Humana Inc (HUM) 2003 Q4 法說會逐字稿

…my name is Janice and I will be your conference facilitator today. At this time I would like to welcome everyone to the Humana fourth quarter earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer period. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question press the pound key.

At this time I would like to turn the call over to Regina Nethery, Vice President of Investor Relations. Thank you, Ms. Nethery you may begin your conference.

Thank you and good morning everyone. We appreciate you joining us this morning for a review of Humana’s fourth quarter 2003 performance and an update on our earnings guidance. Participating in today’s call are Mike McCallister, Humana’s Chief Executive Officer; Jim Bloem, our Chief Financial Officer; and Art Hipwell, our General Counsel.

This morning’s call and virtual slide presentation are being recorded for replay purposes. That replay will be available approximately two hours after the conclusion of this call on Humana’s Web site, humana.com.

As we begin this morning’s call I need to remind each of you on our cautionary statement. Certain of the matters discussed in this conference call are forward-looking and involve a number of risks and uncertainties. Actual results could differ materially. All participants in this conference call are advised to read Humana’s press release issued this morning, February 2, 2004. Call participants are also advised to read the following documents as filed by Humana with the Securities and Exchange Commission — our Form 10-K for the year ended December 31, 2002; and our Form 10-Q for the quarters ended March 31, 2003, June 30, 2003, and September 30, 2003. These SEC filings contain detailed discussions of important risk factors.

This morning’s earnings press release includes operating cash flow measurements that are not in accordance with generally accepted accounting principles. A reconciliation from GAAP operating cash flows to the non-GAAP financial measures is included in this morning’s earnings press release. That release is available via the Investor Relations’ page of Humana’s Web site.

Please note that all references to earnings per share made during the course of this call represent diluted earnings per common share. Also, all forecasts exclude Humana’s pending acquisition of Ochsner Health Plan of Louisiana. Today’s call includes a question-and-answer session for industry analysts, so we encourage the investing public and media to listen in.

And now I’ll turn the call over to Humana’s Chief Executive Officer, Mike McCallister.

Thank you and good morning. Today Humana reported earnings per share for the fourth quarter of 2003 of 41 cents, compared to a loss of a penny per share in the fourth quarter of 2002. For the full year, our earnings per share of $1.41 represents operating earnings progress for each of our business segments, the result of our sustained commitment to a diversified customer base.

In fact, the fourth quarter is a culmination of a year of significant growth and successes. I’d like to take a few moments this morning to review some of our accomplishments for 2003.

We successfully positioned our Commercial segment to become a meaningful contributor to our consolidated results, accounting for 35 percent of our pre-tax income in 2003. The pace of our SmartSuite sales continue to accelerate with membership in these plans now exceeding 200,000. We launched the individual product in 14 States and currently have more than 50,000 members enrolled. Our expectations are for a continuation of this strong trend in growth.

The Department of Defense awarded us the TRICARE contract for the new South Region, recognizing our leadership and expertise in this specialized business.

Our increased administrative efficiency led to the consolidation of seven Service Centers into four. This all happened seamlessly with no disruption in service for our members.

And we completed the sales and distribution infrastructure investments necessary to make us a top-line player in the health benefits industry.

Turning from our own accomplishments to our relationship with the industry as a whole, in 2003 we continued our drive to redefine value in health benefits. In so doing, we pledged to disrupt the industry, leaving behind the old world notion of health benefits as a commodity product and embracing a new world total solution for employers and employees.

This solution, uniting wide choice in plan offerings with a robust menu of consumer engagement tools, education, and programs is not a product in the traditional sense, but a new process around product. It achieves two breakthrough outcomes. It reduces double-digit health cost inflation to middle single digits, and it empowers consumers to choose and use their benefits with confidence, producing a better health plan experience for themselves and their families.

Success in this new space was recognized in July when Forrester Research name Humana an industry leader in health benefits consumerism, and rating Humana first for both its strategy and current offerings. Forrester commented, “Humana positions its CDHP offerings as a part of a broad spectrum of employer and employee product options and wraps them all with exceptional online services and tools.”

This wrapping is the essence of the process around product in the Smart family of Humana plans. By providing guidance and actionable information, much of it through Internet technology, Humana transforms passive healthcare users into active healthcare consumers. Employees then start, for the first time, making informed health spending decisions in their own economic self interest and thus, by extension, in their employers.

This total solution now involves more than 200,000 Smart members. In addition, we have been renewing 100 percent of the eligible early adopter customers. And a related extension of our consumer expertise, the technology-driven services that support consumer engagement within the Smart family, are increasingly being applied across the board to our traditional Commercial, Medicare, and TRICARE membership.

Last month we announced our intent to acquire Ochsner Health Plan of Louisiana, a market leader both in New Orleans and throughout the State of Louisiana. The addition of Ochsner provides us the opportunity to enter a new market with critical mass, the support of solid provider deals, and the opportunity to introduce a host of innovative products to this market. Ochsner is a terrific fit for us strategically from many perspectives.

One, it provides an opportunity to broaden our footprint, making us more attractive in the mid-market and national account space.

Two, it enables us to leverage our existing presence in the Texas markets with our new presence in Louisiana, a key attribute, due to the number of companies that have overlapped between these two states.

Three, it overlays with our soon-to-be-expanded TRICARE presence in the new South Region, which includes Louisiana.

We anticipate the transaction to close early in the second quarter of this year, pending Department of Insurance approval. We will continue to evaluate opportunities for potential acquisitions that. like Ochsner, fit strategically and provide an appropriate return on our invested capital, thus adding to shareholder value.

So how does all of this impact us on a forward-looking basis?

For 2004, we anticipate a year of record earnings with equally strong cash flows from operations. We now anticipate earnings per share for 2004 between $1.60–$1.65, slightly higher than we previously forecast.

Given the activity in Washington since our last earnings call, we’ll begin our discussion of the business segments with our Government segment.

We have long been contrarians to many in our industry with respect to Medicare, holding firm in our intent to continue our participation based on our Company’s unique capabilities in administering Medicare HMOs and the huge scale of the market in the senior population. That commitment has now positioned us nicely to move quickly and effectively with respect to new opportunities offered by Medicare modernization.

Based on the recently revised rate books issued in accordance with the Medicare Modernization Act, we are raising our guidance for Medicare Advantage premium yield from a range of two-to-four percent to a range eight-to-10 percent. This additional premium allows us to strengthen networks and offer benefits that we believe position us for growth within our existing markets, as well as possible expansion into new territories.

From our perspective, the Medicare Modernization Act was never about short-term earnings. The changes brought about by this law permanently strengthen the traditional Medicare HMO product long term, but also introduce a host of prospects for other areas of participation by our Company.

I’ve long believed there would be new private sector opportunities in the Medicare program and they are now upon us. PPOs, for example, are the most popular form of health insurance in the United States, and yet, prior to this bill, were not widely available to seniors. This product will be positioned between HMOs and traditional Medicare policies, and in my opinion, will be very appealing to seniors.

The regulatory rules are still being written and we will provide updates on the specifics of our participation as they become clear.

In the meantime, on a separate track, we are complementing our existing array of senior products with the introduction of Medicare Supplement plans. We are in the process of filing rate and benefit packages with approximately 20 States to sell this medically underwritten product, with plans to double that territory over time.

Though we have not included any Medicare Supplement membership of substance in our 2004 projections, we believe this is a firm step towards offering another option to the senior population.

In rolling out the Med Sup product, we’re taking a page from the playbook we used in launching the individual product. Whereas we leveraged the small group distribution channel when we introduced the individual product, we plan to leverage that same distribution channel for our Medicare Sup business as well.

With respect to our TRICARE operations, the new North Region contract is set to begin in July of this year, at which time our TRICARE membership will decline by approximately 1.4 million members as our Region Two and Five membership becomes part of that new Region. However, we anticipate TRICARE membership to increase again to around 2.8 million when Region Six becomes a part of the new South Region during the month of November. This temporary membership decline was previously anticipated as part of our earnings guidance.

All told, we continue to forecast a TRICARE pre-tax margin in line with the historical range of two-to-four percent, with TRICARE premiums and ASO products projected to approximate $2.1 billion in 2004. As a whole, our Government segment is now expect to perform better than previously forecast.

Turning to our Commercial segment, we anticipate another good year progression in our pre-tax income, with an expected range of between $140–$170 million. Though we are increasingly differentiating ourselves from other health benefit companies and thus becoming less of a commodity, we are competing effectively with our traditional products as well.

Within our traditional book the mix of our business is beginning to change as we migrate towards individual and small group, mid-market large group, ASO and Smart products, and migrate away from larger insured accounts in general and slice business in particular.

As for the self-funded space, we have been saying for some time that we would become a player in the ASO market. Given the results we are seeing this January, I believe we can say with confidence that Humana is now a player. We continue to anticipate a growth rate for medical membership in the range of six-to-nine percent for 2004, and are forecasting nearly all of that growth to be in the ASO business. This is a space where customers select from an expansive list of potential services. Their choices can vary among such options as full service, network rentals, pharmacy, dental, disease management, utilization management, or our Call Center services. We are now positioned to provide any and all of these services to meet market demand.

Total Commercial medical membership, fully insured and ASO combined, has increased by over 200,000 new members on a net basis in January alone, substantially all of which is ASO.

Though we’re excited about our progress in the traditional space, we’re particularly encouraged with respect to the uptake in Smart plans. Approximately 70,000 of the January membership additions relate to our innovative Smart products, with total Smart product membership now exceeding 200,000.

Not only have we transitioned to being a player in all the traditional lines of business, we’re succeeding in changing the rules of the game for the industry as a whole. Humana’s technology-powered consumer choice offerings position us uniquely and attractively at the center of the Commercial space, between traditional insurers on the one hand and pure-play consumer-directed startups on the other.

In summary, 2003 was a year of achievements from many perspectives and we expect 2004 will again demonstrate how operational discipline effectively translates to growth in earnings per share.

With that, I’ll turn the call over to Jim for a detailed review of the financials. Jim?

Thanks Mike, and good morning everyone. Since we’ve extensively detailed the fourth quarter results in this morning’s press release, I’m going to focus my comments on the full-year 2003 results in order to provide context for our 2004 guidance. Let’s start with revenues.

The 2003 consolidated revenues of $12.2 billion increased more than eight percent over 2002. Three of the factors contributing to the higher level of 2003 consolidated revenues are:

First, Commercial premium yields were in the 12–14 percent range;

Second, organic growth of 72,700 or 2.4 percent in our Commercial medical membership;

And third, higher revenues associated with TRICARE, as monthly premiums increased for the new contract year and we settled outstanding bid price adjustments.

The 2004 consolidated revenues should approximate $13 billion, with Commercial revenue increases and additional Medicare reimbursements constituting the bulk of the increase. Total Government revenues likely will not see a significant increase because higher forecasted Medicare premiums are expected to be partially offset by anticipated decreases in TRICARE revenues as we transition to the new contracts and the South Region during the year.

Turning next to each of our business segments, as Mike commented, the Commercial segment contributed a significantly higher percentage of our pre-tax income in 2003 than in 2002 and prior years. We expect the percentage of pre-tax income from the Commercial segment to be at least the same percentage of total pre-tax in 2004.

Looking more specifically at various components of our Commercial earnings, premium yields and medical cost trends for 2003 were in the 12–14 percent range, as we previously projected. For 2004, several factors have moderated both our premium yield and our medical cost trend estimates.

With respect to premium yield, we are now forecasting a range of 8–10 percent. Four of the elements leading to the new premium yield range are as follows:

First, benefit buydowns were deeper overall than originally projected, primarily due to two customers revising their pharmacy benefits.

Second, one of our higher premium and cost groups converted from fully insured to ASO.

Third, our individual product membership is now anticipated to comprise a higher percentage of the total fully insured block than previously was forecast.

And fourth and finally, a greater portion of our SG&A savings is being reflected in our bids as a result of the competitive pricing environment.

With the exception of this fourth item, each of the three other factors also result in a commensurate reduction in our medical cost trend, which is now forecast to be in the 9–11 percent range. Additionally, our 2004 cost trends include the anticipated impact of the dynamics associated with the actions of a large insured account. In the case of this account, which represents about 85,000 members, the customer permitted a competitor to exit the bidding process. That exit fundamentally changed the dynamics of the process by altering the risk selection profile on which our bid was based. The exit shifted the mix to a higher medical cost population. While this is a unique situation, it does validate our preference for bidding on a full replacement basis.

Based on our revised forecast for Commercial premium yield and medical cost trend, we anticipate an increase in the Commercial Medical expense ratio of approximately 100–130 basis points. This amount largely will be offset by a continuing decrease in the Commercial SG&A ratio as we see greater benefits from the consolidation of our Service Center operations and other administrative cost disciplines.

Accordingly, our 2004 Commercial pre-tax profits of $140–$170 million take into consideration all of these factors. This range represents another record year of earnings for the Commercial segment.

On a quarterly basis, our Commercial profits are expected to be earned more ratably throughout 2004 than in the past few years for three reasons.

First, the front-end loaded pattern associated with the large group fully insured block is anticipated to be somewhat muted due in part to a shift in the mix of our business to a higher percentage of ASO and individual membership. The profits associated with these latter two lines of business tend to be earned more ratably through the year.

Second, several high-cost accounts are forecast to be terminated when their contracts expire in the latter half of this year.

And finally, the fact that 2004 is a leap year will add another day, or just over one percent, to medical expense in the first quarter, while the associated premiums will be spread throughout the year.

Turning to the Government segment, Mike just described a number of changes and opportunities associated with the Medicare Modernization Act, which will help increase revenue line in 2004. We are confident of achieving increased Medicare membership and now are raising our guidance to a range of 340,000–360,000 members by the end of the year.

Based on the revised Medicare filings we submitted last week, we estimate our 2004 Medicare Advantage medical cost trends to be in line with our premium yields of 8–10 percent. While we previously had forecasted a range of two-to-four percent, the increase in our Medicare premium yield guidance takes into consideration the incremental premiums associated with the Medicare Modernization Act, as well as anticipated changes in the geographic mix of our membership as we continue to grow that business.

In addition, we’ve made changes to member premiums as part of our revised Medicare filings. Given the changes with respect to the Medicare Advantage premium since our last earnings call on October 27th, we have revised our forecast for the Government SG&A ratio and now predict a lower SG&A ratio in the range 11–12 percent.

Next, looking at TRICARE, that business is expected to achieve pre-tax margins consistent with its historical range of two-to-four percent. However, we do not anticipate TRICARE products to be weighted towards the back half of the year as they were in 2003. As you likely will recall, we experienced some revenue timing issues associated with accelerated military activity, which resulted in TRICARE revenues being heavily skewed toward the back half of 2003.

With those timing issues now behind us, we have reverted to a more normalized revenue pattern. Given that fact and the temporary membership decline in the latter half of the year, which Mike outlined, we expect TRICARE earnings to be weighted toward the first half of 2004.

Turning now to our balance sheet, our cash position is strong and our balance sheet is more liquid than ever. Consolidated cash plus investment securities were over 55 percent of total consolidated assets at December 31, 2003, versus under 50 percent at the end of 2002. Significantly, cash and investment securities at the parent company more than doubled in 2003, and now total just under $400 million. Also, our debt-to-total capitalization ratio improved by 150 basis points during the year to 25.9 percent.

Regarding medical claims reserves, just as in prior quarters, this amount represents the consistent application of our reserving methodology. Consequently, our 2003 results do not include any impact from prior year medical claims reserve development.

Finally, on a non-GAAP basis, which we use to account for the timing of the receipt of a Medicare premium payment, 2003 cash flows from operations increased by $75 million, or 22 percent, to $407 million. We are forecasting another substantial increase for 2004 with expected cash flows from operations ranging between $475–$525 million on the same non-GAAP basis.

In summary, Humana made solid operational and financial progress during 2003, and we look forward to continuing that trend in 2004.

With that we’ll open the lines for questions from industry analysts. Operator, will you please introduce the first caller?

At this time I would like to remind everyone, in order to ask a question please press star, then the number one, on your telephone keypad. We’ll pause for just a moment to compile the Q&A roster.

Your first question is from Josh Raskin of Lehman Brothers.

Hi, good morning. A question — I just want to drill down a little bit more on the pricing on the Commercial book. The first question is, can you help us with the just the rate of renewals versus the new accounts?

And then also, can you talk a little bit about more specifically that one account that was sliced that I guess they let a contender out? Is that typically how it happens, or are you typically not made aware of changes in the overall benefit structure by a customer, especially one that big?

Josh, this is Mike. I’ll take the second piece first. It’s pretty rate to see this today. The rules of the road relative to managing slice business have been — have gotten a lot tighter over the last few years and you simply don’t bid in a situation where you can’t adjust. This is a very, very large account, 225,000 members, of which we have about 85,000 and this is a unique circumstance just based on the type of account it is and the size it is. But no, it’s not something we would see routinely. As a matter of fact, we have no other account that even looks like this if you sit down and list three or four major attributes of it.

OK.

And then, your other question about renewals, renewals are pretty much in line with where they’ve been before. There still is a lot of churn in the industry, but the good news is, as we said with our new products as they continue to gain acceptance, we’ve had very high renewal rates on them.

I guess, Jim, just more specifically, do renewal rates versus the new customers that you signed up — I know, obviously, a lot of that is ASO — but to the extent there’s some examples on the risk side, is there a differential in what was renewed versus the risk?

And then, one more follow-up to Mike’s comments, do you guys have a size in terms of the actual pre-tax differential that that account is going to cost?

Let me take the end of that first. That account is why there’s a range now, so…

For Commercial earnings.

For Commercial earnings.

OK.

And your point about the new business, I mean, the new business we got in January is virtually all ASO, so pricing issues are not material there. We bid administration with a solid double-digit margin and we’re moving on.

OK. Just my last question, any changes in the competition since the last quarter or the last two quarters?

No. I’ve said for a number of months now that most are behaving very rationally, including the big non-profit Blues that I compete against. But pricing is tighter than it was a year ago.

OK, thanks.

Your next question is from Charles Boorady of Smith Barney.

Hey, how are you? The first thing I wanted to ask was about the drop in the Government MLR in the fourth quarter versus the third quarter and whether there was anything non-recurring or unusual in there, such as changes in IBNR, et cetera.

No, there were no changes. It’s just — again, I can’t point to any specific thing.

It was a pretty big — I mean, it was bigger than any other sequential drop I have seen, so I was a little bit…

Well, we tend — first of all we have the normal TRICARE pattern. Remember, TRICARE in the second half of the year that’s the first half of the contract year. And the second thing is, we true-up a lot of things as we go through the year. And so that may be the real reason, but there really isn’t anything that I see that would point to that being extraordinary.

Yes, I guess the true-ups are one of the things that I thought it — that might explain it in terms of whether what we saw in the fourth quarter is a real good run rate number or if it included some true-ups from being too conservative in reporting the first three quarters.

No, Charles, this is primarily TRICARE. In fact TRICARE, last year was even worse than normal in terms of the front half being poor and the back half being strong, so mostly TRICARE.

Right, OK. On the enrollment guidance you gave 6–9 percent medical enrollment growth. That would imply about 609,000 net new members if it was at the nine-percent range. And you mentioned all of that would come from ASO, which would imply something like 34 percent growth in your ASO business.

Actually, the 6–9 percent is in the Commercial space where you start with a denominator of around 3,065,00. And then we’re saying — so basically, round numbers, those are about 30,000 a percent. So I think your numbers are a little high that you just quoted.

Got you. So it would just be off the Commercial.

That is correct.

Pretty significant ASO growth and I’m wondering how much of that you already have locked in January 1st versus how much we’d see come in through the rest of the year, and also if you can characterize the kinds of new customers in terms of the average employer size, or if you’re going after smaller or larger employers than what you have been in the past.

Let me start with the math first. Nine percent on three million is 270,000. I just told you that we put 200,000, most of which are ASO, on there in January, so we don’t have much of a hill to climb for the rest of the year. That will largely be ASO business that produces the rest of the growth.

In terms of the type of clients, it is very mixed. There’s a very large account in that number, but then there’s a mix of smaller ones. So, I’ve said all along that in the ASO space there’s nothing unique here. This is basically networks, cost of goods sold relative to the services, and it’s back office operations, and that’s strictly administration. There’s some reporting capabilities and other things that had to be built out, but for us to be effectively competing in the ASO space, well, to me it’s not very surprising because I think that’s a space where we — the strengths that are required, we have. And ASO business sometimes can get down as low as 500 or 600 members in terms of scale, or it can be hundreds of thousands.

So, that business is a mix of all of those things.

I mean those are SmartSuite versus…?

70,000 of the 200,000 in January are Smart.

Got you. Why wouldn't the other ones take it, because that's a big percent, that's obviously a great success story for the Smart products, but it seems like such a good product that everyone would want to sign on with it? Is it a pricing issues or is it some just don't need that flexibility?

It's early. If you listen to all of our competition they're just now beginning to speak aggressively about the whole consumer space. And so the truth is up until recently we only went out there on the bleeding edge, if you have it that way, that said this is the way that things need to go. So now the market is starting to come to us, and we do get the chance to look at every piece of business, so it's a combination of the market coming to the idea, it's the idea that we are not the only one talking about it now, and we have enough history. In the real big takeaways we are starting to get enough history with the clients that they don't have to speculate whether it's really going to work. So all of that's generating some traction, and I think that traction will get better over time.

There's also sort of an organizational readiness issue as well, and I think a number of our new customers have said they're going to seriously look at it for the coming year, '05.

One last numbers question on the balance sheet. The other non-recurring assets were up, and other non-recurrent liabilities were also up by similar amounts, but by unusually large amounts. I just wondered what moved those two buckets?

Basically there, what we've had is we've looked at some of our co-insurance that we've had. In looking at that that was netted previously, and now we have grossed it up so that we show receivable now in other long-term assets, and a liability in other long-term liabilities. The result of course, it doesn't change shareholders equity, it doesn't affect earnings at all, it doesn't affect cash flows at all. And the other companies are all AA or better credits, New York Stock Exchange kind of companies. So we thought that would be the more conservative accounting for that.

Any income statement impact to that change?

No, not at all.

Got you. Alright, great. And I don't think you gave the '04 guidance for MOR and SG&A by commercial government except that you said -- I guess you kind of gave directionally where they're going, the 130 bp deterioration on commercial for example. But could you give exact numbers just to make sure?

No, that's pretty good specificity for you.

Okay, thanks.

The next question is from Eric Veiel of Wachovia.

Thank you, just a quick couple of questions. First, on this large account that let one of the competitors pull out of the pool, can you give us a sense of what the underlying medical costs trends in 2004 would be if we adjusted for that account?

Well that's kind of what we try to do by giving you all the variables that were there. Remember we said there were a number of variables that affect the premium yield, and that three of those four variables affect medical cost trend. And then obviously we had medical cost trend a little higher than premium yield. And basically that is the primary reason why. And that's why we now have the range that Mike described of 140m to 170m in commercial.

Versus your old guidance of at least 170, so the worst case scenario at this accounts change and would take 30m out of your commercial pre-tax?

You're generally in the area. Eric, the big takeaway really is we're, as usual, trying to be conservative in giving you as much clarity as we can. What it is, February 2, and we are looking to trying to project a full year of results on this account. It's early to even know. So in an effort to provide some level of range and conservatism we've gone ahead and done that for you. But it's February, there's 11 months to run on this account, a lot of things we can do with it. We will wait and see how it actually plays out, but we are pretty comfortable with what we've told you so far.

Okay, thanks. And just a follow on, Mike, what type of customer was this? Was this a municipality or an employer?

It's a large -- yes, not a municipality but it's a government account.

Government account, non-municipality?

Yes.

Okay. And then my second question, just if we take a look at the sequential decline in the incurred but not reported, and then sort of overlay that with what could potentially have been a different flu season, or at least an earlier flu season. Can you just help give us some comfort that there's been enough reserving, especially for your Medicare book as it relates to the flu?

Again we've used the same conservative and consistent methodology that we've used in the past. We look very carefully at all the variables, including the flu season, and believe that we have the right number. When you look, basically the biggest thing that declined - and I always go to page 20 of the press release to get the components of the total medical claims payable - the biggest thing was the pharmacy cut off this quarter, and again that just happens to fall on what day of the week the period ends. So that's basically the biggest change.

Let me comment on the flu, though. The flu has peaked, and we did see some minor impact later in the year from that. But at this point it has peaked. I don't anticipate it being any issue in '04.

Okay. Thank you.

Your next question is from Christine Arnold of Morgan Stanley.

Hi, first question is on enrolment then I have an MOR question. On the enrolment it looks like if you are getting an incremental 145,000 members from the slice account, if you are guiding for flat, at risk genuine membership, does that mean you are losing 145,000 other members, or am I misinterpreting that?

Well I think first of all the account has 85,000 man hours of about what, 280,000?

We're not picking up those 145,000 Christine.

Oh you're not?

Oh no, no.

Okay, alright, it's just that -- so what's the problem if you are keeping your same 85,000 members?

It's not the same 85,000, it was smaller before. So we picked up a sizeable piece of this account, and it's just not very good business.

Okay, so you have like a negligible -- so it's like somewhere around 80,000 --?

Well obviously it was less than 85,000, but I'm not going to get real specific.

There was another bidder there. When the bidder left then we were one of the people that are left to choose from, so more people chose us.

We got all of their business in several [sectors] of the geography.

You got a little bit something less than 85,000 incremental members with this account, and you are losing 85,000 members elsewhere. So it sounds like this is a bad trade. The ones you lost for just the ones you are getting are higher MOR.

No, no, no, you're really in the weeds on this one.

What you want to remember is we had some first, but we're not going to say how many, but that went up to 85,000.

This was a sizeable account that grew.

But you're losing at risk membership if you are guiding for at risk membership to be flat, and you are gaining this account.

Those are small ups and downs; that's not really material.

Okay, but if gaining this account isn't material then why the MOR guidance for an increase?

This account is material, I was talking about the movement up and down of the risk membership in total is not material. This particularly account is material.

And that's why we are making a change in the MOR.

So it sounds like this is a sick enough book of business that whatever membership you got is moving the needle.

That would be accurate, yes.

And you only gave them a one-year price or two year?

Of course. And we're all over it, that's why there's a range, we don't know exactly how this account is going to play out. We're just --

[indiscernible] incremental members, it's February, they're new to yield, you're not sure, okay.

Exactly.

Okay, next question; do you make money on your self-insured book of business on a net basis all in?

All of our lines of business are profitable.

So your ASO book of business is profitable?

Yes.

Right, thanks.

The next question is from Matthew Borsch of Goldman Sachs.

Hi, thanks. My question is on medical cost trend. I'm wondering if you could maybe breakout some of the components to help us understand which pieces of trend are decelerating and where it's accelerating? Then I have a follow-up question.

Okay. I take it you are directing your comments to the commercial side.

Yes, I'm sorry, yes.

The hospital trend is higher than the aggregate trend. We have seen some moderation there. We expect to see some continuing. That's sort of one of the reasons that 9 to 11 has come out in our guidance for commercial medical expense trend. Physician, those are better than the aggregate trend. RX is a little higher than the aggregate trend. So those are sort of the way we break it out. The ratio is the hospitals are around 40, the physicians are around 45 and the drug benefit is around 15.

What did you say on the drug benefit trend again, I'm sorry?

It's a little higher than the aggregate.

Okay. And do you expect moderation there in 2004 versus '03?

Yes.

Okay.

There's a real takeaway I think that sometimes gets missed in this whole business of trend. At the end of the day it's not about the trend on any of these elements, it's on actual costs, because that determines your competitive position. So drug trend for example, I think we've been guiding to a little bit higher drug transfer cost than some of our competitors have. That's a direct result of the timing of the implementation of multi-tier drug benefits for example. And so we will be having a higher trend off of a lower base. At the end of the day what's important to know is, where is our drug cost in our book versus someone else's - and that's how we look at it.

Got it. My second question relates to what you are seeing in enrolment. Two parts here. The first is, the extent to which you are seeing a pickup in employment levels at your existing accounts, number one. And then number two, I'm trying to understand how much of a shift to ASO you are seeing amongst your employer accounts, particularly your mid-sized employer accounts? And whether you think there's any adverse selection that's going on as some of the mid-sized employers with healthier employment populations move to non-risk?

As a former employer not in the healthcare sector I would say that employers are always making that choice, particularly in that mid sector that you described. Let's say 300 to 3,000 single or dual kind of markets, are always making that choice. So that dynamic continues to go on and on. But I would say the larger customers, the larger high cost, high premium customers, those are the customers that are looking at getting self-insurance, ASO, much more closely. And that's where we've seen one of the changes that we described earlier.

And on the employment trends?

I would say they've stabilized. This time last year we saw some impact from that in terms of employee reductions, but I think that's stabilized now.

Okay, Thank you.

Your next question is from Scott Fidel of JP Morgan.

Good morning. I just have a couple of questions. First on the benefit buy downs. You said that they were a little bit higher than you were initially expecting. Could you quantify what the buy downs were in January of '04?

Well generally I was talking about a couple of specific accounts that was causing the change in premium yield, and those were basically done because people made changes in their pharmacy benefits. But benefit buy down year-over-year have been roughly the same.

Okay, and if you could just remind us what they were in '03 in terms of extensive yield?

Two to three.

Two to three, okay. And my apologies, but I don't know if you had this in the press release, but I didn't see what -- what was your actual medical cost trend in the fourth quarter, just generally with the commercial yields?

Yes, we don't generally do that by quarter because we price once a year. So we kind of see how we are doing through the year and give you the cumulative update as we go. And again we said premium yields in the commercial sector of 12 to 14 and they ended up in that range.

Okay. And then just one last question on the SG&A guidance, which does look pretty optimistic for 2004. And that also is in the context of you guys are seeing almost all your new business coming in ASO which traditionally does have the higher SG&A. So could you maybe just walk us through little bit more, Mike? I know you talked about the Service Center consolidations, and just what some of the other drivers are going to be of the pretty substantial SG&A improvement you're expecting this year?

Well a couple of things. One is you mentioned the service center consolidation. And if you think about the service center consolidation while it was booked in the fourth quarter of '02 and the first quarter of '03, it didn't actually occur until in the third quarter of '03. So we didn't get the full year's benefits of it. So that's one of the things that's going to be driving it going forward. The other thing is, as we look at it, as you mentioned ASO does have higher costs associated with it. But now that we've got the service center set up the way we like it and we've optimized how it is, and we've got a full year of that, I think that will also help the ratio. But you are right, we have made very good -- we've made an aggressive forecast with respect to our decline in SG&A ratio that we think we can keep. Because if you look at 2002 and then go to 2003 and then look at this, you can see the same kind of rate of progression.

I would also tell you that if you are a believer in technology driving productivity I can look at every metric relative to the adoption of all of the build out of capabilities we have done over the last year. And you can see a steady and pretty significant growth in self-service transactions, electronic commerce, amongst every aspect of our business. You can go through the entire thing and you just see continued steady and yet significant adoption in traction.

Okay. Maybe just to quantify that, do you have your latest [quarter] adjudication and EDI rates?

It's north of 75%.

Okay, great. Thank you.

(Caller Instructions). Your next question is from Ed Kroll of SG Cowan.

Good morning. I've got a couple of quick ones. On the percentage of your pre-tax profit coming from commercial, which I think for the full year '03 was 35% and you are guiding to a similar number for '04. Is that right?

Yes. We kind of said, at least, given our range that we just gave you about 140 to 170.

Right, okay. That dipped down, and if you explained this I apologize I missed it. In Q4 of '03 it's roughly 14% of the total. I am just wondering is there any seasonality at play there or is it just a function of the government doing that much better?

It's the timing of the track to your earnings, we talked about that earlier, Ed. The track here always has a good fourth quarter. Do you want to add to it, Jim?

Right. And then on the commercial side again --

But I mean the run rate of Q4 wouldn't get --

There's no carry over effect to 2004 from 2003's fourth quarter in the commercial sense. We made some discretionary spending around new products and things like that, but there isn't anything that's lingering out there that's going to cause a problem that you go from 2003 fourth quarter to 2004 full year.

Okay. And so I guess we should see that bounce back in Q1 as a percentage of the total of the commercial pre-tax pretty substantially?

Absolutely. It always does.

Okay.

We did say it would be a little different in terms of this year, in terms of how operatively it would be earned because of business mix and the exodus [of some] accounts, and leap year, remember those comparative things.

That's right, I remember that. Okay. And then secondly, I wonder can you give us the operating cash flow for '04? Can you give us a GAAP number there? You said it was 475m to 525m non-GAAP.

Well I guess I'd have to sit down and plot that out because what I try to do, and what we try to do as a company is to make sure that there are three Medicare payments. And that's the only exception [indiscernible] that makes it non-GAAP, is what period does that premium actually get booked in for GAAP. And so we make it so that each quarter has got three of them and each year as got 12 of them. And my feeling would be, let's see, since it's leap year the year's going to end on a Friday next year, my guess is that they are going to be close like they were close this year. You can tell, we give you both of them and they're very close, but I can't give you a GAAP number because again the way we run the business here we're looking to make that normalized by just making sure we've got the correct number of Medicare premiums in each period.

Okay. And then my last question or comment back on the benefit buy down. You cited greater than expect benefit buy down as one of the reasons you guided the yields down for '04. But I guess based on your comment to a previous question, it wasn't as big a factor as maybe some of the other things you cited?

Actually all those factors were about the same. Again what I was trying to do is just give you some color around how 12 to 14 gets to 8 to 10. And those four things generally are roughly all about the same, one of which was the buy downs. And I mentioned two specific people there because one of them we basically have the elimination of pharmacy benefits.

Well I guess what I'm confused on is, if that is one of the reasons, greater buy down, even if it's just a couple of accounts if they're big enough, if that is a reason that the yields are coming down 300 bp or so from where we previous thought for '04, why wouldn't that have moved the needle on the average buy down itself, '04 vs '03, which you said was about the same, 200 bp to 300 bp?

Because it stays in that range. But again think of it as maybe roughly a quarter of the overall change that you described, 12 to 14, 8 to 10.

Okay, so it's still in that range, but maybe it's more towards the higher end of the range?

Sure.

Okay, thanks.

Your next question is from John Szabo of CIBC World Markets.

Good morning, thanks, just two things. I just want to make sure I understand this in terms of your guidance with the commercial coming down at least within a range. You guys said that there wasn't going to be a lot of margin on the Medicare business, so it's sort of the offset with the guidance actually going up comes directly from the increased membership in Medicare. Is that the way to think about it?

Primarily, yes.

Okay. And then is there -- I know there can be substantial marketing costs up front, so is that going to contribute to maybe some back end loading of that?

Are you asking marketing costs around Medicare?

Yes.

No, we're not going to see that. Our costs of acquisition of Medicare members is down dramatically over the last couple of years, so no, you won't see any sort of spike in admin relative to that new membership.

Okay, thanks. And then I just want to make sure I understood on the SG&A comment. Was that basically saying that some of the SG&A savings you had expected to realize you were forced to pass on to your clients in the ASO business? Was that the fourth factor?

In all pricing, yes.

In all pricing. Okay. And then I guess on that one account, was there any cost to just walking away from that?

Because of the process it was impossible to do that, that was evaluated. It had been a very good account over the years, but because of the risk -- it was already beginning to have issues relative to the risk pool allocation among the players. There were four companies in there, but in the process based on where we were contractually and legally in the [RP] and all that, we were not able to do that.

Okay, thanks.

The next question is from Christine Arnold of Morgan Stanley.

Hi. I'd like to follow up on the SG&A and why it was so much higher this quarter? You said there were some discretionary expenses. SG&A rose about 13% this quarter, while your revenue only rose 9%. Can you break out some things that might go away next year?

Well maybe not go away, but there were some -- you know we did make some discretionary spending around issues like marketing and advertising. We had to man the service centers to put in this high enrolment that Mike outlined. It was 200,000 we had to put some extra people in there to get everything loaded up. So when I look at those types of things, you know, some product development costs, we're continuing to be very aggressive in developing the SmartSuite product complement to get it ready for '05. So when I look at sort of what that difference would be and why, as you say, the one went up 13 and the other one went up 7, those would be reasons I'd point to.

Okay. And is this just about ongoing expenses to support SmartSuite and your business in general versus discretionary? Can you take a stab at the value of the things that you think you can and will eliminate in terms of costs in the fourth quarter, quantifying that?

No, Christine. We've given you guidance around SG&A for next year, I think it's pretty clear that we are going to have better SG&A next year, and I think that's a combination of lots of things. The fact is, and Jim pointed it out, when you add several hundred thousand members in January you can't wait until January to start taking care of that and getting ready for it. So you have to be loading those consumers and that business all the way back. Depending on how early they made a decision you can be back into November at times preparing for that January 1 business. So you get the expense of that without the revenue to go with it until they go effective January 1. So trying to reconcile timing relative to fourth quarter SG&A, especially in the situation where we are adding this much membership, given the scale of this company, that's not the way to look at that.

Okay, thanks.

Your next question is from Eric Veiel of Wachovia.

Thanks. Just a quick follow up. I'm trying to think about the progression of earnings sequentially then in 2004 versus 2003 and looking back over history; historically you've had a decrease in the second quarter and then things have ramped back up for most of the last five years. Should we be thinking abut this as a much flatter process than some of the things that were driving the flip-flopping with TRICARE profits in different parts of the year? And then if we think about the TRICARE contract transition, do we need to think about any charges or one-time cash flow items to move those contracts when we get into the second half of '04?

Okay, a lot of good questions there. First of all I think what we've been trying to say is, we are going to earn our commercial more ratably and we think that generally speaking that's going to dampen some of the volatility that you talked about with commercial starting out. Having said that, last year, because we have the issues with bid price adjustments and the increased military activity, TRICARE was low at the beginning of the year and higher at the end of the year. Now that we have a transition we think that will reverse itself. So we still think that there will be some volatility, but a difference in our pattern. But the pattern will tighten up, the difference will be dampened or muted, and what caused the spreads in 2003 will almost reverse themselves in 2004 by what the things are.

Okay.

And the other thing you asked was about whether there would be a charge in respect to the change out in TRICARE, and the answer is no.

Okay. Thank you.

Ladies and gentlemen we have reached the end of the allotted time for questions and answers. Mr. McCallister are there any closing remarks?

Yes, let me just finish by reviewing where we are. 2004 is going to represent for this company a record EPS level. Our commercial membership is going to grow organically 6% to 9%. We have an improving risk pot profiled inside of our commercial book of business. Medicare news is very good all around. We have renewed the TRICARE contract. We have set significant SG&A productivity gains as evidence by the closure of centers. We have Smart Product leadership in that space. Our cash flow is going to be very strong. And with all of that I want to thank the Humana associates that are on the call for making it all possible. Thank you for being with us today.

This concludes today's Humana's fourth quarter earnings release conference call. You may now disconnect.