Elevance Health Inc (ELV) 2013 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the WellPoint second-quarter conference call.

At this time all lines 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 and welcome to WellPoint's second-quarter 2013 earnings call.

This is Doug Simpson, Vice President of Investor Relations.

Presenting today are Joe Swedish, Chief Executive Officer, and Wayne DeVeydt, Executive Vice President and CFO.

Joe will start with an overview of second-quarter results and provide an update on progress made on structure and leadership during his first full quarter with the Company.

He will then review our primary business segments and offer his perspective on our longer-term prospects and opportunities.

Wayne will then review the quarterly financial highlights in detail and discuss our updated financial outlook.

Q&A will follow Wayne's remarks.

During the call we will reference certain non-GAAP measures; reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are available on our website at 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.

I will now turn the call over to Joe.

Thanks, Doug, and good morning.

I'm pleased to update you on another solid quarter for WellPoint and our continued positioning for the emerging opportunities across our major businesses.

I'm going to start with some highlights from the quarter and then review the progress we have made in aligning our strategy and structure following the passing of my 100 day assessment.

I will then review our business segments and finally I want to offer my perspective on the value creation opportunity we see looking out over the medium to longer term and I will then turn it over to Wayne to discuss the financials.

We are pleased to report $2.60 in adjusted EPS for the second quarter of 2013, which exceeded our expectations and represented growth of over 27% from the same quarter of last year.

Operating results in the quarter were characterized by continued strong commercial business performance reflecting lower-than-expected medical cost trends and ongoing administrative expense discipline.

We also saw improvements in our Medicaid business, largely driven by benefits from the Amerigroup transaction as well as revenue increases in the legacy WellPoint operations.

We have modestly raised our full-year adjusted EPS guidance to at least $8, which reflects our strong year-to-date performance and our continued expectation for investment spending over the second half of the year as we prepare for 2014.

When we spoke three months ago on the first-quarter conference call, I discussed my three principal focus areas as I assessed our Company.

The first focal point was my initial 90 to 120 days where I would focus on organizational design, infrastructure and continuing the recent operating momentum.

The second was the medium-term review of our market position and our preparations for 2014 and beyond.

And the third was the longer-term strategic outlook.

These all build upon one another and I'm pleased to report progress across all three areas.

During my first quarter as CEO our team continued the operating momentum from the second half of last year, driving better-than-expected financial results for Q2.

During this period I spent much of my time engaging with our leadership team across the enterprise to better understand the ways in which our structure was impacting both execution and preparation for the upcoming challenges and opportunities.

What I would like to do now is review changes to our organizational design and offer some perspective.

First, our Board composition changed during the quarter with four members departing and the appointment of a new independent Chairman, George Schaefer.

We also welcomed a new member, Lewis Hay, who brings substantial leadership and financial expertise as well as a great understanding of operating in an evolving regulatory environment.

This brings our Board composition to eight members including myself.

Next, we realigned the organization around two primary operating divisions -- Commercial & Specialty business to be led by Ken Goulet and government business to be led by Dick Zoretic.

This new structure supports better organizational alignment to promote efficiency and effectiveness of operations and strategic execution.

This structure reinforces our goal of effectively leveraging our skills and the scale of the organization while also allowing P&L leaders the operational autonomy to better respond to changes in the market as quickly as possible.

This process has also consolidated decision-making to drive accountability as I now have seven direct reports, down from the 11 roles traditionally reporting to the CEO.

Along with our governance, executive and business segment realignment we are also moving to deeply instill a purpose driven culture based on transparency, execution and accountability.

We have, in fact, adopted a new companywide purpose reflecting the value proposition expected by the markets served.

Together we are transforming healthcare with trusted and caring solutions.

Our vision is to be a valued and trusted healthcare partner.

Our culture will embed the expected behaviors wherein associates can act to support with consistency and discipline our customers and constituents as they look for answers in this changing healthcare landscape.

I want to emphasize that assessing team structure and process is an ongoing exercise that necessarily flexes with the business.

With my executive leadership team firmly in place we are now reviewing the next tier of leadership and will be evaluating how to best align those teams to support our overarching goals.

As part of this process Ken Goulet recently aligned our local group and individual business into three regions -- West, Central and East.

These regions are each headed by seasoned executives with strong operating track records and direct experience leading state Blue plans.

These leaders will also each assume additional enterprise wide responsibilities such as business growth initiatives including exchanges, specialty and provider collaboration.

In the government segment Dick Zoretic's team will leverage the Amerigroup and CareMore assets across a broader government platform, serving the needs of the Medicaid, Senior, chronic care and dual eligible populations as well as the Federal Employee Program and our government claims processing business.

With my focus now shifting to our strategic positioning in 2014 and beyond my executive team and I recently engaged in a deep dive to analyze the opportunities and challenges across our portfolio of businesses.

This reinforced my view that WellPoint has the key assets and talent to win in the market while recognizing the need to improve performance in certain areas such as our Medicare and legacy WellPoint Medicaid businesses.

CareMore has performed well year to date and we are adjusting our expansion plans to reflect the changing reimbursement model.

We have also made some progress in the California Medicaid market, but continue to work with the state to ensure a sustainable long-term economic model.

I also have initiated the examination of our IT expenditures, which run over $1 billion annually, as I believe there is an opportunity to make that spending more efficient to free up capital to invest in data analytics and information management.

I believe this must serve as a key contributor to further improve our market position and performance, especially around medical management, customer service and predictive modeling.

In summary, I will continue to review our portfolio of assets to ensure that we are most appropriately allocating your capital in a way that best drives us to deliver on the opportunities we see ahead.

Moving now to our business performance, both our commercial and specialty segment and our government segment exceeded our financial expectations for the quarter.

In commercial we continue to perform well and we are encouraged by improving ASO membership trends as we look ahead to the next year.

In the fully insured business we continue to prepare for the scheduled initiation of insurance exchanges now less than 70 days away.

Our current expectation is that fully insured employer-based coverage will likely see membership declines in 2014 with growth skewed to individual coverage offered through the exchanges.

We may see a slower migration to exchanges in 2014 than we had modeled six to 12 months ago as employers and individuals continue to evaluate their choices for 1-1-14 and beyond.

We have filed products in approximately 140 rating regions for individual exchanges across our 14 Blue states and also expect to selectively participate in several small group exchanges.

We are working with regulators on final product and rate approvals and are generally pleased with where our products are positioned relative to our peers.

We expect to be a strong competitor in most regions because our brand and local market experience are meaningful differentiating factors.

Our read of the competitive landscape is that peers are taking a similar stance and focusing their exchange participation in markets where they have substantial local experience and density.

We are still in the process of evaluating details of the products offered in each local market area, which is often required to fully compare offerings on an apples-to-apples basis.

We believe our networks and price points generally strike the right balance of access versus affordability and position us well against other offerings in the market.

For example, we believe our networks, while narrower than those in our legacy commercial products, have the patient volume capacity to support strong membership growth relative to smaller networks we have observed.

So we feel good about the value of our exchange offerings and our price point positioning based on what we have seen thus far.

In the ASO marketplace our local group and National Account membership trends have improved since last fall as customers have accelerated focus and expectations on tangible healthcare cost savings.

Our ability to outperform on that front, as well as our investments in clinical capabilities, have driven substantial client savings and increased interest in our ASO services.

This advantage was apparent in a recent consultant study which showed that the Blues plans have the leading cost structure in over three times as many markets as the next closest competitor.

The 2014 selling season remains in progress, but at this point we expect to be a net membership gainer with larger customers next year.

We currently expect approximately 750,000 new ASO members by year end 2014 for growth of nearly 4% from current levels.

This is above our earlier expectation for new member growth.

We are particularly pleased with this performance in what has been a comparatively low RFP season as many customers are taking a wait and see approach to some of the market changes next year.

The common theme has been a focus on underlying medical cost containment and our ability to deliver lower healthcare costs for members.

Employers remain interested and creative solutions to addressing their healthcare cost challenges.

Private exchanges may become a growing part of that dialogue over time, but employers' immediate 2014 focus is generally on traditional coverage options in the larger end of the market.

We have proprietary private exchange capabilities in nine Local Group markets and for national accounts and we're also working with a variety of consultants offering other private exchange options.

I would also note that while we now expect to gain more members next year, we've been able to lever our cost structure by redeploying some of the investments previously planned for the Medicare business to support our commercial growth, which is positive.

Turning to the government business segment, we are pleased with results in the quarter.

In Medicaid the Amerigroup integration remains on track and we continue to expect at least mid-teens EPS accretion this year net of integration cost.

We are pleased to have been recently selected to serve new beneficiaries through upcoming Medicaid, dual eligible and long-term care program expansions in multiple markets.

We look forward to working with the various states on these important programs.

We are also actively preparing for the ACA related eligibility expansion beginning next year.

At this point we expect about half of our Medicaid states to participate in the expansion effective January 1, with other states potentially expanding at a later date.

Medicaid is clearly a high-growth area for our Company and, while it is still early, we see the potential to gain several hundred thousand new Medicaid and dual eligible lives by year-end 2014.

Overall, we are pleased with the contributions from the Amerigroup transaction and the outlook for enrollment and revenue growth across our Medicaid business portfolio.

With respect to Medicare, performance was on target with our expectations for the quarter and we continue to evaluate our Medicare Advantage business ahead of the challenging rate environment we expect for 2014 and 2015.

It's important to emphasize that the longer-term volume opportunity with Medicare Advantage is compelling and we remain focused on serving this population with the most affordable and competitive offerings.

As we indicated last quarter, we have evaluated our Medicare investment in light of the lower reimbursement for chronically ill patients.

We've decided to scale back our expansion plans for CareMore and will instead look to apply its unique care management capabilities to other parts of our business that also serve high need populations.

We believe there is an opportunity to implement some of CareMore's acute care, institutional and home care services in other market areas without the upfront investment associated with establishing traditional bricks and mortar care centers.

Of the roughly $150 million previously targeted for Medicare investments this year, we are redirecting roughly one-third of this amount to other growth areas including exchanges, new commercial account wins and our Medicaid business.

In the Blue Medicare Advantage business our 2014 bids were based on our county-by-county assessment of the competitive landscape.

We're making progress with repositioning our product portfolio and our margin enhancing initiatives to help offset the coming reimbursement challenges.

Overall we will likely see some paring back in certain service areas in 2014, though generally expect less member transition than we experienced this year.

Finally, with a strong first half behind us, and an improved outlook for the balance of 2013, I wanted to wrap up by offering my perspective on our Company's longer-term potential, one of the compelling factors that influenced my decision to join the Company.

For 2014 it is early to comment in too much detail as we continue to work through our internal planning process.

Directionally we are targeting growth over our current 2013 EPS guidance.

This goal will be a challenge as there are a number of moving parts flowing from the implementation of coming reform provisions including the exchanges, nondeductible industry fees, dual eligible rollouts and Medicare Advantage reimbursement cuts.

We need to be prudent in assessing the impact of these changes on our business.

We will update you as our business planning process progresses over the balance of the year.

I would stress that our primary goal is making the right decision for the business for our long-term prospects.

Now I would like to step back and offer some context around where we believe our business is going over the next few years and how this drives our optimism in the franchise.

Put simply, we see an opportunity for profitable top-line growth that for WellPoint is more compelling than we have seen in several years.

This top-line growth will flow from the exchanges as well as Medicaid expansion and the dual eligible opportunities.

We believe we have best-in-class assets in each of these areas.

While growth always comes with uncertainty, it is positive that these substantial opportunities build off our baseline franchise and strong capital position and are additive to our processes and existing business footprint.

To frame our outlook we start with our current projected 2013 operating revenue base of approximately $71 billion.

Over the next few years enrollment growth in Medicaid, Exchange and other products could drive our annual run rate operating revenue to around $90 billion by 2016.

This potential for top-line growth far outpaces anything we have seen in recent years and lines up particularly well with our capabilities and business footprint, both geographically and by market segment.

The timing is uncertain, but we believe the opportunity is real.

As we progress in growing our franchise the cash flow implications are also positive and this supports our focus on share repurchases to return value to our shareholders.

We continue to target repurchasing an average of 4% to 5% of our shares annually subject to Board approval and market conditions, in addition to paying an attractive dividend.

Margins remain a clear swing factor, given the potential for commercial margin compression due to the exchanges and an increase in our tax rate because of the non-deductibility of the insurance fee.

However, we are also optimistic that opportunities in our government business and continued expense leverage and efficiency efforts across the enterprise can serve as a longer-term offset.

This underlying view drives an informed optimism about our previously stated prospects for longer-term low double-digit EPS growth on average, as well as our ability to sustain an attractive dividend.

We will continue to update you on reform implementation as the year progresses.

We are currently targeting an Investor Day in the first half of 2014.

Finally, I would like to thank all of our WellPoint Associates for their focus on execution while preparing for the coming marketplace changes, pursuing growth opportunities across our businesses and keeping a vigilant eye on underlying expense controls.

You are exhibiting our purpose to transform healthcare with trusted and caring solutions and our vision to be a valued and trusted healthcare partner.

With that I will turn the call over to Wayne to discuss the financials.

Thank you, Joe, and good morning.

My comments today will focus on the key financial highlights from the quarter.

Please note that the inclusion of Amerigroup business in 2013 results impacts the quarter-over-quarter and year-to-date comparisons.

I would also highlight that we adjusted our reportable segment structure during the quarter following Joe's organizational realignment.

Prior-year amounts have been reclassified to conform to this presentation and are available on our website.

Overall second-quarter results were stronger than we expected reflecting continued improvements in our core operating performance primarily in the commercial and Medicaid businesses.

On a GAAP basis we reported EPS of $2.64 which included approximately $0.09 per share of net investment gain partially offset by $0.05 of costs associated with the early termination notice of Amerigroup's PBM service contract.

Excluding these items our adjusted EPS was $2.60, an increase of 27.5% from the second quarter of last year.

Our quarterly results were comfortably ahead of our forecast and supported by higher-than-expected operating cash flow, a strong balance sheet and stability in the operating environment.

We have modestly raised our full-year EPS and operating cash flow outlooks reflecting our stronger year to date performance.

However, we are still being prudent given our continued expectation for a fluid environment and investment spending over the second half of the year as we prepare for 2014.

We ended June with approximately 35.7 million medical members, down slightly on a sequential basis, but generally in line with our expectations.

Looking ahead, as Joe described, we are having increasing success in the ASO market in response to our strong value proposition which is driving better-than-expected membership trends in those businesses.

That said, our forecast continues to include the potential for some fully insured membership pressure later this year in advance of the exchanges opening on January 1.

Operating revenue totaled $17.6 billion, an increase of $2.4 billion or 16% versus the 2Q of 2012 driven by the inclusion of Amerigroup this quarter.

The revenue increase from Amerigroup was partially offset by lower Medicare revenue due to the decline in membership.

Operating revenue in the commercial businesses declined slightly compared with the prior year quarter as the impact of lower fully insured membership was mostly offset by rate increases designed to cover cost trends.

The benefit/expense ratio was 83.9% in the quarter, favorable to our expectation and down 150 basis points from the 2Q of 2012.

The decline occurred primarily in the commercial businesses and our California Medicaid operations and was partially offset by the inclusion of Amerigroup in the current period as Amerigroup carries a higher benefit/ expense ratio than our consolidated company average.

Our commercial medical cost experience has been favorable through the first six months of 2013 and we now expect underlying Local Group medical trend to be in the 6.5% plus or minus 50 basis points range for the full year.

Our hospital unit cost contracting is running favorable to our plan this year while utilization has also been lower than anticipated through the first six months.

In Medicaid, Amerigroup contributions are tracking slightly ahead of our expectations to date.

During 2Q we also recognized increased reimbursement in our Medi-Cal business for current and prior service periods.

I would note that, while this impacted the quarter-over-quarter comparison, it was consistent with our expectations and therefore is not meaningfully contributing to the increase in our full-year earnings guidance.

Our SG&A expense ratio increased by 30 basis points from 2Q of 2012 which reflects our investment spending in preparation for the exchanges and other growth opportunities as well as higher incentive compensation due to our year-to-date operating performance.

These increases in SG&A expense were partially offset by the business mix impact of Amerigroup, which carries a lower SG&A ratio than our consolidated Company average and favorable underlying expense performance.

We have remained disciplined with our core administrative spending while continuing to invest incrementally in our future growth initiatives.

As Joe noted, we have reallocated some of our planned SG&A spending for Medicare towards commercial and Medicaid and as a result our updated 2013 guidance continues to include approximately $300 million of incremental investments albeit now more focused on the exchange base and other growth activities.

Our second-quarter SG&A expense also included one-time costs related to the early termination notice for Amerigroup's PBM contract.

Pending regulatory approval, we expect to begin transitioning Amerigroup's pharmacy benefit services to Express Scripts in the middle of next year, which is earlier than we originally planned.

While this decision results in an upfront expense during the quarter, it is expected to drive substantially lower pharmacy cost for our consolidated Company over the duration of our service contract with Express Scripts.

Moving on to the balance sheet, consistent with our past practice, we have included a roll forward of our medical claims payable balance in this morning's press release.

For the six months ended June 30, 2013 we experienced favorable prior-year reserve development of $532 million which was in line with our expectations.

Development was slightly higher than the prior year-to-date period and weighted more towards the government segments of 2013 reflecting the new mix of our business after the acquisition of Amerigroup.

We continue to maintain our upper single-digit margin for adverse deviation and believe our reserve balance remains strong and appropriate as of June 30, 2013.

DCP was 40.5 days as of June 30, essentially flat compared with 40.7 days as of March 31.

I would also highlight that we are pleased with our operational performance around claims inventories as of June 30, which are currently at the lowest level in the last few years.

We've been working down inventory levels as part of our preparations for 1-1-14 and our adjudication rates are now approaching 85%.

Our debt to capital ratio was 37.7% at June 30, essentially stable with March 31.

We continue to expect this ratio to be below 35% by the end of 2014.

Our parent cash balance was approximately $1.8 billion at June 30.

We expect subsidiary dividends of approximately $1.7 billion over the second half of the year.

We do not have any debt maturity schedule during the second half but may choose to opportunistically refinance certain debt if market conditions are favorable.

Such activity could result in one-time costs not included in our current guidance.

We generated stronger-than-expected operating cash flow of $425 million during the quarter.

As we've described in the past, the second quarter is a seasonally low quarter for operating cash flow due to the timing of income tax payments.

We made two federal income tax payments totaling approximately $725 million during the quarter.

Operating cash flow is ahead of our plan through the first six months of 2013 and we now expect to generate approximately $2.8 billion for the full year.

We repurchased nearly 3.7 million shares for $275 million during the quarter bringing our year-to-date total to over 9 million shares or 3% of the shares outstanding as of December 31, 2012 for approximately $616 million for an average price of $67.31.

We continue to expect approximately 1.5 billion of repurchases for the full year of 2013.

We used $113 million during the quarter for our cash dividend.

Our annualized dividend yet now sits at approximately 1.7%.

I'd like to turn to our updated 2013 outlook.

We now expect adjusted EPS of at least $8, up from our prior guidance of at least $7.80, which primarily reflects a lower commercial medical cost trend expectation for the year.

We continue to expect to end the year with 35.3 million to 35.5 million members, although we now expect slightly lower fully insured enrollment than we originally planned given the potential for member attrition as we approach 2014.

This is being largely offset by better-than-expected ASO membership.

Just to address a possible question proactively, our guidance does contemplate a lower second half EPS result that we reported in 2012.

It is fair to say that we did not incorporate the full level of op performance we achieved in the second quarter in our updated full-guidance.

We would note that much of our incremental investment spending is planned for later this year as we finalize preparations for the exchanges and ramp up for 2014 open enrollment.

Our forecast also continues to reflect a level of conservatism for uncertainties given the dynamic nature of the current market environment.

Further, as you know, we do not provide specific quarterly EPS guidance.

I would note that from an earnings seasonality perspective the fourth quarter has traditionally been our weakest quarter.

As Joe highlighted, we continue to work through our 2014 planning process and directionally are targeting growth over current 2013 EPS guidance.

We plan to provide more commentary about our specific expectations for 2014 in the months ahead.

In summary, we are pleased with our strong year-to-date performance and confident about our overall business trajectory.

I will now turn the call back to Joe to lead the Q&A.

Thanks, Wayne.

With that, operator, please open the queue for questions.

(Operator Instructions).

A.J. Rice, UBS.

Just maybe ask to flesh out a little more the commentary on exchanges.

Obviously we have gotten a little data since the last conference call as to who is participating with you on some of the various exchanges and at least at a high level what some of the rates and proposed plans look like.

We have also had the delay on employer mandate and the decision to ease some of the upfront documentation.

Laying that out, can you just tell us what -- has this changed in any way your -- either opportunities or risks that you see heading into 2014?

And are there any surprises, either positive or negative, from the way that has played out that are worth highlighting?

Thank you, A.J., appreciate the question.

We continue to closely monitor the regulatory developments around ACA implementation.

Generally speaking we do not expect the recent announcement, such as employer mandate delays and changed premium rating for tobacco use, to have a material impact on our implementation of ACA.

We are continuing to work with our regulators at both the state and federal levels to make the implementation as smooth as possible.

We are actively preparing for an October 1 open enrollment period on the exchanges in the markets we serve.

We expect Medicaid eligibility expansion in about half of our states, as we mentioned in the commentary.

At this point we do not expect any material delays but should there be any changes we will adapt and adjust as necessary as I believe we have developed contingency plans and we are well prepared for any kind of headwind of the nature just mentioned.

Okay, sounds great.

Thanks.

Justin Lake, JPMorgan.

Can you -- first, can you give us some color on where you see that $20 billion of revenue growth opportunity coming from in terms of breakdown from the different business segments, as well as updated thoughts on your employer dumping expectations over that time period?

And then also you mentioned the industry fee as a headwind several times going into 2014.

Just wanted to get your thoughts on what percentage of the fee liability we expect might be passed through versus a headwind to earnings next year?

Justin, good morning, this is Wayne.

Let me start with your latter question first regarding the industry fee.

We are cautiously optimistic about our ability to pass the industry fee itself on as part of the general pricing and have been doing that so far and have been in active dialogue as well with our states on the Medicaid front regarding the importance of this fee and the sustainability of these programs for the long-term.

That being said, I think it's also important to recognize, though, that the lack of deductibility on the fee is an incremental challenge, though, that needs to be managed as well.

So passing on the fee in and of itself is not enough, you have to manage the fact that the fee is not deductible.

And for that we believe over the immediate term through actions around pricing that we're trying to do coupled with the longer-term actions we can do around G&A efficiency that we can manage this over the longer period, which gets to your second or your original question which was how our revenue is built out to come up with that $20 billion of incremental revenue between now and the end of 2016.

And while we will provide more details at an upcoming IR day, I would simply say that a substantial portion of that fee comes from both the Medicaid expansion and the individual on exchange expansion with nominal growth necessarily coming from local group.

I would also highlight that it's important to recognize we clearly expect headwinds in the current small group markets.

So while we would get a trend adjustment in our fees as we would each and every year over the next three years in Local Group, a big portion of that would be offset by the migration of small groups to the exchanges.

So Local Group today we don't -- we expect to be positive for revenue growth over the next three years, but it is a very nominal contributor to that $20 billion with really individual on Exchange and Medicaid and Part D being the biggest contributors.

So you don't expect Local Group revenues to shrink in terms of the potential for dumping, although you would expect maybe some modest dumping offset by growth in employment and growth in -- just in terms of pricing?

Over a three-year period we expect those to be fairly neutral to one another.

The last thing is the one item that is a little bit of a wildcard here, although we think that our estimates are reasonable, is the pace of duals.

Got it.

And then just quickly on -- you mentioned some very strong ASO gains for 2014.

Just wanted to delineate there whether -- is that coming from the ASO conversions accelerating in 2014 in your mind or just in terms of more opportunity there or is it really just market share gains in your mind and the ASO conversion -- the pace of ASO conversions for 2014 is not dissimilar from 2012 and 2013?

Well, we expect a level of ASO conversion.

These are absolute new wins in the market, these are market share gains.

Kevin Fischbeck, Bank of America-Merrill Lynch.

I just wanted to go back to the exchanges for a second.

I think that you highlighted in your prepared comments that you think that there might be a slower adoption around the exchanges and wanted to understand exactly how you were thinking about that.

Because it sounded like you were thinking about it both from the context of maybe individuals picking it up, but then also maybe small group shifting and dumping employees onto the exchanges.

And I know that in the past when you've talked about the dynamics of profitability on that business you have kind of indicated that individual is already at the margins you might expect on the exchange and that a lot of the impact to you would be from small group dumping.

So I just wanted to see if there was a change there in how you thought about small group dumping and any commentary you could provide around that.

Hi, Kevin, good morning.

I will take a stab at this.

What I would say is, Joe makes this quote occasionally, right, when we make bets on a crystal ball we usually eat glass.

And so, let me first start off by saying that we have a framework of what we think is going to occur around small group and we think maintaining a conservative posture there is the right posture until we see otherwise.

That being said what we are seeing is that more of the small group employers today still can't make a decision on choices yet because those choices are not readily available in the market until the exchanges are fully up and running.

And the longer we see that delayed the more we think there is an opportunity that those small group employers will choose to maintain their existing products for another year.

That being said none of us would be able to predict what type of volatility we might see and actual pace.

So we believe maintaining a conservative posture is appropriate, albeit we think there is reason to believe it may be slower than we initially thought.

The second thing I would say is, though, we think in terms of the uptake on exchanges, it is going to be largely driven by a combination of what our efforts are to educate the market regarding the exchanges as well as what the local state efforts are to educate the markets on exchanges.

California is doing a very robust marketing plan in the state.

And as you know that is our largest individual market today.

So there is a state where we see a combination of their marketing efforts coupled with ours that we think is a promising formula for exchange growth.

Okay and then just on the SG&A ramp that you expect in the second half of the year, how do we think about that?

Is that largely investments in front of all of the changes that are happening in 2014?

Or is there a portion of this as you guys are going through your new review that says you know what we were under investing in a good portion of this may end up being kind of run rate numbers as we think about 2014 and beyond.

Let me start by saying that we are still building our 2014 plan, so I would not necessarily assume things are run rate or not.

I think we recognize the need for G&A efficiency to get the leverage off the growth that we expect over the next three years.

That being said, of our original $300 million we are reallocating about a third of those dollars away from Medicare, which is still investing almost $100 million in Medicare.

But moving those dollars to some of the growth opportunities we continue to see in Medicaid, plus with the new membership we believe will have coming on and the open enrollment period being October 1 of this year we are trying to self fund that growth with those dollars.

So in some cases I would say if it becomes run rate it should be run rate because we are growing top-line with it.

But as Joe mentioned earlier, we think there are opportunities to invest in the short-term in our IT over the next say 24 to 36 months and at the same time drive longer-term value in the out years.

So again, too early to declare what is run rate or not, but recognize that we think we are deploying the dollars commensurate with that revenue that we are getting.

Chris Rigg, Susquehanna Financial Group.

I actually just wanted to come back to that sort of last comment on deploying some of the money back to IT, and then Joe's comment earlier about the $1 billion of IT spending annually.

I guess can you just help me understand the $1 billion and what you think the right number might be?

And then sort of frame out what kind of additional monies you might want to be deploying into that if you think the overall spend is already too high?

Thanks

Thank you.

Yes, it is north of $1 billion, it's an extremely large scale IT infrastructure.

So we do have to acknowledge that.

So the level of spend is to be expected.

Where we are spending a lot of our time right now and we are still in a very significant analytical phase to better understand the distribution of spend around what I would call lights on compared to let's say improved technologies that better prepare us for engagement in the marketplace, particularly around the points that I mentioned earlier, which is data analytics, customer service, medical management.

So I really can't give you specifics at the moment in terms of any sort of what I would call better allocation.

Obviously we want to optimize, we want to create more efficiency and effectiveness in our spend and my sense is throughout the remainder of the year we are going to be focusing very heavily on the balance of all of those spends against our future outlook in terms of the need for the technology to better prepare us for the future.

So I would tell you maybe to maybe keep an eye open for this.

We will speak more to this through the balance of the year and certainly leading up to the Investor Day.

Okay, and then just one follow-up on the potential membership pressure heading into the end of the year.

I guess is that sort of just an academic assumption at this point or is there some sort of hard evidence that suggests that that pressure is indeed likely to occur?

Thanks.

Chris, I would not call it an academic assumption at this point.

We continue to see small group attrition accelerate even more as we get to the back half of the second quarter and we expect that to continue.

And we are seeing it necessarily being lost in the competitive environment as much as it appears some of it is going into the uninsured ranks.

And I think it's fair to say that some employers have started taking actions based on what they think will happen with the open enrollment period.

We are also seeing in the individual market that fewer individuals are necessarily buying coverage right now as it appears to be in preparation for the exchange.

So from our perspective, we think it is a prudent view in light of what we've seen in the first six months of the year to make an assumption that trend will continue.

And we believe it will probably slightly accelerate as more education on the exchanges become to come out in the back half of the year.

Scott Fidel, Deutsche Bank.

First question, just interested if you can give us some of your thinking on how your decision not to participate in the small group exchange in California, especially given how statewide you are going to be going into the individual market.

And then just maybe just remind us what your current small group membership in California is at this point.

Yes, let me first point out that we are very pleased to have been selected to participate in all 19 regions of the individual exchange in California.

So we do have a very significant presence in terms of the rollout.

We expect most of the volume growth from the ACA expansion to come through this individual exchange proposition, given PAC subsidies, etc.

So again, we are very honored to have been selected to participate on such a broad scale.

You probably know that initially, the exchange board in California had a requirement that all plans participating on the individual exchange also participate in the shop or the small group public exchange.

They recently removed this requirement in June and as a result, we then chose to withdraw our shop application and then are prepared to focus all of our efforts on the individual exchange in the state.

As we said in the prepared remarks, we do intend to selectively participate in shop exchanges, and I would envision there sort of being an evolutionary kind of migration path to shop in California as time marches on.

We will continue to offer small group coverage outside of the exchange in the state, and we look forward to serving a lot of new individual customers as part of covered California.

So my sense is it is a very balanced engagement that is now set up because of the choice made by the state.

And we feel we are very, very well-positioned to move forward and migrate to maybe a bigger position in the later time.

But right now, I think we are in a very strong position.

Okay.

And then just a follow-up.

Just thinking about framing the anticipated declines in the fully insured business in 2014, clearly are going to be more than offset by likely the ASO growth.

But is there a way to think about it relative to the pacing that we are seeing so far in the first half of the year?

I think fully insured is down around 450,000 lives.

Would you expect to see sort of a comparable rate of attrition of fully insured next year, or do you think that pacing could accelerate a bit, given some of the factors you discussed?

The first thing I would say is while we are not giving 2014 guidance yet at this point in time, I think it is important to recognize that clearly the Medicaid fully insured we expect substantial growth in that will offset some of this.

We are expecting meaningful growth in the exchanges based on what we know today.

And it would be our anticipation that the broader trends would begin to at least start stabilizing.

What we can't quite answer yet is what the behaviors will be of the individual consumer as the exchanges roll out, those that will be eligible for subsidies, how efficient of a process it will be for them to get enrolled.

So it is difficult to estimate the trends from the standpoint of saying, do we think what we see this year.

I would like to say that it shouldn't repeat next year, because this year is about a lot of dropping coverage as people prepare for the exchanges.

But ultimately, the behaviors of the consumer are going to be the primary decision-maker in this level.

But we see growth from Medicaid fully insured, we expect meaningful growth on the exchanges in fully insured.

And depending on the small group attrition, if that slows down, could actually result potentially in growth.

But more to come.

Matt Borsch, Goldman Sachs.

My question is on what you said about the 2014 -- your view on earnings.

I think you said you are directionally targeting growth, but it will be very challenging to get there.

Are you saying that you expect earnings growth in 2014 or are you saying we don't really know yet, stay tuned?

I would say, Matt, that we are building plans and that would allow us to grow over the current guidance levels we have this year.

But again, there are just too many unknowns.

And as these exchanges begin to evolve our outlook may change.

So at this point I would say that our mandate is very clear from Joe and the initiatives we need to take to both invest in the business and grow profitably and that is our focus.

That being said, too, as we get more details around the exchanges and the small group and how that is all going to migrate, we are not going to make a short-term decision for growth if we know that in the longer term we can make a better investment for the business.

So more to come, but we are targeting to growth next year over our current guidance.

Okay.

And just on the industry fee as a headwind.

I think that I had understood your earlier view, maybe going back to last year, that you would fully price in the industry fee, meaning the fee and the tax impact of the fee.

Has your view evolved on that?

And is there a factor that you can point to there?

Matt, the one thing I would say that is challenging is that when you are pricing for a new environment using an expectation for medical trend plus the known fee of 2% plus what you think the risk pool will look like, I would like to tell you that we've priced for the potential impact of the non-deductibility of the tax.

But there are so many moving parts around what mix may ultimately look like that remains to be seen.

So I would tell you that it is clearly our intention to price at that level and to be able to do that.

But I would also tell you that there is a challenging dynamic out there which is the consumer who has to make the buying decision as well and the affordability of that.

I think it is also probably more important to recognize that on the Medicaid front, this is a business that you know are looking at 2% to 3% margin business.

And I think for sustainability of the program you have to be able to pass on the fee or the program doesn't have sustainability.

The bigger challenge is ensuring that we can get the gross up for that as well.

As you know, states are still having challenges within their own fiscal budgets.

And so, it is a dynamic process, it is clearly our intention to move down that path.

But we want to make sure our shareholders fully understand that this is going to be a challenging market to manage through in terms of how we price for this.

Christine Arnold, Cowen.

A couple questions.

One, on the MLR second half of the year for this year it looks like you are thinking kind of 87% to get to your 85.5% guidance.

Could you talk about the factors that might raise the loss ratio?

I think you were talking a little bit about some small group attrition and individual attrition.

Are you seeing healthier people attrit?

What might bring that loss ratio up?

And then, Joe, if you can speak to the numbers that you guys had given in December about your long-term double-digit $600 million MAA contribution and exchanges' [350].

Do you feel like those targets are still on?

Wayne, do you want to take the first one?

Yes, let me start with the first one, Christine, and part of it is obviously the seasonality pattern that we would typically see occur in the back half of the year.

And I think it is important to recognize that we continue to see deductibles rise to unprecedented levels that we have seen in recent periods.

And so, what ends up happening is the seasonality spike that you typically saw happen in the back half of the year becomes even more pronounced as it takes a longer period to work through the deductible.

So one is we are assuming the seasonality will be, again, a little more pronounced than what you have seen historically because of the deductible levels we are seeing.

The second is exactly what you said, Christine, is we are assuming a further level of attrition in both small group and individual and primarily in the healthy lives as those individuals will make choices then to enter into the exchanges and potentially go naked, if you will, on coverage for a short period of time between October 1 and January 1.

Great.

And, Christine, let me take the other part of your question, which dealt with our EPS outlook regarding what we have expressed about our CAGR looking into the future.

we believe that what we have said is certainly still a reasonable target over the next five years.

You may recall we said that it would be a low double-digit EPS CAGR over the next five years and it is broken out as follows -- about 4% to 6% organic growth.

And maybe let me just add that this component I believe has been a maybe historically challenging component for the Company.

And we believe that it is an area that we are very heavily focused on in terms of improving the various parts of the organization that bring this strengthened outlook.

Number two, the 2% to 3% M&A driven component we believe is achievable particularly in light of our acquisition of Amerigroup.

We certainly have seen the accretion come to the Company as we have outlined.

And so, we continue to look forward to a continued uptick regarding Amerigroup's accretion as well as other possibilities.

And finally, 4% to 5% share repurchase of capital deployment, it's been a historical strong execution effort on the part of the Company.

And as I said in the commentary, we continue to pursue that and envision that based on market conditions as well as Board approval that we would continue to support that.

Wayne?

Yes, one item, Christine, to Joe's comments is that you had asked specifically about the $600 million of MA and that was in the 4% to 6% organic growth.

And we have said in the last quarter and we continue to say this, which is that we think that becomes challenging with the current rate environment around the $600 million of growth.

We think we have some other opportunities, though, because improving our Medicaid margins on the WellPoint business by just 1% ads over $100 million of incremental growth that we had not originally planned for.

So, I think we are comfortable still saying we believe in our double-digit long-term EPS growth.

And as Joe has commented on -- but again, the reason we have a range there is for exactly things like what happened with Medicare, which is there are going to be moving parts and it is our job to figure out if we can offset them someplace else.

Okay, thank you.

Josh Raskin, Barclays.

First question on the ASO at 750,000 lives.

That is more than just sort of incremental change.

That looks like the best year you guys have had in sort of seven or eight years I guess at this point.

So I am curious what has changed?

I can't imagine it is just simply slightly better market dynamic or something like that.

So I am just curious as to where those adds are coming from, who you think you are taking share from, etc.

And then the second question just on the 2014 growth.

If I think about the components here, you guys talked about Amerigroup adding as much as $1 in EPS in 2015, I'm assuming, I think we have spoken about about half of that amount in 2014.

With the PBM transitioning faster I would assume you are at last halfway, probably slightly more.

You have got the Medicaid growth, you've got the ASO growth that we are going to talk about.

You have got 4% to 5% accretion from share repurchases, etc.

So as I think about the headwinds, whether that's small group or Medicare Advantage, it seems like those would have to be pretty material to land you on the down EPS side of things for next year.

So I am curious just if you could flesh out a little bit more maybe the magnitude of potential pressure.

Great.

Maybe let me take the ASO growth in lives and maybe shift over to Wayne for the balance.

But as you know, the selling season remains in progress and as a result we have I think some insight looking into the possibilities for 2014.

At this point we do expect to be a net membership gainer next year based on our visibility into a variety of accounts, as you point out, with approximately 750,000 new ASO lives possibly coming into the membership rolls.

I should point out that our gross wins are even higher, though we continue to expect some in-group attrition next year given some attrition related such as state prisoner accounts moving from commercial coverage to state Medicaid programs.

So, net-net, we do feel good about the uptick in our ASO membership and I am sure we will be providing a lot more insight to you as the year progresses.

Yes, thanks, Joe.

Josh, one part of the question you asked was who the market share is coming from.

And I would say that we are being successful across the board on many fronts.

And I think we'll allow competitor to speak to that on their calls.

Relative to your question on headwinds and tailwinds, the one thing that I would highlight is I agree with the numerous tailwinds you have highlighted.

I think we all would agree that with the growth on exchanges that should ultimately be a tailwind.

But I think you would also agree that there are still uncertainties on how the risk corridors are ultimately going to be settled out, how we will be able to calculate those as well as how the risk coding, which is still not fully defined yet on that.

So there are a couple unknowns there that from our perspective we would agree conceptually should be a tailwind, but we still need to see some more of these data on how we account for our expected growth.

Obviously Medicaid we expect to be growth ASO and the accretion from Amerigroup we agree with.

One item on Amerigroup I do want to highlight though, is we cannot transition that account -- contract until a year from now.

So we will have the integration associated with transitioning that contract.

So we won't get the full-year benefits of that initially next year but we do start to pick those up the following year.

But in terms of some of the headwinds.

We do think the commercial EBIT right now would be a headwind for us.

Now again, only time will tell how that eventually evolves.

But we have got strong underlying trend this year.

If you assume a lot of that small group membership attrits you lose not only the strong underlying trend, but you use the absolute dollars associated with it.

We expect some light pressure on Medicare just because of the reimbursement similar to what you have highlighted.

The timing of duals is an important factor, because if it rolls out sooner it could potentially be accretive sooner.

If it rolls out slower it could actually be dilutive because of how we have to invest relative to that roll out and how much timing we get to actually start managing the care of that group.

So that is a little bit of a wild card right now as we wait on the timing.

The effective tax rate is expected to rise meaningfully and I don't think it would be an appropriate assumption to believe that every portion of the non-deductibility would be passed on.

I think you have to assume that that is not going to be the case across the board.

And we will see where medical trend goes.

So I can absolutely appreciate doing the sum of the parts and saying that says we should be able to grow and that is why we are targeting growth over our current guidance.

But we just want to make sure folks understand there are really a lot of unknowns that still have to get defined over the next six months.

Ralph Giacobbe, Credit Suisse.

Just wanted to go back to exchanges.

First one, just want to -- I guess I assume Exchange products are carved out products negotiated separately from other parts of your book.

First, is that correct?

And then within the markets, within your markets at least, what percentage of contracts have you been negotiating?

Can you give us a sense of rates?

And then last part of that question -- you talked about 140 regions that you submitted bids for.

Just want to make sure that that is all in your existing or are there -- have you ventured at all into new markets?

Thanks.

Ralph, how are you?

Let me start -- I'm going to kind of hit these in reverse order.

The 140 regions represents our 14 states, it does not represent every region in every state though.

So the population was larger.

I would simply say that our focus was clearly on where we thought we had density and a cost of goods sold advantage.

So if we didn't feel like we had that in a particular region within a particular state we did not choose to participate.

Second thing I would say is from a product perspective and a pricing perspective we feel like we are baked.

And what I mean by that is that we have got our contracting done with the products we filed.

And as we said historically, we think that over time that rates are going to migrate somewhere between Medicare and commercial and be more biased over time towards the Medicare rates.

Now the only way to do that is to have narrower networks, which we have accomplished and to have the willing participants, which we have, because the volume we think we can bring to them.

So at this point we like our positioning in most regions.

It is fair to say that in some regions we don't quite understand the bidding that we have seen relative to our pricing knowing the market share we have and the knowledge we have of the underlying population because of the market share we have.

But in general, fairly optimistic about where we are at.

The next key component is how we market though because this isn't your typical direct to consumer, this is educating on the exchanges and getting those lives to enroll.

So I think this will evolve literally day by day and month by month and I think on the next call we will have even more details.

But even today we still haven't seen what final pricing looks like in all 14 states relative to our competitors.

Okay, that's helpful.

And then just a quick follow-up.

Can you quantify at all the level of second-half investment spending maybe compared to what you have done in the first half?

Yes, the one thing I would say, Ralph, is it's meaningfully higher than the first have spend, meaning I think you could still consider roughly the $300 million level at this point in time.

It is very fungible though, so we have many dollars allocated to be spent on an absolute basis in the second half.

But recognize that we may turn those dollars off depending on how the exchanges evolve or we may reallocate those dollars depending on how we move forward.

Recognize though that, as you have heard us say, on a net basis we expect at least 750,000 new members by the end of 2014.

On a gross basis, as Joe said, we are well north of that already.

And because we are well north of that we are going to have to spend considerable dollars in the fourth quarter to ramp up for all that new enrollment that doesn't even relate to the exchanges at this point in time to get those folks done properly.

Which is one of the reasons we paid our inventories down so much in both the second quarter and plan to do in the third quarter so we can shift some of those resources.

But there is clearly going to be incremental dollars.

But we believe we can cover those in our original G&A budget for the year.

Yes, and I might add that I think your question is really a strong question regarding our outlook as we prepare for 2014.

We have over the last 90 days engaged heavily in analytics around kind of creating the building blocks for 2014.

And our view is the next six months are going to be fairly dynamic regarding building our organization to execute on our commitments in and around the exchanges and other facets of our Company in terms of securing member growth, etc.

So, my sense is all the effort we have been putting into our alignment with -- and preparation for 2014 has been very strong.

And I look forward to beginning to execute in a variety of spaces as we move into 1-1-14.

Ana Gupte, Dowling Partners.

I had a question first on CareMore specifically and then also on your broader network strategy.

So on CareMore specifically, when we do the [step] analysis it looks like outside of California, the other states, Arizona and Nevada, are not profitable.

I am just wondering what your thoughts are about scalability of a model like this outside a specific market like California?

And also just on the $150 million you had earmarked, specifically $50 million you said would be redirected.

How much of that is likely to fall to the bottom line for this year and going forward?

Let me take a run at the first part of the question; Wayne can maybe jump on how it might translate to bottom line.

Just as a reminder, as you may know, CareMore, as we look at it, has been historically built on three pillars.

Number one, it's a care center model, which I think you are referencing.

Number two, it is a model that provides acute-care and institutional and home care service support that we believe has great potential to both serve our organization, WellPoint, in a variety of spaces where we deal with chronically ill and high need patients.

But also we now believe that we have the ability to reach outside of WellPoint in terms of alignment with a variety of organizations that also need that kind of support.

So we believe we will be able to leverage that so-called intellectual property to benefit both internal as well as external needs.

And the third pillar deals with preventive care aspects of the program.

As we provided in our remarks, we have maybe pulled back with respect to bricks and mortar expansion, recognizing that reimbursement rates this last quarter as it came to us -- as that insight came to us were very -- very kind of strong to the negative.

And so, we have adjusted and we believe we have repositioned CareMore for a good run.

And we certainly will avoid the $3 million to $4 million in investments that go along with building out the bricks and mortar capabilities.

And so, I think our kind of restructured emphasis and outreach in some new areas will create a strong CareMore and that will benefit us in the long run.

So, Wayne.

Thanks, Joe.

The one thing I would highlight too is in Arizona and Colorado, those are the newest markets for the buildouts.

And just as a reminder, it takes 18 months just to get to roughly breakeven.

And so, coupled with the volume you need.

So I would say in Arizona we have actually one market that is well exceeding those expectations to date and we have one market that is slightly behind in those.

But to look at the blank by itself would not necessarily show you those pieces.

So we want to let you know, those markets are progressing in total where we thought they would be at.

But the challenge, as Joe said, is the headwind from the new rate reimbursement that doesn't allow us to get the ultimate tail of the benefits in the long-term, which is why we did redirect roughly $50 million and it is not redirected to go to the bottom line.

It is redirected to one help self fund the significant growth we've seen in our ASO contracts this year as well as some of the growth that we expect in exchanges and how we plan to further market and advertise our exchanges.

So, at this point in time we fully expect to spend the $300 million we talked about at the beginning of the year, albeit with some of those Medicare dollars redeployed to commercial enrollment, both ASO and exchanges.

I would also like to add that, just as a reminder, CareMore represents about 13% of our Medicare Advantage membership portfolio.

So it is, in our view, an integral part of our portfolio.

And we really are looking favorably at it in terms of being able to leverage it to provide greater support to our MA book.

Okay, thanks.

Just to follow-up then on the broader strategy related to this in the sense -- and Joe, with your experience coming from the provider side of the house.

You talked about the $71 billion to $90 billion in 2016.

Much of that growth is coming from government business, rates obviously are under pressure everywhere.

We hear a lot from some of your peers on either vertically integrated strategy, a primary care medical home from CareFirst, for example, accountable care.

How are you thinking about your leveraging that competitive advantage you have on market share?

And what type of medical cost structure advantage could you develop to keep your margins healthy as well with that top-line growth?

Okay, there are various parts and pieces to the question.

First of all, that growth from $71 billion to $90 billion we believe is achievable related to enrollment growth in exchanges, Medicaid, duals and other products.

I just want to maybe encourage that I think we're maybe best positioned at the moment to tell you that we are going to give more details at our Investors Day.

We are deep in analysis on those very questions.

But we do believe it is a reasonable target based on where we sit today and what we see.

So I would just ask you to stay tuned for us to give you more insight in the near future.

Thank you.

I would now like to turn the conference back to Mr. Swedish with the Company's closing comments.

Thank you for your questions, I really appreciate the opportunity to receive them as well as be responsive.

In closing, we are pleased with the strong financial results of the first six months and we are on track for a better-than-expected full year of 2013.

Looking ahead we will deliver on our purpose to transform healthcare with trusted and caring solutions., and our vision to be a valued and trusted healthcare partner to those we serve.

We are encouraged by the positive momentum we see building in our membership and revenue trends and we continue to plan and prepare for uncertainties around the near-term implementation of Health Care Reform provisions.

Longer-term I believe there is a clear opportunity for the Blue Cross and Blue Shield plans to leverage their local market expertise and familiarity to broadly advance both care access and affordability.

This strong competitive positioning leads to a substantial value creation opportunity for our enterprise driven by -- accelerating top-line growth opportunities; strong cash flow generation; our continued focus on returning capital through our share repurchase and dividend programs; and as we continue to review our portfolio of assets we will ensure we are most appropriately allocating your capital in a way that best drives us to deliver on the opportunities we see ahead.

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

Operator, please provide the call replay instructions.

Ladies and gentlemen, this conference will be available for replay after 11.30 today through August 8 at midnight.

You may access the AT&T replay system at any time by dialing 1-800-475-6701 and entering the access code 272703.

International participants dial 320-365-3844.

(Operator Instructions).

That does conclude our conference for today.

Thank you for your participation and for using AT&T teleconference.

You may now disconnect.