Elevance Health Inc (ELV) 2014 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the WellPoint conference call. (Operator Instructions). As a reminder, this conference call is being recorded. I would now like to turn the conference over to the Company's management.

Good morning and welcome to WellPoint's third-quarter 2014 earnings call. This is Doug Simpson, Vice President of Investor Relations. Presenting today are Joe Swedish, President and CEO and Wayne DeVeydt, Executive VP and CFO. Joe will start with a discussion of our Q3 2014 financial results and the macro backdrop and then Wayne will review the quarter's financial highlights in more detail and update you on our 2014 outlook. Q&A will follow Wayne's remarks.

During the call this morning, 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.

Thank you, Doug and good morning. I'd like to begin reflecting on a solid third quarter with membership and margins tracking well. We are pleased to report strong third-quarter results of $2.36, which exceeded our initial expectations and builds upon the strength of our first six months and positions us for an improved EPS outlook for the full year. We grew by another 259,000 members in the third quarter driven by contributions from the Medicaid, local group and national businesses. Through the third quarter, we have now added almost 1.9 million new members served so far in 2014 representing a growth of 5.3% versus year-end 2013. Our growth has been balanced in 2014 as we've added 699,000 Medicaid members through the third quarter. National has added 610,000 members and Local Group has added 438,000 members. With attrition in the third quarter as expected our public exchange enrollment stands at 751,000 members at the end of the third quarter.

What I'd like to do now is discuss the specifics in and around the third-quarter results. We're pleased with our third-quarter results with solid contributions from both Commercial and Government divisions. Specifically, in the third quarter, we reported earnings per share of $2.22 on a GAAP basis and $2.36 on an adjusted basis. Our GAAP EPS and adjusted EPS increased from the third quarter of 2013 driven by our growth in membership, improved medical loss ratio, administrative expense control and opportunistic capital deployment. Further supporting the quality of our earnings, we generated much stronger than expected operating cash flow of approximately $600 million in the quarter bringing our year-to-date cash flow to approximately $3.1 billion.

We've remained focused on our capital deployment strategies as well, repurchasing almost 5.1 million shares during the quarter for approximately $579 million and paying $119.2 million of dividends. Year-to-date, we repurchased 27.6 million shares or 9.4% of the shares outstanding at the beginning of the year for approximately $2.7 billion at a weighted average share price of $96.20.

Let me turn to providing you an update on business development activity. As we've discussed previously, we believe affordability and access will be even more critical in the future to enhancing the consumer experience with the healthcare delivery system. I want to take the opportunity to update you on a few selected items that show we're working to advance our goal of improving healthcare costs for our customers and their families.

First, we're enhancing our medical cost management efforts to comprehensively review our medical cost profile and identify actionable opportunities to further improve medical cost management in both our commercial and government segments. Components of this strategy include establishing line of sight accountability and enhancing trend analytics and identification of actionable trend drivers. This will partially include some realignment of clinical support assets to the state plan Presidents to improve their ability to react more quickly to their specific market dynamics.

Finally, while each market has different opportunities, we will look to leverage best practices at the enterprise level. The structure of this effort has now been established and we have seen early-stage savings and we expect contributions to increase in the coming years. At the same time, we continue to move ahead with our provider collaboration efforts. By partnering with leading providers and aligning incentives, we have the opportunity to drive better quality care at more affordable prices. We believe this directly impacts our ability to compete in the market as evidenced by our broad-based enrollment growth thus far this year.

In September, we announced, through Anthem Blue Cross of California, the formation of a joint venture named Vivity with seven hospital groups in the Los Angeles market. Through Vivity, we will offer medical plans to the large group market in 2015 that provides a level of coordinated, high quality and efficient care at a competitive price. This is a substantive example of how our local market experience and community presence uniquely positions us to help change the landscape of care coordination in the marketplace.

I'd like to now turn to Commercial and the execution of our strategies. Our Commercial business had a solid quarter with membership largely steady on the back of the strong growth in the first half of the year. Commercial revenues declined in the third quarter by 0.2% year-over-year to $9.8 billion with contributions from new membership growth in the business being offset by the previously announced conversion of a New York State account to self-funded, which impacts revenues by about $2 billion a year.

Commercial operating margins improved as expected from 7.2% a year ago to 9.3% in the third quarter of 2014 due to the changing mix of the product portfolio within the business as we have discussed with you previously. While we do not break out MLR by business segment, we can say that our third-quarter commercial MLR came in better than expected in the quarter. Echoing the membership trends seen in the first six months of the year in our Commercial business, our National and Large Group membership trends in the quarter remain favorable while Small Group attrition continued, even slightly faster than expected.

With the open enrollment period ending in April and normal seasonal attrition, our individual membership stood at just over 1.9 million members at the end of the third quarter 2014, down a net 108,000 members during the quarter. Year-to-date, our total individual enrollment is up a net 159,000 members. To update you on the various metrics, we added 751,000 individual members on the public exchanges year-to-date through the third quarter. The general characteristics of exchange applicants, including average age, continue to track well versus our expectations. Product selection and benefit levels have also been consistent with expectations. We've been executing on our exchange rollout and the paid claims trends thus far are encouraging, but we recognize many of these new members only joined our enrollment rolls in May. Therefore, we continue to take a prudent view of reserves in light of the potential uncertainties associated with this membership and expect to gain more information as this block matures in the fourth quarter.

For the three Rs, we continue to book reinsurance as appropriate. We have also recorded a modest net payable for risk corridors and while we believe we are in a modest net receivable position for risk adjusters, our outlook still does not include any such recovery.

Open enrollment period for the exchanges is approaching and we are ramping up our activities accordingly. This year, we plan to again offer exchange products in all 14 of our Blue states and we are expanding our served geography within those markets. We plan to build upon the success we had in 2014 and leverage our experience with product design and customer preference in the exchange market. Our strategy for 2015 includes minor refinements based on our experience in 2014 and our overarching focus remains on driving product affordability for our members.

During the third quarter, our Large Group business showed solid sequential membership growth of over 100,000 lives, including 74,000 lives from the contract for New York hotel trades. As we discussed last quarter, with respect to our Small Group business, we continue to be mindful of the potential for employer coverage changes in light of the exchanges and we did see third-quarter Small Group member declines above our expectations. Small Group has now declined almost 300,000 members year-to-date and stands at 1.56 million members. These dynamics are reflected in our outlook.

Finally, we're coming to the tail end of the National account selling season and we feel good about our momentum in the market. We believe our ability to improve healthcare affordability is resonating with customers and we now expect to add over 200,000 net new lives in 2015 and with very strong retention among our legacy customers. This is a solid result reflecting a strong closed ratio against the lower number of contracts out for bid in our markets for 2015 versus a year ago. Discussions are already taking place for the 2016 season and we continue to be optimistic that there will be a rampup in activity among National accounts as we look out to 2016.

I'd now like to turn to the Government sector and speak to the solid third-quarter growth coming online. Our Government business division added 270,000 members in the quarter driven by strong growth in Medicaid and generated revenues of $8.6 billion, up approximately 10.1% quarter-over-quarter. The Government business represented nearly 47% of our consolidated operating revenues in the quarter as our business continues to evolve and diversify.

Medicaid enrollment was up an additional 253,000 members in the third quarter bringing year-to-date growth to 699,000 members. We expect to continue growing Medicaid enrollment in the fourth quarter and we are raising our total Medicaid enrollment outlook from 500,000 to 600,000 previously up to 700,000 to 750,000 driven by organic enrollment growth and ramping up of recent contract awards. We now expect to add 450,000 to 475,000 expansion members in 2014 versus 400,000 to 500,000 previously.

Medicare enrollment was slightly positive in the third quarter with a gain of 20,000 members. Government operating margins declined 50 basis points year-over-year to 3.3% partially reflecting the lower Medicare margins and higher hepatitis C costs. Our third-quarter membership growth reflected contributions from Medicaid expansion, several recent Medicaid go-live implementations in New Jersey, Florida and Kentucky and modest contributions from dual-eligible demonstrations. We continue to see substantial RFP opportunities for new Medicaid business over the next year and we remain optimistic in our ability to gain meaningful net new business from these opportunities.

To update you on the dual-eligible rollouts, programs started to launch in Q2 and Q3 and we currently have about 8,000 lives served in Virginia and over 3,000 dual-eligible members in Los Angeles County, which went live on July 1, 2014. We continue to expect New York, Texas and the remaining counties in California to commence in early 2015.

I'd like to now turn to an update regarding the 2014 outlook, which we believe is prudent. Given the strength of our results year-to-date and our outlook for the balance of this year, we are updating our 2014 financial outlook this morning. We now expect adjusted earnings per share to be within the range of $8.75 to $8.85 for the full-year 2014 reflecting stronger enrollment and margin trends. We're also raising our cash flow outlook, which Wayne will discuss in more detail. We remain optimistic about our cash flow profile and outlook for the future. We do not want to get ahead of our Board, but we are considering moving to a higher dividend payout ratio in 2015 given the strength of our cash flow. We continue to maintain a prudent outlook in light of the dynamic nature of our markets and the potential for future changes in the regulatory framework. We are working through our 2015 budget process and will offer our more detailed outlook in early 2015.

Our goal remains EPS growth over our updated 2014 outlook driven by incremental contributions from new membership in both our Government and Commercial segments. While we are not yet ready to offer specific EPS guidance, the current estimates for adjusted EPS of most analysts in the $9.15 to $9.30 range for 2015 are reasonable placeholders with a 7% to 8% top-line growth. We expect to maintain a prudent posture with our 2015 outlook given the evolution of our business across our served markets.

To conclude, we're very pleased with our third-quarter performance. Over the next several years, we will look forward to serving a growing membership base across both our Commercial and Government business divisions. Our efforts on provider engagement and cost management should further our position in the market while improving the cost and quality of care for our members. Our team remains focused on execution and we will also remain disciplined stewards of shareholder capital. With that, I will now turn it over to Wayne.

Thank you, Joe and good morning. My comments today will focus on the key financial highlights from the third quarter of 2014. I'll also provide an update on the 2014 outlook. On a GAAP basis, we reported earnings per share of $2.22 for the third quarter of 2014. These results included net costs of $0.14 per share reflecting $0.17 per share of debt extinguishment expense partially offset by net investment gains of $0.03 per share. Excluding these items, our adjusted EPS totaled $2.36 for the quarter. These results were favorable to our initial expectation and as Joe noted, we are pleased with how 2014 has progressed so far.

Medical enrollment grew by 259,000 or 0.7% sequentially to approximately 37.5 million medical members as of September 30. This reflected membership gains in our Medicaid, Large Group and National businesses partially offset by declines in our Individual and Small Group businesses. Operating revenue was nearly $18.4 billion in the quarter, an increase of approximately $752 million 4.3% versus the third quarter of 2013. Reflecting enrollment growth in our Commercial and Government businesses, revenue growth versus Q3 2013 was adversely impacted by the previously discussed transition of the state of New York account from fully insured to self-funded on January 1.

The benefit expense ratio was 82.5% in the third quarter of 2014, a decrease of 240 basis points from the prior-year quarter and favorable to our initial expectations. The decline reflected continued strong medical management and the impact of the premium revenue designed to help cover new healthcare reform fees, as well as changes in our earnings pattern we have discussed previously.

We are pleased with gross margin performance on both of our businesses in the quarter and first nine months and we are improving our MLR outlook for the year from 83.5% plus or minus 30 basis points to 83.3% plus or minus 20 basis points. For the full-year 2014, we continue to expect underlying Local Group medical costs trend to be in the range of 6.5% plus or minus 50 basis points with a bias towards the lower half of the range. Our SG&A expense ratio increased by 180 basis points from the 3Q of 2013 as expected largely due to the inclusion of various healthcare reform fees in 2014.

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 nine months ended September 30, 2014, we experienced favorable prior-year reserve development of $535 million, which was modestly better than our expectations. Development was consistent with the prior year-to-date period. We continue to maintain our upper single-digit margin for adverse deviation and believe our reserve balance remains consistent and strong as of September 30, 2014.

Days and claims payable was 44 days as of September 30, down 0.8 days from 44.8 days as of June 30 and up 5.3 days from 38.7 days at the end of 2013. Our debt-to-capital ratio was 38.6% at September 30, 2014, up from 37.8% at June 30 reflecting our August financing activity. We ended the third quarter with approximately $2.1 billion of cash and investments at the parent company and our investment portfolio was in an unrealized gain position of $1 billion as of September 30.

Moving to cash flow, we generated stronger-than-expected operating cash flow of $606 million in the third quarter or 1 times net income on the back of strong underlying fundamental performance and about $200 million of favorable timing of Medicaid payments in the quarter. On a year-to-date basis, we generated operating cash flow of approximately $3.1 billion, roughly 1.5 times net income. We repurchased almost 5.1 million shares during the quarter for approximately $579 million representing a weighted average price of $114.50. Earlier in October, the Board of Directors approved a $5 billion increase in share repurchase authorization to the $1 billion that was remaining at the time. As a result, we had approximately $6 billion of share repurchase authorization remaining, which we intend to utilize over a multiyear period subject to market conditions. We used $119.2 million during the quarter for our cash dividend and yesterday, the audit committee declared our fourth-quarter dividend of $0.4375 to shareholders.

Turning to our 2014 outlook, as Joe noted, we currently expect adjusted EPS to be within the range of $8.75 and $8.85 for 2014. The increase in our full-year outlook reflects a stronger operating income outlook due to a stronger enrollment and continued medical management and expense controls. There is a timing issue we want to flag for you related to the revenue recognition for Medicaid contract rate changes in certain markets, which totaled north of $100 million. Our 2014 adjusted EPS outlook has previously and continues to include these revenue amounts in two of our states and there is no change in our forecast for these amounts. We believe this is simply a potential timing issue related to the administration of these contracts as we approach year-end.

Simply put, we expect to record these amounts in the coming months, but there is a chance a portion could slip into 2015 because of administrative timing. We will be very transparent with you if there is ultimately a delay in recognizing any of these premiums from late 2014 to early 2015. We are raising our enrollment outlook and now expect enrollment in 2014 to grow by 1.55 million to 1.65 million members to 37.2 million to 37.3 million by year-end 2014. We're also raising our cash flow forecast from greater than $2.7 billion previously to greater than $3.3 billion for the full year. We believe our updated outlook is reasonable in a year in which the industry is undergoing substantial change and our bias is to maintain a prudent stance in this dynamic environment.

As Joe said earlier, we are continuing to work through our 2015 budget process and we will offer a more detailed outlook in early 2015. While we are not yet ready to offer a specific EPS objective, the current estimates for adjusted EPS of most analysts in the $9.15 to $9.30 range for 2015 seem to be a reasonable placeholder at this point based on our current definition of adjusted EPS. However, we will move to a cash EPS metric in 2015, which would raise EPS, all else being equal. Specifically, starting in 2015, we plan to also exclude the amortization of intangibles from our adjusted EPS calculation. For 2014, our adjusted EPS includes the impact of $220 million of intangible asset amortization expense related to prior acquisitions, including Amerigroup. With that, I will turn the call back over to Joe.

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

(Operator Instructions). Tom Carroll, Stifel.

Hey, good morning. I wonder if you could just circle back quickly on the point on Texas and maybe give us a bit more color on what may or may not be happening down there and if you have signed agreements and maybe when you expect to get them. And then just staying on the Medicaid topic, maybe touch on -- do any markets stand out as being either more profitable or more costly than expected? And I guess I'm thinking specifically Florida here in this instance. Thanks.

Good morning, Tom. This is Wayne. I appreciate the questions this morning. Let me first address Texas and then I'll address the more broader question on Medicaid. Starting with Texas, our previous outlook actually assumed that we would not collect a non-deductibility, but did assume we would actually collect the tax. We still believe the tax will be collected and we believe it's a prudent part of a sustainable model just as we assume the non-deductibility should be collected. However, we do not believe we would have a contract signed by the end of this year and accordingly, we've excluded that from our guidance now for the full-year outlook.

In addition to that, to your second question on Medicaid, we continue to see no issues in the Florida market versus our expectations. I call that market out specifically as I know there has been a lot of questions there. I think our counties are uniquely different and positioned and we've performed relative to our expectations pretty much aligned with them.

I will say though that many expansion states and the new lives coming through expansion are coming in generally with an overall cost structure better than we would have anticipated and as a result, we are booking collars at this point back to many states regarding those expectations.

Great, thank you.

Justin Lake, JPMorgan.

Thanks, good morning. First question in terms of the 2015, you [blessed] this range of $9.15 to $9.30, which is 4% to 6% EPS growth. Just hoping you can walk us through the headwinds and tailwinds that we should keep in mind here to get to this estimate given the solid top-line growth you talked to and the typical share repurchase.

Justin, good morning. This is Joe. Thanks for the question. Headwinds, tailwinds. On the headwinds perspective, maybe about four or five items that I can lay out for you include the industry fee is going to definitely be up 40% and we clearly believe we will account for that accordingly. Second, as we've repeatedly said that we have seen and continue to see Small Group margin and membership compression, so we're expecting certainly 2015 to continue that path toward compression.

The Medicare Stars bonus cuts certainly impact us. Dual-eligible population startups year one of our engagement in the duals arena certainly provides for some headwind that we believe we'll manage our way through effectively. And finally, increasing hep C spend from new drugs that are coming online. We've mapped out very clearly our hep C exposure. We believe that we've got line of sight both on the cost impact, the volume impact estimates, as well as the clinical protocols that are necessary to effectively manage that.

With respect to tailwinds, we believe that enrollment growth in Medicaid certainly will continue strong specifically related to the expansion states that we envision coming online. One specific state that I can call out that's definitely a headwind for us -- excuse me -- tailwind for us is Tennessee, which that contract is coming online shortly.

Enrollment growth in the ACA engagement, as well as our National business was quoted to you in our materials we just presented to you, the waterfall effective lives added over the course of 2014 and finally, the impact of our 2014 capital deployment strategies that I think have been very effectively executed and look forward to the impact that that will provide for us in 2015.

Great. And then, Wayne, you have talked to the Company's conservatism on reserves this year due to all the reform changes. Can you give us an update here and maybe talk to the drivers of the decline in claims payable from 2Q to 3Q? Thanks.

Sure, Justin. As you saw, our DCP went down about 0.8 days versus where we were at previously in 2Q. One thing I think will be important for our investors to understand is what do we think maybe a more normalized DCP might look like. Our mix of business has changed quite a bit and as we continue to ramp up and grow like we expect to do between now and 2018, you're going to see a rising reserve balance and in theory, it will rise at a faster pace than paid because those members are coming on sooner and then of course you pay claims in arrears.

So we think a more normalized DCP for our business model is probably closer to 40 days and that would assume our high single digit margin for adverse deviation. Obviously, we're currently posting 44 days at this point. So I think you can get a feel for at least a level of conservatism that we think we're maintaining. We think that's prudent though. There is still a lot of moving parts around risk adjusters, around corridors, around MLR rebates once those settle up and even risk collars in our Medicaid expansion states.

And so the way I would look at that extra four days is not necessarily all conservatism that could potentially drop to the bottom line, but rather view it as conservatism against many risks that could go the wrong direction and if they were to all move positive or some move positive, not all of that would drop to the bottom line as some of that then would result in a payable back either through a collar, a corridor or an MLR rebate, but it would be upside to our current expectations.

A.J. Rice, UBS.

Thanks. Hi, everybody. Maybe just to ask you about the positioning for exchanges for next year and your thoughts on that. Obviously, there's projected growth in the underlying overall industry. You guys are expanding your geography and you've done pretty well this year. So in terms of expectations for membership growth, expectations for margin trend, can you give us at least some directional comment on that?

Yes, A.J., good morning. First of all, just to underscore, we're going to continue participating in each of our 14 markets in the public exchange arena. So virtually nothing is changing year-over-year in that regard. We certainly are going to build on what I would categorize as tremendous success this past year relative to the analytics, pricing and our marketing efforts that allowed us to accumulate the enrollment that we achieved. So going into the 2015 timeframe with enrollments cranking up very, very soon, we are going to participate in 139 rating regions this year and we believe that certainly there will be some adjustments with respect to how we approach the market, but generally speaking in terms of our pricing, our marketing efforts, etc., I think it will look remarkably similar to the efforts that we employed in 2014.

Long story short, we really continue to feel strongly about the value proposition we are bringing to the market and as you may know, CBO estimates indicate something like 5 million lives may come into the exchange environment and we believe given our share of the market this time around, we believe maybe we will capture like share in the new round. So again, I think we're well-positioned and aggressively pursuing the markets we have already established ourselves in during the 2014 selling season.

Okay, great. Maybe just a quick follow-up. Obviously, in the last couple days, there's been a renewed discussion around the part of the middle-market, the lower end of the middle-market, 50 to 300 employee groups and that there's maybe some increased volatility in both utilization and churn there. Can you just comment a little bit how big that is for you and if you're seeing anything that surprises you going on in that market?

Thanks, A.J. We're not seeing anything that surprises us in that market. We've always held a very strong marketshare in that space. If you look at our growth in the Q3 timeframe, it's been a lot of ASO growth in our large National business and in the Local Group business, it was a sizable win of one account. But when you get to that 50 to 300 range, this is a space that we're very familiar with. We view it as average margins and we feel like the competitive environment continues to be rational in general in that space. So no real surprises for us in that market at all. So can't really comment on any other questions that have come up other than that regarding us.

Christine Arnold, Cowen.

Hi there. Could you update us on your Small Group expectations? It looks like you're losing maybe more membership than you expected. Have you relaunched those Small Group non-AC products or are you going to be losing those that early renewed year ago and do you still think you will lose about $300 million of the $400 million in profitability and is that $400 million still a good number ultimately?

Thanks, Christine. Small Group definitely continues to attrite at a level faster than we have updated. Even when we did our second-quarter outlook, we assumed a much faster pace and it was slightly worse than that. It wasn't too far off our expectations, but I think now that you've got exchanges up and running and functioning well and that Small Group employers will have an opportunity to reevaluate whether they choose to go to an exchange for their employees, we think will become even probably a more prominent decision that they'll make this quarter as the exchanges start the enrollment process. We have many products we have rolled out to try to retain a Small Group for a period of time, but as we have always said as part of our five-year strategy, we clearly believe that the important part was having a net or a catcher's mitt, if you will, to become indifferent on where that customer wanted to buy their product and whether that would be through Small Group or through the public exchange.

So I think our goal is just to offer the most affordable product we can give to them. We do think that the majority of the $400 million headwind will still occur this year. It will be between the $200 million and $300 million range and it will be closer to the $300 million range in terms of op earnings impact than it will the $200 million range and we still anticipate over a $100 million headwind for next year.

Relative to the $400 million, is that still a good estimate or not, based on everything we know today, it seems like a reasonable proxy still at this point. Margins are starting to become fungible between exchanges and Small Group as they start migrating off and our membership, as you know, is down pretty meaningfully there. So I think we still feel that $400 million is a good number. Could it be a little bit north of that? Possibly, but we also think that the enrollment pickup on the exchanges and the improvements that will happen there should offset that as margins start to expand.

Great, thank you.

Yes, this is Joe. Wayne, I believe, originally, we were estimated something like a five-year migration to significantly reduce membership in Small Group and long story short, we're now believing this is a two-year migration path and obviously, we're managing to that reality, as Wayne pointed out. Hopefully, we'll be shifting members from one of our books to another book and we'd be indifferent where they'd end up, albeit the margin situation may be different, but we believe we can account for that effectively.

Ralph Giacobbe, Credit Suisse.

Thanks, good morning. Can you update us on where you stand at sort of the margin level that you're booking on the exchange business at this point and is there any difference around that cost trend and/or margin level whether you're thinking about sort of on versus off exchange?

Hey, Ralph, let me address first the cost trend in general at margin levels and then come into on versus off. First, I would say we still think we're running margins in the 3% plus range at this point. I say the plus point now because I think as we're starting to get more data on risk adjusters and other items, those would imply that we're in a net receivable position. That being said, I want to make sure that our investors understand that even though that would imply a net receivable position, we have recorded those balances, both payables and receivables, but have booked a 100% valuation against the net receivable position. Again, until we get more clarity, we're not going to assume that. But to the extent that those data points do prove out between now and the end of the year going into early next year, we would be running 3% plus margins at that point.

Again, though, very comfortable with our original goal that we laid out of targeting 3% to 5% margins. It varies by market. No one market is the same. We have opportunities to improve margins in certain markets and in fact, I'd argue we'd have opportunities in all markets to improve margins, but I think right now it's important to recognize that the membership is very critical as we continue to absorb the tax and we will continue to try to balance those margins with the membership goals that we have in our five-year outlook.

Relative to cost trends, probably the best way to look at it, Ralph, is versus our expectations and so clearly, we expected the cost trends on exchange business to be much higher than the cost trends that we would have on our non-exchange business and that has proved to be true. But relative to our expectations, it has proved to be less than we had expected though. So again, I'd say on both books of business, trend in general is playing well. Probably the bigger item is just the SG&A continues to rise on those books as we think investing in medical management, investing in marketing as we go to market this fourth quarter are really the critical initiatives. So we like our position too because we're able to grow while investing in the business and then we think over time as we capture this membership, you will start to see the SG&A ramp down in the later years of our five-year strategy.

Okay. And then just on the three Rs, just to be clear, one clarification. Last quarter, I thought you had been booking or thinking you were going to be in a payable position on the risk adjustment. So has that changed or am I sort of misremembering one? And then two, just on the reinsurance piece, I guess where do you expect to end the year and then what kind of benefit essentially would that have to MLR in 4Q just based on that one R?

Yes, Ralph, first of all, yes, in the second quarter, we assumed we would be in a payable position for risk corridors, not risk adjusters. However, that being said, we had a payable in 2Q and we continue to record a payable in Q3 for risk corridors. We had indicated in 2Q that for risk adjusters we had data that implied a receivable. We chose not to book that receivable because we thought the data was immature. We've gotten better data now in Q3 that would still imply a receivable. We have booked that receivable along with the payables based on that data, but then booked a 100% valuation allowance. Our outlook still does not assume upside, which at least the data to date would imply from the Wakely study that we would be entitled to a net receivable, but we're still not booking one at this point.

Peter Costa, Wells Fargo.

Just as a follow-up to that last question, can you talk about what the timing will be in the fourth quarter and into next year of finalizing whether you should be in a receivable or a payable situation relative to the risk adjuster?

Hey, Pete. How are you? Honestly, I really think it's going to be challenging for anybody to know what the final settlement is going to look like on the risk adjuster. Everybody is submitting their data today. You still have opportunities to code your data if it wasn't coded properly between now and year-end. In fact, you have that opportunity into early next year as well. So realistically, we think we're really not going to know an answer until closer to end of Q1, early Q2 of 2015 on where things really shake out.

Our intention though from this point is because we do have better data now and there is at least a point of view that the industry can begin to take is to book to what we're getting not only on the receivable side, but on the payable side and then if we're in a net receivable position, which we continue to be after two quarters, is book a valuation allowance until we see ultimate settlements shake out. We've seen the number move enough between 2Q and Q3 in a variety of directions that we think booking an allowance is a very prudent thing to do until we see ultimate settlement. But I think ultimate settlement does not happen till 2Q of next year.

Just as a follow-up and staying on the exchange business, your price increases on the exchanges for 2015 were relatively modest; yet some of the second lowest cost silver plan price increases were lower than yours. And that results in higher premiums fairly substantially for some of the lowest income people in terms of a percentage increase for them for your plans. Do you expect some churn of your existing business and if you do, how much or can you give us an idea of what the relative rate increase is for some of the people on the lower end of the spectrum?

Pete, I think it's fair to say we expect some degree of churn as we do with any book, especially in the individual book where it's a highly competitive consumer-based shopping experience. That being said, we expect to be a net grower next year on our exchange book. I don't know that we'll maintain exactly the same marketshare because it's very much dependent upon the competitive environment, but we think what's probably most important for the consumer is predictability and affordability. So the volatility in our pricing we think is very limited versus maybe what we've seen in other filings throughout this most recent period.

One thing to keep in mind though is that our goal is to maintain affordability, but price for a fair return for the value we bring to not only our members, but to state and federal government. And when you look at it with that lens, it's important to recognize too that the data would support these rate increases and probably more importantly, the ultimate impact to the consumer is very dependent upon the product selection they have and the substance they have. So I think as we continue to bring healthier lives into the book over time and as the book gets more medically managed over time, I think you'll see price points begin to tighten even further and you're starting to see that in markets and I think as the three Rs start to wear their course and for lack of a better word the training wheels come off, I think you'll start to see pricing get even more rational in markets where we don't think it's completely rational yet.

Josh Raskin, Barclays.

Thanks. Wayne, I just want to clarify on the cash earnings. I think you said $222 million of amortization. I don't know if there is a tax impact, but is that something in the ballpark of $0.80?

Hey, Josh. Yes, that's a pretax number, so you will need to tax-adjust it. So you'll be south of the $0.80.

Okay, so $0.50 or something like that.

Yes.

Okay, good. And then amortization, is that trailing down in 2015 as you get past Amerigroup? I don't know how many short-tail amortization buckets there were.

It is, Josh. We use an accelerated amortization method. So it is trailing down and if you go to our 10-K and our 10-Q, which will be filed later this afternoon, you will have an opportunity to see the five-year average of what our amortization expense is and you'll be able to see how it trails down.

Okay, perfect. And then just moving to the individual book, the decline in the third quarter, I just want to make sure I got the moving pieces on that. Was that mostly declines as some of the individuals on exchanges were lapsing or was there more going on there and is that what's driving -- you guys had a pretty big drop in the fourth-quarter membership expectation. Is that mostly Individual as well?

Yes, thanks, Josh. Yes, it's basically what I'll call historical normal lapses that we see during a third and fourth quarter and that's pretty much what we saw in the exchanges. Our sales assumptions are aligning with what we expected, which was not that many individuals that would have life event changes. Many individuals are getting jobs in some cases moving from exchange into an employer-based coverage, but nothing unusual or unexpected and we expect that trend to continue going into Q4 with then a rampup back in growth again starting January 1.

We've also made an assumption in our ASO business that we may see some in-group change, negative in-group change in Q4. I hope that proves to be conservative, but there's just been a lot of volatility in employment levels and as we get into Q4, we're not quite sure how that might shake out with the fourth quarter, so we chose to take a more conservative view at this point until we see more, but those are the two primary drivers of the reduction in membership that we're assuming in Q4.

Chris Rigg, Susquehanna.

Good morning. Thanks for taking my question. I was hoping you could give us your latest thoughts on Medicare Advantage for 2015 and how you think enrollment will trend in that book next year.

Hey, Chris, good morning. I think at least our views at this point -- we clearly have a headwind in 2015 due to the Star ratings that were out there and as Joe has indicated many times, our path to this turnaround is a multiyear path. And I will tell you based on what we've seen for progress this year relative to our future ratings, we're very encouraged at the strides we've made as a company. That being said, we would expect membership to be down slightly next year as we continue to refine our business, maintain zero dollar HMO plans in key markets where we want to get scale and leverage, but I do believe we can have op gain growth next year because a lot of our strategies are starting to play out and a lot of the investments we're making this year, which are impacting our Medicare margins, including SG&A investments and risk or adjustments that we're doing, will then start to flip next year. So I think you'll see membership down next year, but you'll start to see operating earnings improvement really starting to occur next year and then start to ramp up in 2016 and then really ramp up in 2017 with Star improvements.

Great.

Yes, Chris, this is Joe. Just so I can maybe add a little bit more meat to it. I think quarter-over-quarter we keep talking about our MA focus and how we're trying to realign, restructure, renew our MA market presence. And I think that we've got some very key strategies that will be exercised in 2015 going into the subsequent years. And I do want to underscore that we're going to achieve a lot of that through incremental investments. It's really important to note because as I've always said that we believe MA is an important part of our portfolio going forward. We don't tend to back off of that. We're investing heavily in medical cost management and I think that's going to be a very robust contributor for us going forward.

Managing the business locally is really important to underscore and probably most critical is that we've created a more effective operating team and we've got an entirely new executive infrastructure that is administering the growth dynamics in and around MA. So we have bid strategies, we've got a focus on not overreacting or reacting irrationally in the market. And I think in the long view, we're certainly going to focus on performing in a more stable construct than I think history would suggest. And again, we've got specific strategies related to every one of those points that I made.

So I'm pretty optimistic about our efforts going forward. I guess one key driver is Stars ratings and I think we've got a very significant plan of action there and we're hopeful that as we did experience an uptick in our Stars rating this year, most recently announced, which we believe was materially in the right direction, we do believe that over time that we will achieve our goal to attain 51% of our members' four-star plans. So put all that together, I think we've got a very significant opportunity ahead of us and of course, a lot of that is being driven by our provider collaboration activities, which I think undergird a lot of what we're doing, not just in MA, but in a variety of other domains in the Company as well.

Got it, great. Thanks a lot.

Dave Windley, Jefferies.

Hi, I wanted to follow-up on some of your spending initiatives that you've mentioned and focus in I guess on SG&A. SG&A was a little higher I think than the street and we were looking for this quarter and then it looks like, for your guidance, it actually drops down a little bit in the fourth quarter and that's I think counter to normal seasonality. So I wondered if some of that spending was going into these investments in programs that you're talking about or was it related to something else?

Good morning, Dave. No, a lot of the spending that you saw in 3Q really wasn't to these initiatives. I would say that, keep in mind, the duals really started rolling out and ramping up and so you're starting to get real run rate value there. But as we continue to have new RFP wins in Medicaid, as we continue to see lives expand, a lot of our initiatives around our exchanges beyond the marketing, there's a lot of other initiatives we're doing to build products, redefine how we go to market and we're doing a lot of those sooner versus waiting right before open enrollment.

So you're seeing a lot of that come through in Q3 and it's important to recognize that, on a year-over-year basis, last year, you had three months of open enrollment. This year, you're only getting two months of open enrollment and so you don't have quite the same marketing level of spend as you saw last year for the last three months because you only have two months. So there's a few things that influence Q4.

The important point I think we want our investors to understand though is we are investing for growth. We're not cutting the growth and I think that's probably the most important point we want to make is that the SG&A is really a variable cost to us now. We're using some of the fixed cost leverage though to shut down systems and platforms. Joe has put forward a very clear initiative for IT on we will get to a unified enterprise and unified IT platform. And I think the real value of these investments, when you see G&A coming down, really is not until you start getting out to the 2016, 2017, 2018 timeframe. So view us investing through 2014, view us investing through 2015 and then begin to see how the leverage of that top-line growth really comes to play in 2016 and beyond.

Great, thanks. And then my follow-up question is coming back to your broad bookends on 2015 and the headwinds and tailwinds that you gave Justin earlier. I guess the essence of the question, the simple question would be do you expect that you can grow op gain or operating earnings in 2015? In particular, like I'm thinking you gave Medicare Stars as a headwind, but you also talked about op gain growth for Medicare in 2015. So again, bottom line, do you think you grow operating earnings in 2015?

We do, Dave. And if you look at our five-year model we laid out in early March, we indicated an operating earnings growth of between $1.4 billion and $2.1 billion. If you look at where we started this year at being greater than $200 million, I think you can see through three quarters of results and now backing into the fourth quarter an EPS number that we will be north of 10% of operating earnings growth. This year, we're $400 million of op gain growth. We would fully expect that that trend would continue and then in the later years, as I said, we'll begin to get substantive G&A leverage with that top-line growth. So yes, op gain we expect to grow next year.

Again, I think reflecting back to our Investor Relations day and the outlook we provided you there, we're still very committed to our outlook in terms of where we're going to land in 2018, strongly committed to that. At the moment, we don't see anything that would distract us from achieving the goals that we established at that time, notwithstanding there may be some bumps along the way. But in the main what we're seeing right now we believe we still have clear line of sight to 2018 outlook.

Ana Gupte, Leerink Partners.

Yes, thanks, good morning. I wanted to follow up on the Individual off and on exchange question, but slightly different aspect of it. I think a couple of your competitors are now beginning to acknowledge that the public exchange is actually profitable, but their bearish outlook is largely because net across on and off exchange, they're seeing margin compression and even losses. So just wanted to understand relative to last year in 2013 what type of margin performance did you see into 2014 and was that a tailwind or a headwind? Did that differ geographically and then what is the expectation into 2015?

Hi, good morning, Ana. This is a good question. If you were to look at run rate margins last year versus expected run rate margins for this year, I would say year-over-year margins are very comparable on a run rate basis. However, what's the primary difference? Well, one is this year you have a lot more members that are starting to migrate into the book and those are coming over, but probably more importantly was last year you had all the buildout activities though of exchanges, which really did tap down margins for last year as we built out our strategies, put forward our marketing, but had no revenue coming through.

So year-over-year, margins have improved this year versus last year, but that's because of last year's investments, not because of necessarily the underlying run rate. We clearly believe though and have expected in our pricing there would be volatility in the book and a lot of unknowns and so we don't believe margins are optimal at this point though and we think it's very similar to what you see in a Medicaid program. We think as we begin to manage these lives and begin to put them through more managed care programs that over time we will actually see the underlying trends with the exchange business start to migrate more to a non-exchange individual business that we've seen historically, which then ultimately would reside in even higher margins over time. So we still think 3% to 5% is reasonable and our goal would be to eventually target closer to the 5% than the 3%.

So on a follow-up basis then, your competitors have even talked about forced attrition from off exchange to on exchange. Will you do any of that? Do you need to do that into 2015?

Unfortunately, I can't speak to what our competitors are actually talking about. I mean, from our perspective, there isn't a need of forced attrition and again, I would simply say that the catcher's mitt we built starting over two years ago was exactly to get to the point where we were indifferent to where the customer decided to buy and what mechanism and whether that was a buy through a public exchange, a private exchange, a broker or just online. Our goal was to build a mechanism that said we'd like to catch them regardless of where they're at. The real issue for us is offering them that choice and then giving them the most affordable product. And so I will tell you that Joe's focus for this leadership team is to make sure that the choice and affordability stay paramount in that and that's why the provider collaboration efforts that we're driving because that influences the affordability more than anything.

Matthew Borsch, Goldman Sachs.

Yes, hi, good morning. Maybe just give us an idea what you're putting through as the rate increase for 2015. I guess I'm really talking about off exchange in your Commercial insured business. If you don't have a point estimate you can share, are the rate increases that you're putting through for 2015 generally higher than what you put in for 2014? Can you characterize that?

So, Matt, while we don't give specific rate increases by market or product for competitive reasons, I can tell you that we are assuming across the book that we will have a rising medical trend over the levels that we have today. There are many reasons to assume that. There's also arguments why others may say you shouldn't assume that, including an improving book over time. But the reality is we think hep C costs will continue to rise and even if you were to exclude hep C costs, we still think the underlying core book is poised at some point to have trend and utilization move back to a more level place. So we're comfortable with our 6.5% for this year plus or minus 50 basis points in the bias to the low end, but we're pricing for a level higher than that as we go into next year for core medical trend.

Great. And gee, if I could just -- one more. If you can just remind us on the Medicaid business where you stand with most of the states. I know Texas is a special situation, but are you now getting both in most cases the fee and the gross up or is it mostly just the fee?

Hi, Matt. Yes, on that question, the answer is both, which is what's very encouraging for us. We still believe we will get that in Texas. We believe it's part of a sustainable business model. We just have not included that in our outlook. The one thing I want to highlight though, as we said in the prepared remarks, is we have about 100 million, just north of 100 million of items that we have arrangements with a couple states. They have been signed off with them in writing. Those arrangements now are with CMS and we're just waiting for a final signed contract and they go retroactive to within the year. So we continue to include that in our outlook for the year, but I would tell you we don't see a reason why we won't get there with all the states. We just think there may be timing on those and we'll call that out if it happens, but Texas, we feel like that's going to be more next year now than it will be this year in terms of a signed contract. And that's what we were referring to when we talked about administrative items. It's the timing of getting the final signed contract is when we record the revenue.

All right. Thank you, Wayne. Thanks for the questions, really robust discussion today. I know there's still folks in the queue and I'd like to suggest that if there are lingering questions, both Doug and Wayne are available to take your calls later today and fill in some of the gaps that might have been created.

But let me just underscore a couple closing points. First of all, we are very pleased with the substantial progress our Company has made, not just in this quarter, but over the course of the entire year and I think it's really important for me to underscore that perspective. This has occurred in a year of remarkable change. Our game plan for 2014 has played out better than expected. I think we're very proud of that. In addition to the financial success we've enjoyed this year, I'm really pleased with our progress in driving toward a performance-based culture within the Company. The financial results for 2013 at 2014 and the foundation for growth that we've established support our confidence that I hope you detect that our structure, our leadership and our strategies are all pointed in the right direction. We do remain focused on execution, as well as the need to continue to invest in our future to drive greater healthcare quality and affordability, which I believe is a hallmark of our focus going forward.

To recap on the back of the strong third quarter today, we raised our enrollment, cash flow and EPS outlooks for 2014. We're targeting growth in 2015 and remain optimistic about our longer-term opportunities across both our business segments. I want to thank all of our associates who really performed remarkably well for their -- and given all their hard work that underpins our success as a company and our transformation into this performance-based culture that we now have embedded throughout the Company. Thank you for joining us this morning and for your interest in the Company. We look forward to speaking to you next quarter.

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