Elevance Health Inc (ELV) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Wellpoint conference call.

At this time, all lines are in a listen-only mode.

Later there will be a question-and-answer session and instructions will be given at that time.

(Operator Instructions).

As a reminder, this conference is being recorded.

I would now like to turn the conference over to the company's management.

Good morning and welcome to Wellpoint's second quarter earnings Conference Call.

I'll Michael Kleinman, Vice President of Investor Relations.

With me this morning are Angela Braly, our Chair, President, and Chief Executive Officer, and Wayne DeVeydt, Executive Vice President and Chief Financial Officer.

Angela will begin this morning's call with an overview of our second-quarter results, actions, and accomplishments.

Wayne will then offer a detailed review of our financial performance, capital management and current guidance which will be followed by a question-and-answer session.

Ken Goulet, Executive Vice President and President of Our Commercial Business and Brian Sassi, Executive Vice President of Strategy and Marketing and President of our Consumer Business are available to participate in the Q&A session.

During this call, we will reference certain non-GAAP measures.

Our reconciliation of these non-GAAP measures to the most directly comparable measures calculated in accordance with GAAP is available on our Company website at www.Wellpoint.com.

We will also be making some forward-looking statements on this call.

Listeners are cautioned that these statements are subject to certain risks and uncertainties, many of which are difficult to predict, and generally beyond the control of Wellpoint.

These risks and uncertainties can cause actual results to differ materially from our current expectations.

We advise listeners to review the risk factors discussed in our press release this morning and in our quarterly and annual filings with the SEC.

I will now turn the call over to Angela.

Thank you, Michael, and good morning.

Today, we're pleased to report second-quarter 2011 earnings per share of $1.89, which included net investment gains of $0.06 per share.

Earnings per share in the second quarter of 2010 totaled $1.71 per share, and included net investment gains of $0.04 per share.

Excluding the net investment gains in each period, our adjusted EPS was $1.83 for the second quarter of 2011, an increase of 9.6%, compared with adjusted EPS of $1.67 in the same period of last year.

Our second-quarter results exceeded our forecasts and reflected the significant administrative cost savings that we've been able to achieve through our continued improvement and efficiency initiative.

Our performance continues to be strong in our Commercial segment and in the capital management areas of the Company, while we are experiencing lower than expected results in our senior business this year.

Based on our second quarter results, today, we're raising our full year 2011 earnings per share guidance to a range of $6.90 to $7.10 on a GAAP basis, which includes $0.15 per share of net investment gains realized during the first half of the year.

On an adjusted basis, or excluding the net investment gains, our full year EPS guidance equates to a range of $6.75 to $6.95.

Our medical enrollment totaled nearly 34.2 million members as of June 30, 2011.

Membership was stable on a sequential basis in the quarter as we've achieved organic membership gains in our State-Sponsored and Senior programs, which were substantially offset by in-group membership attrition in the Commercial segment.

While we have experienced negative in-group change during 2011, it has been much lower than the in group losses we experienced in 2010.

Unfortunately, the economy remains challenging, and we expect to continue experiencing modest attrition throughout the second half of this year.

We currently anticipate ending 2011 with 33.9 million members.

As we look ahead to 2012, while we're not projecting an economic rebound, we are optimistic that the headwind of negative in group membership change will further abate.

We also expect to maintain our leadership position in the national accounts marketplace.

The current national accounts selling season has been very active, with many large customers conducting formal RFPs, including several of our existing accounts.

The marketplace continues to be significantly focused on the ability of health plans to deliver positive medical costs and we continue to be very well-positioned in this area.

We already have a number of new sales for January 1, 2012.

We're remaining disciplined in our national accounts pricing for both new business and renewals and as a result, we expect to lose some targeted accounts that are currently unprofitable.

Overall, we expect our national account membership to remain stable next year and our national account operating margin to expand.

Operating revenue totaled approximately $14.9 billion in the second quarter of 2011, an increase of $681 million or nearly 5% from the second quarter of 2010.

This was driven by premium increases designed to cover overall cost trends and membership growth in the senior business and in the federal employee program.

These increases in revenue were partially offset by a decline in fully-insured commercial memberships.

Overall, the marketplace is competitive but generally rational, and most competitors appear to be adjusting to minimum medical loss ratio requirements as we expected they would.

Our benefit expense ratio was 85.7% in the second quarter of 2011, an increase of 280 basis points from 82.9% in the second quarter of 2010.

The increase was driven by higher benefit expense in the senior business and lower prior period reserve development.

Medical costs in the senior business have been significantly higher than we expected in 2011 due to higher membership growth and adverse selection in certain Medicare Advantage products.

This issue is particularly impacting us in Northern California, where one of our PPO products has attracted more seniors with a higher risk profile than we anticipated, due in part to a competitor's exiting from the market.

The higher-than-expected costs we're incurring in Medicare Advantage this year are being partially offset by increased risk pool revenue and we are addressing this issue through our Medicare Advantage bids for 2012.

In the second quarter of 2010, we recognized an estimated $100 million of higher-than-anticipated favorable prior year reserve development, while we modestly strengthen reserve in the second quarter of 2011.

Our local group benefit expense ratio increased from the second quarter of 2010 due primarily to changes in prior period reserve development.

Our Commercial Benefit Expense Ratio was stable on a year-to-date basis as the impact of lower prior period reserve development was offset by lower-than-expected underlying medical cost trends during the first six months of 2011.

We continue to project that underlying medical cost trend in our local group business will be at the lower end of our 7.5%, plus or minus 50 basis points, range for the full year of 2011.

Utilization has remained lower than we anticipated.

We're experiencing an increase in the intensity of services and continue to anticipate that medical trends will increase during the remainder of 2011 and we continue to price our business accordingly.

Providing access to affordable quality healthcare for our members is our highest priority.

We recently announced a new approach to reimbursing hospital partners that will shift payment reimbursement from the current system to one that rewards value, by linking rate increases to hospital improvements in safety, quality, patient care, and outcomes.

Moving forward, our approach to hospital reimbursement will ensure that rate increases are tied to demonstrated improvements in quality, safety, and service and we will reward hospitals that perform highly on 51 nationally-accepted indicators of treatment quality.

Our formula for measuring quality of care is based 55% on health outcome, 35% on patient safety measures, and 10% on patient satisfaction.

It includes indicators such as effective treatment of heart attacks and pneumonia, and whether a safety checklist is followed, and how satisfied the hospital's patients are with their treatment.

We've already completed more than 200 hospital contract negotiations thus far in 2011 and we're having success with many agreeing to lower rate increases than they had received in prior years, or where an appropriate increase is made, it is based on quality performance scores.

We'll continue to work closely with our hospital and physician partners to develop sustainable solutions that reward value, promote safety, and provide fair reimbursement, while improving the quality and affordability of care for our members.

As we announced during the quarter, our future efforts in this area will be lead by Dr.

Harlan Levine, who recently joined Wellpoint as Executive Vice President of Comprehensive Health Solutions.

Dr.

Levine brings a unique combination of business and clinical experience to Wellpoint, making him ideally suited to lead our healthcare value efforts into the future.

He will be responsible for clinical program development, provider engagement and contracting, quality and outcome evaluation, care management, pharmacy management with Express Scripts and the work of our Health Core Medical Research subsidiary.

We're very pleased to have Dr.

Levine joining our executive team.

I'd also like to thank Dr.

Sam Nussbaum, our Executive Vice President and Chief Medical Officer for his invaluable leadership of Comprehensive Health Solutions over the last nine months.

Sam will continue to play a vital role for Wellpoint by overseeing corporate medical and pharmacy policy, serving as a key spokesperson and policy advocate for the Company in many external forums and helping us build out our international and healthy care solutions future growth strategies.

We intend to capitalize on new opportunities for growth in the changing healthcare marketplace by investing strategically in our core insurance businesses, expanding with purpose into new complementary areas, and developing new products and services that positively impact the way customers access care in the future.

Consistent with these objectives, during the second quarter we announced the acquisition of CareMore Health Group, a focused healthcare delivery program that includes Medicare Advantage plans and care centers designed to deliver proactive, integrated and individualized healthcare to seniors.

We believe the senior market will be a growth area for Wellpoint, and we believe CareMore's leading programs and services are providing Medicare recipients, quality care through a hands-on approach to care coordination and intensive treatment of chronic conditions.

This model enhances the ability to create better health outcomes for seniors by engaging members on the front end of our relationship through comprehensive health screenings and enhanced preventive care.

It also improves the ability to document metrics related to Medicare Advantage risk adjustment payments, and leads to higher quality star ratings that will be an increasingly important part of the Medicare program in the future.

We're excited about welcoming the CareMore team to Wellpoint and expanding this model of care to new senior markets across the country.

We recently received anti-trust clearance for this transaction and continue to expect that it will close by the end of this year.

We've also prioritized the state sponsored market as a growth area for our Company.

We've added 82,000 members to our state sponsored program so far this year and there is a robust cycling of new Business potential in this marketplace.

our goal is to be a valued partner for state, seeking cost efficient solutions to maintain Medicaid programs and insure high quality of care for beneficiaries over the long term.

Our managed care programs have enhanced healthcare quality for Medicaid recipients while reducing program costs in several states and we must insure that any new programs we enter will appropriately recognize the value we can bring to the healthcare system.

While our state sponsored performance has been in line with our expectations through the first six months of the year, we've lowered our full year outlook for this Business as we continue to see state budgetary pressures and expect reductions in reimbursement levels and more stringent program requirements.

Longer term, we remain optimistic about the membership and revenue growth outlook for state sponsored business.

We continue to believe there are opportunities to grow profitably within our 14 blue states and outside of them, including potentially as a partner to some of our fellow Blue Cross and Blue Shield plans that traditionally have not participated extensively in the Medicaid business.

As one of the nation's largest Medicaid managed care plans, we have significant infrastructure and expertise that can be leveraged effectively by other plans similar to how we're currently working with Blue Cross Blue Shield of South Carolina to serve members in that state's Medicaid program.

We'll continue to discuss how the upcoming Medicaid expansion may impact other Blue plans and how we could design and implement programs at an at-risk or ASO basis to serve this population.

As we strive for future growth and continue to serve new customers, we remain committed to our objectives of excelling at day-to-day execution and continuously improving as an organization.

We have invested significantly in our Company-wide efficiency and process improvement initiatives over the last two years, and our efforts are paying off.

Year-to-date through June, we've reduced our selling, general and administrative expenses by $241 million, or over 5%, and our SG&A ratio has declined by 110 basis points to 13.8%.

We accomplished this while growing membership by 694,000 or 2.1% over the past 12 months, and maintaining a very high level of service to our customers.

In fact, we're seeing stabilization or improvement in a number of service-related areas such as our Commercial claim inventory levels which remain low and generally consistent with the levels we were tracking one year ago.

Our EDI rate or the percentage of claims we received electronically has exceeded 90% every month this year, and our auto adjudication rate or the percentage of clients who process without manual intervention is approximately 80%.

Our member cost satisfaction scores continue to exceed our goal as over 70% of the service calls we receive are getting resolved the first time and we continue to foster increased usage of our website, both with our providers and our members.

We remain committed to growth, continuous improvement, providing high quality products and services to our members, and creating the best healthcare value in our industry.

By executing on these strategies, we now expect to achieve higher results in 2011, and believe that we can grow from these levels in the years ahead.

We continue to anticipate that our Business model will support earnings per share growth of at least 10% on an annualized basis over the next few years.

We expect to continue attracting new customers through our unique assets and capabilities, which includes the industry's most recognizable brand name, deepest local market connections, and the most comprehensive and cost-effective provider network.

These are differentiated assets that are driving success in today's environment and positioning us to continue leading in the marketplaces of the future.

We also expect to realize greater administrative savings and efficiencies in the years ahead as we continue to execute on our plans to standardize products, systems, and processes across our Company.

Most importantly, we will remain relentlessly focused on optimizing the cost and quality of healthcare in our communities because we know that as we create greater value for our current and future customers, we will drive increased value for our shareholders.

I'll now turn the call over to Wayne to discuss our financial results and updated outlook in more detail.

Wayne?

Thank you, Angela, and good morning.

Premium income was $13.9 billion in the second quarter, an increase of $657 million or 5% from the prior-year quarter.

This reflected premium increases designed to cover overall cost trend and membership growth in the Senior and FEP businesses, partially offset by a decline in fully-insured Commercial membership.

Administrative fees were $958 million in the quarter, an increase of $35 million or 4% from the second quarter of last year, driven by growth in self-funded membership.

As of June 30, 2011, approximately 60% of our medical enrollment was self-funded and 40% was fully-insured compared with 58% and 42% respectively as of June 30, 2010.

Overall membership was slightly higher than we expected at June 30, 2011, although we expect modest in-group attrition to continue over the last six months of the year.

We currently anticipate that we'll end 2011 with 33.9 million members and that full-year operating revenue will be just under $60 billion.

The benefit expense ratio for the second quarter of 2011 was 85.7%, an increase of 280 basis points from the same period of 2010.

As Angela described, this increase was driven by higher benefit expense in the senior business and lower prior period reserve development.

We now expect our benefit expense ratio to be in the range of 85.1% to 85.3% for the full year of 2011, which is an increase of our prior guidance,primarily due to the senior business.

We continue to anticipate the underlying local group medical cost term will be at the lower end of our 7.5% plus or minus 50 basis points range for the full year of 2011.

For the rolling 12 months into June 30, 2011, medical trend continued at lower than expected levels.

Inpatient trend is currently in the high single digit range.

Outpatient trend is in the mid to high single digit range.

Physician services trend is in the low to mid single digit range and pharmacy trend is also in the low to mid single digit range.

Unit cost increases continue to drive overall medical cost trend, as utilization has been stable to declining in all categories except pharmacy, which is modestly higher.

We are experiencing higher acuity of services in certain areas as evidenced by the fact that our inpatient admissions per thousand members are down, but the average length of stay has increased.

We continue to implement new programs and strategies designed to optimize medical cost and quality for our customers.

We're also making significant progress reducing our SG&A expenses while continuing to provide excellent customer service.

Our SG&A expense ratio is 13.5% in the second quarter of 2011, a decrease of 170 basis points from the second quarter of 2010.

We reduced our SG&A expenses by $144 million or almost 7% in the prior-year quarter while serving 694,000 more members and growing operating revenue by nearly 5%.

The reduction of SG& expense was driven by execution of our ongoing efficiencies and continuous improvement initiatives and lower incentive compensation expense.

Turning to our reportable segments, commercial operating revenue was $8.6 billion in the second quarter of 2011, a $184 million or 2% increase from the second quarter of 2010.

This reflected premium increase is designed to cover overall cost trends/ partially offset by a decline in commercial fully-insured membership.

Commercial segment operating gain was $747 million in the second quarter of 2011, in line with our forecast and up slightly from the prior year period.

The benefit expense ratio for local group business increased from the second quarter of 2010, primarily due to lower prior period reserve development.

An estimated $40 million of higher than anticipated favorable prior year reserve development was recognized in the commercial segment during the second quarter of 2010 while we modestly strengthened reserves in the second quarter of 2011.

This change in reserve development was offset by lower than anticipated underlying medical cost trend in the second quarter 2011 and reduction in selling general and administrative expense.

For the six months ended June 30, 2011, operating gain in the Commercial segment totaled $1.9 billion, an increase of $148 million, or almost 9% in the prior year period, while operating margin expanded by 110 basis points.

This improvement was driven by a reduction in year-to-date SG&A expense ratio.

The commercial benefit expense ratio was stable with the prior year-to-date period as the impact of lower prior period reserve development was offset by lower than expected underlying medical cost trends during the first six months of 2011.

Our consumer segment operating revenue totaled approximately $4.4 billion in the second quarter of 2011, increasing by $361 million or 9% in the second quarter of 2010.

This was driven by premium increases designed to cover overall cost trends and membership growth in senior.

Operating gain for the consumer segment was $177 million in the quarter, a decrease of $124 million or 41% compared with the second quarter of last year.

This was driven by the higher than expected medical costs in the senior business and also reflected a lower level of prior period reserve development in the current year quarter.

An estimated $60 million of higher than anticipated federal year reserve development was recognized during the second quarter of 2010 while we modestly strengthened reserves in the second quarter of 2011.

For the six months ended June 30, 2011, operating gain in the consumer segment was $383 million, a decrease of $244 million or 39%.

The lower operating gain in our Senior Business during 2011 has masked solid performance in our state-sponsored initiatives for the first six months of the year.

Operating gain in the other segment was $22 million in the second quarter of 2011 compared with $11 million in the second quarter of 2010.

This was driven by lower administrative expenses in the FEP business and at the corporate level.

Net investment income totaled $188 million in the second quarter of 2011, down $15 million or 7% from the second quarter of 2010 due primarily to lower interest rates on fixed maturity investments.

Investment income has continued to run favorable to our expectations through the second quarter, while raising our full year guidance to net investment income to $720 million.

Interest expense was $104 million in the second quarter of 2011, up $3 million or 3% in the second quarter of 2010, due primarily to higher average debt balances in the current year quarter.

Based on our updated capital plan, we've lowered our full-year 2011 forecast for interest expense to $435 million.

We recognized net investment gains during the second quarter of 2011 totaling $33 million pre-tax, consisting of net realized gains from sale of securities totalling $41 million, partially offset by $8 million of other than temporary impairments.

As of June 30, 2011 the portfolio's net unrealized gain position was approximately $1.1 billion, consisting of net unrealized gains on fixed maturity and equity securities totaling $628 million and $436 million respectively.

Our effective income tax rate was lower than we anticipated in the second quarter of 2011, due primarily to the final settlement of prior year tax liabilities.

We expect our effective tax rate to be just under 34% for the full year 2011.

Turning now to our earnings quality metrics.

Overall, earnings quality was higher in the quarter and included operating cash flow of $772 million or 1.1 times net income, despite making two federal income tax payments in the quarter.

We also had sequential increases in our medical claims payable balance and the data claims payable metric.

Medical claims payable totaled $5.3 billion as of June 30, 2011, an increase of $271 million or 5% from March 31, 2011.

Medical claims payables increased by $489 million or 10% from the year-end 2010.

Included in our press release is a reconciliation of Wellpoint's medical claims payable balance.

This disclosure is comparable to the reconciliation provided in our fourth quarter 2010 press release.

We report prior year redundancies in order to demonstrate the adequacy of prior year reserve.

Medical claims reserves established at December 31, 2010 developed favorably and we experienced positive prior year reserve development of $222 million during the six months ended June 30, 2011.

As we anticipated, this amount is significantly lower than the $718 million of positive prior year development we recognized during 2010, which reflects the following items.

In 2010, our pre-tax income benefited from $315 million to favorable reserve releases that did not recur during the first six months of 2011.

In 2010, we also experienced $146 million of favorable development from refunding business that did not recur during the first six months of 2011, however this goes to the benefit of our customers that does not impact our net earnings.

And our fully-insured membership declined by 1.7 million members or 11% during 2010.

We believe our medical claim reserves are conservatively and appropriately stated as of June 30, 2011.

Days and claims payable, or DCP, was 40.8 days as of June 30, 2011, an increase of 0.2 days from 40.6 days at March 31, 2011.

The increase in DCP was driven primarily by reserve strengthening, and to a lesser extent, by provider settlement activity, partially offset by changes in timing of pharmacy claim payments.

DCP as of June 30, 2011 was 1.5 days higher than at December 31, 2010.

During the first six months of 2011 we generated operating cash flow of nearly $1.9 billion, or 1.2 times net income.

In the second quarter, we utilized $715 million to repurchase 9.5 million shares of our common stock, bringing our year-to-date repurchase activity of 20.8 million shares or 5.5% of the shares we had outstanding as of December 31, 2010, for approximately $1.5 billion.

We also used $91 million to pay our cash dividend in the quarter and yesterday the Board approved a third quarter dividend of $0.25 per share.

We ended the second quarter with $2.3 billion of cash and investments at the parent Company and available for general corporate use.

We expect to receive approximately $1.5 billion of ordinary dividend from our subsidiaries during the second half of the year.

We have approximately $500 million of interest and other payments scheduled during the second half of the year, and we anticipate using approximately $900 million for share repurchases under our remaining Board-approved authorization of shareholder dividends.

We currently expect to end 2011 with approximately $2.4 billion at the parent Company.

These projections do not yet contemplate the financing of our pending CareMore acquisition which is on target to close by year-end.

Although we have sufficient cash on hand and available through our credit agreement we may fund this transaction through commercial paper or the long term debt market.

Our debt to total capital ratio was 26.8% at June 30, 2011, a decrease of 50 basis points from 27.3% at March 31, 2011.

We remain near the low end of our targeted range of 25% to 35% and continue to have a significant financial flexibility, which we value in light of the current health benefits marketplace.

We're in a strong capital position, and we will continue making strategic investments in our businesses and effectively utilizing our capital to drive long term value for our customers and our shareholders.

Moving now to our updated outlook.

We are increasing our full year 2011 guidance for earnings per share and operating cash flow based on the continued strong performance in our commercial segment and in the capital management areas of the Company, which are offsetting higher than expected medical costs in the senior business.

Specifically, we now expect that net income will be in the range of $6.90 to $7.10 per share, including net investment gains of $0.15 per share.

This outlook includes no investment gains or losses beyond those recorded during the first six months of 2011.

On an adjusted basis, or excluding the net investment gains, our EPS guidance equates to a range of $6.75 to $6.95.

Year-end medical enrollment is expected to be 33.9 million, consisting of 13.6 million fully insured members and 20.3 million self-funded members.

Operating revenue is expected to be approximately $59.9 billion.

The benefit expense ratio is now expected to be in the range of 85.1% to 85.3% and the SG&A expense ratio is now expected to be 14% with operating cash flow now expected to be approximately $2.8 billion.

We are currently in the detailed planning process for 2012.

While it is too early to provide specific guidance for next year, we currently expect earnings per share growth in 2012.

Some of the tail winds we see heading into next year include the following.

We expect financial improvement in the senior business as we modify our Medicare Advantage products and pricing.

We expect commercial fully insured pricing to be generally commensurate with medical cost trends and we anticipate fewer in-group membership losses related to the economy.

We also expect margin expansion in the national business.

We expect additional benefits from continued focus on SG&A efficiency and continuous improvement, and our repurchase activity will result in a lower diluted share count.

In terms of headwinds, we currently expect the state sponsored business may be pressured, due to state fiscal situations promotes later changes in certain markets and if interest rates remain low, our investment income may be impacted as we would be reinvesting maturing securities at lower rates.

Overall we're optimistic about Business profits in 2012 and beyond, and I'll now turn the conference call back over to Angela to lead the question and answer session.

Operator?

Please open the queue for questions.

Thank you.

(Operator Instructions).

Our first question comes from the line of Justin Lake from UBS.

Please go ahead.

Thanks, good morning.

My first question is on the Medicare side.

Can you talk about the full-year impact of what the Medicare mis-pricing resulted in, and can you give us some additional color on what type of product or geographies the issues might have been seen in, and then if we once we identify that impact here to run rate earnings, can you tell us whether or not you caught the, issue in time to reflect the higher costs fully in your bids, and if so, can we assume the full impact gets fixed for 2012?

Justin, let me speak to that.

First, we're obviously disappointed with our performance in senior.

If you look at all the other areas of the Company, we feel like we're really executing, staying disciplined there, and our continuous improvement efficiency initiatives are getting the right results and great customer service but we're disappointed about the performance in senior.

Let me address a couple of your questions and I'll turn it over to Brian to give more detail.

The full-year impact is $0.30 on an EPS basis.

Yes, we did see this before the bids were due.

Unfortunately, we can't speak in detail about the bid process for 2012, the CMS regulations don't allow us to do that, but we did see this performance deteriorate prior to the bidding process.

We think we have clarity around it so I'll turn it over to Brian who can get specific about the products where we saw this.

Okay, thanks, Angela.

Hi, Justin.

Let me just add a little more color and frame the issue.

Beginning at the end of Q1, we started to see some increased morbidity in our Medicare Advantage program.

Specifically, we've isolated the vast majority of the issue in Northern California, it impacts our regional PPO product, and looking at kind of April results and doing deep dives into it, we further isolated our issue to the new member cohort versus existing members, and further looking at all of our new Business that we've received in 2011, further isolated the issue to really being directed at switchers.

Some of our membership growth in the PPO has been agents but that appears to be performing as expected, so it's really the switcher cohort primarily in Northern California.

As Angela mentioned, we did see this emerging in early Q2.

We followed it very closely.

We have adjusted and really bid appropriately based on the emerging experience, and do expect that we will resolve this through the bidding process in 2012.

And Wayne, want to speak to that as well?

Yes, so Justin, relative to 2012, we would expect this $0.30 headwind we have for the current year impacting our current earnings would be resolved and we would expect that our previous assumptions regarding run rate and execution in other lines of business would remain consistent with our previous expectation so relative to our growth while we aren't giving guidance for next year at this point in time, we view this as an incremental benefit to our run rate because it was obviously not anticipated to be an incremental detriment to our run rate this year.

Thank you.

Our next question is from the line of Josh Raskin from Barclays Capital.

Hi, thanks.

Want to stay with the Medicare business obviously here.

So it sounds like Brian, you guys feel like you mentioned you saw this at the end of the first quarter but we didn't hear anything about that when you reported last quarter, so is it that things deteriorated significantly after the end of April and before the beginning of June, and then as I look at the California landscape, in terms of switchers and movers, I guess the Cigna exit was about 15,000 lives.

There's no one else that even lost 10,000 lives, so you guys are up about 43,000 lives in California.

I'm just sort of doing the rough math, if you got 40 basis points or something in that ballpark of MLR, I'm coming up with like $220 million.

It just seems like the MLR would be off the charts for the California cohort, so maybe just a little more color as to what exactly is happening and how come you didn't see your product being sort of mis-priced versus the others?

Josh, let me have Wayne answer the question about the timing and then Brian to add the specifics.

Yes, thanks, Josh.

I think the primary thing on the timing I want to keep in mind is that where we're seeing issue is on the switchers, not on the agents, and so for new individuals that switched over to us in January, we really don't start getting any visibility on claims until really early March.

Ultimately, they start seeing doctors in mid-late January, doctor starts meeting claims in later February but you really don't have a lot of real good data at that point for the switchers, so in March, I would say it wasn't really a huge outlier.

It was a small blip at that point but nothing of concern.

When we got April results in, we were more concerned about what we saw being more elevated claims and that's when we did our deep dive to identify where this was being driven from, and that's where we identified that it was in the Northern California location and it was really the switchers.

We then went ahead and estimated a bid process that would reflect as if that was more run rate, under the hope that wouldn't be the case and what we saw in fact was the case, so we know that now having April, May and June versus what we submit as part of the bid process, that we have always considered that activity in there and feel comfortable with that.

To your question about size and scale, $0.30 for us, if you look at number of shares outstanding equates to close to $170 million so if you're looking at numbers you're looking at close to $170 million to put that in perspective and keep in mind that the MLR in this is greater than 100% on this group of cohorts, and we are talking about a small number of members, between 40,000 and 50,000 that are basically this entire group that's impacting us, while the PPO has over 110,000 in it, it's the northern portion we're focused on.

And just to add a little more color, I think your numbers are directionally right.

As we've looked at kind of all of the new members we have the ability to look at kind of where they come from.

Certainly, the Cigna exit in Northern California, we did pick up a large chunk of that membership.

This is a regional PPO, so some of the membership growth, probably about half occurred in Southern California historically as we look at the performance of our PPO, that has been a profitable program for us, more so in Southern California and that does continue, but the Northern California cohort, particularly the new membership from some of the competitor exits, is where the problem lies.

Thank you.

Our next question is from John Rex from JPMorgan.

Please go ahead.

Hi.

A couple things.

First I want to focus on, during the course of the quarter you've often talked to how we should consider quarterly progression here in earnings and Q3 being higher than the Q2, what you typically expect the guide you'd have out today would indicate that's not the case, I guess, unless we should be expecting a dramatically lower Q4, and I just wanted to get your sense for the 2H progression here and if it's changed from the pattern you were indicating.

So Wayne, why don't you address the quarterly pattern question for John?

Yes, John.

On a quarterly progression basis now, we do expect Q3 now to be slightly lower than Q2 at this point in time, so primarily because of some of the tax benefits we received and we did take a cautious view on the back half of the year regarding senior.

Obviously we hope to do a number of medical management to potentially alleviate it.

We took a cautious view on commercial trends, that those would potentially rebound in the back half of the year, and we also took a view around some of the regulatory environment changes we were seeing out there, in particular AB 97, that could have some potential impacts as well, so for that reason, I wouldn't call it down substantially.

I'd say slightly lower than where we finished Q2 on an adjusted diluted basis right now.

Okay and then just the other thing that you'd mentioned.

I think very early in the quarter, in the Q2, you noted you were seeing some signs in your script data that would indicate that maybe utilization was edging up and I want to focus more on your commercial book rather than your Medicare book.

Was that borne out over the course of the quarter, it doesn't seem like that you saw broadly utilization coming, edging up in the Commercial book, however, and is that a fair characterization?

Yes, John.

Let me let Ken speak to the commercial book.

Performance has been good there, and so I'll let Ken talk about the commercial trends.

Thanks.

John, the second quarter did develop slightly better than we expected and we've had good performance as you can see.

I would say the utilization has been stable to declining in all categories except pharmacy, which is modestly higher, however we are expecting an uptick to occur in the second half of the year and we priced accordingly.

Your next question is from the line of Doug Simpson from Morgan Stanley.

Please go ahead.

Hi.

I guess just you guys have a history of conservatism in your guidance so to come at that question a little differently, how would you characterize your confidence in the $6.75 to $6.95 that you've laid out?

Wayne you mentioned you took a cautious view of the second half of 2011.

The seasonality would imply then really a sort of a number in the Q4 that's closer I guess to around a $1, so just how would you characterize your level of confidence in the range you've laid out?

We believe our guidance reflects our expectations.

We've always been cautious about trend in the second half of this year.

Where pricing, as Ken said, for it.

We continue to be very focused in our medical management areas and working on cost of care very intently and so we do think the guidance range reflects our best estimate.

Wayne can speak to how we looked at it for the overall year and below the line.

Yes, I mean Doug, the one thing I would say is this is a unique industry that we continue to see many state budget deficits, a regulatory environment that evolves by the day and I think it's fair to say that for those reasons, that both from an operating perspective, we generally try to err on the side that many things will come to light in sometimes a less-than optimal level of expectation, whether that occurs or not, will remain to be seen, but we would rather not have shareholder surprised by things that we see out there that are evolving that could occur.

Below the line, we have very solid confidence in those numbers, those updated guidance numbers and where that's at so I think to Angela's point, the $6.75 to $6.95, we wouldn't have guided to that range if we didn't have a level of confidence we would be able to achieve it, and we do believe that it contemplates a number of potential downsides for the back half of the year.

Thank you.

Our next question is from Scott Fidel from Deutsche Bank.

Please go ahead.

Thanks.

Just wanted to follow-up on the change in the Medicaid view that you discussed, and maybe if you can frame what the operating margins look like for Medicaid in the first half and what you're assuming for the back half of the year, or maybe what the deterioration is that you're building in, and then give us an update on what your composite rate expectation is for Medicaid for the full year and for the back half of the year.

Thanks.

Let me speak a little bit to that and then I'll turn it over to Brian, because state sponsored, our Medicaid managed care business has performed in line with our expectations for the first half of the year, but as we look out at the states and their budgetary pressures and some of the issues, specifically in California, we're expecting pressure on the reimbursement levels and tougher program requirements, so Brian, do you want to speak more specifically?

Yes, so as we looked at the second half of the year, particularly given some AB 97 in California, we did establish a reserve for potential adverse impacts of that.

Certainly, while AB 97 is a law that has been passed in California, the subject of CMS approval, that has not occurred yet.

We do know that there are a number of potential challenges to that legislation, but to be prudent, we felt that in our analysis of the law and all of the different components of it and our ability to kind of react to it, we felt that it was necessary to put up a reserve in the last half of the year, which we feel will adequately cover us.

Looking ahead, in terms of as Angela talked about, many of the states are being pressured with state budgets, a lot of which since Medicaid is either number one or number two in terms of expenditures, we do see a tightening in potential reimbursement levels and are expecting compression in the level of increase down into potentially the low single digits for next year.

Let me say longer-term, this Business is one we do think there are opportunities, we think scale, the scale that we can bring to this is important, but we are committed to staying disciplined in how we do this, so we'll continue to focus on opportunities, but will only take them where we think it's appropriate.

Thank you.

Our next question is from Christine Arnold from Cowen & Co.

Please go ahead.

Good morning.

I'd like to just talk about the starting point on the Medicare MLR.

I'm thinking around 95% this quarter and that your guidance assumes you rise to 96%, 97%, kind of in that range.

Am I ballpark in kind of my starting point and where you're going on that?

Wayne, can you address that?

Yes, Christine, we obviously don't give MLRs by lines of business.

We want to be careful at this point as we're still in the bidding process as to certain things we're allowed to discuss and not discuss as we're still working with CMS.

That being said, what I am confident in telling you is that we had obviously significant deterioration in the quarter due to the California that is over 100%.

We expect that to continue into the back half of the year, although we are putting mitigation strategies but we've taken a more cautious view on that, and we do expect to get to a normal run rate for next year on our MLRs.

Our next question is from Matthew Borsch from Goldman Sachs.

Please go ahead.

Yes, thank you.

Could I just, I just want to try to better understand the issue in the Medicare Advantage product.

In Northern California, are these members where the issue is primarily their acute health status in the fact the CMS risk adjustors don't adequately correct for those and therefore, with those types of members they need to be spread across several plans to be able to absorb the impact rather than concentrated in the way that you found yourselves with the exit of a competitor, or is it more the product premiums and the product offerings?

Brian, do you want to address that?

Yes, I think it's more the former than the latter.

If you look at the competitiveness of the RPPO product, it's generally not an overly rich product.

It's better than traditional Medicare, but it's not super rich when compared to other offerings around the country.

I think your characterization in the front of your statement is accurate.

We've had the RPPO for a number of years.

The new membership that we've received essentially doubled our Northern California membership because most of our membership has historically been in Southern California so the combination of the increased morbidity and the unique situation with competitors exiting and potentially not gathering or knowing that in advance, maybe not gathering the optimal risk data that would impact risk scores in 2011 have created kind of a unique situation for us.

Of course, some of which, it's a calendar year issue, as we see increased morbidity over a population, it's difficult to correct that in the current calendar year but certainly, that increased morbidity and our ability to provide the data to CMS could have a positive impact into next year's final settlement that we receive in 2012 based on 2011 data.

Thank you.

Our next question is from Kevin Fischbeck from Banc of America.

Please go ahead.

Okay, thank you.

I wanted to talk a little bit about the CareMore deal.

I guess Wayne, the Company hasn't been talking very strongly about how when you think about capital deployment it's always being evaluated against share repurchase and it sounds like I guess maybe we can get there over time but I just wanted to hear your thoughts about that transaction accretion and what you think you're going to be getting from that and how you think about deploying capital outside of share repurchase going forward.

Let me speak to CareMore.

We're obviously really pleased about the announcement of our acquisition of CareMore and it does a number of things for us that I think will be important, of course we hope that the transaction is going to close by the end of the year, hopefully sooner.

We have gotten through the anti-trust regulatory process and we have more steps in the regulatory process to go on the State but are optimistic about that.

A couple of things that this transaction brings to us.

Obviously, they have a unique model that both addresses the needs of the seniors in terms of health outcomes, both on the front end in terms of the way that they bring in membership, they encourage and have a very large percentage of their members come in for a healthy start visit which really helps them gather the information that's relevant to the risk adjustment process as well as the star rating process, and then in the most chronic care cases, they have an extensive model that really addresses the needs of the seniors who are the most ill and have the greatest needs and do so in a really cost efficient and effective way.

Our commitment with respect to CareMore is it can bring immediate value, obviously to us bringing on its membership as well as its capabilities to address the membership that we have ourselves in Wellpoint and can grow together.

We do believe that part of our model with CareMore is to invest in the ability to expand the care center model that they have and that through their earnings and the earnings we generate together, we can reinvest for those, that expansion plan so that we can double the number of care centers we have over the next hopefully couple of years, bring this model out throughout our other states and serve a bigger footprint for senior members there.

Wayne, do you want to speak to the accretion question?

Yes, thanks, Kevin for the question.

We continue to be committed as our Board is to deploy capital at the most optimal use for our shareholders and one of those things we continue to evaluate in any transaction is whether this transaction is more optimal than other alternatives, whether that be a buyback program, dividends or other investments in the business.

In the case of the CareMore situation, we believe that this is a better long term return for our shareholders and it will help support our broader expansion strategy into Senior.

It is very challenging to have anything in day one be better than a buyback.

The reality is you can buy the share.

There's no execution risk and you get immediate lift but when we evaluate our transactions we have to look over not just the immediate term but the longer term impact of both the buyback as well as accretion from these investments.

I want to reiterate on CareMore for 2012, we expect it to be neutral but the neutral on CareMore is not due to CareMore by itself, it's due to the fact we want to expand and more than double the number of locations over the next two to three years.

These locations have about an 18 month breakeven period and then the IRR is substantially higher than anything a buyback could return.

Clearly, we could choose an option of not doing anything and have this be very accretive next year and similar accretion to what you may see in the buyback but we think the longer term investment is the better play here, so I do want you to know, Kevin and other investors that our focus has not changed around deployment and we will continue to evaluate all transactions with that same lens.

Thank you.

Our next question is from Thomas Carroll from Stifel Nicolaus.

Please go ahead.

Hi, good morning.

Question for you, and I realize you aren't talking about 2012 just yet, but wanting to starting to think about the pricing process into next year in particular for the commercial business.

So maybe give us a sense of how you're thinking about pricing your commercial fully insured book into next year, given lower utilization we've seen and given the fact that states are going to be better prepared to perhaps oversee a bit more than in the past, what insurers are doing with their Commercial price increases and also understanding that sometimes the Blues tend to be a regulatory target, so let me stop there and maybe just let you chat about that a little bit.

Tom, let's let Ken speak to the pricing environment.

Obviously, we're staying disciplined.

We're also looking at trend and have expectations about it growing for a number of reasons, so that discipline is important but Ken, do you want to speak to your hopes there?

Yes, Tom.

I would just say we always priced what we believe forward costs will be and we are assuming an uptick in the trends and therefore, pricing to it and when I look at the market overall, I would say the market is competitive but very rational and seems to be pricing the same way right now.

We're insuring that our pricing is consistent with our historical pattern of being disciplined but using our advantage to win customers in the market so I would just say it's disciplined, it's covering forward-looking costs and our forward-looking costs assume that there will be an uptick in trend.

Thank you.

Our next question is from David Windley from Jefferies.

Please go ahead.

Hi, thank you.

I wanted to have you comment on SG&A and the gains that you've made so far, I'm wondering how sustainable those are, how much lower, how much more cost and how much lower you think your SG&A ratio can go and then if you'd also please comment on what triggered the lower tax rate in the quarter, and where you expect the tax rate to be for the full year, that would be great.

Yes, let me speak to the SG&A piece and then Wayne can speak to it as well.

Importantly, I think the key for us has been on getting the SG&A expense in the right way and we're doing that through initiatives that we've described as building a better Wellpoint.

There are continuous improvement, we're training all of our Managers, delivering these savings frankly because of the history of having so much variation from coming together as 14 separate companies over time, and so we can get this SG&A in the right way and continue to improve services to our members.

So we're executing well on our continuous improvement efforts.

We're executing well on systems migration that we have accomplished over the last two or three years in particular and we're confident about our ability to do that.

Now, we do think there is runway with respect to SG&A expense declining, but we also need to balance that with the investments that we are making for future growth for the Company, so Wayne, do you want to speak to that question?

Yes, so just one last comment to Angela's comment about the SG&A.

As an organization, we are committed though on a per member per month to continue to be more efficient and so while we believe absolute dollars will continue to come down this year, as you know, we had committed to taking out almost $400 million this year.

We believe we're well on pace to achieving that, and we expect much of that to run rate with some incremental benefits to next year.

That being said, we balance that with investments, but on a total basis we expect it to be leveraged off our existing membership growth, so in theory, PMPM should continue to be flat to down year-over-year, not just for the near term, but we believe the long term as we build the longer term operating model.

Relative to the tax rate, we, as you know, we continue to take a cautious conservative posture regarding tax exposures that may exist and we generally have had favorable outcomes regarding those exposures of which we had some favorable outcomes this quarter as well.

That being said, we expect our full year tax rate to be just below 34%, some of that of course is the release and the benefit of what we received this quarter.

Some of that is run rate but it's not run rate I hope that we will not have repeat next year, specifically that when you're not making money in a particular state, an individual or in senior, which is a higher state tax rate, you're not paying taxes in that state which in general drives your rate down so ultimately, we expect some of that to actually pop back up next year as we improve in those markets.

Thank you.

Our next question is from Carl McDonald from Citigroup.

Please go ahead.

Thanks.

Can you talk about your outlook for the rate review bill in california, likelihood for amendments over the next couple months, likelihood of passage and if it did get passed in the current form, how that would change the view for 2012 given the relatively strong profit margins that you've historically had in small group in the state?

Well obviously in California and other states, where we are working on either rate filings or the potential for rate regulation, the level of transparency that we now have in terms of the rate review and regulation process is so significant and the fact that the minimum medical loss ratio exists creates a number of protections for members and for protecting to make sure that the industry is very transparent about what our opportunities are there, so like in California, we bring the view of what does this mean for our customers in the end because ultimately, this is about the customers, so it's too early to say what exactly will happen in California.

There are amendments being discussed, what that means in terms of the ultimate end result for AB 52 we can't yet say.

We obviously are believing its in the best interest of California and all other states for there to be a sustainable market for consumers to buy products in both individual market as well as in the group employer market so we're going to continue to advocate in that way.

I think we have time for one more question Operator?

One moment for that question.

That question will come from the line of Michael Baker from Raymond James.

Please go ahead.

Thanks a lot.

I was wondering if you could comment on the expected benefits you would anticipate, particularly from a capability standpoint with the pending merger of Express Scripts and Medco, assuming that goes through, and then if you could just comment in general from your perspective, how important is Walgreens as part of the network as you move into the selling season for seniors?

Well, let me say that our partner Express Scripts brings us significant benefits in the PBM process, and scale is obviously important so as they come together, hopefully with Medco, that will benefit from that enhanced scale and the capabilities of the two, together we think will be important for our customers, and so we'll look forward to that.

In terms of Walgreens I think it's early in the negotiation process there and it gets them plenty of time to work that out and I think that's how the market is viewing it overall.

So with that question, I want to thank everyone for the questions that you've had today.

Let me say in closing, I want to reiterate that we're pleased to have exceeded our plans through the first six months of 2011, we're now forecasting higher earnings for the full year and we expect continued growth and success in the years to come.

We're successfully executing on our strategies to reduce general and administrative costs while adding new customers and improving our service.

I'd like to recognize our more than 37,000 associates for their discipline and their dedication.

We are achieving our goals by keeping our customers first and committing to our continuous improvement culture.

I want to thank everybody for participating on our call this morning.

Operator, would you please provide the call replay instructions?

Thank you.

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