Elevance Health Inc (ELV) 2004 Q2 法說會逐字稿

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  • Operator

  • Ladies and gentlemen, thank you for standing by, and welcome to WellPoint Health Networks' Conference Call to discuss Second Quarter 2004 Financial Results.

  • This conference call is being recorded.

  • There will be a question-and-answer session at the conclusion of this conference call.

  • In order to ask a question, please press the "*" key, then the number "1" on your telephone keypad.

  • To withdraw your question, please press the "#" key.

  • During the course of call, WellPoint's management may comment on expected pricing or cost trends or may make other projections or forward-looking statements regarding the future financial performance of the company.

  • WellPoint cautions you that these forward-looking statements are merely predictions based on current circumstances and that these statements involve a number of risks and uncertainties that may cause actual results to differ materially from those projected.

  • The factors that can cause actual results to differ are discussed in WellPoint's most recent Form 10-K and the company's other periodic filings with the SEC.

  • At this time, I would now like to turn the conference over to your host, Mr. Leonard Schaeffer, WellPoint's Chairman and Chief Executive Officer.

  • Please go ahead, sir.

  • Leonard Schaeffer - Chairman & CEO

  • Thank you, very much, operator.

  • And thank all of you who joined us this morning for discussion of our second-quarter results.

  • The agenda on today's call will have three parts: first, I'll begin with an overview of WellPoint's second-quarter performance; then Dave Colby, our CFO, will review the financials; and then, finally, I'll conclude with a brief comment or two before we take your questions.

  • We had another strong quarter.

  • WellPoint's very strong second-quarter performance reflects our continued focus on providing value to our customers.

  • Our topline exceeded $5.7 billion during the quarter, a 17% increase from last year's second quarter.

  • WellPoint's second-quarter diluted earnings per share of $1.86 was a 25% increase over the same period last year.

  • We rolled out several new products and services in the individual and small group markets, as we continue our efforts to penetrate the uninsured and underserved markets.

  • Our programs to attract the uninsured are yielding excellent results.

  • Based on a review of recent data, 43% of our new members at individual and small group company-wide products were previously uninsured.

  • Given the number of uninsured with incomes well beyond the federal poverty level, there is a significant growth opportunity for us, going forward.

  • In addition, we continue to take the lead in managing pharmacy spend with programs like Generic Select, a program we launched in early 2003, which encourages the use of generic drugs that can be appropriate substitutes for many brand name drugs within the therapeutic class.

  • This program has been expanded to include the mail order through our wholly owned mail order facility, PrecisionRx.

  • Membership results were also very good.

  • Our sales were strong in the second quarter.

  • We added 540,000 new members in the second quarter of '04; 491,000 were insured members, and 49,000 were ASO.

  • Following two quarters of a positive trend, we experienced a decline of 47,000 members in existing accounts.

  • This came as a surprise to us, considering job growth and the apparent improvement in the economy.

  • We expect this to improve, going forward.

  • In addition, our BlueCard host medical membership increased by 73,000, during the second quarter.

  • Host members are members covered by another Blue plan who reside in our Blue geographies and use our networks.

  • Note the strong growth in the program from 744,000 members at the end of the second quarter of '03 to nearly 1.3 million members at the end of the second quarter of this year.

  • Now, I'd like to briefly discuss same store membership results in each of our key geographies.

  • In California, large group membership growth was essentially flat, which is normal for the second quarter.

  • Most large groups renew in January.

  • And since we have a robust public entities business within our large group segment -- that means municipalities, school districts, state governments, and alike -- July and October also tend to have a higher rate of large group renewals.

  • Our fully insured membership, led by our key accounts area, grew by approximately 17,000 members and reflects renewed sales efforts in and the introduction of new lower-cost benefit alternatives into this segment.

  • We also have been successfully targeting student health plans.

  • Effective September 1st, we contracted with the UCLA Student Group, representing 25,000 new members, and the University of California at Santa Cruz, which represents almost 9,000 new members.

  • We continue to see momentum in the individual and small group markets in California.

  • We added almost 3,000 net members, during the quarter, despite rate increases in the individual market on March 1st and the small group market on May 1st.

  • This was the third consecutive quarter of growth, and enrollment trends continue to look positive.

  • We saw significant improvement in our retention rates in both individual and small group, following the rate increases this year, versus what happened last year.

  • This is due to new retention efforts, such as making it easier for members and employees to switch to more affordable plans.

  • In our small group business in California, we rolled out Select HMO product, which is a narrow -- which has a narrow, more affordable HMO network.

  • We also introduced the GenRx PPO, which uses a generic-only drug benefit to reduce the premium level; and we're hopeful that, like the individual Wright plan, this product will appeal to a younger, price-conscious small group employee.

  • As we mentioned, during the last two quarterly calls, the Right Plan 40, the individual plan aimed at what we call the "young invincibles," continues to perform very well.

  • This plan is proving successful in attracting a younger uninsured set of buyers and is now our second best-selling individual product.

  • On March 1st, we introduced a 3500 PPO product, which is a simplified benefit plan in which the member is responsible for a $3,500 deductible and then is covered 100% for in-network benefits.

  • This plan is aimed at a slightly different segment of the uninsured -- those who are a little older and have a little more disposable income.

  • We also have had recent successes marketing our commercial products via local community resource centers that exist for our Medi-Cal business.

  • We found that many visitors to these storefronts did not qualify for government programs and, therefore, are candidates for our commercial products.

  • Finally, in the second quarter, we hired an executive with outstanding credentials in the area of multi-cultural, multi-lingual outreach to accelerate our efforts to reach the uninsured, who face difficulties -- cultural difficulties and language barriers.

  • Lenore McCall-Rodriguez joined us as Vice President of Emerging Markets for our individual and small group businesses.

  • An accomplished speaker, author and entrepreneur, Ms. McCall-Rodriguez most recently was president of a firm providing consulting services to corporations seeking to expand businesses -- expand their business in Hispanic markets.

  • Overall, we continued to achieve significant milestones in building our California business.

  • We're raising the bar on quality.

  • Blue Cross paid out $56.9 million in the second quarter to 134 physician groups as part of our quality scorecard program.

  • This is 30% more than the amount paid last year to only 80 physician groups, an indication that our program for quality is being embraced by more of the medical community and is having a significant positive impact.

  • We also launched a Mobile outreach program during the second quarter, to assist children applying for health coverage.

  • Two new vans will travel to local events and community-based organizations throughout the state to encourage onsite applications for California's Healthy Families program.

  • We're proud that our California Medicaid business was awarded an excellent accreditation from the National Committee on Quality Assurance; our plan is the first Medicaid HMO in California to receive NCQA's highest possible rating.

  • Let's turn now to Georgia.

  • In Georgia, we continue to experience strong sales activity in individual and small group.

  • Driving membership growth in individual was our new Blue Value suite of products, which was introduced in late 2003.

  • Blue Value plans feature higher member cost-sharing and lower premiums.

  • Small group and major accounts growth is being driven primarily by the basics -- good service, broad networks and excellent product choice.

  • I'd like to highlight the uninsured opportunity we see in Georgia.

  • While we have a very high market share of people, who buy individual products, our market share drops to about 15%, if you include individuals who are currently uninsured and that earned 200% or more of the federal poverty level.

  • To address this uninsured opportunity, one of the products we've recently introduced in the individual market in Georgia is the Right Plan PPO.

  • Similar to the Right Plan 40 in California, this product is geared toward the "young invincibles."

  • This plan has the same 0 deductible and $40 office visit co-pay, as the Wright plan 40.

  • The aging community in Georgia sees this as a cost effective alternative, which matches this segment's anticipated healthcare consumption with appropriate benefits at a very attractive price point.

  • It's also unlike any other product that is currently being offered in the Georgia market, where our competitors still offer only traditional products.

  • Turning to Wisconsin, one of our other two Blue states, we continue to capture integration efficiencies that keep us competitive and help us attract more members.

  • We're on track to achieve first-year synergies, and we're beginning to see accelerated small group member growth, as we introduce the WellPoint approach and products to that market.

  • I'd like to point out that, as expected, our Wisconsin operations were accretive by 3 cents per diluted share in the second quarter.

  • In Missouri, we've had sales of nearly 16,000 in the ISG market.

  • A number of new products were introduced in the ISG market as well with some major IT initiatives focusing on productivity improvements and better customer self-service.

  • Effective July 1st, we launched HSA-compatible high deductible health plans in both the individual and small group markets.

  • And although it's too soon to report sales results, the products have received quite a bit of interest from brokers.

  • Also at the beginning of June, we implemented online sales application capabilities to our individual market in Missouri.

  • This e-service is friendly to both brokers and those who wish to both purchase healthcare coverage directly.

  • We were encouraged by the initial applications we received to-date, which have been much higher than expected.

  • In Illinois and Texas, where we market under the UNICARE and HealthLink brands, large group experienced a sequential decline in membership due to lapses of some unprofitable accounts.

  • However, we've seen an increase in RFP activity for January 1 in response to some of the new products and programs we're rolling out, including the Health Advocate, which is patterned after successful programs in California and Georgia, a high deductible plan designed for HSA.

  • The individual and small group segments in Illinois and Texas are experiencing good membership growth, as we continue to introduce new products to serve those markets.

  • We've rolled out a complete HSA compatible product line in all of our UNICARE states, except Nevada, where approval is still pending.

  • In Texas, our Consumer Choice PPO, which was first introduced in the first quarter of this year, is a low-cost product that contains fewer mandated benefits, per legislation passed there last fall.

  • By the end of the second quarter, we'd attracted over 3,000 members to the product, and over 40% of those members were previously uninsured.

  • We're working toward legislative changes in Illinois that would allow for a similar product offering in that state.

  • Now, let me turn to a discussion of our pricing cost trends.

  • During the second quarter, we did not experience any significant change in trends.

  • We continue to see increases in premiums and costs of just under 10%, which was consistent with our prior guidance and down slightly from 2003.

  • Pharmacy trend remained stable compared to the first quarter.

  • Due to the success of Generic Select, we saw slight decreases in the trend and certain pharmaceutical classes.

  • We're looking forward to rolling out Generic Select II in the third quarter.

  • This is a supercharged version of Generic Select, providing up to four months of certain generic drugs for free.

  • This program provides additional incentives for our members to embrace using generic drugs, where medically appropriate.

  • In the third quarter, we also will be launching programs to allow our members, working with their physicians, to access maintenance therapy with Prilosec OTC through our mail-order pharmacy and a significant discount to their current out-of-pocket costs.

  • Now, let me turn to an update on our "healthy parenting" initiative.

  • At WellPoint, healthy lifestyle education is a top priority.

  • In the first half of this year, the WellPoint Foundation announced a collaboration with the American Heart Association Western States Affiliate to address growing concerns about the cardiovascular health of America's youth and to combat the rising rate of childhood obesity.

  • A key element of the program is the participation of both physicians and teachers -- two groups widely trusted by parents -- in the development of bilingual, family-friendly, educational resources for use in homes, schools and medical offices nationwide.

  • This effort expands on WellPoint's national initiative to address the youth obesity epidemic, which includes a collaborative effort with the American Dietetic Association on a host of child nutrition initiatives, including the widely distributed Healthy Habits for Healthy Kids Guide.

  • The guide provides parents with recommendations for healthy eating and gives healthcare professionals a much-needed vehicle for discussing childhood obesity with families.

  • One million copies of this guide have been distributed nationwide.

  • Finally, let me give you a brief update on our program to jumpstart physician connectivity and to improve quality.

  • Recall that this program, worth $42 million, offers physicians free of charge, a choice of either a prescription improvement package, including a wireless PDA, or a desktop computer to facilitate online communications and to reduce paperwork.

  • We also extended this program to include our California Medi-Cal physicians.

  • To date, we have about 16,000 participating physicians.

  • More than 2,000 physicians, or about 13% of the total, have selected the prescription improvement package. 10,500 desktops and PDAs have been delivered and are in various stages of installation.

  • As more physicians adopt this hardware and technology, we'll continue to promote the program in the media through advertising and other channels.

  • Now, I'd like to turn the call over to Dave Colby.

  • Dave?

  • David Colby - CFO

  • Thank you, Leonard.

  • And we are very pleased with our second quarter 2004 financial results.

  • Our continued focus on operations -- that is sales, underwriting, pricing and expense management -- has resulted in yet another quarter where WellPoint has met or exceeded analyst expectations.

  • As we announced yesterday, we are increasing our 2004 guidance from $7.50 to $7.55 per diluted share.

  • Our second quarter net income was $299.9 million or $1.86 per diluted share, which is 4 cents higher than consensus estimates. 2004 earnings per share in the second quarter represented a 24.8% increase over results for the second quarter of 2003 of $1.49.

  • As expected, during the second quarter of 2004, the Cobalt acquisition contributed about $15.5 million to WellPoint earnings, or about 3 cents accretive based on the number of WellPoint shares issued in that transaction.

  • The quality of our earnings is supported by GAAP operating cash flow of $226 million, which is more than twice the second quarter of 2003 levels of $108 million.

  • Our GAAP operating cash flow this quarter was negatively impacted by $320 million of tax payments in the quarter, compared to tax expense of only $200 million in this quarter.

  • This level of operating cash flow supports the high quality of our reported earnings.

  • Also, our balance sheet claim reserve estimates continue to base on WellPoint's consistent application of our historical methodology, which includes an assumption of moderately adverse conditions.

  • Days in claims payable decreased by 2.1 days during the quarter.

  • This change can be explained by the following three factors; first, higher accrual for pharmacy claims due to the biweekly payment cycle timing in our PBM; second, a decrease in the average claim cycle time from the first quarter; and finally, the physician incentive payments, Leonard referred to, that were made in the second quarter, but actually accrued in 2003.

  • The six-month medical claims payable roll-forward schedule, we have provided with the press release, continues to show our conservative reserving practices with another year of positive development.

  • As I will discuss later, the magnitude of positive development is less than that experienced in the first six months of 2003, due to negative development in certain identifiable reserves, such as, our yearend accrual for flu-related claims due to the heavy flu season at the end of 2003, some additional litigation reserves booked by certain existing legal cases, and additional accruals for our Physician Quality and Technology Initiative.

  • I will now briefly discuss some key income statement and balance sheet items.

  • Our continued year-over-year insured enrollment growth and disciplined pricing resulted in healthy revenue growth.

  • Our 2004-second quarter revenues excluding investment income, were $5.7 billion, that is a 17.1% increase from the second quarter of 2003.

  • During the past year, WellPoint has seen faster growth in its non-risk medical membership, primarily due to the success of the BlueCard program and the Cobalt acquisition, which had a higher percentage of non-risk lives.

  • Year-over-year, in the second quarter, our insured members were up 5.4%, our non-risk members were up 15.4%, and insured lives now represent about 56.5% of our total.

  • As Leonard discussed, new sales of approximately 540,000 members in the second quarter were very strong.

  • We were also, however, surprised by the negative in-group change of approximately 47,000 members when the economy appears to be improving.

  • Our medical care ratio in the second quarter of 2004 was 80.7%, which was 101 basis points higher than the first quarter, and 28 basis points lower than the second quarter of last year.

  • The sequential rise in the medical care ratio was, as expected, due to the impact of deductibles early in the year.

  • On a year-to-year -- year-to-date basis, the medical care ratio is down 116 basis points in 2004, versus the first half of 2003, indicating our ability to price products to cover medical cost increases.

  • The SG&A ratio continues to show good year-over-year improvement.

  • Selling, general administration ratio in the second quarter of 2004 was 15.6%, a 40-basis point improvement from 16% in the second quarter of last year.

  • This improvement is due to improved productivity from our e-business and technology initiatives, for example, our EDI rates on a year-to-year basis improved from 63.5% to 64.8%, and our auto adjudication rates on a year-over-year basis increased from 52.4% to 60.3%.

  • The SG&A ratio was also favorably impacted by our ability to spread fixed SG&A costs over the larger membership base.

  • We remind investors that over the past five years, since the second quarter of 1999, WellPoint has reduced the SG&A expense ratio by 316 basis points.

  • Our investment income for the quarter was $68.5 million, which included only $100,000 of net realized gains in our investment portfolio.

  • I think it's important to point out that while pre-tax income for the quarter increased year-over-year by 34%, investment income, which represented 14% of pre-tax income in the second quarter, increased only 7% from the second quarter of 2003.

  • Accordingly, pre-tax income excluding investment income, increased by -- year-over-year by almost 40%.

  • In the last five years, WellPoint is seeing the percentage of our pre-tax income coming from investment income decline from 37% in 1999 to 14% in the second quarter of this year.

  • Interest expense and other expenses, primarily amortization were $13 million and $9 million respectively in the second quarter.

  • Interest expense was consistent with our prior quarters.

  • Other expenses decreased in the second quarter of 2004 from the first quarter, primarily due to somewhat lower profitability of our consolidated Atlanta joint venture.

  • The Community Health Partnership network leading to a lower minority interest charge and increased income from our Medicaid joint venture in Puerto Rico.

  • The second quarter 2004 effective tax rate of 40% is consistent with recent experience and prior guidance.

  • Let me now turn to the balance sheet.

  • Due to solid financial performance, cash flow and the repayment of our outstanding commercial paper in anticipation of Anthem merger, WellPoint continues to enjoy a financial position that allows it to take advantage of future opportunities.

  • Our second quarter debt-to-capital ratio of 11.4% is down from 20.9% at the second quarter of 2003.

  • Cash flow was again strong for the second quarter, despite the higher tax payments due to two estimated tax payments in the quarter.

  • Cash investments at June 30 were $8 billion.

  • Our GAAP operating cash flow in the quarter was $226 million, which was negatively impacted by the tax payments of $320 million, which exceeded the quarter's income tax expense by $120 million.

  • We continue to feel comfortable with our balance sheet reserves for medical claims.

  • Medical claims payable were $2,650,000 at June 30.

  • Our days in medical claims payable decreased from 57.4 days to 55.3 days during the second quarter.

  • This 2.1-day decline is due to the following three items:

  • First, a decrease in our average claim cycle times from the first quarter of 1.8 days.

  • Second, the actual payment of physician incentive payments that were made in the second quarter 2004 that were accrued during 2003, that resulted in a decline of 1.2 days, and those two impacts being offset by the timing of our PBMs bi-weekly pharmacy claims payments which would have increased the day's in claims payable by 0.9 days.

  • The impact of those three events is the decline of 2.1 days.

  • For the past few years, we have included an annual roll-forward schedule of medical claims payable to assist investors in understanding this accounting estimate.

  • As we did last year with the second quarter earnings release, we were providing a six-month roll-forward schedule of medical claims payable for the past three years.

  • For WellPoint, this schedule shows that in the last three years, a conservative claims estimates in the prior year have resulted in positive development in the then current year.

  • The magnitude of positive development in the first six month of 2004 is lower than the same periods during the past two years for the following reasons.

  • First, at December 31st, 2003, WellPoint established a special blue accrual to account for anticipated higher claims due to a severe flu season at the end of 2003.

  • Based on claim payments to the first half of 2004, it appears actual flu-related claims in 2003 were $32 million more than the amount accrued.

  • This caused negative development for this specific accrual.

  • Second, during the first half of 2004, we increased an existing litigation reserve by $9 million, based on new information.

  • This caused negative development for this specific reserve.

  • Third, during the first half of 2004, we increased our 2003 accrual for our physician quality and technology initiative by $2 million to include certain safety net providers.

  • This caused negative development for this specific accrual.

  • And finally, we experienced somewhat lower positive development due to slower provider billings in the November 2003 lag chronicles which we believe may have been due to HIPAA compliance issues for physicians with a new standard transaction codes that were implemented in October.

  • Long-term debt declined $436 million during the quarter as we repaid our outstanding commercial paper in anticipation of the Anthem merger.

  • In the second quarter, 2004, WellPoint did not buy back any common shares as we prepared to complete the Anthem transaction.

  • From the third quarter of '98 to today, WellPoint has used $1.2 billion in cash to purchase 29.3 million shares of its common stock at an average price of $42.26.

  • We currently have board authorization of repurchase up to 6.2 million shares, given the events of this past week and subject to Anthem approval, we may recommence our share buyback program.

  • In accordance with past practices, we look at acquiring WellPoint stock based on the stock price, future cash flow, alternative opportunities to invest cash in acquisitions and our commitment to maintain or improve our current credit ratings.

  • In conclusion, I think the second quarter of 2004 was a strong quarter for WellPoint, where we exceeded first call estimates in our prior guidance by 4 cents.

  • This level of performance results from our business fundamentals being strong, sales, underwriting and favorable pricing environment resulted in premium and management services revenue growth of over 17%, which covered increases in medical costs.

  • Our pre-tax income margins, which is pre-tax income as a percentage of premiums and management services revenues increased from 7.67% in the second quarter of 2003 to 8.75% in the second quarter of 2004, a 108-basis point year-over-year improvement in that margin.

  • We've also been able to demonstrate our e-business and technology investments, have shown material improvements in productivity and the lower SG&A ratio, and we continue to generate strong cash flow.

  • Our prior guidance for 2004 earnings per share was approximately $7.50.

  • Since this quarter exceeded guidance by 4 cents due to the strong fundamentals, we are now increasing our guidance for the remainder of the year to approximately $7.50 -- $7.55 per diluted share.

  • Finally, this discussion does contain certain non-GAAP financial measures as defined in the rules of the Securities and Exchange Commission.

  • As required by those rules, a reconciliation of those most directly comparable GAAP measures is available at our Web site which can be found at www.wellpoint.com.

  • Also an audio link of the entire call we be available on our Web site following the call.

  • I will now like to turn the call back over to Leonard to make some comments about the Anthem merger.

  • Leonard Schaeffer - Chairman & CEO

  • Thanks, Dave.

  • Let me concludes our call with a brief comment about the actions of the California regulators last Friday, regarding our pending merger with Anthem.

  • As you know, the Department of Managed Health Care approved the merger.

  • The DMHC regulates our Blue Cross of California subsidiary, which represents approximately 90% of our California business.

  • Anthem and WellPoint agreed to more than two-dozen extensive undertakings, negotiated with the Department of Managed Health Care staff that aggress important programs designed to improve the quality of care provided to California members.

  • The undertakings include specific initiatives that would provide investment resources to underserved communities and to help fund efforts to enroll uninsured Californians in government-provided medical insurance programs.

  • As you also know, the California Department of Insurance disapproved Anthem's application to acquire our BC Life & Health subsidiary.

  • We believe the Commissioner clearly overstepped his regulatory authority.

  • Anthem has reviewed the DOI's written decision and will promptly initiate appropriate legal proceedings to challenge it.

  • Together, we'll also consider other options that may be available to us in order to complete the merger.

  • Now I'd be happy to take your questions.

  • Operator, can you facilitate that process?

  • Operator

  • Certainly.

  • Ladies and gentlemen, we will now open up the call for questions and answers.

  • In order to ask a question, please press the "*" key, then the number "1" on your telephone keypad.

  • To withdraw your question, press the "#" key.

  • Ladies and gentlemen, please limit yourself to -- excuse me, two questions per person.

  • Thank you.

  • One moment please for our first response.

  • Our first question comes from Ellen Wilson with Sanford Bernstein.

  • Ellen Wilson - Analyst

  • Yes.

  • I was wondering if you could elaborate a little bit more on the SG&A ratios.

  • I remember at the first quarter, you talked about a 200-basis point possible decline in the coming couple of years.

  • But you got 130 basis points, which is a great sequential decline.

  • How does that revise your guidance from here for that particular ratio, kind of what do you ultimately think you can reach now in the next couple of years and how?

  • David Colby - CFO

  • Well, Ellen, let me -- this is Dave.

  • The 130 basis points was a sequential and we always see some sequential decline between the first quarter when we're bringing on a bunch of new cases we have and incur a lot of overtime.

  • And that year-over-year, the improvement is more like 40 basis points, which, you know, is what we sort of historically averaged.

  • I have said that, you know, over the last five years, we have taken 300 basis points out of the SG&A ratio and with some of the programs that Ron ponder and his team have in terms of IT initiatives, we believe there is continued opportunity and we said that even absent the synergies that would be available in the Anthem merger that we expected over the next three to five years, 150, 200 basis points to come out, primarily by doing more things electronically and utilizing technology to a greater extent.

  • Ellen Wilson - Analyst

  • OK.

  • And then also on the cost run front, would you just give the breakout by component for the quarter for physician, inpatient, etc?

  • David Colby - CFO

  • We really have seen, you know, no dramatic difference from what we've historically said.

  • I mean the physician component has been in the mid single digits.

  • The hospital inpatient side in the mid to upper single digits, pharmacy costs in the low double-digits, you know, 10% to 11%, and the outpatient, which includes work at hospitals, but done on an outpatient basis, free-standing outpatient, still continues to be in the low teens.

  • Ellen Wilson - Analyst

  • OK.

  • Thanks.

  • Operator

  • Our next question comes from Josh Raskin with Lehman Brothers.

  • Joshua Raskin - Analyst

  • Hi.

  • Thanks.

  • Good morning, I guess, for you guys.

  • Just one question.

  • Could you help us understand your pricing philosophy?

  • How do we think about your underwriting methodologies with regards to the pricing of your products?

  • Do you target, you know, an increase in the gross margin dollars or is there an MLR target that you use?

  • Just help us understand the process there.

  • David Colby - CFO

  • I think this is obviously, you know, very complicated process.

  • I think, you know WellPoint -- you know, Leonard and I have been very clear with the street when you look at how we get to our 15%, you know, growth target.

  • The concept is try to price your products to cover medical cost trends so that the medical care ratio stays approximately the same.

  • And then through productivity initiatives, try to bring down the SG&A ratio so that can drop to our shareholders' benefit and by doing that, you know, we think we can get the 15%, you know, growth going forward.

  • That is, you know, how it works out.

  • I mean, actually in terms if you sit down with actuaries, they do look at everything on a per-member, per-month basis.

  • But the end result is we tend to, you know, cut price to cover the medical trend increase and then try to improve the G&A as much as we can and have that drop...

  • Leonard Schaeffer - Chairman & CEO

  • The key is that this is done with great discipline and it's done on a monthly and sometimes a weekly basis.

  • I mean, the fact is nobody is perfect about identifying the trends.

  • But the point is, as you get more information, you adjust your pricing.

  • As long as it's done dynamically, it's done in real time and it's done with discipline, if we think that costs are X, we will price the cover whatever that cost is.

  • And we don't use pricing as a way of gaining market share and we don't say, gee, last year was a good year, so this year we're going to fool around with our margins.

  • We have had consistent disciplined pricing from the very beginning because that's the only way you maintain financial integrity of a company this size and it's about execution.

  • It's about doing it, and not getting, you know, confused about anything else that may be going on in the marketplace.

  • So, what has happened year after year after year is that we have maintained our margins and maintained our profitability.

  • We have not had the big jumps that some others have had.

  • We have not had the big declines that some others have had, and we don't price based on the way other people are pricing.

  • We base on what we believe costs are.

  • This is one of the reasons why we think paying timely is very important.

  • If you can get claims in quickly, if you can pay them quickly and understand your costs, you price more accurately.

  • And the key to this business, and the reason that we haven't seen the dramatic kinds of ups and downs we used to see years and years ago, is that everybody is being more careful about pricing.

  • And I believe we are still the leaders in, if you will, real time pricing and making sure we're covering our costs.

  • Joshua Raskin - Analyst

  • I agree.

  • I think Leonard, you know, it's helpful.

  • We've gone back and looked at obviously MLRs, if you look over the last seven years, you guys are really within about a 160-basis point gain for all seven of those years.

  • So, is it fair to say that the MLR you're seeing right now, that's sort of the target area around 81% and we should not expect really any deviations going forward?

  • That's sort of what your target is?

  • David Colby - CFO

  • I think that's, you know, it's more complicated than that.

  • Obviously, we have different targets by different customer segments and we're going to run a higher MCR if we grow more in large group than individual and small group.

  • Obviously our Medi-Cal business runs higher than that.

  • Our senior runs a little bit higher on the HMO side.

  • So, if you get down to each individual segment, you know, yes, we are trying to maintain that, you know, care ratio.

  • We think that's an appropriate, you know, level.

  • But you can see some fluctuations just based on, you know, geographic...

  • Leonard Schaeffer - Chairman & CEO

  • I think this is an important point and very interesting analysis, Josh.

  • You know, mix and geography have big impacts.

  • But we will - we will come back to equilibrium, you know, overt ime and that's the name of the analytic endeavor is to understand how the dynamics of all of our customer segments, to make sure we're building products that meet the needs of people in those segments, and then make sure that these ratios are kept in line.

  • It is a very complex, you know, undertaking, and I think we've said this before, when we acquire a new, you know, we make an acquisition, that typically changes some of these ratios.

  • But then over time, they come back because, over time, we're able to do a better job of pricing.

  • And you will see that if you follow Wisconsin.

  • You will see that initially Wisconsin had very different numbers but it will come back in line with the rest of the company.

  • We saw that in Georgia.

  • Georgia is -- I think they've done an outstanding job there.

  • But it has to do with discipline.

  • It has to do with making -- with executing on a very detailed level, you know, the grimble of that particular product and that particular geography at that particular time, and then over time, it does add up to where we want to be.

  • Operator

  • Our next question comes from Charles Boorady with Smith Barney.

  • Charles Boorady - Analyst

  • Hi.

  • Good morning.

  • Thanks.

  • First just a brief question on the pricing environment in Illinois and Texas.

  • I know they're small markets for you.

  • But a competitor mentioned that they saw what they believe was aggressive pricing in those markets.

  • Is that something you can comment on?

  • David Colby - CFO

  • No.

  • I think that we've said that as many of our competitors have gotten stronger, they're no longer playing catch-up and pricing closer to trend and that's more competitive.

  • Again, I like to point out that when we sell 540,000 new lives just in one quarter, you know, the market is not irrational.

  • We're able to sell.

  • It is much more competitive.

  • In Illinois and Texas, you know, you do have a nonprofit Blue plan there, but that is a very well run, you know plan.

  • I think the Chief Executive Officer is an actuary and the CFO is an actuary and the actuary is an actuary.

  • So, I mean, it's a fairly disciplined plan and does not act irrationally.

  • But it is a strong competitor and those are competitive markets.

  • Charles Boorady - Analyst

  • Second question is on Medigap.

  • We don't spend a lot of time talking about it on the call.

  • But I'm curious about what the pricing and cost trends are in Medigap, and in light of the Medicare PPO rules being formulated, does the Medicare PPO product appeal to you more than the Medicare choice or Medicare HMO use do which was not a lot?

  • And does the Medigap distribution that you have in place, does that contribute somehow to your expectations for growing in the Medicare PPO business once it's launched in '06?

  • Leonard Schaeffer - Chairman & CEO

  • It doesn't.

  • The PPO doesn't appeal that much more than other opportunities.

  • What is appealing, I mean, the good news about the senior market is that the government is moving in the direction of offering choice.

  • I think what you're going to see is continued innovation and continued flexibility in developing new products.

  • And if that happens, I think you'll see that seniors will choose the products that make the most sense to them.

  • What we need is an environment where the government understands that people have experienced different kinds of products than the classic Medicare product in their work life, and that many of them want to continue with those different kinds of products.

  • The issue for elected officials; it's a very complex issue, is that individuals who are in traditional Medicare and like it, like it.

  • Individuals who are in some of other products and like it, like those products.

  • But there is a huge wave of baby boomers that have had much broader experiences, that are much more knowledgeable about healthcare, and frankly, have much higher expectations about what these programs are going to give to them.

  • And that's going to be the, if you will, the challenge for elected officials to meet the expectations of baby boomers as they age, at the same time as we make Medicare affordable.

  • So, I think that the direction is good; more products, more diversity.

  • The devil is in the details and we look at everything very carefully and we pursue those products that both offer choice to our members and that allow us to get the appropriate financial return.

  • Charles Boorady - Analyst

  • Is the pricing and cost trends in your current Medigap book of business -- are they consistent with what you're talking about on the commercial sides or are they meaningful different

  • David Colby - CFO

  • They become just a little bit lower.

  • But there's not been a dramatic change in any trends.

  • Charles Boorady - Analyst

  • Got you.

  • OK.

  • Great.

  • Thanks.

  • Operator

  • Our next question comes from Christine Arnold with Morgan Stanley.

  • Christine Arnold - Analyst

  • Good morning.

  • I'd like to explore cost trends in a couple different ways.

  • Can you start by kind of looking back on 2003, if you put those HIPAA-related costs that should have been in the fourth quarter in there, and then, readjusted 2003 for prior period positive developments, what does your 2003 medical trend really look like in retrospect?

  • David Colby - CFO

  • Well, if you put those -- I mean, those have some impact on our roll forward schedule.

  • But if you look at the magnitude of that compared to our total claims payments in a year, it is very small.

  • So, it really does not impact what we've said, you know, where last year we were seeing cost trends in the 10 to 11%, and this year is coming in just slightly below 10%.

  • Christine Arnold - Analyst

  • And then switching gears, can you give me the dollar value in-house versus out of house claims in your medical payables category?

  • David Colby - CFO

  • I don't have those immediately available.

  • But we do run between five and six days of inventory in-house.

  • Christine Arnold - Analyst

  • So, it is five to six days now.

  • What was it a year ago?

  • David Colby - CFO

  • That has been pretty stable.

  • Where we've seen over the last two years, we've taken over 10 days out of the average time between service date and pay date.

  • Almost all of that time has come out from the date that our member receives service to the date that we get a clean claim to process.

  • Leonard Schaeffer - Chairman & CEO

  • See, this is a big issue, we talked about it last year, maybe the year before.

  • What we found, through our amazement was that the time it takes to pay a claim is most heavily influenced by the passage of time between the delivery of care and the submission of the bill.

  • Christine Arnold - Analyst

  • It's down 10 days over what period of time?

  • I'm sorry?

  • Leonard Schaeffer - Chairman & CEO

  • I'm sorry?

  • Christine Arnold - Analyst

  • It's down 10 days over what period -- a year, two years?

  • David Colby - CFO

  • Over the last two years.

  • Correct.

  • Christine Arnold - Analyst

  • OK.

  • And then the final question...

  • Leonard Schaeffer - Chairman & CEO

  • So, that's what we're trying to get at and that's why we have put all this money into the hardware and software we're making available to physicians to try to reduce that gap.

  • Christine Arnold - Analyst

  • Right.

  • And then final question is, is there any prior period development that you can talk about in the second quarter related to the first quarter?

  • David Colby - CFO

  • Well, there will always be, because if you look at the magnitude of positive development that we consistently have, you know, that -- we use a very standard, very consistent reserving methodology of booking to the high end of our actuarial range.

  • So, obviously, just like the first quarter had some positive development from December 31st, the second quarter would have positive development from March 31st, probably, very similar to what we've experienced every quarter.

  • Operator

  • Our next question comes from Patrick Hojlo with CSFB.

  • Patrick Hojlo - Analyst

  • Good morning guys.

  • I wanted to ask a question about medical cost trends.

  • You mentioned there were some areas of though pharma span that were up, and you were able to counter that with some effective generic substitution.

  • Can you give us a little detail in what areas of pharma were up, was it the impact of the OTC switches we saw last year that are anniversarying or the one in particular, rather, or anything else?

  • David Colby - CFO

  • Well, yes.

  • I mean there is a combination.

  • You know, clearly new drugs get introduced.

  • We do have the wearing off of the favorable impact of non-sedating antihistamines and hormone replacement therapy.

  • We've offset it by, you know, better generic penetration in things like statens and antidepressants.

  • But we really are looking forward.

  • Rob Simon and his people are focused on getting our members more accustomed to talking to their doctors about generic alternatives.

  • Because if you look at the pipeline coming up, starting in 2005, but really in 2006 and beyond, there is some major drug categories that move to generic and we want our members today to start getting more comfortable with talking to their physicians about generic substitution because that's when we'll have even a bigger benefit.

  • Leonard Schaeffer - Chairman & CEO

  • The decreases that I mentioned in my comments on generics, as a result of generics, are the antidepressants and the statens, specifically.

  • Patrick Hojlo - Analyst

  • Yes.

  • Any uptick this quarter in the radiological imaging or radiological diagnostics area?

  • David Colby - CFO

  • No.

  • I mean, obviously as I said, out patient ancillary services are our fastest-growing segment.

  • But that's actually from the 2003 level, one of the reasons for the slight decline in trend.

  • We've seen a little bit of reduction there in the rate of increases; it's still our highest new growth number.

  • Patrick Hojlo - Analyst

  • Sure.

  • One last quick question.

  • Given the fact that you had some of these one-time negative reserve developments in the first half of this year from late '03, safe to say that your current run rate of earnings is even better than it looked in the first half of the year.

  • And, therefore, your guidance for the second half of the year is pretty conservative?

  • David Colby - CFO

  • Well, I mean, our guidance is our guidance.

  • I think, we tended to be conservative just like the way we run the company.

  • But it obviously, we don't expect to have another $32 million of negative development on flu claims.

  • I think, you know, the flu season is over.

  • We should have gotten most of those claims by now and so -- I mean -- what you said is probably correct.

  • Operator

  • Our next question comes from Eric Veiel from Wachovia.

  • Eric Veiel - Analyst

  • Sorry.

  • Hi.

  • Just a quick question here.

  • The 2001 and 2002 MCR pattern as we went through the year was pretty consistent and it goes back further than that where the trend was slightly better as we got into the third and fourth quarter.

  • That reversed a little bit in 2000 -- I'm sorry -- deteriorated a little bit in the back of the year.

  • That reversed a little bit in 2003 where the MCR got better in the back half.

  • This year, we're expecting it to go to the more consistent pattern.

  • So the comparisons in 3Q and 4Q might look a little difficult.

  • Can you just speak to those now so we can get those explained before they come and people talk about it at that point in time?

  • David Colby - CFO

  • Yes.

  • I mean, I think normally what we would tend to see is a -- because of the seasonality, the way we price them and the movement over the recent years to more deductibles, we tend to have a little bit lower medical care ratio in the beginning part of the year and then toward the, you know, end of the year, you'll see a slightly higher medical care ratio, particularly, you know, in the fourth quarter where people who have potential for elective procedures would try to get it done if they met their deductible.

  • They want to get it didn't in December before a new deductible starts.

  • So, you do sew that trend.

  • You know, last year, if you remember our calls, we did see slightly better performance than we did.

  • A lot of that was due to some mixed changes.

  • We talked about the number of lapses of customers that ran significantly higher medical care ratios than our existing books of business.

  • And so, I mean, you can't count on that occurring every year.

  • So, there may be a little bit tougher comparison.

  • But it will still follow the trend that we really think occurs.

  • Leonard Schaeffer - Chairman & CEO

  • This goes back to the earlier comment about mix.

  • We're focused on achieving certain goals, but if you sell more than you expected of one thing and you had changes in the mix, it has an impact.

  • But so that's the good news that, you know, sometimes alters these numbers.

  • But net of mix, Colby has it right.

  • Eric Veiel - Analyst

  • OK.

  • Glad Dave has it right.

  • Then just a quick -- my second question is a two small part follow-up.

  • The new business from the UCLA and UC Santa Cruz that you're expecting in the third quarter, if you could just let us know, guys, if that's at risk or fully insured -- or self-insured.

  • And then, Dave, if you could just give us a cash flow on operating cash flow and CapEx update for the full year?

  • Leonard Schaeffer - Chairman & CEO

  • That's a risk business, but recall these are students.

  • So, it is a small premium.

  • These are young, healthy people that are a full-risk business.

  • And the other is for you, Dave?

  • David Colby - CFO

  • In terms of operating cash flow, we are running, on a year-to-date basis on operating cash flow, ahead of, last year, which we expect to continue.

  • And so, I would maintain our guidance of $1.5 billion to $1.6 billion in operating cash flow.

  • I think we're running right on it.

  • In terms of, CapEx, I think, we were in the first, half of the year about $112 billion.

  • I think we'll come pretty close to what our guidance was about $200 million for the year.

  • Almost all in data systems and applications.

  • Operator

  • Our next question comes from John Szabo with CIBC World Markets.

  • John Szabo - Analyst

  • Good morning, thanks.

  • Two quick questions just on the apparently divergence between the in-group disenrollment and growth of jobs in the economy.

  • Could you just provide a little color as to what might be happening there?

  • David Colby - CFO

  • You know, the early -- it was somewhat surprising and we don't have a good answer for it.

  • It was the one thing on the enrollment side that was, you know, different than what our guidance was.

  • We had certainly budgeted and expected that the historical declines that we saw last year in existing accounts would moderate.

  • We have seen it starting to improve actually.

  • But the second quarter, it was negative.

  • Now what happens sometimes is that large groups, you know, do, you know, clean up their first quarter, enrollment stuff that runs through in the second quarter.

  • We also had, you know, particular cases, if you remember the commercials the grocery store workers when they signed a contract, we had lost those members and go them back.

  • But we got back fewer than what we originally had and that would show up as negative, you know, in-group change.

  • But it is surprising number and one that we do really believe based on all the economic data that we see.

  • We don't think we'll be fighting that headwind the rest of year.

  • John Szabo - Analyst

  • Could you Just to clarify, Dave.

  • The 47,000, was that only in large group or was that across the board?

  • David Colby - CFO

  • It wasn't only in large group, but it was primarily in large group.

  • John Szabo - Analyst

  • OK.

  • So, small employers still may be a little ahead of the large employers in terms of that stabilization?

  • David Colby - CFO

  • Possibly.

  • John Szabo - Analyst

  • OK.

  • And then just on the merger, did you incur significant merger-related costs in the quarter?

  • I mean, was that capitalized or --

  • David Colby - CFO

  • No.

  • We have been expensing, you know, those amounts and I think in the second quarter, it was about $12 million.

  • John Szabo - Analyst

  • OK.

  • And then, Dave, you mentioned on the share repurchase, the -- you said that you'd require Anthem approval.

  • Could you just talk a little bit about...

  • David Colby - CFO

  • Technically under the merger agreement, I think we would have to get Anthem approval.

  • But I am, you know, very confident that they would have no problem with us buying our stock at this price.

  • Operator

  • Our next question comes from William McKeever from UBS.

  • William McKeever - Analyst

  • Yes.

  • I had a question about the roll forward schedule.

  • For the first six months of the year, you are at $241 million as the table shows.

  • That's less than where you were in the six months of 2003.

  • So, still a favorable development, but since it's a smaller number, you had a bit of a headwind.

  • So it showed some very good results.

  • But my question has to do with, in the future, that because we're seeing somewhat of a deceleration in premiums, a deceleration in costs that you might not have as favorable positive developments going forward.

  • So, to some extend you've got some headwind or maybe that's not the right way to look at it, that you expect that over time that that absolute dollar amount of favorable developments from prior periods says at about the same level.

  • I'm just trying to think of will this number decline again in the future as you -- as it did in this six months, given the dynamics of the industry are that premium rates are slowing and we're not going to get the kind of deceleration medical costs in 03 that we saw.

  • David Colby - CFO

  • Bill, I think that is a good question because, you know, again, I think a lot of, you know, investors sort of confuse actuarial assumptions used for pricing, which is sort of a prospective look versus the retrospective view of what we're, your claims.

  • You know, declining, trends does not really impact the roll forward schedule that much because you're looking at, you know, historical claims and historical experience and trying to estimate it.

  • So, you know, I don't think you'd see, you know, dramatic uptick or down tick in terms of development based on, you know, whether, costs are increasing or decreasing unless you saw -- I mean, if we go from a year where cost trends went from 10% down to 3%, I think you could see something like that.

  • But we're not talking about big changes -- I mean these are very gradual.

  • But, you know in terms of total dollars, you know, still large.

  • But I don't think it really impacts, you know, this point of time estimate of what claims work.

  • It is much more impacted by things like, for example, if because of HIPAA, you know, providers have been a little bit slower getting us claims and, therefore, we didn't factor that in, then we could have a little bit more, you know, moderately adverse development than we, would normally anticipate.

  • I think -- so, I don't think the trends going up or down really, you know, impact that very much.

  • We still use a very consistent, you know, conservative methodology of basically booking actually high end of our actuarial range.

  • Operator

  • Our next question comes from Scott Fidel with JP Morgan.

  • Scott Fidel - Analyst

  • Yes.

  • Hi.

  • Thanks.

  • Good morning.

  • I actually want to just piggyback on those questions on the roll forward and just the primary component that you talked about with that physician HIPAA trends.

  • Specifically wondering, if you could first explain the HIPAA protocols that actually changed in November.

  • Then also if there was any differences in claim submission between some of docs that are on electronic trends passing at this point or paper.

  • Then also, just how you've seen those claims submissions trend out between the first quarter and the second quarter relating to that issue.

  • David Colby - CFO

  • Complicated question.

  • Let me see if I can explain it.

  • First, I think the HIPAA standard transaction codes went in place October 16, 17 or 19, somewhere around that timeframe.

  • Those were fairly, you know, significant.

  • If you follow the, you know, news, I mean it did really require anybody who submitted claims electronically to use new definitions and new standard codes.

  • While I think a lot of hospitals have gotten pretty good at that because of Medicare requirements for it, a lot of doctors offices, particularly those that use mom and pop billing operations were having difficulties, along with some of the major clearing houses, having difficulty getting all of the programming done.

  • And even though I think CMS or HHS sort of gave a pass to people, by saying they wouldn't prosecute people who didn't submit HIPAA compliant claims, I think it did cause some slowdown as people were working to make sure those were implemented and tested properly.

  • Of course, some who didn't want to and couldn't get their systems HIPAA compliant, could get around it by just dropping a paper claim, which we really did not see a huge, increase thereof which we were, concerned on.

  • But it did have some effect of slowing down payments.

  • But I think we're back to, more of a steady state now.

  • You don't hear about people complaining about HIPAA, except for some isolated clearinghouse problems sometimes.

  • Scott Fidel - Analyst

  • OK.

  • And then, I think, the way I remember is that -- was that CMS was going to actually implement these HIPAA protocols in a series of stages, and just wondering whether that was the last stage or whether we have some more of those to come.

  • And if so, that might -- you know, the actuaries will probably factor that into their assumptions given what happened in October?

  • David Colby - CFO

  • I think there are other HIPAA requirements that have to do it security and privacy, along with the standard transaction codes.

  • The standard transactions code is really is what affects the billing side.

  • Leonard Schaeffer - Chairman & CEO

  • The dynamics of this turedn out to be more complex than I think anybody expected.

  • Because the assumption for hospitals and for health plans is that, you know, we have the size and the staff to make these changes ourselves.

  • When you get the smaller physicians offices, sometimes the offices that have sometimes the clearinghouses and the coordination there was not all that good.

  • So there are some physicians who believe they submit it on time, and actually it was a hold-up at the clearinghouse that was not communicated to the physician or us because they had some kind of a problem in dealing with their aggregation process.

  • And its just -- there are lot of players in this process and not all the players were as they though they're going to be.

  • So, I think that's what happened and that's why it was hard to spot.

  • Operator

  • Our next question comes from Joseph France with Bank of America.

  • Joseph France - Analyst

  • Thank you, David.

  • The 540,000 new sales were sales that were counted in the current quarter or July 1st to January 1st?

  • David Colby - CFO

  • Those were sales of new lives that we brought up in during the second quarter of 2004.

  • Joseph France - Analyst

  • What was the breakdown between risk and non-risk?

  • Leonard Schaeffer - Chairman & CEO

  • I think I had mentioned it.

  • David Colby - CFO

  • Yes, I think 491,000 were insured and 49,000 were ASO.

  • Joseph France - Analyst

  • Great.

  • If you had 47,000 in in-group losses, that implies a significant number of lapses, and I apologize, if Len said to whom and where those losses were, but I'm just curious.

  • David Colby - CFO

  • I don't think I have a detailed analysis of where, you know, what carriers took those lives.

  • I mean, but we did have, you know...

  • Joseph France - Analyst

  • Were they dozens of accounts or just a handful of small -- large ones or...

  • David Colby - CFO

  • It was -- there was no, big large ones.

  • It was...

  • Leonard Schaeffer - Chairman & CEO

  • We call it in-group change and ...

  • David Colby - CFO

  • Those are lapses.

  • Leonard Schaeffer - Chairman & CEO

  • I'm sorry.

  • David Colby - CFO

  • He is asking for the 500,000 lapses.

  • Leonard Schaeffer - Chairman & CEO

  • Right.

  • Joseph France - Analyst

  • OK.

  • David Colby - CFO

  • Actually they went some place else.

  • I think you see in periods of time when medical costs are rising, our customers do, go out to bid more often and make sure they get the best deal they can.

  • Joseph France - Analyst

  • Were your costs...

  • David Colby - CFO

  • Despite our insurance commissioner, California is a very competitive insurance market.

  • Joseph France - Analyst

  • Well, your rate increases don't seem that out of line with the rest of the industry.

  • I'm just curious of it, how is that that would lose that many lives to another vendor at this point.

  • Leonard Schaeffer - Chairman & CEO

  • Well, it also has to do with pricing discipline.

  • You know, we set our prices and we stick to them, and there is a lot of negotiation that goes on with -- others might want to come in and offer lower prices, if that happens -- it happens.

  • But -- and we maintain the discipline I mentioned earlier, and that's how we get the consistent result over time.

  • Operator

  • Our next question comes from Michael Baker with Raymond James.

  • Michael Baker - Analyst

  • Yes.

  • In the past, we've seen WellPoint from time to time take aggressive actions to address price inefficiencies such as your action on Claritin.

  • Are you seeing any excesses, kind of, emerging and, if so, what are your plans to address those?

  • David Colby - CFO

  • As Leonard pointed out, we're doing a lot, Simon and his group on the pharmacy sides are trying to come up with more significant plans there.

  • We are implementing higher deductible plans that are HSA compatible and coupling that with things like our care advocate plan, where we actually help our members identify high-quality cost-effective providers and star channeling our members through information to those better outcome providers which, in our cases is almost always lower cost if we can get the right care at the right time at the right place.

  • Leonard Schaeffer - Chairman & CEO

  • There is a very significant difference in both the price and the rate of increase in generic drugs as opposed to brand name drugs.

  • And this GenRx. program, if we can convince physicians who make the decisions that the generic drugs are out there and they are whether medically appropriate to prescribe them, it will, over time, have a very substantial impact.

  • But it is an education process and its also a process where we don't want to interfere with the physician's discretion.

  • If he or she thinks the brand name is appropriate, then that's what's going to happen.

  • But, overtime, what I think we're going to see is more generic drugs used and that will reduce both absolute cost and rate of increase overtime.

  • That is a very significant change.

  • Michael Baker - Analyst

  • And then just one follow-up, could you update us in terms of how the selling season is going with respect to your PBM?

  • Leonard Schaeffer - Chairman & CEO

  • Yes.

  • I think we're on track with the PBM.

  • Again, it has to do with mix.

  • We lost a while ago a big account that did not have any impact on members; it didn't have any meaningful impact on the bottom line.

  • So, I think from a financial point of view, we're doing very well and the issue for us is that a lot of the activities that PBM does is not branded with our name.

  • We sell to other parties.

  • So, you don't hear about it, and we don't make a big deal out of it.

  • People are walking around with cards in their wallets that have other people's names on it, but we're getting the business behind the scenes.

  • Operator

  • Our next question comes from John Rex with Bear Stearns.

  • John Rex - Analyst

  • Yes.

  • I was wondering if you could help us understand your expectations in terms of being able to continue a meaningful reduced cycle times -- claim cycle times fee over the next 12 months, if you look at the initiatives you know about now, that you have in place, how should we think about this going forward in terms of, kind of, the impact we saw this quarter.

  • Is that an impact you expect to kind of a level you could sustain for several quarters, or is it somewhat outsized and you wouldn't look for that level?

  • Just what are your own internal targets in terms of bringing in the cycle time for that timeframe?

  • David Colby - CFO

  • Well, I've always said that my personal goal would be getting it down to zero times, where we can do everything on an online real time basis to a point of service, ID card almost.

  • But obviously, that's not realistic, given physician adoption rates.

  • If you look over the last two years, we have taken 10 days out of that cycle time.

  • I'd like to try to continue that trend.

  • Obviously, I think some of the lower hanging fruit we've gotten and it's going to be tougher to get that kind of improvement each and every year and quarter.

  • But I think, we have the opportunity to come down.

  • I think again because of our market position that we are in most of our markets, the number one health plan, doctors and hospitals are willing to work with us to try to speed it up because we are an important percentage of their business.

  • So we have the advantage of -- we get their attention, as opposed to we're just, one of 20.

  • Leonard Schaeffer - Chairman & CEO

  • We do our customer segmentation.

  • We go through, you know, what people want.

  • Physician's and hospital's number one priority is to be paid timely and accurately.

  • And so, you know, Dave is right.

  • We would like to be able to do it online real time.

  • For a bunch of reasons, you know, it will take a while to get there.

  • But we will continue to try to reduce this cycle time.

  • And the biggest piece of it is the gap between the data service and the data submission.

  • We don't control that, but we're working with the hospital partners to try to make that happen much more quickly.

  • And part of the reason we have given away $42 million -- will give away $42 million worth of hardware and software is to expedite that process.

  • That is the big gap.

  • John Rex - Analyst

  • I mean, do you think if you look over the next 12 months, would assuming another five-day reduction in the next 12 months be too aggressive given the low-hanging fruit has been reached and we should think something a little bit lower?

  • I'm trying to get a sense on the expectations.

  • David Colby - CFO

  • You know it is just hard to say that, you know, we've hit the point of diminishing returns, yet, because there still are opportunities.

  • We're implementing new things to try to improve getting a clean claim the first time by better up-front edits rather than having to send stuff back.

  • So we still have a lot of initiatives.

  • And I think we can continue to bring it down.

  • Operator

  • Ladies and gentlemen, thank you for joining us today.

  • This concludes our conference call.

  • You may now disconnect.