Elevance Health Inc (ELV) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the WellPoint second-quarter conference call.

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

Later, we will conduct a question-and-answer session.

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.

Please go ahead.

Good morning, and welcome to WellPoint's second-quarter earnings conference call.

I'm Michael Kleinman, Vice President and Chief of Staff.

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, and then we'll discuss our revised full-year 2012 outlook.

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

Ken Goulet, Executive Vice President and President of our Commercial Business, and Raja Rajamannar, Executive Vice President of our Senior Business and Chief Transformation Officer, are available to participate in the Q&A session.

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

Reconciliations of these non-GAAP measures to the most directly comparable measures calculated in accordance with GAAP are included in today's press release, and available on our Company website, at www.WellPoint.com.

We will 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 today's press release, 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.

I'm going to start by discussing the quarter, and some of the dynamics in the marketplace that have contributed to our decision to reduce our full-year 2012 earnings guidance.

I'll then turn the call over to Wayne for a more detailed discussion of our results, medical cost trends, and the changes to our outlook.

Earnings per share in the second quarter of 2012 totaled $1.94, which included net costs of $0.10 per share.

These net costs included expenses related to a litigation settlement, and the closing of our 1-800 CONTACTS acquisition, partially offset by net investment gains.

Earnings per share in the second quarter of 2011 were $1.89, and included net investment gains of $0.06 per share.

Excluding the items in each period, adjusted net income was $2.04 per share in the second quarter of 2012, an increase of 11.5% compared with adjusted net income of $1.82 per share in the prior-year quarter.

While our second-quarter EPS results improved from the prior year, and are ahead of our plans for the first six months, the combination of lower enrollment and slightly higher medical cost trends are driving a reduction in our full-year 2012 outlook.

We're disappointed with the need to lower our guidance, but believe it's the right action to take, given the challenging marketplace we see, our commitment to maintaining pricing discipline, and our intention to continue investing for the strong future growth opportunities ahead of us.

We now expect full-year 2012 net income to be in the range of $7.30 to $7.40 per share.

This represents a reduction of $0.25 to $0.35 per share, or approximately 4% at the midpoint of the range from the guidance we gave on our first-quarter earnings call for full-year adjusted EPS of $7.65.

Most of the reduction in our outlook relates to lower than expected membership volumes.

Medical enrollment declined by 126,000 during the second quarter, and totaled 33.5 million members as of June 30, 2012.

Commercial membership decreased by 169,000, driven by our strategic product repositioning in the New York small group market, competitive situations, and continued economy-related and group membership attrition.

The pricing dynamics in the marketplace are varied across our different geographies, but overall are more intense this year, and we are being thoughtful in our competitive strategies as we maintain pricing discipline.

This has resulted in lower than anticipated commercial enrollment through the first six months of the year.

Although results in our commercial segment are lower than we would like, this business remains strong, with attractive operating margins, and we remain committed to maximizing its contributions through targeted approaches to the unique dynamics in each market.

Specifically, our plans to improve profitable enrollment growth include -- one, leveraging our strong cost position; two, expanding our investments in product design, including narrower or more efficient network offerings; and three, continuing to invest in customer-facing capabilities.

We also have a number of cost of care initiatives underway to mitigate the short-term impact of higher than expected medical trends and also achieve more significant incremental savings for our customers over the long-term.

We are cautiously optimistic about our ability to improve commercial enrollment trends over the next year, obviously with an eye on the macro employment background.

We have seen commercial membership pressures in California, Virginia and Georgia.

In those markets, there are a number of market dynamics in play, but in general, competition has intensified in 2011 and has continued into 2012.

We are starting to see some marginal signs of those markets stabilizing, and we remain focused on pricing appropriately to cover our expected cost trends while providing consumers with attractive product offerings.

While the market remains very competitive, our value proposition continues to resonate in the marketplace.

We were recently awarded the Motion Picture Industry contract, and will begin providing services to approximately 100,000 new members beginning August 1. In addition, we have secured several new national account wins for January 1, 2013, and the overall national accounts growth picture will become clearer in the next few months.

At this point, we expect greater account persistency and lower turnover in 2013.

Our leading brand and scale position will create opportunities as the industry evolves.

While the environmental background is challenging, we are working to build on our leadership position to drive greater long-term value for our customers and our shareholders.

The breadth of our diversification positions us well, as the market evolves to address challenges of access and affordability.

Last month, we completed our acquisition of 1-800 CONTACTS, the largest direct-to-consumer source for contact lenses in the United States.

1-800 CONTACTS serves more than 3 million active customers, and provides us with direct-to-consumer expertise, as well as an opportunity to expand into a growing business segment.

They bring new capabilities to our specialty business, and I'm confident we'll build stronger customer relationships as a result of this acquisition.

In our state-sponsored business, membership increased by 21,000 members during the quarter, primarily due to growth in existing programs.

Our state-sponsored operating gain declined from the prior-year quarter, as we had anticipated it would, due to higher medical costs and the impact of state budgetary pressures, particularly in California.

Through this first six months of the year, we have continued to conservatively record revenue in our Medi-Cal program business at the lower contractual rate.

However, as has been the case in the past few years, we expect that higher reimbursement rates for this program will soon be formally approved and will be retroactive.

In accordance with our accounting policy, we will not record the increase in rate until we receive formal approval.

We look forward to adding new programs and services to our state-sponsored business through our pending acquisition of Amerigroup.

This transaction will significantly enhance our future growth potential in both traditional Medicaid, and the emerging dual-eligible and long-term services and support market.

Our combination will broaden our Medicaid footprint to include 19 states that have nearly 60% of the nation's overall Medicaid enrollment.

The transaction brings us an important Medicaid presence in the Texas, Florida and Georgia markets, and expands our existing service areas in New York and Virginia.

We will also have a presence and enhanced capabilities to serve complex populations in many states engaged in dual-eligible demonstration project planning.

And we'll have a leading presence in the four largest states that have combined over $100 billion in annual dual-eligible spending.

Amerigroup's experience in serving high-acuity members will also supplement the capabilities we have through CareMore to serve the needs of seniors, and persons with disabilities.

There are low levels of coordination in these programs today, which has led to higher costs for states, and lower quality for beneficiaries.

Through improved management, we believe we can lower future trends in these programs, while also enhancing the care that is delivered.

The broadening of our Medicaid footprint will also enhance our positioning in future health insurance exchanges.

Due to the combination of expanded Medicaid-eligibility thresholds, and the introduction of premium tax subsidies, we estimate that approximately two-thirds of the population in our blue markets will be eligible for some form of public healthcare assistance in 2014, based on current income levels.

While we are already uniquely positioned for the exchange-based growth opportunity, given our strong brand name, leading market share, valuable provider network relationships, and underlying cost advantages, the addition of Amerigroup increases our flexibility to meet market demands, as individuals migrate to and from commercial and Medicaid products.

Our senior membership increased by 19,000 during the second quarter, bringing our year-to-date growth to 45,000 members, or 3%.

Senior operating results have also improved, and we continue to invest in this business to further enhance our growth potential.

We expect to expand our Medicare Advantage service territory again next year, and the integration of CareMore into our business model is enabling us to serve new and more highly acute market segments.

We have 30 CareMore care centers in operation today, and the return on these investments is running ahead of our plan.

We opened a new location in Nevada this May, and plan to open another in Arizona before the end of the year.

We're also on track to open 12 additional centers in January of 2013 in California, New York, and Virginia.

While we fully funded our CareMore expansion and significant other business investments in our 2012 plan, we are now committing an incremental $110 million to strategic growth initiatives this year related to our senior business transformation, the dual-eligible opportunity, and to expedite our preparations for health insurance exchanges.

While we could have elected to reduce or postpone this spending to offset the concerns we have around membership volume and medical cost trends, we feel we must move forward with investments now to position us for the growth opportunities in the post-2014 environment.

It's equally important to continue our efforts to create better healthcare value in the marketplace.

We've made significant investments in our infrastructure to lead in the area of payment innovation.

We will continue implementing our patient-centered primary care program, also known as PC2, and at the same time further enabling our capability to partner in ACO relationships with hospitals and organized medical groups.

We will continue to balance our growth and transformation initiatives with our financial commitments and administrative efficiency goals.

Our second-quarter 2012 SG&A expense increased by $71 million, or 3.5%, from the prior-year period, due to the inclusion of the CareMore business and the settlement of a litigation matter.

In the second half of the year, our ongoing expense initiatives will produce savings to help fund business reinvestment to capitalize on future growth opportunities.

In summary, we believe our decision to maintain pricing discipline, and to continue investing in our strong growth opportunities, despite difficult market conditions, will lay the groundwork for improved performance over time.

We have a strong foundation, brand, and market footprint, and expect to deliver greater value to the marketplace in the future.

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

Wayne?

Thank you, Angela, and good morning.

I'm going to review the results as we usually do, and then move on to the outlook, in light of the issues raised by Angela.

Premium income was $14.2 billion in the second quarter, an increase of $247 million, or nearly 2% from the prior-year period.

This was due primarily to growth in our senior membership, including CareMore, and premium rate increases designed to cover overall cost trends.

Premium revenue was modestly below our expectations for the quarter, which reflected lower fully insured membership, resulting predominantly from a more intense overall competitive environment.

As we've said in the past, we do not sacrifice appropriate business decisions for short-term membership gains, and we believe this strategy is in the best long-term interest of our Company.

Administrative fees were $978 million in the quarter, an increase of $20 million, or 2%, from the second quarter of last year.

This reflects our strategic decision to obtain pricing in line with the significant value we provide to our ASO customers, which drove higher administrative fee revenue, despite a reduction in self-funded membership.

The benefit expense ratio for the second quarter of 2012 was 85.4%, which represented a decrease of 30 basis points from 85.7% in the same period of last year.

This was driven by the senior and local group businesses, and was partially offset by an increase in state-sponsored.

In senior, we anticipated that the ratio would decline this quarter, due to the product changes we implemented in certain markets for 2012.

In addition, CareMore's benefit expense ratio is lower than our historical company average, and therefore, helped improve the overall benefit expense ratio.

In local group, the decline in the ratio was driven primarily by changes in prior-period reserve development.

We experienced favorable prior-period development during the second quarter of 2012, consistent with our expectations, while we slightly strengthened reserves in 2011.

The impact of changes in reserve development was partially offset by higher than expected medical cost trend experience.

During the second quarter, we saw an uptick in trend, most notably in outpatient and physician visits, but also in the increasing use and cost of specialty pharmaceuticals.

We believe the increase has since moderated somewhat, as our claims inventories declined during June and remain at historically low levels.

However, based on our second-quarter experience, we currently believe full-year 2012 medical cost trend will be in the upper half of our expected range of 7%, plus or minus 50 basis points.

To give you the components of trend, for the rolling 12 months ended June 30, 2012, inpatient trend is currently in the high-single-digit range, and is unit cost driven.

The admissions per 1,000 members and average length of stay are only slightly higher than in the prior year.

Outpatient trend is in the high-single-digit range, and is 75% unit cost driven and 25% utilization.

Physician services trend is in the mid-single-digit range, and is 75% unit cost and 25% utilization related.

And pharmacy trend is currently in the high-single-digit range, and is approximately 90% unit cost and 10% utilization driven.

Unit costs have been modestly higher than expected, due in part to new drugs for conditions such as hepatitis C, multiple sclerosis and cancer treatment.

Pharmacy trend is expected to improve over the balance of the year, due primarily to generic drug introduction.

Net investment income totaled $169 million in the second quarter of 2012, down $18 million, or approximately 10%, from $188 million in the second quarter of 2011.

The decline was driven primarily by lower investment yields in the current-year quarter.

Interest expense was $118 million in the second quarter of 2012, up $14 million, or 14%, from the second quarter of 2011, due to higher average debt balances in the current-year quarter, partially offset by lower short-term rates.

We recognized net investment gains during the quarter totaling $65 million pre-tax, consisting of net realized gains from sales of securities totaling $71 million, partially offset by $6 million of other than temporary impairments.

As of June 30, 2012, the portfolio's net unrealized gain position was approximately $1.1 billion, consisting of net unrealized gains on fixed maturity and equity securities totaling $768 million and $295 million, respectively.

Our effective tax rate was 38.6% in the second quarter, 820 basis points higher than in the same period of last year.

Our second-quarter 2012 effective tax rate was impacted by the non-deductibility of the litigation settlement, while the second quarter of 2011 effective tax rate was abnormally low due to settlements of prior-year tax audits.

We now expect our full-year 2012 tax rate to be approximately 35.8% on a GAAP basis, and 34.8% on an adjusted basis.

Moving to claims liabilities.

Medical claims payable totaled $5.4 billion as of June 30, 2012, a decrease of $73 million, or 1.3%, from December 31, 2011, as our fully insured enrollment declined by 2.7%.

Included in our press release is a reconciliation and roll forward of the medical claims payable balance.

This disclosure is comparable to the reconciliation provided in our fourth-quarter 2011 press release.

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

Medical claim reserves established at December 31, 2011 developed favorably, and we experienced positive prior-year reserve development of $482 million during the six months ended June 30, 2012.

We believe our balance sheet continues to be appropriately and conservatively stated.

Our consistently low claim inventory levels and the continued increase in the speed with which we are processing claims electronically provide additional assurance that our reserve position and forward medical trend projections are appropriate.

Our auto-adjudication rates increased to nearly 84% in the second quarter.

As of June 30, 2012, days in claims payable, or DCP, totaled 40.8 days, a decrease of 1 day from 41.8 days at March 31, 2012.

This was driven primarily by an increase in the speed of claim receipts during the quarter, as provided from clients with HIPAA 5010 improved.

Turning now to cash flow and capital deployment.

During the first six months of 2012, we generated operating cash flow of approximately $1.7 billion, or 1.2 times net income.

Operating cash flow totaled $522 million, or 0.8 times net income in the second quarter of 2012.

Please recall that the second quarter is a seasonally low quarter for our operating cash flow, as two estimated federal income tax payments are made during the quarter.

We continue to forecast strong operating cash flow of at least $2.7 billion for the full year of 2012.

This amount is slightly lower than our previous guidance, which reflects the change to our earnings expectation and a payment we made in July for the litigation settlement.

We utilized $494 million during the second quarter to repurchase 7.2 million shares of our common stock, bringing our year-to-date repurchase activities to 17.4 million shares, or over 5% of the shares we had outstanding as of December 31, 2011, for approximately $1.2 billion.

We used $94 million to pay our cash dividend in the quarter, and yesterday the Board approved a third-quarter dividend of $0.2875 per share.

We also funded our acquisition of 1-800 CONTACTS, Inc.

during the second quarter.

We ended June with approximately $2.5 billion of cash and investments at the parent company, and available for general corporate use.

Over the next two quarters, we expect to receive approximately $1.5 billion of ordinary dividends from our subsidiaries.

We've estimated debt and interest payments totaling $1.2 billion during the second half of the year, and expect to utilize at least $1.5 billion for share repurchases and cash dividends.

We expect to end 2012 with approximately $1.3 billion at the parent company.

These figures assume no cash impacts related to the pending Amerigroup acquisition.

Our debt-to-capital ratio was 32% at June 30, 2012, up 330 basis points from 28.7% at March 31, 2012.

We expect this ratio to come down when we pay off an $800 million senior note that matures in August.

Once we complete the financing of the Amerigroup transaction, the ratio will likely be above our targeted range of 25% to 35%, and our intention will be to reduce it below 35% over the subsequent 18 to 24 months.

Moving on to our forecast, the updated outlook primarily reflects two things -- lower enrollment, and slightly higher medical cost trend expectations for the full year of 2012.

As Angela described, commercial enrollment is lagging expectations as the market has become more competitive in certain geographies.

Commercial margins, while improved in the second quarter, and above 10% on a year-to-date basis, are also modestly below our plan, due to the uptick in medical trend.

While we believe the increasing trend we experienced during May moderated more towards anticipated levels during June, we have increased our full-year outlook for the benefit expense ratio to reflect our expectation of higher claim costs for the year.

I want to also point out that our updated guidance assumes we will incur costs during the second half of this year related to the Amerigroup acquisition financing.

We continue to expect this transaction to close in the first quarter of 2013, but are likely to issue debt later this year to take advantage of historically low interest rates.

We estimate that these financing costs will total approximately $0.10 per share.

Our guidance also includes approximately $0.22 per share of costs related to the second-quarter litigation settlement and the 1-800 CONTACTS acquisition, for a total of $0.32 per share.

These costs are currently entirely offset by the $0.32 per share of net investment gains we recorded during the first six months of 2012, leaving our GAAP earnings per share guidance of $7.30 to $7.40, equivalent to the adjusted EPS guidance.

As Angela noted, this revised forecast represents a reduction of $0.25 to $0.35 per share from the adjusted EPS guidance we provided in April.

With respect to other specifics of the updated outlook, year-end medical enrollment is now expected to be approximately 33.4 million, consisting of approximately 20.1 million self-funded members and 13.3 million fully insured members.

Operating revenue is now expected to be approximately $61 billion.

The benefit expense ratio is now expected to be approximately 85.5%, the SG&A expense ratio is expected to be 13.9%, and operating cash flow is now expected to at least be $2.7 billion.

I will 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)

Justin Lake, JPMorgan.

Thanks.

Good morning.

Let me start off with a couple of numbers questions.

Wayne, you talked of cost trends being a little bit higher, but I didn't see really any change in the actual components.

Can you walk us through what you saw in the quarter?

Maybe breakdown April, May, and June, what you specifically saw in physician and outpatient.

And also maybe you can walk us through the 2013 headwinds and tail winds, once you do that.

Thanks.

Justin, I think Wayne's going to do that for you.

But keep in mind, I know there's a lot of focus on the trend, but as we tried to emphasize in our remarks, this is driven primarily through membership, which Ken can break down for you, too.

But we'll give you more detail on trend.

Yes.

Thanks, Angela.

So, Justin, to Angela's comment relative to medical trend, in the first six months of the year, let me first start with our guidance, which was originally 7%, plus or minus 50 basis points, and we're maintaining that guidance.

When we generally provide a guidance range, we're usually using the midpoint as our premise for putting the brackets around the plus or minus 50 basis points.

And on that, Justin, we have to remember that our trend number relative to others in the industry might be an apple and an orange.

We used a group trend, fully insured group trend.

Others combine other segments in their trends.

And trend always relates to where you're starting from, as well.

An apple to apple comparison is not appropriate.

But go ahead.

So relative to that expectation, we still believe we'll be in the 7% plus or minus 50, but our bias is towards the upper half of that range.

Not to the high-end, but towards the upper half that range.

Now the reason for that bias is -- and we've taken that bias in our outlook for the year, was that in the first six months of the year, we really saw expectations aligned with our trend expectations that we had planned for and priced for, with the exception of the month of May.

And in the month of May, we saw higher than anticipated costs, both in physician visits and outpatient.

And I would size those at around $50 million or so is what we saw, higher than our expectation.

We did not see that repeat in June.

So said differently, we saw that elevated level return back to more normal levels, but we didn't see it improve, meaning that while we got back to our expectation in June, we did not recover May.

What we've decided to do, though, with our guidance change is, because it's predominantly an enrollment issue, we thought it would be prudent, though, to at least consider the fact that June could repeat in the back half of the year -- I'm sorry, May could repeat in the back half of the year.

We have no evidence of that at this point in time, but we think it's a prudent thing to at least look at our trend from a forecast perspective and give you as much transparency around why we're making the decisions we're making.

So if that doesn't repeat, then obviously we could perform better, but for now we think it's prudent to take a cautious outlook.

Okay.

Great.

And those '13 headwinds, tail winds, --

I think the thing I would say right now, Justin, is we're not obviously not in a position to give guidance yet for '13.

We've made a number of investments, though, in our senior business that we expect will create tail winds for us next year.

We're obviously making a number of investments to prepare ourselves for the exchanges that are coming in 2014.

And so I see more investment dollars going into '13, incremental to probably what we're doing this year for exchanges that are going to be important.

And we're going to continue to be building out for the dual expansions.

So from a headwind tailwind, Justin, it's a little bit premature at this point to provide those.

But I would say nothing beyond what you and others are fully aware of, which is the dual expansion, preparation for the ACA, and in a number of our businesses we do expect to see regular ongoing improvement, including Medicaid and senior.

But importantly, we expect that the Amerigroup deal will have closed.

And that creates a diversity in our revenues and opportunities and helps secure some of these dual opportunities, as well.

And we continue to be committed to returning capital to shareholders.

So even with our Amerigroup announcement, we plan to continue to provide the kind of share buybacks that we committed to you in connection with that announcement.

Great.

And I just had -- my follow-up was on strategy.

And first, Angela, I just wanted to confirm something.

Is it fair to assume that the Board was aware that the Company was off its financial plan when they voted to approve the Amerigroup deal?

Justin, let me say this about where the Board is and the strategy.

I think it's important to know that we were beating plan for the first six months of the year.

And what we are doing in terms of providing guidance is, we do think we are the first company that sees these changes in the marketplace.

And we tend to be the first one to tell Wall Street about it.

And so what we're doing here is being proactive.

We think we have had very consistent performance in our inventories, our auto adjudication rates.

And so our analysis of what is in trend and in our experience is important.

And we think we've seen changes that affected our disciplined pricing posture.

And we've stayed disciplined, which we're seeing in the enrollment numbers.

So throughout the first six months of the year, we're always very transparent with our Board, in terms of where we are and what we think our prospects are.

As I said, we met our plan for both the first and the second quarter.

In fact, for the first half of the year, we're exceeding our plan.

The strategy for Amerigroup was not a knee-jerk reaction, either.

The strategy is to diversify our revenue stream through a number of things.

One is being in a position to service not only seniors, but frail seniors through CareMore.

We're strengthening and expanding our senior business.

We're moving into Medicaid through the acquisition of Amerigroup and giving us an opportunity uniquely in the marketplace, between Amerigroup and CareMore coming together, to serve dual eligibles.

We're growing unregulated businesses, like 1-800 CONTACTS, where we have a right to win.

Because it's what the consumer will need and associate with healthcare in the future.

And we are preparing for exchanges.

So the Board is very involved in our strategy and understands where we are, really throughout every period.

Got it.

So this is less a performance issue and more conservatism, in your mind.

And the way you see it, in your discussions with the Board, are that they are content that the performance has been in line with their expectations and they're excited about the strategy?

I think it's clear that they're excited about the strategy.

No doubt about it.

And being the first company to see the changes and then take the posture of pricing to do that, is important.

It's important to us and it's important to them, as well.

And they've been very supportive throughout this process and throughout the process of the CareMore, 1-800, and Amerigroup acquisitions, as well.

Great.

Thanks for all the color.

And as a reminder, ladies and gentlemen, in order to get through as many questions, please limit yourself to one question and one follow-up.

Scott Fidel, Deutsche Bank.

Thanks.

First question, just was hoping you could drill a bit more into the pricing environment in commercial, and talk about first, is the pressure that you're seeing in those three markets that you cited.

Is that being driven more by the for-profits or by the nonprofits?

And then maybe just give us a little more detail on California specifically, and then on Georgia, since I think this is the first time that I've heard you guys mention Georgia.

I know you had talked about California and Virginia previously, but I think this is the first time I'm hearing Georgia.

So Ken, why don't you break down the enrollment?

I'll start off, Scott, I would say we have continued disciplined pricing, and the market, in general, is remaining disciplined.

There are differences this year as last with rebate positions, MLRs, but we use a forecasted medical cost and make our decisions off that.

There is some more pressure in the markets indicated.

To answer specifically, in Virginia, there was pressure throughout both mainly large group, with both some for-profit and not-for-profit.

The not-for-profit, which made an impact, really has changed, from what we can see and the data we have, has changed our pricing.

And usually we wait things out.

We make sensible decisions and over time, it works for our business model.

In California, there is an impact from one not-for-profit.

It is the one area where we complete with another blue, and there's slightly higher pressure in that, from the other blue.

And then in Georgia, is a mix of both for-profit, not-for-profit.

But it really is, and we'll find when the filings come out in this quarter, we'll find how much is directly related to MLRs and which are not.

But we feel pretty comfortable it's rational pricing, but impacted by MLRs and rebates.

Okay.

And then my follow-up question, wanted to get your response to the CBO report that came out yesterday, where they updated some of the ACA forecasts for the coverage expansion post the SCOTUS decision.

And particularly, they took down their view on the Medicaid expansion by around 6 million lives, but added around 3 million lives to their view on growth in the exchanges.

And wanted your thoughts on how they're seeing it post- SCOTUS and whether you agree with that assessment.

Let me say, in the context of the discussion we had post- the Amerigroup announcement, and our view of the Medicaid business.

We think there's organic growth opportunities in the Medicaid business independent of the Medicaid expansion, because when you look at the penetration of managed care into Medicaid, it's woefully low compared to the commercial market, for example.

And so comments were made yesterday in response to the CBO comments that as state budgets are more constrained, it may in fact create more organic Medicaid growth opportunity.

We were appropriately cautious when we looked at the Medicaid expansion opportunities post- SCOTUS and took that into account in terms of our model.

and then we also believe we're uniquely well-positioned, as the pilot programs go forward in terms of dual eligibles.

And not only because of Amerigroup, but because of the unique capabilities we have through CareMore and CareMore's position in California where the pilots are going forward, and in the places in which CareMore is already established.

And that, combined with the footprint that the Amerigroup transaction creates for us, we think those are critical things, the least of which is, when you think about the future of exchanges and having people move in and out from the exchange to Medicaid, we think having a position in both of those markets will be critical for the future.

So long story short, Scott, to say our model, we think, is a good one and was not impacted by what the CBO said yesterday.

Okay.

And on the exchanges do you think that the growth could be as substantial as CBO is forecasting?

Clearly that's an area where there's a lot of uncertainty about if they build it, will it all come or will there be less enrollment in the exchanges than some of these folks are modeling?

We are looking at two things, in terms of a long-term plan.

We're looking at our expectations about what the uninsured may do relative to the exchanges and the subsidy levels, and the way in which the regulations come forward to further define what the requirements are for coverage.

That's still pretty important.

But as we've done our studies, we have looked at the potential for being effective in the exchanges.

And we think we're differentiating in that way and that the brand is very powerful.

We can design networks and product that will meet affordability points for the customer going forward.

So at the same time, we're looking at the employer market and making sure that they have a number of alternatives.

Some may choose that their employees would participate in public exchanges, but we also have an opportunity for them to go in private exchanges.

So we think there's a number of paths that the uninsured, and those who might be eligible for subsidization, and exchanges, or through their employer could also access private exchanges.

And so I think it's difficult to say -- we'll talk about it a little bit more later when we do the five-year plan and bring that forward in terms of the longer-term picture, in terms of numerically what we're thinking about membership in the exchange.

Okay.

Thank you.

Kevin Fischbeck, Bank of America.

Great.

Thank you.

Wayne, maybe you had alluded to and answered one of the questions earlier that you could walk us through the breakout of how much of this earnings cut is really from membership versus the cost trend numbers, because when I think about, relatively speaking, the membership losses in the context that you've outlined those, as you're already assuming some membership losses, it's hard for me to get to a guidance cut that is in the range of what you've done here.

It feels to me like it's more cost trend, but I think Angela had indicated it was really more as a result of membership.

So can you reconcile how much is trend in pricing and how much is membership?

Do you want to go through that?

So, Kevin, while we're not giving the specific forecasts, it's pretty easy, though, to do a membership run rate on fully insured.

And that's the key.

You have to look at the fully insured piece versus the ASO piece.

So we're adding 100,000 member lives that's ASO in August.

But that's not going to contribute to the PMPM profits that a fully insured member does.

So you're looking at it on a fully insured basis, you can easily get to the $10 million to $15 million op gain impact per month from volume.

So if you look at it from that perspective, the vast majority of this change in guidance is a volume change.

And what we've done is the delta is simply, depending on what math you use, the delta is really just us taking a cautious view on trend for the back of the year.

And then I guess you're saying that you're ahead of plan for 1H, but you cut guidance for the second half of the year by $0.30.

I guess $0.10 of that is due to the Amerigroup financing, but what's the reason that we shouldn't be taking that annualized $0.40 number, heading into the 2013 estimate?

What else is there in the second half of the year?

I think the big thing is that in the first half of the year, we had to make some decisions around certain administrative costs to cut to help us achieve our plan.

Clearly, we had the volume miss happen in the second quarter, as well as for the remainder of the year.

So we took some initiatives there, where we thought cuts in G&A were appropriate and were efficient ways of using shareholder dollars.

But our concern is that for the back half of the year, we don't see the volume returning to a positive situation.

And for that reason, we had to evaluate whether we would cut further or make the key investments that we think are needed.

And our choice was to make those key investments with the expansion of duals in California and our additional counties being selected now, and with the opportunities to continue to improve our senior business over a multi-year period.

And so I think the primary difference is that we could have made additional cuts to benefit the short-term and maintain guidance, but we did not believe that was the prudent thing to do for the long-term.

But I guess --

To be very explicit about that, we continue to have a run rate of finding $200 million plus of SG&A savings.

What we have done this year is we have reinvested, or self-funded essentially, investments to do the things that are strategic for the long-term.

So we're rolling out CareMore in Virginia and New York, for example, and more in California.

We're strengthening our senior business.

We've done a number of home visits with our senior members in some geographies.

And we are preparing ourselves for the exchanges and have done a lot of consumer research that relates to that.

So we're going to continue -- we have an initiative called Build a Better WellPoint.

We are continuing to find efficiencies and use the scale, particularly for the core business, as we reinvest in the capabilities that we're going to support the more diverse revenue stream of the future.

I guess you're talking about this guidance cut in the context of lower membership, and your plan to hold the line in what is becoming a more intense pricing environment, that lower membership theoretically should be going forward, as well.

So the question is, what can you do on G&A, what can you do around these other initiatives over time to offset that?

But what you're reducing your earnings for this year should flow through into next year, based upon where the pricing competitive environment is right now?

Kevin, I think that's a fair comment, that clearly, if we lost a member on July 1, we only get six months of a detriment this year.

Next year you get the incremental six months from the first half of the year.

Probably the one thing to keep in mind, though, is that we have a number of things, obviously, that we believe will help improve us our membership outlook for next year.

Our senior business is clearly moving in the right direction and will be a continued tailwind for, we believe, multiple years, over the next five years.

And Amerigroup is going to give us a new growth trajectory that will begin to help offset some of this short-term membership decline losses.

As Ken said, we are starting to see some strengthening in pricing.

The question is how will that come about on 1/1/13 renewals?

That's what really starts to matter is 1-1 of '13, because a big part of the business comes due on that date.

So depending on pricing starting to strengthen in the back half of the year, it may be less of a headwind for the membership that we lose throughout this year, going into next year.

Okay.

Great.

Thanks.

Melissa McGinnis, Morgan S Stanley.

Good morning.

Thanks for the question.

First, in just looking at your consumer business, year-to-year, I would have expected the $177 million op gain reported last going to $211 million, just in thinking about headwinds and tail winds year-to-year with MA issues last year, and then the contribution of CareMore, I would have thought that would have been an easier comp than it ended up.

Can you help me bridge those two numbers?

And what's the headwind there?

Is it Medicaid?

Is an individual, or is that just the reinvestment that you're making in the senior business?

Wayne, do you want to go through it?

We are making reinvestment in our business, and as you point out, in our consumer segment there is senior plus individual is in there, as well Medicaid.

Melissa, two things I would point to, both related to Medicaid.

The first one is, we had clearly anticipated that Medicaid would be a headwind going to this year versus last year's 2Q.

Many of the state rates went effective October 1 or July 1 of last year.

So now what you're getting in this 2Q is the first full-year impact versus the prior year.

The second one on Medicaid, though, is that we have rates in California, and it's our policy, we've always taken a very conservative posture, that until the rates are officially signed into contract and we get the check that we don't generally record them.

And in this case, it's always been our history to have a delay in getting rates in California, it's not unusual, that are retroactive.

We've got verbal comments on those rates, but we don't have a signed contract yet.

But that did impact our quarter, for the first six months actually, by almost $25 million of revenue that we still fully anticipate getting.

But usually by this time, we have it.

We still don't have it as of June 30.

And so that was the second item that did impact both our quarter, as well as the comps.

Okay.

But still kind of -- you provided a really helpful bridge, I thought, on your Q4 of '11 call to help us kind of understand magnitude of the MA role.

And you can't provide any further quantification of, we got this sort of tailwind from Medicare Advantage getting righted, Medicaid, maybe the moving parts a little bit?

No, Melissa.

And I'm not trying to avoid the question, as much as to say, we just don't run our business in three month increments.

And so from our perspective, I can tell you that our Medicaid was still slightly ahead of our plans, but we had it being in a headwind for the year.

Now it's ahead of plan for the year, because we're going to get this money retro.

But for the quarter, Medicaid was going to be a headwind for us, and it was a bigger headwind because we did not get the revenue retroactive.

We're expecting that, though, in our full-year forecast, which would still put us ahead of plan.

I can tell you that our senior business, for the first six months of the year and the quarter, was slightly ahead of our plan.

So things are aligning with expectations.

On the individual business, which falls under the consumer, the same items we saw in the commercial book in the month of May also we saw in individual.

That trend does not differentiate between the individual consumer or the employer-based consumer.

So that is in the quarter, though, what we saw in the month of May.

And that is in our forecast.

Okay.

Great.

And then I guess just something more about strategy and looking into '13, with some of the challenges that we saw last year on around the senior product and then the negative earnings revision today, I think there's questions in the marketplace about the visibility into your underlying trends across business segments.

What gives you comfort going forward that you have enough visibility to get positioned for 2014 implementation, take on a $4.9 billion deal with Medicaid, with that new business, and then also move into an ancillary business of the 1-800 CONTACTS deal?

I would challenge that assumption or result -- this is about really having good transparency.

And seeing -- we have had 36 months of very consistent inventory levels, great stability, great improvement, in fact, auto adjudications are way up.

And I think it's the ability to see that and use that in the forecasting and in the pricing to look forward and make announcements like we did today, which while unfortunate, I think they are a reflection of some of the challenges in the industry.

In terms of the strategy going forward, though, I think it's clear that a revenue base that is more diverse will be strong.

And one example, while we didn't break every element down, as you were asking in your prior question, CareMore is outperforming its plan today.

And it's rolling out in new geographies and it's continuing to deliver this differentiated experience for seniors, and is working very diligently to prepare for the dual eligible.

So that integration is going well.

I think we have every expectation that 1-800 CONTACTS is going to continue to create this revenue source that is less regulated, higher margin, faster growing, and in a place where our customers have identified that they benefit by the vision, insurance and relationship with 1-800 CONTACTS and Glasses.com.

The Amerigroup, we're very excited.

They're bringing a great new team to us.

They have Medicaid expertise and strength.

And so we see that as just a win-win situation.

So I think -- that's not to say that we're not going to have a period of time where we are preparing for the future, including exchanges.

And you ask, how do we know?

We have done very significant research around the consumer and their approach to the exchanges.

And I said earlier that they like the brand, and they will move to the brand as we think about the exchange opportunities in the future.

Great.

Thanks.

Matt Borsch, Goldman Sachs.

Yes.

Good morning.

I'm wondering if you could comment on the cost trends side and where you saw the higher physician and outpatient utilization, particularly in May.

Is that -- does that have any material geographic variation that you can point to?

Number 1.

And number 2 is, what about by product?

Is that something you sort of see across commercial Medicare and Medicaid?

Or can you differentiate a little bit?

Wayne, do you have detail on that?

Matt, we didn't really see it materially different across geographies.

So that wasn't anything that was really concerning or alarming to us.

Our Medicaid, again, had it not been for the revenues, things have pretty much been in line with expectations.

So it wasn't really affecting Medicaid as much as it was the commercial and the individual book.

That's really where we saw that was on the commercial and individual books.

So again, not so much on the Medicaid or even the Medicare for that matter, it was pretty much commercial and individual, and it was pretty much across all our markets.

And where you referenced it, that you may be seeing some hopeful signs of pricing pressure easing off a bit?

Is there any geographic variation on that?

Ken, do you want to speak to that?

Matt, those were specific to those geographies.

Again, there's pricing pressure in certain geographies that occurred for a short period of time, and MLR related.

So yes, those are geographic related.

And we have seen a subsiding in -- specifically in those markets.

Again, it's relatively rational, but MLR and rebate related.

Okay.

And last one, if I could.

As you look ahead to the national account -- well, we are in national account selling season/ what are you seeing in terms of the number of employers relative to prior years that appear to be going out for bid and how you think you stand?

Obviously, it's very preliminary, but at this early point, looking ahead to that?

Matt, good question.

And it is early, but right now, I would say we've seen less going out to bid.

And I think it's because a number of groups are waiting to build strategies around 2014 and beyond, and putting more of their focus on that.

And of the largest ones that went to bid, including one of ours, they stuck, meaning they didn't move.

So there was greater persistency, again, as I believe some of the larger groups are going to wait and build it into longer-term strategies.

However, as we did going into this year, going into next year, we have several very nice sales already.

We're going to wait and see how it all develops.

I think you'll recall on a part of our membership change going to this year was, and we began stating it around second quarter last year, was a very specific intention to purge some cases that were not carrying their weight on fees.

We do not have that phenomenon going into next year.

That's already been taken care of.

So our persistency will be higher.

But I believe there'll be, across all carriers, less movement, as larger groups seem to be putting less to bid and more are sticking with their current carriers.

Great.

Thank you.

Christine Arnold, Cowen.

Hello there.

My first question relates to premium yield, and my second to payables versus premiums.

The premium yield in commercial looked like it was roughly half what you had last year, full year, and about one third of last year's second quarter.

So about a 3.3% commercial premium yield.

Can you help me understand why the premium yield is coming down.

I know you're exiting New York.

Can you put some numbers around why the premium yield would be so low in commercial?

Christine, I'd have to look at your calculation, to be fair.

I'm not really sure how it's coming up.

But I can tell you is on our active versus canceled, where we actually look at those members that are staying with us versus those members that are leaving us, we continue to have a positive spread.

In fact on a PMPM basis, when you look at kind of a PMPM absolute dollar basis, our active retention numbers are up almost over 25% where they were a year ago.

So said differently, our gross underwriting margin on those that are staying with us are that much higher.

So my assumption is it's got to be a mix on how it's being calculated, but without being able to sit down in more detail and look at that with you, I really can't answer that.

And buy-downs have been similar to last year, so I don't think buy-downs are really a driver of that.

So again, I'd have to see more of the details on that.

Okay.

We're going to have to follow-up on that.

And then on the payables versus premiums, it looks like both first and second quarters they're a little bit upside down.

And it looks like in your roll forward, you're assuming that you're paying 79.3% of current year medical claims as a portion of incurred medical claims.

So it's 79.3% now versus 78.5% a year ago.

So you're assuming that you're paying claims about a percentage point faster.

Obviously if you are, things are fine.

If you're not, then you're upside down on payables versus premiums.

Can you help us figure out -- the adjudication rate was up.

Can you give us some numbers that give us comfort that the reserves are in fact adequate, given this assumption?

Yes.

A couple things Christine, at least from the data that we track.

First of all, let me talk about cycle times.

Cycle times have been in a narrow range of 40, plus or minus 2 days, for 34 of the last 36 months.

So there's real consistency in cycle times.

The other thing I would highlight is our electronic submission rates.

Now a lot of providers have adjusted for HIPPA 5010 -- we started this with them last year and then have been building up to that, to make sure that they were submitting electronically.

But our EDI rates from the docs to us are actually over 90%.

So we're getting the vast majority of claims now very real-time.

And then of course, our auto adjutes are at an all-time high, at 84%.

We track our inventories.

Our average inventory, we generally try to target five days work on hand.

We are below that, which would be our best-in-class watermark that we like to be at.

We are below that across the board.

We're not seeing any issues from a cash flow perspective, anything of that sort.

And it's our intention, and our guidance reflects, maintaining those conservative reserve levels.

So beyond that, I can't really point to anything different, other than to say that we don't have an inventory issue.

We don't have a volume issue.

We don't have a visibility issue here.

We have a volume issue on membership.

And that's the primary driver.

And then -- as a follow-up, you said that your admissions per thousand were down slightly last quarter's conference call.

Did you say that your admissions are up this quarter?

Is that a change, or am I misremembering, misreading, or mishearing?

Let me go back to that prior question, and then Wayne can address that one.

Inventories per thousand are down 12% since this time year-over-year.

So we have accelerated our claim cycle.

And we feel very comfortable about that.

Do you want to talk about admits versus --

Angela, can you give me a dollar value on that so I can adjust the payables?

No.

I don't know it.

Okay.

Alright.

Fair enough.

Christine, on the inpatient, the admissions per thousand members and average length of stay are only slightly higher.

And when we say slightly, we're literally talking basis points, not points, things of that sort.

So it's really tight, still.

Okay.

Thank you.

Chris Rigg, Susquehanna.

Thanks.

Good morning.

Thanks for taking my question.

I just wanted to go back to the June 15 guidance reduction.

You took it down by $0.23.

You cited the Ormond litigation.

And the number that you're showing today is only $0.10 pre-tax.

Can you reconcile the difference to that $0.23 reduction a month and a half ago to the $0.10 reduction today?

Or the $0.10 impact you're highlighting today?

Wayne, can you do that?

Chris, so a couple things.

Keep in mind, the Ormond settlement was for $90 million.

It is not tax-deductible, and neither are legal expenses tax-deductible.

So if you go to the roll forward schedule we put in our press release, we are showing all amounts pre-tax.

And then for the tax implication of that line item, it's in the line item referred to as taxes.

So you have to actually look at that line with it.

It's important to recognize, we had reserves on Ormond.

So that's why you're only seeing $0.10 on the pre-tax number, because we did reserves.

But even those reserves are not tax-deductible.

So in essence, what I'll call kind of an above the line operating impact was roughly $0.10, and then all the rest came through as a net impact to us on the below the line from a tax perspective.

And we've outlined that on the roll forward schedule that supplemented with the press release.

Okay.

And then I just wanted to clarify the commentary on the call about the additional $110 million of development spending.

Was that in the prior guidance or is that new spending that you're highlighting today for the second half of 2012?

It's new spending, of which some is being self-funded and some is reflected in our decision to amend our guidance.

Okay.

And so, is that all being expensed or will some of that be capitalized?

That's an expense number.

So that's about a $0.20 headwind?

Is that the right way to think about that in the back half of the year, that wasn't in the previous outlook?

Yes.

But again, some of that we're going to self-fund through G&A and some of that is reflected in our guidance.

Okay.

Great.

Thanks a lot.

Okay.

Well, in closing, while we're disappointed by the revision of our 2012 outlook, we're confident that we are taking the right steps to fulfill our long-term goals and objectives.

As we think back, it's clear, we're the first company to see changes in the marketplace, and the first to tell Wall Street about them.

We believe our 36 months of consistent and stable inventories gives us insight, which has resulted in disciplined pricing.

Consistency in the market is critical, and we believe it's been the right thing to do for our Company and our customers.

I want to thank everyone for being on our call today.

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