen.

Fidelis.

I know that you put in the assumption that CSRs wouldn't be paid out.

Can I assume that they bid similarly assuming CSRs wouldn't be paid out?

And then also on individual.

Can you give us a sense for the enrollment you might be thinking about next year given who you've seen leave versus stay.

And were you able to build in things in the executive orders like the skinny short-term plans, the lower enrollment time, lower money spent to attract people in, was that built into your business?

Or was there something surprising that could come from the executive orders that we should be thinking about?

I'll handle the first part on the no CSRs for Fidelis, That is correct.

They did have rates that -- no -- assuming no CSRs and a lot of questions there.

So on the second piece, what was the -- what was your second question right after the CSR?

How do you think about individual enrollment next year given who stayed who left recognizing that we don't have access to all of this until November 1?

Yes.

We're not going to get into any specific enrollment projections here.

So more of that will come on our -- on Investor Day in December.

And then on your bid strategy.

I understand that you were thinking about CSRs, you rightly built them into bids for worse case scenario.

But what about the short-term plans coming in potentially skimming healthy risk, the lower open enrollment period, them spending less and all the other stuff they're doing to kind of sabotage the risk pool.

Will you able to anticipate that and build all of that in or how do we think about that?

Yes, Christine.

This is Jesse.

I think the executive orders are what captured most of the -- the things you're asking about the -- so as you look at the specifics there, most of the -- the starting point is really asking the various kind of relevant agencies to come up with their plans within the next 60 to 90 days.

So there is not a level of specificity in those plans to being effective certainly for the beginning kind of open enrollment in the beginning of 2018.

So at this point, we're really thinking about those as 2019 impact.

I think there's 3 different regulatory agencies involved in establishing the rates forum and with an [outlet.] So it has a ways to play out, Christine.

Our next question comes from Josh Raskin with Nephron.

So the first question, just taking a step back on all of this is, as you think about 2018 and assuming Fidelis closes early in the year, you're approaching a run rate of, it's called almost $60 billion in revenues.

You'll have a debt-to-cap after the deal below 40%.

And so as you think about sort of that change sort of from where you were before Health Net to sort of where you are at Fidelis, what are some of the new advantages that that size brings and then what areas of investment are you most excited about maybe that you haven't been able to do in the past due to size?

Well, I think with this Health Net as you've talked about at this time, that gave us the critical mass that we look forward to bringing down the debt-to-cap.

The debt-to-cap was higher only because of the stock price at that point.

So from the cash flow and every else standpoint, nothing really changed.

When you see the ongoing match between the fourth large data of the floor, this is the second largest in the country and it's growing.

And they have a lot of capabilities.

So we see being in there just gives a -- it proves some buying leverage in various things that we do.

So it's -- I don't know that we have a lot more capabilities we had before.

We have a very strong balance sheet coming out of this.

We've always been balance sheet managers.

And it puts us in a position when we see some technology companies and others of that nature that we are interested in, we're in a strong position to take the actions that makes sense.

Great.

Got it, Michael.

And then I guess, the second question, a little bit related, as you know, Fidelis is one of the larger Medicaid deals we've seen, I guess, not just Medicaid deals, but one of the larger deals we've seen for a little while, at least in terms of revenues.

Are there other opportunities as you guys were going through your analysis of the deal?

Do you think there's other opportunities of similar size?

And then I'm curious in what's the sellers motivation now?

And why do you think a seller would be interested today?

Well, I think, you have to look at the -- I think there's a couple of things.

One, I'm not going to go in there (inaudible) anything than -- that's competitive, you understand that.

But I think what you're going to see in sellers is that you need the critical mass that we have now achieved as a minimum to be able to afford the investments in technology.

I mean, we are spending hundreds of millions of dollars to get the kind of medical management and technology systems that we need.

So that's the motivation.

The Fidelis 1 -- the church saw an opportunity to monetize its assets and still put in the foundation and be able to continue the charity work in the things that they'd like to.

So I think there's a case.

They also realized, as we've talked about the efficiencies we're going to get from the medical management that they also work in plenty huge investment and probably in some cases, beyond what a company even worth $10 billion in revenue can do at this point in time.

So it's a -- it gets back to when we did the Health Net.

We've talked about the need to have critical mass to be able to build on.

Our next question comes from Mike Newshel with Evercore ISI.

So how are you thinking about the risks from expiration of CHIP funding?

Do you think any of your states could actually move to restrict enrollment if the reauthorization flips further to like year-end or later?

Or do you think there's enough unspent funds or other stopgap measures to last until Congress finally actually passes that line?

Well, I think I'll take the glass is half-full.

I think that, that's just going to be an additional motivation for Congress to act.

And the CHIP program has been successful and I'm not sure anybody really wants to start it now taking funding away from disadvantaged youth.

I mean, it's -- we'll talk about vulnerable populations and vulnerable youth.

And -- so I would say that I think the need to restore the CHIP funding with given vehicles to look at the total impact they're having on the -- the Congress will take a total of that -- the impact they're having on vulnerable populations.

So I see it as a -- it's giving us some upside.

Got it.

Can you actually break out how many CHIP lives you have out of that TANF CHIP category?

We have that nearly about 400,000.

400,000?

200,000.

Our next question comes from Zack Sopcak with Morgan Stanley.

I just wanted to follow up on the additional $0.04 business expansion cost and just clarify, is the bigger issue with that is shortened open enrollment period or is it just the lack of dollars being spent by the federal government.

And then should we think of that -- is that a onetime type expense to be prepared for this?

Or is this something where if we continue with the lack of funding, shortened season could bring on additional expenses in future years.

Yes.

let me -- I think when we saw what -- we anticipated what could happen there.

Yes, we think about -- we knew we could do direct enrollment until we start to put together the program and training the people to take those calls and start doing the direct marketing.

All of the things one does when one is building a business.

But we have been doing ongoing evaluations of member satisfaction.

We know it's high, and Jesse might add to some of this.

But it's said that we have a strong business.

We want to protect it and we believe we're going to grow it through these kinds of activities.

You might get a sense of what you're dealing in, how we're applying that incremental funding to offset some of the government spending as a cut back.

So we -- obviously, we're ramping up our investment in the fourth quarter.

So there is a combination of a few things that you'd referenced, both the shortened open enrollment period, all of which is in 2017 towards 2018 as well as the reduced funding.

So we're obviously taking a very targeted approach.

And we've seen very high engagement from our -- the marketplace members on our Ambetter products.

So that's something that we really try to take advantage of throughout the course of the year.

So this is not something we're just initiating now.

We've had a number of campaigns on all fronts.

So TV, print, there's direct kind of engagement, digital, all the things that you would anticipate.

We had good kind of penetration with respect to what we did last year.

So what we're doing is, really leveraging that success and expanding it with a focus on our population and we expect similarly positive results for next year.

Our next question comes from Gary Taylor with JPMorgan.

I just had a couple.

I'm not sure I caught quite, Michael, the complete discussion about the STAR ratings, maybe in particular, what is your outlook for potentially cross-walking that to another STAR rating given the success you may and others have had in mitigating rating pressure with cross-walking.

Well, I think that's one of the techniques one will use to presumably appeal to -- to place course of action close to the appeal, Leader's have good progress with that.

After that, then you start looking for cross-walking and you do it, particularly

-- and the companies have done to mitigate

the impact of it.

It's kind of a standard procedure

what one would do.

Okay.

Just wanted to make sure you weren't ruling that out.

And then just quickly for the...

You've probably noticed by now, we don't rule anything out that is positive to guide.

Yes.

I appreciate that.

Just wanted to clarify.

And then just a last quick one for Jeff.

When we think about the marketplace plans.

I mean, generally, I think we'd be expecting MLRs north of 100 for 4Q and that's just the seasonality in those plans.

Can you give us a ballpark on 3Q as -- or exchange is still making money in the 3Q?

Are we moving closer to break even and then moving to that seasonal loss in the fourth quarter?

Yes.

They are still making.

I think you're -- you mentioned the 100%.

It's not that high in the fourth quarter.

But I would say that the bulk of the profitability is made in the first 3 quarters, absolutely.

And is the -- I know your enrollment almost -- has doubled year-over-year.

But is the actual MLR in the exchange business third quarter of '17 versus third quarter of '16, is that similar, materially higher or lower?

I think they're relatively similar to maybe a little bit higher in this quarter, but not much -- year-over-year, that is.

Our next question comes from Justin Lake with Wolfe Research.

Just want to come back on a couple of things.

First, the MLR implied in the fourth quarter.

With the -- just some back-of-the-envelope math, I'm getting to about 86.5% give or take in terms of kind of the implied EPS in terms of what you'd have to do on MLR.

Is that a ballpark, Chris?

Well, I mean.

Obviously, you're backing into it, so you're relatively close.

I mean, to get to the full year where we are full year.

I mean, there's only 1 quarter to go, right?

So...

Okay.

So that declined by about 150 bps sequentially.

And I'm just thinking about the drivers there.

I know we declined a little bit sequentially last year but there was a benefit last year I think, from the California true-up on Medicaid expansion.

And this year, instead, you're dealing with a pretty large rate cut.

And then in addition, you're much bigger in the expansion side, which I think is -- has higher sequential MLRs.

So that would be a headwind.

So I'm just thinking about what are the offsets to those 2 kind of points that I mentioned there, that will drive that kind of sequential decline.

I mean, I think it's is going to be normal seasonality in the business.

I mentioned before that November is usually, I think I've said this historically, November is usually one of the best months of the year for the Medicaid business, which continues to be the majority of our business.

So -- and usually June and November are 2 very good months in the Medicaid side of the year.

I'd say the 2 best months.

Okay, great.

And then on the specialty side.

Just anything else you can kind of parse out in terms of just -- an incredibly strong quarter from a gross profit perspective at least.

And then how -- what should we think about for the contribution of that specialty business in Q4 as well?

I think I've mentioned a little bit earlier that I wouldn't expect the fourth quarter to be as profitable as the third because some of these programs, specifically in the home health business, those are reconciled and announced annually roughly at the same time in the third quarter.

So I think on an annual basis, it's much more in line with our expectations.

So I guess, that would be my thoughts.

Yes.

I think I was just looking for a little more specificity in terms of is it -- is it still closer to the Q3 performance or closer to the Q1, Q2 performance?

I would say that it's probably closer to the annual performance if you look at the full year.

So it's -- yes, I think the fourth quarter is going to be more in line with what you would expect on a full year basis.

Got it.

lastly, on CSRs.

Can the -- clearly, from your 10-Q disclosure and your discussion today, you think the -- that you'll be able to reconcile through the end of the year on that payable on the CSRs.

Can you just tell us has the government made that very clear that a reconciliation will be as of 12/31?

Or is that just your working assumption?

I mean, I think that's the federal law.

So if you actually read the Code of Federal Regulations around these programs, I mean, this isn't just CSRs, by the way, it's risk adjustment.

It was all of the 3R programs.

Those regulations establish specific criteria.

And that's what we're basing that conclusion on.

Our next question comes from Michael Baker with Raymond James.

I just wanted to get your perspective on the Massachusetts waiver, particularly as it's related to their request for more active formulary management in Medicaid.

As you speak with other states, is this something being closely watched so that if the government does agree to it, there would be others that will join in?

Are people taking more of a wait-and-see approach?

Just trying to get a general sense on that particular dynamic.

Yes.

In the context I find out there, I haven't seen any of those other than Massachusetts as an example for that type of in -- it's an unusual market.

There's more doctors in Massachusetts almost than there are patients.

So it's a very unusual market.

I have seen no indication where they’re going to be a trendsetter on that.

Our next question comes from Ana Gupte with Leerink Partners.

So Following up again on the exchange margins.

I think I'm estimating you're at the upper end of your 4% to 6% range.

When I go back to the true-up that happened in July, I think it came out roughly $200 million better-than-expected.

And I'm just trying to get a sense for are you -- as you're monitoring this on a go-forward basis, have you any data points from weekly for this year and then for 2018?

Is the methodology likely to change?

Or as you think about the interspace with the potential defunding of CSRs and possibly mix shifting of healthier folk to more bare-bones plans with this executive order?

How predictable do you think the risk-adjustors are for the rest of 2017?

And to the extent today, they're contributing a fairly big percentage of your margin for exchanges this year into '18.

Yes.

I mean, I can handle the risk-adjustor comment.

I mean, we've had a very consistent methodology here on risk adjustment, which is proven to be very accurate.

So we consistently use that methodology and use information from the data aggregators on that.

So I think I don't see any difference going forward.

Yes.

I think that -- I would -- it is -- real quick.

You mentioned the potential impact of the -- any short-term plans and the NOI impact on the risk.

So I think as we said before, we still need a lot more information with respect to what those are and when they would be effective before we could comment on any potential impact.

Okay.

The second question was about Fidelis.

And you're doing really well on improving margins.

So if you think about the top line growth, where do you see the growth coming from?

And is this likely to be in line with your aspiration of low double-digit cross-Medicaid expansion, which is leveling off now.

Exchanges, whether it's potentially and tell me if that's the biggest driver.

Fidelis has been a weak program and you have LTSS, and then I think in Medicare, this all downgrade as well on the rating from STAR 4 to 3.5.

Yes.

I mean, Anagha, in terms of -- we'll give guidance on the [12th]December.

I wanted to cover a little bit of guidance on one (inaudible), but that can create the wrong image.

And it's a sorry situation in Fidelis (inaudible) as well.

Yes.

I would just go back to I think what we mentioned on the call when we announced the Fidelis transaction is that and we believe that was in line with our double-digit growth percentage on a ongoing forward basis.

So -- and that we believe that, that was not going to change that.

And will you be appealing the decision?

Are you and Fidelis on the star rating?

Am I correct that I think we absolutely observe there was a downgrading for them in addition to Health Net?

No.

Our understanding is they don't intend to appeal that, but some will tell our situation, and every organization who's in with the MA business continue all focus on improving kind of the fundamentals around STAR course.

The next question is a follow-up from Lance Wilkes with Sanford Bernstein.

Could you just give an update on the RFP pipeline, and in particular, what portion of it is higher acuity?

And then in general, how is the size of that looking and are states behaving as they had in the past given all the uncertainty with federal regulation?

I think there's a -- as you know there's a robust pipeline coming up with Texas, Florida and large states.

They typically have done well and (inaudible) will not continue to do generally well.

And as it relates to states, I think I've not seen any indications where they are changing their approach to things.

When things getting rougher, that's when they need us more than ever.

We've saved them a lot of money with higher outcome.

So I don't see any material change there.

You may have one (inaudible) action but there'll be a counteracting and actually benefit of having 28 states, soon 29 with Fidelis.

At any given site, funds that have invested.

You always have one stock as a problem but you have others that offset it.

So let me tell you when you look at across a whole book of business and we're very comfortable with what the opportunities are there.

And are you seeing more states that are looking at putting higher acuity populations out to RFP or initiating in the...

I would say that we're encouraging that.

We're talking all the times trying to encourage them to do that.

We have the systems and capabilities to manage that and that's where we'd be doing the most good . So we really -- we're pushing at every level.

And if there is on, I mean, -- particularly, a Governor or Medicaid Director, what their attitudes are.

I would say there's probably a propensity of wanting to higher acuity.

And this concludes our question-and-answer session.

I'd like to turn the conference back over to Michael Neidorff for any closing remarks.

Well, I just want to thank you for your continued interest in Centene.

We're pleased with this quarter and as emphasized, we believe, we have the momentum going into the fourth quarter and going into '18.

And we look forward to seeing you at our Investor Day.

We'll give you a lot more information as to how we see the future.

So thank you, and have a good day.

The conference has now concluded.

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