Elevance Health Inc (ELV) 2012 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the WellPoint third quarter conference call. At this time, all participants are in a listen-only mode. Later, there will be 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.

Good morning, everyone, and welcome to WellPoint's third quarter 2012 earnings call. This is Doug Simpson, Vice President of Investor Relations. Presenting this morning are John Cannon, Interim President and CEO, and Wayne DeVeydt, Executive Vice President and CFO. Also available for Q&A is Ken Goulet, President and CEO of our Commercial and Individual Business.

John will start this morning with an update on the CEO search process and the pending Amerigroup transaction, discuss interim priorities and actions, and provide some perspective on our investment plans. Wayne will then review the quarterly financial highlights and our updated outlook. Q&A will follow Wayne's remarks.

Just to walk through the disclaimers quickly. During the call we will reference certain non-GAAP measures. Reconciliation of these non-GAAP measures to the most directly comparable GAAP measures are available on our website 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 today's press release and in our quarterly and annual filings with the SEC. Also, just a reminder that our current 2012 GAAP EPS outlook does not include any impact from the pending Amerigroup acquisition other than costs primarily related to the pre-financing of the transaction. I will now turn the call over to John.

Thanks, Doug, and good morning, everyone. First, let me start off by saying how honored and privileged I am to serve as Interim President and CEO of this great Company. I'm confident about the future and our ability to better leverage our assets into the opportunities we foresee in areas such as dual eligibles, coming exchanges, and the Medicare market. With better execution and incremental, yet disciplined investment, I believe we can drive greater shareholder value over the long term. As Doug mentioned, this morning I'm going to focus my remarks on three areas. The status of the CEO search, I'll update you on the pending Amerigroup acquisition, and I'll discuss the near term focus areas for our Company.

With respect to the CEO search, our Board continues the process of an internal and external search. That's being carried out by a search committee. When thinking about criteria, I would note that there are different combinations of skills and qualities that may be attractive in a CEO. So, there's not one specific profile or combination of qualifications being considered. And, for obvious reasons, it would be inappropriate for us to discuss potential candidates. In fact, the search will be conducted in strict confidence. So, we do not expect to comment further on this topic until the search is concluded and the permanent CEO is announced except to say that the search committee's outside advisors have indicated that something on the order of three to six months is a reasonable time frame for this kind of search. Which could, therefore, extend into the first quarter of 2013. Nevertheless, let me stress that during the interim period, I'm very much focused on keeping us actively moving forward. And, that includes addressing areas of clear opportunity to better position us for improved results under a permanent CEO. As long as I have the job, I intend to do the job. And, I'll touch on some specifics in a moment.

With respect to the Amerigroup acquisition, we continue to expect the transaction to close by the end of this year, likely in December. As previously announced, Amerigroup reached an agreement to sell its Virginia business to Inova and that includes approximately 55,000 members. We continue to work with the Department of Justice on the Hart-Scott-Rodino approval. With respect to the state approvals, a number of those have been received while several remain outstanding at this point. That said, the process with the states is proceeding well and continues to move along in accordance with our expectations. As you know, Amerigroup shareholders overwhelmingly approved the transaction last month. And, as you also know, we secured financing on favorable terms.

Integration planning has commenced. A steering committee meets every two weeks that is jointly led by Gloria McCarthy of WellPoint and Dick Zoretic, the Chief Operating Officer of Amerigroup. There are 30 functional teams meeting on a weekly basis. And, all in, 300 people are involved in integration planning. We look forward to welcoming to WellPoint the very talented Amerigroup management team who have built, what we believe, is a best in class company.

We also made some key initial decisions around our organizational structure post closing which were designed to increase accountability and clarify decision rights. Some have questioned why are we doing this now? And, I certainly understand that the permanent CEO will have his or her own ideas and focus areas. But, during this interim period, we still need to make decisions to best position the company for the coming market opportunity. Consequently, we'll be organized around four core businesses following the close. First, Commercial and Individual. That will include our exchange strategy, and that will be led by Ken Goulet. Our second segment will be Specialty, to be led by Lori Beer who will also continue to oversee Information Technology and our Federal Government Solutions business.

Our third segment will be Medicare programs to be led by Leeba Lessin, who has been successfully overseeing the integration and expansion of our CareMore model and has a proven track record of success in this business. Finally, Medicaid, to be led by the Amerigroup leadership team. As previously communicated, Jim Carlson, Dick Zoretic, and Jim Truess have agreed to join WellPoint's senior management team post closing. I've also asked Leeba and the Amerigroup team to jointly recommend the best structure to execute our dual eligible strategy. We'll also be making some realignments in our clinical care management areas, Customer Service operations, and other enterprise wide shared services to ensure each business unit has the resources and decision making authority to ensure success while driving greater efficiencies as a combined company.

As I said earlier, now is not the time to stand still. In addition to our focus on the Amerigroup transaction, we are working on our 2013 plan and related investments to support growth. We will continue to focus on execution. And, there are a few areas we specifically need to target. For example, in our Commercial Business, we need to evaluate optimal product positioning and prepare for 2014 with the introduction of exchanges now basically just one year away. We're using extensive market simulation and pilot programs to develop our strategies for how best to position our brands and products for profitable membership growth on a state by state basis. Partially based on these efforts, we're looking hard at our product price points and network strategy. Our existing small group business will likely face headwinds in '14. But, based on our research, we like our positioning on both cost and brand awareness.

On the government side, we need to prepare for the dual eligible opportunities while enhancing our Medicare Advantage operations. Specifically, we're focused on the buildout of 12 new CareMore centers during 2013 which is in addition to the 12 new facilities that we'll be opening January 1 next year. The dual eligible opportunity in California is also rapidly approaching with three of our counties going live next June. We plan to participate in Alameda and Santa Clara counties directly and as a subcontractor in Los Angeles county. In our broader MA book, we are repositioning our product offerings and enhancing our data analytics. We have started down the path on these multi-year opportunities and we believe our MA margins can rise into and through 2014 from current levels.

So, to summarize, we are moving ahead with an emphasis on finishing 2012 on a strong note, preparing for a successful Amerigroup integration, and ultimately better positioning our combined company for the growth opportunities in front of us. Now, before I turn the call over to Wayne, I would like to note that we believe our third quarter results were solid and reflected more consistent execution across our businesses. Commercial performance improved in the quarter with both operating gain and operating margin increasing from the prior year period. We also began our incremental investment spending during the quarter, particularly in the consumer segment area. On balance, the quarterly results increase our confidence in our ability to achieve our 2012 EPS guidance.

As we've said previously, 2013 will be a year of meaningful investment, focused on areas including exchanges, Medicare, duals, as well as other initiatives. I want to stress that we recognize the need to demonstrate progress with these investments to our stakeholders. Consequently, we've upgraded our internal business investment process to strengthen its linkage to our strategy with greater quarterly accountability to ensure execution against clearly defined milestones. Investment returns will be closely monitored to ensure resources are being allocated as productively as possible. I would also note that this investment plan is flexible. And, the level and pace will be tailored as necessary based on business and regulatory development.

Finally, I would particularly like to thank our associates for their focus and dedication during this period. I know change can be both distracting and stressful. So, I'm deeply grateful for their efforts and very pleased with our ability to deliver on our financial targets this quarter. And, with that, I'll turn the call over to Wayne who will discuss our third quarterly results in detail. Wayne?

Thank you, John, and good morning. My comments today will focus on the key financial highlights from the quarter. Additional details are included in this morning's press release and will also be in our Form 10-Q that we file this afternoon. Our Investor Relations team will also be available after the call to address additional questions. What I'd like to do this morning is at least spend a few minutes on some of the quarterly highlights and then I'll get a little more detailed on both the balance sheet and the income statement.

Overall, results in the third quarter of 2012 compared favorably to our expectations and give us increased confidence of our full year outlook of $7.30 to $7.40 in adjusted EPS. Our third quarter '12 GAAP EPS was $2.15, which included $0.06 per share of net positive contributions resulting from net investment gains, partially offset by acquisition related costs. Excluding these items, adjusted EPS was $2.09, an increase of 18% from $1.77 in the prior year quarter. Quarterly earnings results reflected a combination of improved core operating performance, administrative expense management, and favorability in the capital management areas. We feel comfortable with where we sit at this point in the year in terms of operating trends, reserves, and investments.

Just to anticipate a possible question, we are not raising our outlook for 2012 which could reflect some measure of conservatism as the solid trends we experienced in Q3 run through the end of the year. We believe this is the most appropriate way to handle the outlook given the volatility we've seen this year. Recall that in terms of earnings seasonality we expect Q4 to drop from Q3, due to deductible, leveraging, and increased SG&A spending among other dynamics.

Let me spend a few moments now on the income statement. Membership declined slightly on a sequential basis by 54,000, or 0.2%. We continue to expect that we'll end 2012 with approximately 33.4 million members. This obviously translates into operating revenue which was essentially stable versus the prior year period, as the impact of lower fully insured local group membership was partially offset by growth in the senior business, premium rate increases designed to cover cost trends, and the inclusion of 1-800 Contacts in the current quarter. Benefit expense ratio of 85.4% rose 30 basis points from the prior year quarter. The increase in the Consumer segment, which was expected, was partially offset by an improvement in the Commercial segment ratio. We currently expect that full year 2012 underlying local group medical cost trends will be towards the middle of the 7%, plus or minus 50 basis points range.

Unit cost increases continue to be the primary driver of medical trend while utilization has moderated to some extent relative to our view last quarter. We are not going to comment in detail on 2013 at this juncture for competitive reasons. But, our bias would be for a modest increase in trend relative to 2012 as factored into our pricing.

SG&A expense reflected disciplined expense management across the company. Our SG&A expense costs were favorable despite covering approximately $0.06 per share of higher than expected severance costs in the quarter. We continue to expect an increase in SG&A expense in the fourth quarter of 2012, due to our strategic investments and the seasonal increase in marketing and enrollment cost.

Moving to our balance sheet and cash flow. Our reserves have developed favorably and remain appropriately conservative. Favorable prior year development of $483 million year-to-date through September 30, 2012, was essentially unchanged from June 30, 2012 and greater than the $206 million year-to-date through September 30, 2011. We remain within our targeted range of a mid to high single digit margin for average deviation as of September 30, 2012. Our DCP increased 1.6 days sequentially to 42.4 days as of September 30, 2012, driven primarily by sequential increase in medical claim reserves and claims payment seasonality including the impact of fewer claims processing days in the third quarter.

Our debt to cap ratio of 36.3% and [parent] cash balance of $4.9 billion at September 30, 2012, reflect our September debt issuance in preparation for the Amerigroup closing. Our debt to capital ratio will likely be close to 39% when Amerigroup closes, and we would expect to end 2012 with approximately $1.2 billion at the parent after funding the transaction. Our operating cash flow of $240 million for the third quarter of '12 included only two monthly CMS payments. Our July payment was received early in June. And, had it been received in the third quarter our quarterly operating cash flow would have been $952 million or nearly 1.4 times net income.

We repurchased 11.3 million shares for $655 million in the third quarter of '12. And, then repurchased an additional 10.4 million shares for $634 million during October following the convertible debt issuance. Year-to-date total as of October 31, 2012, was over 39 million shares, or 11.5% of the shares outstanding as of December 31, 2011, for nearly $2.5 billion.

I'd now like to move to the competitive environment. The pricing backdrop feels about the same with some hardening in certain markets as we near 2013, 2014. From a commercial perspective the fully insured business remains competitive but rational overall. We're currently in the middle of the pricing season for our January 1, 2013, business. We remain disciplined in advance of 2014. This is expected to result in continued pressure on our commercial risk enrollment in 2013 although we expect somewhat less pressure than we experienced this year. We also anticipate some membership loss in the individual market during the second half of next year as some people may choose to withhold buying coverage until the exchange is open in 2014.

From an ASO perspective, the 2013 national account selling season is nearing completion. And, with fewer accounts out to bid this season we expect modest pressure on ASO enrollment next year. We will be lapsing a few cases on January 1 due to the carryover impact of some legacy pricing decisions from 2011. We had fewer opportunities to offset these cases with new business wins this season. We also expect some continued pressure from in-group membership attrition as a result of the economy.

In terms of the environment for Medicare, we are comfortable with our positioning for 2013. We have modified some of our Medicare Advantage benefit offerings and coverage areas which will likely limit enrollment results next year. But, this should be partially offset by continued growth from our CareMore expansion, including the entry into New York and Virginia. Overall, we're comfortable with our 2013 outlook. But, there continues to be opportunity to drive greater value in our Medicare Advantage business longer term. In terms of Medicaid, performance improved sequentially in the quarter as we recognized higher reimbursement rates for the Medi-Cal program this quarter, including some retroactive revenue. However, the California Senior and Persons with Disabilities program has experienced some unfavorable activity. The state is aware of the funding issue for this program and we are cautiously optimistic about improved rates in the future.

I now want to take a few minutes to talk about our 2013 outlook. We are in the process of finalizing our 2013 business plan. And, currently expect relatively stable adjusted net income from 2012 through '13 with lower commercial risk member months and our incremental planned business investments largely offset by contributions from the Amerigroup transaction. Below the net income line, we expect share count to decline from 2012 to '13 as a result of share repurchase activity. As John highlighted, we expect 2013 to be a year of investment as we prepare for coming industry changes and opportunities. At this point, we would expect something around $200 million to $300 million pretax of incremental investments for 2013. Or approximately $0.40 to $0.60 per share focused on our exchange, dual eligible, Medicare, and other growth initiatives. I want to emphasize that this is incremental investment spending. And, would note, that our total extra strategic business investment plan, including both capital and expense, is approximately $1 billion next year. These investments will include both people and technology and are reflected in our current view of 2013.

We would note that we're working through our 2013 outlook concurrent with the pending CEO search and we expect to offer more detail in early 2013. We are currently planning to release our fourth quarter '12 earnings in late January. I'll now turn the call back over to John to lead the question-and-answer session.

Thank you, Wayne. Before I open the call for Q&A, I would like to take a moment to congratulate President Obama on yesterday's re-election. We look forward to continue to work with his administration on ways to improve our nation's healthcare system. Clearly, the need to improve access to and affordability of healthcare remains a critical issue. This underlies our Company's continued focus and investment in cost and quality initiatives as we strive to create better healthcare value for all of our customers. With that, Operator, please open the queue for questions.

Thank you.

(Operator Instructions)

Justin Lake, JPMorgan.

Thanks, good morning. First question would just be around small group. You mentioned there would be some headwinds there in 2014. Certainly a lot of uncertainty, but can you flush that out for us any further?

Yes, Justin, good morning. When we're looking at the small group, and really focusing more on 2014, we do fully expect that as you look at the size of an employer group and being the smaller the size of an employer group, the more that we anticipate that it would migrate to an exchange versus the larger the smaller group the less likely that they would move to an exchange. While we built a number of strategies to keep those employers within our current book of business, basically being incentive in certain ways of whether they would want to move to an exchange or not. We want to be prepared for the fact that the vast majority of our small group business is smaller scale in size.

If you look at the average size of our small group membership the average employer size is about 8.5 lives. We think there's a larger amount of that, that will actually shift to the exchanges. So, with that being said, our focus in '13 is to maintain the book as it is today, begin to position that book for migration to the exchanges, and to be able to offer brokers many alternatives between now and then.

Great. So, you mentioned the average size of a group is 8.5 -- or 8.5 members, I should say. Can you tell us what percentage of the book, maybe from a membership perspective, sits in what you term micro group? And, how the margins there look versus the typical?

Justin, it's Ken Goulet. The question is a good one. We're not going to get into that level of detail. As Wayne said, the average size group we have in our small group segment is under 10. What I would highlight is small group's always been competitive. And, as John mentioned earlier, we're going to go through a transition because about 10% of our book is grandfathered and the remaining 90% will be going to our [medal] products. We've done an awful lot of work on developing products for our medal products for 2014 and feel ready for it. As Wayne mentioned, for the exchanges, it's actually -- it's a change but an opportunity.

And, there will be a lot more people covered. And, we feel that with our brand and with our product positioning we're going to be in good shape to be able to participate on the exchanges which will be a market by market decision on whether to participate. But, we feel that in working with our regulators, we'll have a good opportunity to drive growth in 2014 and beyond.

Thanks. Just my second question would be on membership growth for 2013. Your PBM partner yesterday mentioned the uncertainty around the economic environment for next year. And, obviously you've had some -- you've seen some of that in your membership this year. I'm just curious how you're thinking about 2013 membership even just at a high level? And, how you think it might compare to the 800,000 or so members you lost this year, ex-Amerigroup let's talk. Thanks.

Hello, Justin, I'll take that one as well. It's across multiple lines of business. But, I'll talk through as I think you were mentioning more on the Commercial and Individual segments. So, first, we do believe both our fully insured and ASO enrollment will decline a bit in 2013 for the reasons we've discussed. But, that will be more stable than we were in 2012 and that we feel comfortable with the direction we're turning right now. We do expect less enrollment pressure than we experienced this year.

Now, first -- and we openly discussed our New York small group transition in an earlier call. And, that transition's nearly complete which was our small group business transition. And then, our California, Virginia, and Ohio markets are stabilizing well. We do anticipate some additional turnover in Individual, in the second half of next year, not offset by new business growth.

Essentially, we're believing that there will be normal trends going into the first half of the year, but in the second half of the year there will continue to be some new turnover. But, new sales will wait until the exchanges become available in 2014. So, our Individual segment marks down a little bit in the second half of 2013, but will pop back up once we head into 2014.

Great. Thanks, for all the color.

Matt Borsch, Goldman Sachs.

Yes, thank you. Could you just give us any more granularity you could on the -- you mentioned the hardening, a little bit of hardening on the Commercial pricing, maybe relative to what you saw earlier this year? Any regional variation there? And, would you think it's reasonable to attribute some of that to pre-reform implementation repositioning?

First, I would say that we, and I believe the market, in general remains disciplined on margin. And, we continue to price for our forward view of our underlying costs. We did see earlier in the year some impact in certain markets that we don't quite know what competitors are doing. But, they may have been more MLR related or activity related to medical loss ratios.

As we went into the third quarter, we're seeing our membership is firming up and we feel pretty good going into the fourth quarter as well. So, our price point and products that we've rolled out, we feel comfortable with them. I would say that there is -- continues to be a persistently weak employment environment and more so in our 14 states than the 50 across the board. So, as the economy turns, that will be favorable to us as well.

And, could you comment at all on your thoughts in terms of the set-up so far of the California exchange? And, what you think of that model relative to what some other states may be doing?

Matt, it's Ken. I'll continue on that one as well. I think for the other folks on the line I would just say California is the first of our markets to go out with an exchange bid. And, it is an active bid, meaning that California is identifying the products and conducting an RFP process where each carrier will be actively participating in a bid selection process. Our intent to bid was due in October and we delivered an intent to bid. And, in the first half of January will be our submission. I would say the difference is that first of all, California is ahead of most of our other markets. Although, we feel that markets will start moving forward fairly quickly now that the results of the election are concluded.

We also feel that California will be one of probably just two or three active bid processes across our 14 markets, that the others will be more of an open market bid and that California will be more in an active solicitor process. We feel very good about the interactions on the exchange between the consumer groups, the carriers, and the regulatory agencies. And, everyone's working very close to be able to pull our bids together in January for the 2014 roll-out.

Just one last one. Any thoughts on where you think utilization trend will be going next year?

Matt, at this point in time we're not providing guidance. Although, I would say as we mentioned earlier our bias is that trend will be moving upwards and we're pricing accordingly for that.

Got it. Thank you.

Ana Gupte, Sanford Bernstein.

Hello, thanks, good morning. I'm looking at your consumer margins and it seems like the turnaround is largely -- or the new CEO and the new Management team will need to focus on bringing your Medicare margins back to health. If you compare them to 2009 they've come in significantly. I'm just trying to understand beyond your commentary in your press release on the risk scores. How do you parse out the margins and, the down side that you're seeing from your networks? Possibly because you have more PPO networks? Humana has certainly been seeing some issues there relative to the mix shift issue to aging boomers perhaps with lower scores. And then, finally, on underwriting and what is your turnaround plan and the trajectory back to health, if you will?

Thanks for the question, Ana. Overall, we are comfortable with our positioning for 2013. We've modified some of our Medicare Advantage offerings and coverage areas, as you know. That will likely limit, somewhat, enrollment results next year. But, we expect that to be partially offset by continued growth from our CareMore expansion including the entries into New York and Virginia. With respect to specific products, we are comfortable with our HMO product pricing. That is generally performing as we'd expected. With respect to our local PPO products, as you know we've exited some of those markets in 2013. We've also repositioned some of those product offerings in other markets and we expanded into some new geographies.

Overall we have Medicare Advantage offerings in 484 -- excuse me, 484, yes, counties in 2013. That is a net increase of about 11 counties over 2012. And, CareMore will be in five states, California, Nevada, Arizona, New York, and Virginia. So, I would say generally we're comfortable l with our outlook for 2013 but that's not to say there aren't opportunities to drive greater value in that business longer term. We started down that path in what I would expect to be multi-year opportunities. As you know, there's some pricing constraints year-over-year in this business. But, overall, we are comfortable with the actions we're taking and our outlook.

Thanks, John. You don't think that there's any structural issue then relative to the Blue brand and/or your focus? As largely a Commercial player, your networks are primarily to service the Commercial population and then Medicare and Medicaid are built around that.

Ana, yes, let me elaborate a little on that too. I would say that no, we actually -- we don't think there's a problem with the Blue brand itself or the branding there. I do think, though, the key is going to be the HMO products. Again, only about 40% of our membership is within the HMO. And, you're going to see us slowly migrate from PPO products to more HMO products. We really think to really effectively manage this population, and as you're moving to the 85% MLRs, that to really improve our margins you're going to see more of a migration to that HMO market.

I do think over the next two years, though, what John was highlighting, is that we are starting to exit as we did in '12, and you'll hear us exiting some more in '13, in the PPO markets and entering more into the HMO markets along the way. It's probably going to take about two years to migrate to that. But, with that, that's why John had commented earlier on in the call that we should see margin improvement continue not only into next year but through 2014 as we are starting to reposition our products.

And, that, Ana would include our regional PPO product too. As you know, we did exit Northern California last year and we are repositioning that product as well in the Ohio, Indiana, and Kentucky region.

Thanks, that's helpful. One last question on Commercial. You're structurally advantaged because you don't have the Blue competition in your state. So, who exactly is gaining share from you on your local group fully insured? Does it move largely to self insured? Is it Cigna or is it more Aetna and United that are doing it? They don't seem to be growing much anyways other than Aetna.

Ana, there's a couple of dynamics in place with the Commercial Business. First, in the small group, a third of all business that is leaving us is not going to a competitor. It's going to either an uninsured or an Individual rank. Which our Individual Business has grown slightly year-over-year.

And, has done a good job on a membership basis. I would say that when I look at different carriers, there is some migration to ASO. So, that's both to our own ASO products or possibly to competitor ASO products. But, it really is a combination of a declining membership base overall, because of the economy, and then combining with some movement to ASO.

I would say local competitors, while we don't have other Blues, usually in our markets the national competitors comprise about an equal -- one-third of the market share of ourselves. We're two to three times larger. But, the regional players make up the remainder and is larger than the national players. So, regional players remain key competition. We have certain markets where you have up to 15 to 20 competitors that you are participating against. And, there are ups and downs amongst the regional players. But one-third goes away, a portion going to ASO and the remainder is a zero sum game, as you know, between regionals and ourselves.

Got it. That's helpful. Thank you.

(Operator Instructions)

Tom Carroll, Stifel.

Hello, good morning. Can you hear me okay?

Yes, we can.

Very good. So, a question on just the spending, and Wayne, thanks for the forward look on that. But, how do you -- how discretionary do you believe the $200 million to $300 million next year potentially is? In terms -- I guess said differently, how flexible are you with it in terms of either doing it all or pushing more into 2014? And then, I guess secondly, and related to that, is it your goal to include as many AGP integration costs as possible in 2012 results?

Tom, good morning. Let me hit the different questions there. The first one is on the $200 million to $300 million. It is very flexible. And so, the one thing I would highlight, for example, is we're assuming though that all exchanges will still move forward with a January 1 effective date of 2014. At this point in time we have no reason not to believe that. But, we all recognize too that many states have a long way to go and may be challenged. And, we're still waiting for rules to be finalized at this point. We are giving you what I would view as an all-in number as if markets are all going to go live on January 1. It also assumes a pace for duals that may go faster or it may go a little slower. That's flexible as well.

Relative to the AGP transaction, to the extent we are able to close this year, we will take a significant portion of the costs that we anticipate for next year in the current year. Specifically, we would assume we would take, obviously, all banker and legal fees. We would take as much of the restructuring cost that we would need to take for integrating the two companies that we would be allowed under the accounting rules to come forward as well. That could provide, obviously, a nice tailwind relative to some of our expectations.

As you know, when we close a transaction we expect it to be approximately $0.15 accretive for next year, inclusive of those costs. So, clearly bringing those costs forward would make that number better. At this point I would say we're very pleased with where our debt offering came in relative to our expectations. We're very pleased with the work that the teams have done on synergies versus the expectations we were modeling. So, I think we feel good about those two areas at this point in time.

The last piece that we'll have to finalize will be upon closing is modeling in the EBIT and the revenue growth. But, my understanding is that from a membership and revenue perspective everything is coming along as planned at Amerigroup right now. All in all, feeling pretty good that if we can close in December time frame that we'll have a little better accretion from the transaction.

And then, just a second quick question. Your deferred tax assets saw a large decline this quarter. What was behind that drop?

I'm sorry, Tom, on the deferred tax asset?

Yes.

The biggest thing was that we had a settlement with the IRS, that was one of the items we tried to highlight. If you recall years ago we had a number of entities that demutualized. We had been in discussions with the IRS for a number of years and getting those items settled. That is the primary driver was that settlement.

Thanks.

Melissa McGinnis, Morgan Stanley.

Good morning, and thanks for the question. Maybe just sticking with $200 million to $300 million in spending. Can you just confirm, is that actually incremental to the $110 million you'll already spend inside 2012? And then, beyond that, can you help break down the various buckets of that spending around are exchanges the biggest piece? Are duals the biggest piece? Are you actually including the California dual start-up cost inside that $200 million to $300 million? Thanks.

Hello, Melissa, good morning. Yes, this is incremental to our 2012 investments. If you were looking at the other $200 million to $300 million for next year, about $150 million is exchange related, incremental exchange related. It's important to recognize. That is pretty much people, product, and technology build-out to interface with the exchanges. And so, a big portion of that cost, of that $150 million, will go away. But, there is a core underlying run rate of G&A associated with exchanges that is part of that broader $1billion spend that we've talked about.

The other components of it, about the other 50% of it, is a combination of repositioning our products and our Medicare markets, building out more risk coding, expertise in those markets, and, of course, Leeba, who does that quite well at CareMore, is going to be leading that effort for us now for all the senior. It does include our build-out for the dual activities as they relate to California for the three counties that we specifically talked about as well. And then, other growth initiatives depending on how the Medicaid may expand over time. So, in general, I'd say about 50% of it, though, is exchange related of the incremental component and the other 50% is a combination of both our dual strategy work and our senior repositioning.

Maybe just to stick with that a little bit, because it does sound like some of your $1 billion spend is certainly run rate but some of this is incremental. Should we think about a certain chunk rolling off in '14 and '15? How should we think about the lapsing of some of these investments.

The way I would describe it is view the $200 million to $300 million as being the true incremental. We're making a conscious decision to invest at levels higher than we have in the past. There's obviously fungible investments within that $1 billion that we are able to shift dollars, for example, from certain business lines that we expect to migrate to exchanges over time and then move those dollars over. Some of the dollars are fungible. But, if we're looking truly to incremental, you're looking at $200 million to $300 million on a pretax basis which equates to about $0.40 to $0.60 to earnings.

As we get into '14, if the world was perfectly flat and all things were equal that, would go away. What we haven't modeled, though, is how quick will the pace of additional duals but at that point in time. Will there be even more legislation coming out with the ACA? But, for now we would view that truly as incremental.

Great. Thanks for the question. And, John, also thanks for all the detail about what you've been doing since taking over.

Thank you.

Chris Rigg, Susquehanna.

Good morning. So, I just wanted to, again, follow up on the investment spending theme. And, to make sure I understand. What is the exact amount of investment spending you guys are projecting for 2013?

The total spend, what I'll call non-discretionary dollars, whereby we have -- obviously we have a workforce, we have real estate, we have to pay claims, et cetera. But, if you said what is your absolute capital and expense that you're spending on strategic investments, it's $1 billion, of which $200 million to $300 million of that is incremental of our historical spend.

Right. When I think about the $1 billion, how much of that is permanent and will be in your cost structure in perpetuity versus how much will roll off?

Again, consistent with what we talked about earlier, view it as around $700 million is permanent. And, about $200 million to $300 million is the incremental component of it that, in theory, would roll off in '14 assuming that there aren't more aggressive investments needed because maybe duals are coming on sooner. Again, in that $700 million, though, there is a run rate for exchanges. There is a run rate for duals. There are other dollars in there. That does include, of course, the portion that's capitalized with it.

So, I would say, though, each year you're going to spend about $700 million a year just to run your businesses. And, that includes how our business is shifting. And, again, the $200 million to $300 million is a discretionary piece that we can lever up and lever down on.

Okay. Changing gears a little bit, can you just remind us of once AGP is done, what the share repurchase posture versus debt pay down will be for you guys? What's the right way to think about that again?

Yes, Chris, I would view it for 2013 -- and I don't want to get ahead of our Board, but I will reiterate comments that we said previously. We do expect to still deploy about $2 billion in capital in 2013. It would be a combination of share repurchase and dividends. The dividend is currently in the range of about $400 million. But, that's before the Board has an opportunity to review our dividend policy. So, that could change slightly.

And then, of course, that would leave somewhere in the $1.6 billion for share repo for next year. If you're modeling, look at it as about $2 billion being deployed in total. With right now using about $400 million for dividend and about $1.6 billion for repo. You could see that fluctuate a little bit between the two depending on the dividend policy that the Board will evaluate in December.

Okay, great. Thanks, a lot.

Scott Fidel, Deutsche Bank.

Thanks. First question, just wanted to follow up on Medi-Cal. And, given the new contract announced by Health Net recently where there seems to be some pretty advantageous protections from the states surround losses that could accrue as the build-out of Medicaid and the duals plays out over the next couple of years. Just interested in your conversations with the state and whether there's any potential for a similar contract structure? Clearly, you've seen similar margin pressures in your Medi-Cal business that Health Net has this year. And then, in the past relative to uncertainty around rates.

Hey, Scott, good morning, thanks for the question. We're very cautiously optimistic. Obviously, the Health Net thing is a positive thing for their business. We would anticipate a similar approach within our business model. I do want to emphasize that the SPD program in California has really been experiencing unfavorable activity. But, only in the new mandatory enrollment portion. The legacy voluntary SPD program has been really profitable for us.

I think it's the state's seeing where it's mandatory and as they're looking at the program they're recognizing the needs to either adequately fund it differently or to change the mechanisms with which the benefits are provided. All in all, yes, we view that as a positive sign for the markets in general. We're having our ongoing discussions with the state as well. So, I'd prefer not to comment on those. But, in general we see that all as very positive.

Okay. And then, just the second question, just in terms of context on 2013. Wayne, didn't really hear you touch on MLR specifically. So, interested in trajectory in particular of the Commercial MLR. You said you guys are going to be pricing to trend. And then, you should have some extra pricing to start pricing it for the industry tax. So, interested in the outlook for the Commercial MLR next year.

Yes, Scott, I apologize, but we're really not going to give detailed guidance at this point in time. And, we would like to reserve that for a little bit later, early in the January time frame when we finalize some of our pricing decisions. And, it's more for competitive reasons. But, we are going to be moving forward in many of our lines beginning to price, though, for the tax that's coming due in '14. We think that's a prudent thing. That will obviously have some implications on the MLR. We prefer to wait until future calls to provide more details.

Okay, thank you.

Christine Arnold, Cowen.

Hello, there, a couple questions. One, it looks like your Medicaid MLR was over 100% this quarter. As I think about your SPD that's 90,000, it's $525 per member per month which gives you close to $600 million in revenue there. Was that MLR over -- first of all, was the Medicaid MLR over 100%?

No, Christine, I'm not sure where that calculation was coming from. It was not over 100%. The one thing I would highlight is the Medicaid in all the markets is performing fine with our expectations. And obviously, trend is coming in very stable, in some ways better than expected. But, the SPD by itself is the one area -- and it's on the mandatory piece only, which is about 60,000 lives that I would say that we're seeing closer to that 100%. But, outside of that, no, we did not see that.

Okay. And, can you give us a sense for how much you think that Medicaid MLR could l improve next year?

At this point, no, we're still negotiating rates with the state and anticipate finalizing that soon. I also think it's fair to say that as we start to integrate the Amerigroup model into our model the pace at which we're able to push that through and move forward could also affect that. So, at this point, not able to speak to that.

Okay. And, can you clarify that you do expect the 2013 Medicare Advantage loss ratio to improve?

Yes, at this point we expect it to improve, yes.

Final question. How much utilization are you pricing for in the Commercial book in 2013 relative to '12?

Again, at this point, Christine, we're not commenting at that level of detail. We will provide more of that in the future calls.

Okay. Thanks.

Thank you.

Kevin Fischbeck, Bank of America-Merrill Lynch.

Okay, great. I wanted to go back to the point that you made about the strong Q3 but not really raising the guidance for the year. And, I understand that there's some conservatism in the number. Is there anything else to keep in mind? Any movement from Q4 into Q3 during the year? Some of your competitors talk about a Part D experience that made them re-evaluate earnings progression intra-quarter. Is there anything like that we should be thinking about that might have also explained the strong Q but lack of update this year?

No, Kevin, nothing of any significance to the operations of the Company. I think it was our position that it would be best to maintain a conservative and cautious outlook. We are in the process of closing October at this point in time but aren't anticipating any surprise from what we saw in the quarter. So, nothing more than a cautious view. You do have the normal seasonality in the fourth quarter, though. Obviously, deductibles are being met at that point. So, you get that.

And, you always have a better MLR for Part D in the third quarter. But, Part D doesn't really move the needle for us. Really from our perspective, nothing other than just thinking that there was an important desire to consistency in execution and maintaining a cautious view. And, we thought that was a prudent thing to do.

Okay. And then, the lower risk score revenue in the quarter, is that something that you view as something you can recapture later on this year? Or some one time issue? Can you just talk about what that was and what that means prospectively?

Yes, the one thing I would highlight, is it's more of a timing issue regarding the true-ups that we do each year. So, from a comp perspective it makes the quarter of this year versus quarter of last year look a little distorted. If you look at the full nine month period to nine month period, you'll see the consumer segment is only down about 2 percentage points. It's more about timing on that.

I do fully expect, though, that we will see improvements in our risk coding going forward. I think there are many opportunities to improve in that area. We have investment dollars earmarked for the fourth quarter of this year as well as going into next year. As you know, Kevin, even when those dollars are put forward, the actual value and benefits of those dollars don't start ramping up until the subsequent year. We'll see some improvements next year. We'll see a big improvement in the following year and then building up from there.

And, we're leveraging the CareMore model. They have, obviously, incredibly strong risk scores and good star ratings as well. And, we're leveraging that as well as we're building out our new products.

Just a quick clarification. You're maintaining your trend guidance range for this year but I think -- are you qualitatively lowering it? Because I think last quarter you had the same 6.5% to 7.5% range. Last quarter you guys said you felt like the upper end of the range, now you're just saying the range. Do you feel like it's more in the middle now given the moderation in trend in Q3? Or you still feel like the higher end of the range is more likely?

Kevin, very important point to focus on. In the last quarter, because what we saw in May, we said our bias was going to be to the upper half, not the upper end, but the upper half, meaning in the 7% to 7.5% range now. But, seeing a very muted third quarter that we saw we really think it's really fallen pretty much in the middle of that range. Really, pretty close right now to right about 7% is our best estimate at this point in time. It could get a little volatility but we're not expecting much based on what we saw in the third quarter.

Okay, great. Thanks.

Carl McDonald, Citigroup.

Great, thanks. Wanted to come back to Medicare Advantage. A year ago you talked about margin improvement in Medicare this year because of the repositioning that you've done. Margins have improved, but I don't think they've come back to where you anticipated. So, as we look forward to the repositioning for '13, can you just talk about some of the differences? And, I would also be interested in the reasons behind the relatively rapid management change in the business.

Carl, let me start out on the margin improvements. And, yes, I agree with your comments. While there's been some improvements this year we're obviously far from where we want to be. We're even far from where we think we should be even with a more muted margin in the future for Medicare which we think is closer to a 5% margin. We have an opportunity to obviously grow into that 5% margin versus being hit or negatively impacted hard in '14 when the MLRs go into play.

I'd say fundamentally what's really shifted and changed, one is our focus with CareMore leading this and our strategy around this is around the HMO model, is really where we need to position ourselves. It is very hard to obtain very strong star ratings in a PPO like product model than it is versus an HMO model. It also, then, allows you to leverage your investment around risk coding much more efficiently in an HMO model than a PPO model. Strategically, that's one major shift you're going to see start to happen. The shift that started over a year ago was starting to exit PPO. But, the more dramatic shift is going to be moving much more to the HMO and focusing on both star and risk coding along the way. I'll let John comment more on the structural changes that were made and why the timing.

Yes, Carl, thanks for the question. I would say that the leadership change that you referred to is largely reflective of the fact that, as Wayne commented, our CareMore model and the HMO model is going to be our primary chassis going forward. And, I think the leadership change reflects the experience level of Leeba Lessin in that business. And, I have complete confidence in her ability to bring that about.

So, our structure is designed to follow our strategy and that explains much of what we did. I felt the need to clarify roles and responsibilities, and I think we've done that. We've got some more work to do at some levels. But, I think at the senior levels of the Company the structural changes that we made are designed, as I said, to align with our strategy.

Okay. Thank you.

Peter Costa, Wells Fargo.

Thank you. John, and Wayne, just back on the $700 million in annual spending, is that what -- for investment spending. Is that what you spent this year or was that higher from systems conversions? And then, are we done with the systems conversions at this point? Where do we stand on that and what was that spending for this year?

Hey, Pete. No, the $700 million is pretty consistent with where we're at for both expense and CapEx for this year. We did shut down two more systems by the end of this year, that has gone well on those migrations. We still are going to be close to six systems by '13 when ICD-10 goes live. And, our instate is really down to three. We are working on a few more systems for next year which gets us to the six so that we're not investing dollars for ICD-10. We would rather shut the system down than invest those dollars. At that point we're down to three systems.

The important point, though, is the vast majority of our membership will be on the surviving three systems by October of 2013. You won't necessarily see a ramp down in the spend but you definitely see a ramp up. And, then it will just be a question of what pace do we move those remaining three systems out. And, that will be very flexible at that point on.

Our goal at this point, Pete, for some of that, is to really just start allowing the new business to ride on the primary platform. As exchanges roll out, as duals come into play, as our new senior business rolls out we're really migrating most of that to those platforms. We'll make a more strategic decision after we get through '13 on remaining platforms. On is it prudent to shut them down or just let them run their course at that point.

Great, thank you. In terms of the merger with Amerigroup, can you describe what states are left? Have any scheduled hearings at this point? What states are left for approval and have any scheduled any hearings? I think the second request on Hart-Scott-Rodino was regarding Virginia. Is that now put away at this point or why have you not gotten the Hart-Scott-Rodino clearance at that point.

You're right about that. The Hart-Scott-Rodino approval was keyed off of the divestiture of Amerigroup's Northern Virginia business -- actually all of its business which was about 55,000 members. What we're waiting for now is for the Virginia department to do some testing of Inova's capabilities with respect to taking over this business. And, that's expected to take place during the course of this month. So, we're not expecting any surprise there at all.

It's the normal process and we would expect, as I said, to have the transaction completely closed by the end of this year. We have had public hearings on the acquisition. They've been held in Tennessee, Louisiana, and most recently, earlier this week, in Georgia. We have approvals in Tennessee and Texas. There's some other public hearings likely in Washington that's being scheduled as we speak. As I said earlier, we fully expect all of the approvals to be completed by the end of this year.

Great. And then, just a last one, if I could ask one more. John, I think you said something important regarding while you have the job, doing the job. You've already done some substantial management restructuring of the business which I applaud. But, what other things do you think need to be done here in the very short term to get WellPoint moving in the right direction.

I think we've mentioned a number of them. First of all, we are in the process of developing our 2013 plan. Obviously, we cannot stand still during this period. Our competition is moving forward. And, I don't mean to suggest that I plan to do anything radical or that doesn't make sense. If a decision does have to be made, I'm prepared to make it because we can't be in a state of suspended animation. There's a lot to be done. With respect to Amerigroup, there's a lot to be done getting ready for 2014.

I hope you realize that I'm taking a common sense approach here. I am looking forward to what's best for the Company and trying to make rational decisions. It was not a case where the reorganization was something that I just suddenly decided to do when I assumed this role and flex my new executive muscles, if you will. The discussions about structure were ongoing for several months before the Management change took place and continued thereafter. So, it was a thoughtful process.

And, it was designed as I said earlier to make sure that people understood who had decision rights to make sure that people knew what they were accountable for, who they were going to work for, and who they needed to work with. Nothing more than that. So, I'll continue to discharge these duties to the best of my ability until there is a permanent CEO named.

Has there been anything that you've had to unwind or substantially change in terms of the direction of where the Company's been going. Because preparing for the exchanges, and all that stuff, that was stuff the Company was doing anyway. Yes, I understand, there's decisions along the way. Were there anything you really wanted to change the direction of the Company?

One area of focus was to approve our ability to make key operational decisions, particularly in the Medicare business. But, I would say, overall, the goal was to align our structure with our strategy and there was some work to be done there. It wasn't necessarily work that wasn't contemplated. But, it needed to be completed. So, that on day one, particularly with Amerigroup, we could hit the ground running and people, as I said, know what they're responsible for and what their roles were.

We also are taking action, as Wayne indicated quite a bit during the course of the call, to ensure that our investments are aligning with our strategy. And, that is still a work in progress. We look forward to discussing that with you later as we firm up our 2013 plan and our Board approves it and we do promise to do that. I would point to those areas as the principal areas of my focus now and most likely for the next couple months.

Changes to the Medicare business that you contemplate, now that you've seen the way the products were positioned relative to others, did you increase your marketing spend for the fourth quarter? Seeing how you did better here in the third quarter? Or your plans for marketing spend in the fourth quarter, given whatever you perceived as the issues in the Medicare business?

Hello, Pete, it's Wayne. Where we have the HMO products and we are executing well, relative to our star ratings and our risk coding, we obviously did reposition our marketing dollars within those markets. We are obviously de-emphasizing our PPO markets, as you can imagine. So, I would view it as not increasing the dollar spend but reallocating the focus of those dollars to where we think the strategy needs to go.

And, I would say philosophically that's the big thing that, when John talks about aligning structural strategy, was to say that our strategy, we thought, needed to be more aligned around the HMO market driven more from stars, and driven more by risk coding and how that could actually be functionally applied within an HMO market versus a PPO. That's the big philosophical strategic shift. The strategy then, of course, gets aligned in structure, which is where John then looked at the leadership groups and aligned them underneath the structure that had an HMO model, drove an HMO model, and was successful with an HMO model. Which that being Leeba and the CareMore leadership.

And then, finally, our investment dollars then are being repositioned. But, in the case of senior for this year in the fourth quarter we're simply reallocating investment dollars to focus on the HMO markets. But, going into next year we have substantial dollars being invested to improve star ratings and to start building out more HMO product.

Thank you, very much.

David Windley, Jeffries.

Hello, thank you. Following on that last question. So, you've identified very well the $200 million to $300 million for next year. If you're not increasing spending in Medicare in the fourth quarter, I believe you are increasing your SG&A numbers for 4Q. What is that money going toward? Is it similar to what you're directing the $200 million to $300 million for next year?

Yes. Keep in mind, too, that in the fourth quarter we are starting some work on the duals already for the California. We have our RFP for exchanges in California that we're working towards. You always have open enrollment, though. So, it's important to remember that from a Medicare perspective, we always spend more the fourth quarter, regardless of the previous quarter, regardless of the year. Part of that incremental spend in the fourth quarter is really about the idea that we're going to be spending more than we typically do but not abnormally more. I would lastly just add that our fourth quarter has a conservative outlook to it. And, I think that's probably the most concluding comment I could make on that.

Okay, and then, skipping over, Wayne, you, at some conferences, had talked about 2013 and then characterized 2014 as a resetting year. I think we understand from the call today more detail around 2013. I'm wondering if you could help to understand what your comments really mean about 2014? What is the resetting year in 2014 mean? And, is it predominantly around the share shift vis-a-vis exchanges?

Yes, David, it's exactly that. It's the share shift vis-a-vis exchanges. And, while we would expect as we see some of our small group membership drip from the small group bucket and moving to the exchanges, we expect some margin contraction within that group. At the same time, though, we do expect a fairly large amount of membership that we will gain. Both our existing membership that moves there, coupled with the broader market of new lives that will be coming into the market. And, we are investing heavy in the exchanges for that purpose.

So, when we talk about a reset in '14, it's not a reset for all of our book. It's not a reset for seniors, it's not a reset for -- it's a reset specifically to the idea of the exchanges. And, the fact that some of our small group business will migrate, will get margin contraction, but will pick up new lives. And, that becomes the new base to measure our Commercial book off of.

Okay, if I could ask a last question on that. You've talked about small group, a lot of the studies that are now pretty dated, but a lot of the studies have looked at the possibility of large employers with perhaps wage labor, significant amounts of wage labor, that might also consider dumping. I'd be curious of WellPoint's views on the potential for share shift into exchanges apart from small group.

David, it's Ken Goulet. When we look at our membership and segments going forward, there will be some attrition from large group. But, I believe that the interest is more emerging into private exchanges, driven both by the employer group's interest and the consultants who are providing options to them. So, we saw some transition to private exchanges this year. You are right, that if there were -- if there is movement it will be by accounts who have lower wages and are eligible for subsidies.

But, remember that there's so much emerging, at least in 2014, '15 on state by state differences, that a multi-state employer will have difficulty moving to exchanges. Because it will vary very significant state to state. There will be migrations over time. But, we don't see that happening in the early years of the exchanges. It's something that would occur over time.

Okay. Thank you for that.

Thank you, everyone, for your questions. I'd just say in closing that we are pleased with our third quarter results. And, just hopefully you gathered we're taking steps to ensure that we're well positioned for increased growth and success in the future. We also promised, and we will, share with you more information about our investment plans, our 2013 outlook, and the longer term strategies in the coming months. Thanks, again, everyone, for participating in the call this morning. Operator, if you could please provide the call replay instructions we'd appreciate it.

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