Elevance Health Inc (ELV) 2002 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the WellChoice fourth quarter earnings conference call.

As a reminder, today is Thursday, February 13, 2003, this call is being recorded.

All lines have been placed on mute to prevent any background noise.

There will be a question and answer session at the conclusion of the speaker’s remarks.

In order to ask a question, please press the number 1, star, then the number 1 on your telephone pad.

To withdraw your question, please press the pound key.

Thank you.

At this time, I would like to turn the conference call over to Deborah Bohren, Senior Vice President of Communications.

Thank you and good afternoon everybody.

Welcome to WellChoice’s full year and fourth quarter 2002 conference call.

I’m Deb Bohren, Senior Vice President of Communications and joining me today is Mike Stocker, President and CEO of WellChoice and John Remshard, Senior Vice President and Chief Financial Officer.

Mike will start off the call with some brief comments about our transformation through a not for-profit company to a publicly traded for-profit company in our 2002 performance.

John will then discuss our financial results in detail after which Mike will conclude our prepared remarks before we go to questions.

On today’s call, we will be making some forward-looking statements.

Listeners are cautioned that there are factors that can cause actual results to differ materially from our current expectations.

For a detailed discussion of these and other risk factors, please see our press release issued earlier this afternoon, as well as the company’s filings with the Securities and Exchange Commission, including the risk factors contained in WellChoice’s final prospectus dated November 7, 2002, and the information contained in the company’s form 10-Q for the quarter ended September 30, 2002.

Mike.

Thanks, Deb, and good afternoon everybody.

Thanks for joining us today on our first earnings release conference call.

I’m going to say a few words about WellChoice and some highlights, and then I’m going to turn the call over to John.

Let’s just say that we’re really pleased with our financial results for the first quarter as a public company and the fourth quarter 2002 represents the 17th consecutive quarter of underwriting gains.

Specifically, first year reported net income was 367.5m, an increase of 245.5m over the prior year income of 131m.

Our pro forma earnings per share are $4.51 for the year.

And adjusted earnings per share are 50 cents for the fourth quarter and a $1.81 for the full year 2002.

Commercial managed membership excluding the New York City and New York State accounts increased by 15.2 percent to 2m.

Our overall medical loss ratio declined 280 basis points to 85.3 percent at year end.

Looking ahead, WellChoice expects GAAP earnings growth for 2003 to be approximately 20 percent, resulting from increases in commercial managed care membership and pricing in line with medical cost trends.

I’d like to talk a little bit about how we achieved these results.

First, you’ve heard me say this before, but I’m a little biased here, we have a very experienced management team that has done very well in this marketplace.

Our current senior management averages 8 years with the company, that’s the top 20 people in management and is composed of a majority of individuals that led our corporate turnaround.

As you know, we have 4.6m members in the New York marketplace and we have 20 percent market share, by far the largest market share in the market.

Our size and our market share and presence in the 68-year history allows us to establish significant discounts with providers, and I’d like to provide a quick update on hospital contracting.

In our marketplace, there are three hospital networks with ten or more hospitals: the North Shore Network, the Long Island Healthcare Network and the New York Presbyterian Network.

In the road show, we talked about the conclusion of our negotiations with Long Island Healthcare Network.

In the fourth quarter of 2002, we concluded negotiations with the North Shore Long Island Jewish Network -- that’s a single network -- and the New York Hospital Presbyterian Network, the second network.

These three networks comprise about 60 percent of our total down state hospitals.

Each of the networks have out clauses in excess of one year or more, so we should have very stable hospital network contracting during the year.

Finally, I want to just talk about our presence in our marketplace in terms of our diverse customer base and broad array of products.

If you combine that with our brand -- the Blue Cross and Blue Shield brand, and this marketplace is very well known, and a very disciplined approach to managing medical costs -- it gives us a very, very strong position in our marketplace.

Just a few words about WellChoice, the company and the history of the company.

Empire, as does most Blue Cross and Blue Shield companies, has a huge amount of history in this marketplace.

We’ve accomplished a lot and we’ve been through a lot.

The hallmark of these plans that have been successful is their ability to rapidly reinvent themselves based on their past experience, but most important, looking forward in the marketplace to what the needs of the marketplace are.

We have done that repeatedly and I just want to reassure you that we are firmly looking forward to this marketplace, and we’re fiercely committed to shareholder value and profitable growth as we progress as a new for-profit company.

With that, I’m going to turn the call over to John.

Thank you, Mike, and thanks everyone for joining us tonight.

I know it’s a late hour and I appreciate you sharing your busy day with us.

I’d like to do a couple things tonight.

First, take you through the full year and fourth quarter earnings slowly, especially explaining all the nuances as we transform from not for-profit to a for-profit corporation.

Then we’ll discuss our guidance for 2003.

Lastly, we’ll have a question and answer period.

As noted in our press release, WellChoice reported net income for the full year on a GAAP basis of 376.5m, which is $4.51 per share on a pro forma basis.

This represents an increase of 245.5m over the prior year income of $131m.

WellChoice reported income from continuing operations before tax for the full year of 2002 of 309.7m or $3.71 per share on a pro forma basis, an increase of 162.1m over the prior year, pre-tax income of $147.6m.

As a result of the company’s conversion and initial public offering, earnings per share are reflected on a pro forma basis as if current shares had been outstanding of 83.5m shares for the full year.

In addition to our reported results, we have decided to present the results on an adjusted basis.

Our adjustments eliminate one-time items while adding the impact of premium and sales and use tax, as well as state and local taxes for the full year.

We’ve included the table, which is listed as Exhibit C, renumerating all of the adjustments attached to our press release.

As the table shows, we reported 309.7m pre-tax income for the full year 2002.

On adjusted basis, our after-tax earnings for the fourth quarter was 50 cents per share, or $41.9m; and for the full year was $101.81 per share, or $150.9m.

These results are in line with our expectations.

Our adjusted pre-tax income of 260.2m for the year was the determined by removing some one-time items, specifically [indiscernible] related to the World Trade Center event, severance and restructuring charges, and a litigation reserve release.

Additionally, we added premium taxes and sales and use taxes as if we had been a for-profit corporation for the entire year.

We then applied a 42 percent effective tax rate to the adjusted pre-tax income to arrive at our adjusted year-end result of $1.81 adjusted earnings per share.

We applied the same method to the fourth quarter 2002 results beginning with reported pre-tax income of $82.7m to arrive at the $31.9m adjusted income result, which equals 50 cents adjusted earnings per share.

Exhibit C of the press release discloses all of the details.

Before discussing the major contributors to these financial results, let me explain a few 2002 tax issues which effect our reported net income and were necessary as part of the conversion to a for-profit entity.

As many of you will recall, during the third quarter, we recorded a net $167m tax benefit due to the recognition of a prior [indiscernible] as a deferred tax asset.

Partially offsetting this tax benefit is a fourth quarter charge of $99.3m, which is required as a result of the conversion to a for-profit status and deals with the potential loss -- and I would just emphasize potential loss of certain tax benefits which are afforded for Blue Cross and Blue Shield plans.

For those of you who follow Blue Cross and Blue Shield plans, I’m referring to the special 833B deduction of the IRS.

We had to remove this deduction retroactive to the beginning of the year in the fourth quarter.

As a result, the fourth quarter 2002 tax expense of $99.3m resulted a reported GAAP loss of 16.6m or 20 cents per share on a pro forma basis.

These tax items have no current cash implication to the company.

In 2003, the company expects to incur federal and state income taxes at the rate of the effective rate of 42 percent.

I’d like to make two points about taxes.

Use the word “potential” in describing the loss of the 833B deduction.

When we file our tax return, we will take the position that we [technical difficulty] to take the 833B deduction.

Our recording of the potential loss of this deduction merely reflects a conservative financial reporting posture.

Two, we have recently received a ruling from the Internal Revenue Service that our conversion is not being viewed as a change of control and, therefore, did not result in limitations in the use of our existing net operating loss carry forward and alternative minimum tax credits which, as you recall, our prior NOL’s totaled about $500m.

However, subsequent sales of our shares of common stock, including sales by the fund and/or foundation, could result in such a limitation when they exceed 50 percent of the 83m shares.

This ruling is consistent with the accounting treatment that the company has adopted at the time of the conversion.

We will now discuss factors which led to the financial results we experience.

The favorable growth in pre-tax operating income resulted from higher premium yields, especially in our core managed care book of business, which held about 10.7 percent favorable year-over-year the membership driven revenue increases in service fees on self-funded accounts, and improved claim trends, especially for our managed care products.

The primary driver of these results is the significant growth in our commercial managed care membership and changes in the mix of self-funded versus insured enrollment.

Both of these trends affect our reported results.

The report membership is based on two segments: commercial managed care, which includes all of our network products; and other insurance products and services, which include indemnity and individual products.

We then break our commercial managed care business into two components: the New York State and the New York City PPO accounts and our core commercial managed care membership.

Core commercial managed care membership includes group PPO, HMO, EPO and other membership, but excludes the state and city accounts.

The core commercial membership grew by 15.2 percent during the year, compared to the prior year.

Our small group or middle market membership grew to 394,000 members in December 2002, up from 366,000 members in December of the prior year.

This represents a 7.7 percent increase.

Continued growth in this segment is a strategic imperative for us and is one of the reasons we will implement a POS product in mid 2003.

In short, product membership and our other insurance [indiscernible] product and services segment declined by 228,000 or 33 percent in 2001.

A large portion of this decrease stems from the conversion of a 130,000 member account from [indiscernible] hospital only indemnity coverage to a full-service, self-funded managed care product.

Membership declined in this segment, which is primarily indemnity, is a continuation of our long-term shift to managed care.

Turning now to total corporate membership, I must first remind you of a change that was made early in 2002 in the reporting of out-of-area members with the New York State PPO account.

Due to a change in our contract with the state during 2002, we began to include our enrolled state account members who did not reside in our service area.

The December 31, 2002, enrollment includes 175,000 New York State PPO members.

To put the prior year 2001 on a comparable basis, you must add 167,000 New York State PPO members to the December 31, 2001, result.

Including these adjustments, total corporate membership grew 1.3 percent as of December 31, 2002.

This rate of growth is in line with our expectations of 1 to 2 percent.

Including the adjustment, the commercial managed care segment as a whole, which includes New York City and State PPO involvement, grew to 3.8 members from 3.5 members -- or 3.5m members in December of 2001.

This represents a net 9.3 percent increase.

For our revenues, overall revenue increased to 5.1b for the full year, up from 4.6b for the prior year.

This represents a 10.2 percent increase.

Total premiums for our core commercial managed care group business, which excludes -- I remind you the state and city account membership grew 9.4 percent.

Premium yield, which is defined as a change in premium [PMPM], improved by 10.7 percent for the full year 2002, driven by premium increases and product mix improvements from our core commercial managed care group products.

And this is consistent with our expectations.

Insured premiums for all segments grew by 9 percent to 4.6b for the full year.

Self-funded membership increases led the strong service fee growth of 74.2m or 23.1 percent for the year.

This was especially true in our commercial managed care segment, where service fees increased by 37.7 percent for the full year.

In summary, the strong growth and self-funded membership, together with higher premium yields in our insured business, drove revenue higher for the entire corporation.

In medical costs, our fourth quarter 2002 medical loss ratio was 83.5 percent, or 330 basis points lower than the prior year.

Medical loss ratio for the full year 2002 was 85.3 percent, a 280 basis point improvement over 2001.

A number of factors fueled the improvement in medical loss.

One, the increased premium yields which we talked about previously [indiscernible] the favorable settlement of large case, which we mentioned earlier this year, which totaled $15.4m.

This was a class action litigation, our exit from the unprofitable insured national EPO business where medical loss ratios were very high in the high 90’s.

Next, our implementation of a capitation arrangement for laboratory costs for our HMO and, of course, increased margins in our Medicare Plus Choice product, which came about due to our premium increases and benefit design changes.

And finally, we continue to experience improved medical trends pretty much across the board throughout the year.

In addition, 2002 results benefited from a $40.1m of favorable prior period claims development for our at-risk book of business.

The corresponding amount for the fourth quarter was $13.6m.

These fourth quarter releases primarily arose from improvements in medical costs and trends and our HMO product, including our Medicare Plus Choice HMO.

Releases this year reflect the dampening of a trend which we began to experience around the time of the World Trade Center disaster.

As you recall, we had been very cautious in reserving last year after we saw utilization drop sharply after September 11, 2001.

We waited during the year to be sure that the dampening of trend was credible and to be sure that the revised numbers we were looking at were real.

As 2002 continued, our pre member per month medical cost trends proved to be rather stable, resulting in a release of favorable prior period reserve developments.

The medical loss ratio for our core commercial managed care products was 81.6 percent compared to 85.8 in the prior year.

For other insurance products and services, our medical loss ratio for the full year was 82.4 percent, a 380 basis point improvement over 2001 driven by improved Medicare supplemental results and the litigation reserve release which we mentioned previously.

That brings us to days claims payable.

Our days claims payable dropped by 5.4 days to 52.9 days in the quarter ending September 30, 2002, down from 58.3 days in the quarter ending September 30, 2002.

I’d like to make a few comments about it.

We previously mentioned $13.6m positive prior period development accounted for the reduction of six-tenths of one of these days.

Conversion related claim payments, which we experienced twice this year as we transferred our business from the article 43 non-profit corporation to our for-profit subsidiaries, resulted in the reduction of days claims payable by about 2.8 days.

Also, the lag time between service and payment dates continues to shrink.

Lag time we define as the average length of time from a service date to the payment date.

In the fourth quarter, our lag time declined 52 days, down from 53.4 days in the third quarter.

In addition, our first pass rate, which is paying claims on their first pass through system rather than having to re-adjudicate them, improved during the quarter from 85 percent to 86.8 percent.

Third, during our retracted and public negotiations with Long Island Health Network last summer and then through the third quarter, claim volume from the Long Island Health Network facilities decreased.

And some of the hospitals simply held claim submissions ending finalization of the contract.

During the fourth quarter, the held claims were submitted and processed.

This accounted for reduction of 1.2 days of this decrease.

Finally, the settlement of the major litigation item that we spoke to previously [indiscernible] about 15.4m had a half of a day reduction.

We changed our timing of claim payments to our Medicare Plus Choice HMO during the fourth quarter as we converted that business to the for-profit subsidiary.

As a result of going from the second, the fourth, the first, and the third week, we wound up paying an extra week of claims during the fourth quarter, resulting in reduction of two-tenths of one day.

So if you were to put all of the items talked about previously just now, that accounts for about 5.3 days in the reduction.

Having said that, it’s really important to note several things about the relationship of days claims payable to the broader subject of reserve adequacy and overall financial results.

First and foremost, we have historically been conservative in our estimates of all the claim payouts and continue to be so.

During 2002, we experienced a number of conversion related processing changes, which caused our pay claims to fluctuate somewhat, thus causing days claims payable to vary.

Although we still expect that the trends in days claims payable will decline as a result of continuing claim processing improvements, we do not expect days claims payable to fluctuate that much during 2003.

Second, we need to exercise some care in interpreting any movement in our days claims payable.

A little over 50 percent of claim reserves are held for retrospectively rated and non-risk accounts, such as the city and state.

Related reserve movements within these accounts have no impact on our earnings, but do impact generally days claims payable.

While we have adopted the position, we’ll just simply tell you about prior period activity on our at risk [indiscernible] and how it impacts current financial results and what that activity has as an impact on our current days claims payable.

Any remaining movement in days claims payable will be the result of processing changes or claim developments in our non-risk book.

For administrative costs -- and I’m sure we’ll talk more about days claims payable later -- but, for administrative costs for the full year 2002, administrative expenses increased by $103.8m and totaled 845 -- or 848.5m.

As a percent of premium plus service fees, the expense ratio was [16.9] or a 60 basis point increase over the prior year and in line with our expectations.

The shift in membership to self-funded accounts previously discussed and our percentage of our book of business in self-funded accounts and not at risk accounts, moved from 28 to 33 percent during the year.

This significantly affects our administrative expense ratio, as these accounts obviously do not pay the full level premium, affecting both the numerator and denominator.

Restating the expense ratio on a premium equivalent basis actually shows the 20 basis point improvement in the administrative expense ratio moving 11.7 percent in the prior year to 11.5 percent in 2002.

Our investments in fixed maturities, equity securities, and short-term investments increased to 1.3b at year end, which represents an increase of 99.8m from year end 2001.

Cash and cash equivalents increased by 78.8m, driven by both strong operational performance and the $28m which we received in net over allotment funds [indiscernible] in the IPO.

Cash flow from operations was 182.7m in 2002, on a GAAP basis a decline of 31.6m from 2001.

Several margin items really impact the cash flow of 2002.

First of all, a $75.8m return of funds, which have been held on deposit for the New York State account was made.

The IRS delayed third quarter tax payment of 22m, which was made in 2002, which was permitted as a result of the World Trade Center event, also adversely impacted cash flow.

Offsetting this impact, the company received 46.5m in World Trade Center insurance proceeds, which of course, are net of recovery expenses.

Excluding these items, the cash flow from operations would have [technical difficulties] $234m, a $19.7 increase over the prior year. [technical difficulties] for capital expenditures was about 33.7m for the full year versus 33.8m for 2001.

Our capital position continues to get stronger.

Year end December 31, 2002, GAAP surplus was now 1.2b, an increase of 407m, or 49 percent from year end 2001.

WellChoice continues to have no debt on its balance sheet, although we do have available a $100m revolving line of credit.

Our year end risk base capital ratio was 549 percent on an enterprise-wide basis.

Since this now exceeds the 500 percent level, we’ll have more flexibility going forward in managing capital at our subsidiary level while still continuing to meet Blue Cross and Blue Shield association requirements.

Of course, we still want to maintain a superior claim paying ability counter-party credit rating in ourselves, which will be a factor we will consider in any future dividends.

In November, WellChoice executed its initial public offering, including the sale of the over allotment option.

We currently have 83.5m shares outstanding and have no common stock equivalents.

So the primary and fully diluted earnings per share are the same.

This concludes our overall review of 2002 operating results.

Now we can talk a little bit about earnings guidance for 2003.

We expect earnings for the full year of 2003 to be in the range of $2.17 to $2.22 per share, based on 83.5m of shares outstanding.

This reflects growth of approximately 20 percent on a comparable adjusted basis and is driven by improvements and increases in commercial membership, as well as stable medical costs.

We also expect that earnings for the first quarter of 2003 to be in the range of 54 to 58 percent. [technical difficulties] support for this is we expect a continuing of some of the trend dampening that we’ve seen.

Second, we have either successfully implemented, or are about to implement, a number of medical management initiatives, some of which have already begun to pay off for us in 2001, such as the [lab capitation] arrangement.

Third, we have achieved great adequacy for our insured business will extend from a number of years of hard work from everyone here at WellChoice, and this permits us to have stable pricing in the future.

Fourth, the new premium base that Mike referred to earlier has helped make Medicare Plus Choice a profitable line of business for us and now enrollment on Long Island continues to be stable.

Fifth, in the area which we have experienced our greatest enrollment growth national ASO, which successfully moved all of our accounts to rates that are profitable.

And growth in this area confirms the strength of our brand, the strength of our networks, and the importance of the national Blue Card program.

A few additional statistics on our earnings guidance for next year.

We expect membership growth in the range of 2 to 3 percent with core commercial managed care products, which of course, exclude the city and the state account, to be in the 10 to 12 percent range.

Commercial business price increases we’re looking at in the 8 to 11 percent range, which mirrors medical costs trends, which we are also looking to be in the 8 to 11 percent trend line.

On a corporate basis, we expect medical loss ratio to be around 85.5 to 86.5.

And excluding the New York City and New York State account, which runs in the low to mid 90’s we expect would be adjusted medical cost ratio to be 83 to 84 percent.

We will continue to manage our administrative expenses, which include capital spending, to be in the 16 to 17 percent level, which when combined with the above, gives us the ability to produce earnings we believe in the $2.17 to $2.22 level.

With that, I’ll give it back to Mike for closing comments.

Thanks.

I just want to clear up one thing just in case there’s a misinterpretation.

The expected earnings for the first quarter 2003 is to be in the range of 54 to 58 cents per share.

And with that, I just want to say I hope our presentation gave you a solid feel about the company in terms of our financials and business fundamentals.

But, in addition, we’d be very happy to take questions.

At this time, we would like to open the call up for a question and answer session.

As a reminder, in order to ask a question, please press star then the number 1 on your telephone key pad.

To withdraw your question, please press star, then the number 2 on your telephone key pad.

Thank you.

Your first question comes from William McKeever of UBS Warburg.

Yes.

Congratulations on the quarter.

Just on the cost trends going into ’03, where do you think that they might dampen with categories?

Bill, I think what we’ve seen this past year especially is significant dampening in the HMO line.

And we’ve seen drugs which have averaged about 17 to 21 percent overall being in the 10 to 13 percent for HMO.

We think in terms of overall dampening, we’ve seen utilization decrease somewhat about a point, point and a half for all lines of business, for all segments, while unit cost trends ten to be in the 11 to 11.5 percent level.

If you break it down, everyone likes to know what the inpatient/outpatient, medical and drug is.

It’s hard -- outpatient gives you some funny numbers, but I think in drug, we’re looking at 17.5 percent pretty much on a combined basis, and that being about 4 percent for utilization, 13 percent for cost.

Medical, pretty much flat, about 1 percent trend for utilization and maybe 8 percent for cost.

And on a impatient basis -- and as Mike pointed out -- our contracts are very stable now, looking about a 4 percent unit cost and 2 percent in utilization.

On a pricing level, we would expect our pricing to sort of reflect -- having achieved adequate rates in all these levels -- would reflect the medical cost trends.

Okay.

And the contracts that you signed, how long do those contracts last?

The -- there’s some variation -- let me talk a little bit -- this is Mike Stocker -- about contracting strategy.

We try to stagger the contracts and we try to go for long-term contracts.

Long-term contracts, in general, mean three years.

And I want to stress there’s some variation in that.

Okay.

And then just one last question.

On the economy in New York, obviously, recently it’s been a tough environment and, of course, your recent alert.

Any comments there on how you’re seeing that effect possibly your membership trends in ’03.

Well, I mean, you’ve got the membership trends so you know what we think the combined effect would be beyond that.

It’s an issue.

There’s no question about it.

But, the fundamentals of the business remain the same.

It’s a product that has very high demand in general.

It means that it’s important for us to be priced in a price-sensitive market, priced as good as or better than our competitors in terms of price.

And we are also seeing some buy downs in terms of lower cost products with cost sharing in the products.

Okay.

Great.

Just while I have you, do you have the buy down number in front of you for ’03?

Yeah, buy downs, we’re seeing more than we saw last year.

I think last year when the question was asked, I said, it was very nominal.

And I think what we’re seeing now, especially in the low end in the small group segment of the market, people selecting increases and deductibles and co-pays, we have [indiscernible] the premium is we believe is not significant, it’s around 1 to 3 percent overall.

Okay.

Great.

Thanks again, and congratulations on the quarter.

Thank you.

Your next question comes from Charles Brady of Salomon Smith Barney.

Thanks.

Good evening.

Just a couple questions.

First, on the taxes, there are a few different moving parts to reconcile.

I wonder if you could just help me adjust the operating cash flow -- the $183m you reported for -- you know, what that would look like in a normalized year, and how much you actually paid in cash on taxes in 2002.

So if we adjusted for the several moving parts on taxes and made it look as though you were a full taxpayer all year, what would the operating cash flow have been on the operating cash flow statement?

Well, Charles, what we have in taxes is -- I think the impact for us for the full year is we continue to pay at the AMT rate, which is 20 percent.

Okay.

So I think the cash impact for taxes for us was about $80m to $84m.

The thing that I think is complex when you view our tax situation is that the cost of our prior net operating loss carried forward, we had recognized that a $167m asset in the third quarter.

Right.

I think what’s also confusing to everyone when they look at our fourth results, on a GAAP basis, you see 82.7m, then you see an after-tax loss of about [16.6].

They say, gee, what happened.

If you [indiscernible] that, it gives you an effective tax rate for the quarter of 120 percent.

That’s because of that $99.3m that is representative of that change in status of potential, as I said, loss of the 833B deduction.

I think the 80 to 84 number is probably a good overall number.

I think if we add to it, the franchise taxes, the down state MTA taxes, I think that number would probably expand on a full level up from 84 -- or 80 to 84 -- to about 108.

And just to complete the loop on the tax issue, do people want to worry about the model and want to see what the model what would be our exposure on a full year for premium sales and use tax net, it’s about $27m.

Got it.

So the 182.7 operating cash flow, you’re saying about 108 -- take out about 108 if I wanted to pro forma ’02 to make it look like a full tax paying year to X out the unusual tax related items?

That -- I think there would be some recovery of some of those taxes.

Okay.

We can take this one off line.

I just thought you might happen to have that.

Let me just ask a couple other questions, if I could.

On the base claims payable, you mentioned the conversion related payment acceleration.

Could you just expand on that just to explain what that meant.

I recall from your road show slides the June 30 days claims payable drop of about five days related to an acceleration in payments that I thought related to getting the approvals for the conversion that went back and now we’re back down to that level again.

And so I was just a little bit confused about that 2.8 day decline in the fourth quarter.

Well, there were two things that were involved.

We moved business in two segments.

In June, we moved the effective July 1st.

We were putting the HMO business out of the article 43 and into the HMO subsidiary, the article 44.

So consequently, I think what I said during the IPO and road show process is that we sort of accelerated the payment of claims in general to sort of bring down the inventory to practically zero by the end of the month.

We did that for a really solid operating reason.

Since everybody is looking at what is the implications of the conversion from non-profit to for-profit, we didn’t want anybody to think for one minute that we would slow down our payment --

Sure.

-- cycle going forward.

Okay.

That was only the HMO.

The rest of it we did in November as we got closer to the IPO process, what happened is we moved the rest of the business, which is the indemnity business and the other products -- UPO and PPO -- in November.

And we did the same thing.

We started increasing the payment on a processing cycle in November so that when -- in October, actually, so in November when the business moved, we wouldn’t have any delay in payments.

So we had two events -- if you will -- that affected it by a couple of days.

Okay.

Great.

And cash at parent on September 30 and 12/31, and what you’d expect in 2003 to be able to either generate at a parent or dividend up from a sub -- from your subs to the parent?

Yes.

It’s a question that comes up a number of times.

As of year end, the cash at the parent level was around $160m.

As you recall, we capitalized the parent company with $250m -- or $225m -- which was dividend with the approval of the state insurance department.

Of that amount, some of it was other assets, some of it was things that would be non-admitted at the insurance company level.

So we had free cash of $160m.

Now, the question that comes up a number of times is how would you maximize with the cash flow or the cash into the parent company?

Now, there are a series of different rules that I’m going to have -- bear with me for a moment -- review with you.

Number one, there’s the New York State insurance requirement where I should have a minimum of 200 percent of authorized control level in the subsidiaries.

Number two, there’s the Blue Cross Blue Shield Association requirement that requires you to have 375 percent of RBC in the subsidiaries --

RBC or ACL?

Well -- ACL.

I got it.

Okay.

Yeah.

And the third thing is there’s a requirement that sort of would be the need to keep our credit analysts happy and to keep an A- counter party credit rating.

So when you go all through this, you sort of have to mush around those different requirements and see where we would be.

Let me ask you a question -- two part.

The most practical point of view would be that if we dividend -- and we haven’t put in any dividend requests and all dividends are obviously subject to the approval of the insurance department.

But, if we were to dividend enough to keep all parties in sync and have a little bit of a cushion in the subsidiaries in case of any adverse development, the new cash at the parent level would be about $300m.

However, since WellChoice is now over 500 percent of ACL.

Okay.

The Blue Cross association will change it a little bit.

And excuse me if I got long here but, these are the things we deal with.

And what it says is that if the consolidated company is over 500 percent in its RBC calculation of ACL, Plus is going to give a parental guaranty, then you can keep only the minimum cash in the subsidiaries.

If you chose to keep the minimum cash in the subsidiaries, that would make available $519m of cash to move to the parent.

Now --

519 plus the 160?

Yeah, it would be 519 plus the 160.

We’re not going to do that.

Okay.

If we did that, we would leave the bear minimum of cash in the subs and we would sacrifice our A- [indiscernible] credit rating and we really don’t want to do that.

Now, we haven’t decided -- to be honest with you -- what we would dividend.

On a reasonable range for a dividend would be another, say $140m.

That would give sufficient liquidity to the parent company while at the same time, keeping a fairly robust level of capital in the subsidiaries, allowing all parties over regulators, association, and credit analysts to be very happy and also provide WellChoice with a solid margin in surplus in those subs to absorb any unusual business risks.

Got it.

Would your percents all stay the same assuming that 140 dividend, or does that assume you achieve an even higher percent.

So in other words, is that the amount that would keep you at the same percent of ACL?

Yeah.

Got it.

Okay.

Good.

And that’s roughly equal to your net income?

Yeah.

Got it.

Great.

Terrific.

Thanks for all those details.

You’re so welcome.

Your next question comes from Matthew Borsch of Goldman Sachs.

Hi.

Thanks.

I have a question on the self-funded in the ASO business including Blue Card.

You had back in the early part of the road show provided us some information about your profit margins by product for the 12 months ended June 30.

And as I recall, the Blue Card product at that time had a margin of about 5 percent, and the local ASO business was actually at about a 5 percent loss.

Can you talk about maybe directionally where those margins have gone since then and if you can give us a number that would be even better.

And also, just how we should think about the Blue Card margin in looking at WellChoice in comparison to other companies -- other Blues, I mean.

Yeah.

First of all, a couple of things.

As I said, now the non-risk business has grown from 28 -- five points -- from 28 to 33 percent.

Second of all, the 5.5 percent margin reflected the fact, and the fact that we had some accounts in a loss position, reflected the situation that we had a number of those accounts with multi-year deal -- with multi-year contracts, which came up for renewal during the course of the year.

This is on Blue Card or on the local --

See, this would on national -- this would be on mostly self-funded national PPO, which is a product that would have the Blue Card attached to it.

Now, moving all of those contracts into a profitable position was a major goal for the company over the last 18 months.

Right now, our profit margin is running about 5.8 percent.

And does that 5.8 percent incorporate a wide range of margins with some at a loss and some at a much higher margin?

Well, actually, most of these are large accounts.

Most of them come through the same benefit consultant and the margins are fairly similar.

Okay.

They sort of naturally equal out over time.

And just out of curiosity, I don’t know whether your know, but do you know how that compares to some of your Blue brethren with their national accounts through Blue Card?

No, but if you find out, I’d appreciate it.

Okay.

Thank you.

Your next question comes from Christine Arnold of Morgan Stanley.

Good afternoon.

Could you talk to us about your new products that you’re planning to launch and your efforts to penetrate the small group segment of the market.

Are you going to do that with a point of service plan and on what network [indiscernible] ?

Yeah, Chris.

We have -- as you know, we’re targeting the middle market segment with a newly designed point of service product which we’ve previously mentioned.

We expect to introduce this product during the second half of 2003.

Now, where we are with this is we filed the small group POS product with the state in December 2002, and we’re actually getting ready right now working on the filing for the large group product.

It’s hard to -- we have a benefit and benefit differentials to offer.

But, until we get the state approval, it’s really hard to say exactly what will be finally offered.

But, our plans are mid year ’03.

Will you have a shrunken network offering or will it be the same network?

It’s going to be launched off the HMO network -- very broad network.

Great.

And then a clarifying question.

What was your underlying medical cost trend in 2002?

If we go to managed care?

Yes.

Our total -- our core commercial managed care business, we had over-year-over trend of 9.7 percent.

And as you recall, we mentioned we had --

[indiscernible]

-- yeah, of 10.7.

A point more in terms of yield.

Does that include -- and would the [indiscernible] positive development from prior quarters or were they prior year?

No, prior year.

Basically, it all comes from -- I’m glad you asked.

It all comes from 2001.

As you recall, in 2001, we started writing a lot of HMO business that was reportedly not going to be profitable.

Well, it was.

The second thing is as I’ve said to some folks during the year, we saw a significant dip in utilization after the World Trade Center disaster.

We kind of expected it to come back to its prior level and sort of come back higher to make up for the utilization fall off during the fourth quarter.

The fact of life is, it never did.

Now if you want to know if -- and I’m sure you’re all thinking it -- is $40m normal for us?

The answer is no.

We book our reserves based on our best estimate.

And while we see some improvement year-over-year, $40m is unusual this year.

In the prior two years, we saw pretty much a very stable 15 and 16m for 2001 and 2000.

Okay.

Is some of this associated with the Aetna membership that you rolled on.

You weren’t sure that it was --

Yeah.

I wasn’t going to say that on line, but yeah.

Okay.

Thank you.

Your next question comes from Josh Raskin of Lehman Brothers.

Hi.

Thanks for taking the call.

Quick question just on a days claim payable.

I think over the four quarters it was, you know, a little bit rocky this year.

If I have the numbers right, I think sort of 59 down to 54.5 up to 58.3 and 52.9.

It sounds like a lot of it had to do with the speed up of the claims.

But, just wondering, what would have been the trend if we could sort of normalize some of that.

And I’m just trying to think a little bit about expectations where we’ll be in the first quarter of ’03.

And obviously, with the increase or I guess, a decreased time delay on the claims, it sounds like there would have been a normal progression downward.

But, just trying to get what a normalized level would be and what the expectations are for ’03 is the first question.

Is the question you want to know what the claims trend would be as far as percentage or the days claims payable?

No, actually, in the days claims payable.

Oh, okay.

Then we’re probably tracking around -- if I look at the adjusted numbers -- probably around 54.5, 55.

Okay.

So 54 to 55.

That would be an expectation that we would see sort of if -- you know, through 2003 or at least a starting point from there?

No.

Going forward, I think, with the incremental improvements we’ve seen coming from -- I also mentioned the improvement in the first pass rate for the fourth quarter.

That’s kind of a permanent change.

I’d expect -- actually, I’d expect to see our days claims payable in the low 50’s, in the 52, 53 range and relatively stable going forward.

Okay.

So that’s helpful.

And then just one more quick -- I don’t want to harp on the prior period.

This sounds like the reversal this year -- or I guess in ’02 -- was one time in nature almost as you guys used best estimates.

Going forward, is there any more of that?

Were you guys more conservative early in the year as well, so we’d expect a little bit of a reverse in 2003 and maybe the first and second quarters as well?

Maybe I can answer that by giving -- if I go through some math with everyone.

What I’d like to do is, I’ve listened to a lot of things about the days claims payable and how everybody’s reacted over the last couple of weeks obviously.

And I sort of expect the question about the quality of earnings going forward.

I’d like to sort of take you through an exercise for a few minutes, if I can, and be patient with me.

Sure.

Now, our adjusted earnings per share, if you look at Schedule C, you’ll see we took out all one-time items and everything, it’s about 50 cents a share.

Okay.

With 83.5m shares outstanding, that brings you up to 41.9m on a normalized basis.

Would tax affect that?

Just for fourth quarter, that would come out to be about $72m -- $72.2m.

Now, I want to point out two unusual things for the fourth quarter.

One, if you take that 72.2m and you deduct from it the 13.6 that we had in prior period reserve releases, then you add that to it the 7.2m we had in unusual conversion and IPO expenses, you get the sort of like a normalized fourth quarter of $65.8m.

You take that 65.8 and annualize it, just simply multiply it times four, you’ll get 263m.

If you take our guidance of a 20 percent improvement and you gross that up, it comes to 315.8.

If you take the 315.8 and you tax effect it at what we consider the normal tax rate next year on an effective basis of 42 percent, you come out with about $183.2.

Divide that by the 83.5m shares outstanding, you get right in there at $2.19, which is right in the guidance.

What I’m saying is if you normalize our stuff, you’ll find out that we don’t have reserve releases in our plan for the future.

That’s number one.

The next thing is I don’t want to replace the guidance I already gave you, the $2.17 and $2.22 to $2.19.

But remember, $2.19 would be -- if you did all the math on a normalized fourth quarter -- fourth quarter’s not necessarily our best quarter, first quarter is a little bit better [indiscernible] a little bit different, but more average.

So my answer to the question is we don’t plan for large reserve releases.

It’s also difficult to project on any number like that that’s driven by pretty much a multitude of factors, such as actual versus expected trends, differences in claim processing efficiencies.

However, considering that in 2003, we’re certainly not going to contend with what we had to contend with in 2002 and 2001, which is the World Trade Center disaster and a bunch of speed ups of our claim processing because we’re impending conversion.

I would think that you’re going to see a lot more normalized data claim payable and if we have reserve development that’s positive, it’s going to be a function of some of the new medical management initiatives that as we speak, have been or are being implemented -- which would be a good thing.

We like to book our reserves based on our best estimates.

And we think that’s adequate to cover the ultimate claim amount and we don’t book [indiscernible] any margins.

So I don’t have anything in there.

That’s extremely helpful.

It sounds like you were prepared for the call [indiscernible].

I appreciate that.

Thanks for the opening.

You’re welcome.

One last question.

Just an update on the city account.

If you could just provide a little bit of a background on sort of negotiation process there.

Is it a formal RFP?

Are you aware of others that did?

And just any sort of color around that would be helpful.

Yeah, I’ll do that.

This is Mike Stocker.

Thanks, Mike.

Just for summary, we had mentioned this last week in a press release -- we have, there’s two, as you know, large accounts outstanding -- state account and the city account.

We’ve resolved our contract negotiations with the state account and have an agreement with them over the next three years -- 2003 through 2005.

There’s really no new news on the city account.

As you know, they extended the period of time from negotiations through June 30 and so we are deep in negotiations with the city account.

And there’s really nothing new to say about that.

The city account goes out to bid automatically every five years and last year was the fifth year.

It’s not infrequent that they extend it for a period of time, the first six months as we go through the negotiating process.

The people who are competing for the city account business are ourselves, GHI, and HIP -- HIP.

Okay.

Thank you very much and congratulations.

Your next question comes from Adam Miller of Williams Capital.

Hi.

I was wondering if you could just talk a little bit about where you are in the status of the conversion over to the new system.

And then I also want to get a definition of when you talk about first pass rate.

Are you referring to the percentage of clean claims or are you talking about auto adjudication?

Yeah, on the first two things.

On the first pass rate, we’re talking about the percentage of claims that are paid.

Basically, clean claims which are primarily institutional claims that are paid on their first entrance into our system.

And that’s something that has improved significantly over the last few years here at WellChoice.

And then do you have a number for the auto adjudication rate?

[indiscernible] the first pass rate improve for the quarter?

Or I could just --

Go ahead.

Yeah, let me just try and do a definitional thing. [indiscernible] first pass rate almost -- let’s take hospitals, for example.

Almost all the claims that come in from hospitals come in electronically.

So if the claims clean -- now, there’s always some claims that are going to come in in paper and there’s claims from around the world and other states and things like that.

But, almost all of it in the New York area is electronic.

If the claim is clean -- meaning, all the various portions of the entry fields are filled out and all reasonably correctly -- then the first pass rate means that it’s paid without otherwise human intervention.

Auto adjudication for us means -- and there may be some definitional issues here -- means that you enter the claim into an internet-based portal and we adjudicate it automatically on line real time.

It’s almost like a credit card transaction, which is the vast majority of our claims payments aren’t done that way, but we have the capability of doing that.

Does that make sense?

Yeah, it does.

And thanks for the clarification.

Can you talk a little bit about where you are in the status of the conversion?

I know you had some speed up that you anticipated for this fourth quarter in terms of migrating some of your employees to the outsourcing agreement.

Let me add an additional factor on the first pass rate to help anybody else who’s looking.

Last year in the fourth quarter, our first pass rate -- and as Mike provided for the institutional claims -- was 83.3 percent.

And that improved to 86.8 percent as of now.

So we had like 380 or 350 base of point improvement in the first pass rate year-over-year.

As far as the systems issue, you’re talking about the outsourcing arrangement to IBM.

As we said, the outsourcing arrangement for IBM, when it started -- when the contract sign was June would take about a year for everything to occur.

Well, we are well along the way with that.

So far everything is going extremely well.

The communications set out between here and New York and the satellite locations is extremely good.

The training of all the people who are involved in it has been basically probably about two-thirds completed.

And we are starting to go parallel with some systems this coming -- or next month.

So it’s going very well.

We’re a little ahead of schedule.

I’m not sure how else to quantify that, but we’ve had no roadblocks in it.

We’ve had no issues and everything seems to be moving [indiscernible] with outsourcing.

[indiscernible].

Did that answer your question?

I guess you raised another two-part question.

One would be the -- I guess you have two contracts with IBM.

One is to outsource some of your IT support to them.

But then, also, second is working on the new [indiscernible] system.

Let me address -- you’re right.

So the previous answer is basically addressed to the outsourcing portion of this, which has gone well and is ahead of schedule.

The [indiscernible] we had said in prospectus in the road show is still a coin system that’s in development and it is a 2004 to 2005 issue, not really an issue this year.

I just want to stress since there’s been a number of stumbles here.

In our industry, there are people who migrate their claims systems successfully, do it frequently, and don’t have any problems with it and we just hear of the ones where you do have problems.

We have migrated six claims systems into one, so we have significant experience over the past nine years in claims systems migration.

Our current system works fine.

It is on old technology.

It is on [indiscernible] language, for example.

It needs to be replaced.

But, even if the [indiscernible] engine does not develop the way we expect it to, we are fine and very functional on our current system.

Okay.

That’s great.

That answers my question.

It’s not a 2003 issue.

You know, next year and the year after that.

Great.

Thank you.

Your next question comes from Michael [Collin] of Newburger Burman.

My question has been answered.

Thank you.

Our final question comes from John Rex of Bear Stearns.

Yes.

Thank you.

A couple questions here.

First, just a follow up on the discussion on the state and city account.

With the resolution of the state account, is there any change in your relative profitability on that account?

No.

It’s basically consistent with our expectations period.

Okay.

So built in to your guidance is what you’re saying?

Yes.

Okay.

Great.

Also, in the past, your second quarter has shown the highest -- generally the high seasonality in your medical cost ratios.

Should we expect similar trending still in your medical cost ratios for the quarters here?

John, John Remshard.

Yeah, I think so.

What happened, you have a phenomenon, we have about 41 percent renewal rate in the first quarter and you have a lot of new business come on, and our new business for ’01 was very good.

And you start seeing a lot of the losses develop in the claims coming in the second quarter.

So you have these little -- I wouldn’t say [indiscernible] a little seasonality that affects the second quarter over the first.

Okay.

And also, John, I didn’t know if -- did you provide an operating cash flow outlook for ’03?

No.

We actually didn’t.

Do you have one you can give us?

Well, we think the -- we think on an adjusted basis given [indiscernible] our operating cash flow for ’03 would be around $288m to $300m.

Okay.

Okay.

Great.

And then just one last thing.

In the past, you had provided some segment detail, that is, for the managed care segment and for the other insurance segment.

And also, I had broken out insured and self-insured membership by segment.

Will we be able to get that detail still?

Yeah, what are you look for -- what are you looking for?

Well, you provided -- on the income statement, you had provided the detail for both managed care segment and for the other segment.

And then also, we had gotten a breakout of the membership by segment split between insured and self-funded status.

I was wondering if I could get that.

Yeah.

As a matter of fact, John, that’s for 2002 -- all those segment results, including medical loss ratio with and without the city and state account, administrative expense ratios, [indiscernible] on fewer plus [indiscernible] basis plus related stuff for the other products -- the other insurance services product.

Yes, we will have that in our annual report and we’ll have that in our 10-K.

But, we won’t be able to get that until your K comes out.

I’m saying, for those of us that built our model by using segments, are we going to be able to get those kind of details?

We can provide it to everyone if you like.

Okay.

Great.

Great.

I mean, it’s something that we can get -- I mean, is it something that we can get now?

Yes.

Okay.

Great.

And also on the split of membership self-funded insured by segment, is that something we can get also now?

Yes.

Great.

Perfect.

Thank you very much.

You’re welcome.

Ladies and gentlemen, thank you for participating in the WellChoice fourth quarter earnings conference call.

This concludes today’s conference call.

You may now disconnect.