Humana Inc (HUM) 2007 Q4 法說會逐字稿

Good morning. My name is Mindy and I will be your conference operator today. At this time, I would like to welcome everyone to the Q4 2007 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 session. (OPERATOR INSTRUCTIONS) I would now like to turn the call over to our host, Regina Nethery, Vice President of Investor Relations.

Good morning and thank you for joining us. In this morning's call, Mike McCallister, Humana's President and Chief Executive Officer, and Jim Bloem, Senior Vice President and Chief Financial Officer, will briefly discuss highlights from our fourth quarter and full year 2007, as well as comment on our earnings outlook. Following these prepared remarks, we will open up the lines for a question-and-answer session with industry analysts. Joining Mike and Jim for the Q&A session will be Jim Murray, our Chief Operating Officer, Art Hipwell, Senior Vice President, and Kathy Pellegrino, Vice President and acting General Counsel. We encourage the investing public and media to listen in to both management's prepared remarks and the related Q&A with analysts.

This call is being recorded for replay purposes. That replay will be available on Humana's website, www.Humana.com, later today. This call is also being simulcast via the Internet along with a virtual slide presentation. For those of you who have company firewall issues and cannot access the live presentation, an Adobe version of the slides has been posted to the Investor Relations section of Humana's website.

Before we begin our discussion, I need to remind each of you of 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. Investors are advised to read the detailed risk factors discussed in our most recent filings with the Securities and Exchange Commission. All of our SEC filings are available via the Investor Relations page of Humana's website as well as on the SEC's website. Additionally, investors are advised to read Humana's fourth quarter 2007 earnings press release issued this morning, February 4, 2008. This press release and other historical financial news releases are also available on our website.

Finally, any references to earnings per share or EPS made in this morning's call referred to diluted earnings per common share. With that, I'll turn the call over to Mike McCallister.

Good morning, everyone, and thank you for joining us. The financial results we are reporting this morning reflect another year of significant growth for Humana, further demonstrating our ability to anticipate and focus on the needs of our varied consumers and customers. Through innovative plan design, clinical programs, financial forecasting and consumer education, combined with solid operational execution, we continued to deliver a compelling value proposition to our growing membership base. Our value proposition is built around the idea that consumers, if offered actionable information and guidance, are just as capable of making savvy, cost-effective decisions in health care as they do in their other purchasing choices. In 2007, this approach produced a record-breaking year for membership, revenues and net income on top of a similarly record-breaking 2006.

The combination of leverage from our growing Medicare membership base, higher Commerical pre-tax margins and the continued solid performance of our Military Service business aligned to achieve record earnings per share again in 2007. The $1.43 per share Humana earned in the fourth quarter of 2007 contributed to EPS for the full year of $4.91, approximately 69% higher than the $2.90 we earned in 2006. Our fourth quarter came in above our previous expectations due to a lower-than-expected effective tax rate for 2007 and earnings from a venture capital gain. 2007 was an unusually strong year for earnings growth, as membership increases as operational execution amplified the full-year benefit of the doubling of our Medicare Advantage membership in 2006. As Jim Bloem will explain, we anticipate $0.05 per share additional 2008 benefit due to the lower 2007 effective tax rate. Accordingly this morning we raised our 2000 earnings per share guidance to a range of $5.35 to $5.55, with continued membership growth and strong operational execution driving these results.

Let me briefly recap our most significant accomplishments of 2007. In our Government segment, our Medicare Advantage membership came in slightly better than previously forecast, with ending membership of 1.143 million, representing a growth rate of 14% versus the prior year. Medicare operating margins were slightly above our 5% target driven primarily by the final Part D reconciliation for 2006. In June of this past year, we submitted our 2008 Medicare plan bids, similarly targeting an operating margin of approximately 5%.

Just as importantly, we made further progress in engaging senior consumers, as evidenced by preliminary data, indicating a shift to more proactive care by our senior members. For instance, 34% of our new senior members completed Humana health assessments in 2007, compared to 24% new members in 2006. This is important because the health assessment provides a vital roadmap for positive behavior change through such programs as SilverSneakers and Personal Nurse.

Another example of our progress is with our heart failure disease management program. Between February and August of 2007, our senior members in this program raised their drug compliance rate from 82 to 88%, a significant stride forward. These are just two examples where care coordination across all product lines, including private fee-for-service, is beginning to gain traction and improve clinical results for seniors while offering real hope relative to the managing of cost in the Medicare program over the long-term.

Also in our Government segment, our Military Services unit is fully prepared to respond to a formal our RFP for the next round of contracts once it's issued. We are confident that we will offer a compelling proposal which highlights our deep experience with this unique product, including our exemplary service to beneficiaries during the past twelve years. In 2007, our Military Services unit also achieved success with its VA contracting when it was successful over six competitors in being awarded all four contracts for Department of Veterans Affairs' first-ever network demonstration project known as Project HERO.

In the Commerical segment, we were quite pleased with our improvement in 2007 and anticipate further progress in 2008. In fact, improved operating results in 2007 made up for approximately $50 million in venture capital gains that this segment benefited from in 2006, but did not recur in 2007. Additionally, our provider networks continued to expand and improve, reflecting the synergistic effect of the growth in our Medicare business.

We also significantly broadened our portfolio of offerings in the growing specialty benefits market through two acquisitions completed this past quarter, CompBenefits and KMG America. Here, again, we've enhanced our ability to anticipate the needs of consumers, who are now more likely to opt for these types of offerings than in years past, as well as responding to employers' desire for a comprehensive spectrum of benefits and related services that help foster their employees' engagement, retention and development.

The specialty products market is a growing one, with industry reports projecting mid to upper single-digit growth for this sector over the next few years. With our total specialty membership now at 6.8 million, up from 1.9 million at the end of 2006, we are well positioned to take advantage of this growing market. Integration of these acquisitions is proceeding swiftly, due in part to the strength of senior management and the capabilities of employees at the acquired companies.

We believe the 2007 achievements just described position us well for 2008, both in terms of the existing environment and future trends. Let me touch briefly on what we consider the primary strategic considerations in the external environment and 2008 -- one, Medicare rates for 2009; two, Medicare sales environment; three, the Commerical sales environment; and, lastly, to the political environment.

First, preliminary payment rates for 2009 Medicare are expected in a few weeks, with the final rates due out on the first Monday in April. While we estimate the Medicare rate book rates to the up in line with medical cost trend of four to 6%, a number of technical factors also come into play, which CMS details as part of its final rate release in April. Regardless, as we've done over the past 20 years, we will adjust benefits to ensure the Medicare medical cost trend matches and net level of premium increase.

Turning to Medicare sales, we're pleased with results we're seeing to date, with January Medicare Advantage net enrollment up 100,000. Components of this increase include higher retention levels than we had originally expected, indicative of the loyalty of our senior members. Gross individual sales are on track, while group sales continue to prove challenging as employers continue a wait-and-see approach. Consistent with our long-standing approach to Medicare as a retail consumer business, we prefer individual sales. There are two main reasons -- first, because we can clearly lay out the value proposition we offer directly to the buyer and second, because one-to-one sales volumes are much more predictable than wholesale employer sales. We expect a greater portion of our gross sales for 2008 will now come individual Medicare sales. We remain confident with our forecast for net Medicare Advantage sales of 200,000 to 250,000 for 2008, significantly higher than in 2007, with 65 to 70% of this total now anticipated to be effective by April 1, up from 60% we previously forecast.

With respect to the Commerical sales environment, our membership forecast continued to reflect strong pricing discipline. The Commerical group sales environment is still very competitive, with the most heated competition for mid to large groups and national accounts. Consequently, most of our group sales have come in the smaller case sizes. Our individual product, HumanaOne, also continues to show strong growth, as does our Smart family of consumer-focused products.

Finally, I am often asked about the current political environment and the presidential candidates' various proposals for health reform. Each of the candidates brings a thoughtful perspective to the many health care challenges our nation faces. At the end of the day, we believe each of the candidates' proposed plans can lead to opportunities for our sector as a whole and Humana specifically. With respect to Medicare specifically, we have a long history of working successfully with leaders of both parties in Congress and the White House. In addition, we believe the combination of Humana's expanding market share, widespread geographic presence and high rates of program-wide enrollment, as well as high rates of senior satisfaction, come together to lessen the likelihood of significant changes to the Medicare program over the next several years.

Turning now to a more detailed look at our Medicare business, we're particularly pleased with the growing interest seniors showing in our Medicare HMO and PPO products. In fact, nearly half of our net enrollment growth in Medicare Advantage products through January has come from our PPO offerings.

From a sales distribution perspective, our career agents continued to account for the vast majority of our gross sales, contributing approximately 75% of the total. As we have said on past calls, the remainder of our sales come through the Humana and CMS websites and exclusive broker arrangements. We believe our unique distribution system results in high-quality sale and, ultimately, better membership retention.

One of the best assets our career agents and exclusive brokers have in selling our Medicare PPO plans is the expansiveness of our network's scope. Our PPO network was not built overnight. In fact, it is the result of more than two years of effort and those efforts continue with full force today. We are constantly striving to make the existing networks more robust while simultaneously expanding the geographies that our PPO networks cover. We anticipate continuing as the leader in PPO offerings, the type of benefit plan that most aging and baby boomers have and are happy with in the workforce today.

In addition, as I mentioned earlier, increasing Commerical synergies from our Medicare network are leading to enhanced bottomline growth, as the next slide shows. As you can see from this slide, we gained a lot of ground in 2007 in terms of Commerical operating earnings. As we expected, only a very small portion of our 2007 Commerical pretax earnings came from venture capital gains, while venture capital gains in 2006 were fairly significant. This slide clearly shows the progress of our Commerical operations made in 2007. By strategically growing our individual, small group, consumer and self-funded products in a price-disciplined manner, while adding our recent specialty product acquisitions, we expect to build successfully on our Commerical segment progress again in 2008.

In summary, we again completed a record-breaking year for revenue, membership and net income in 2007 and expect another in 2008. Our consumerism strategy continues to prove its worth across the board, but especially in Medicare, which we've always operated as a one-to-one consumer business. Our 20 plus years of effectiveness in Medicare in virtually every type of a political environment positions us well for the continuing national conversation on health care reform. And our overall strategy, combined with accelerating senior demographics, for which we've carefully prepared, positions us for continued long-term growth and success. The then-and-now comparison in this chart gives a sense of how quickly and effectively we have transitioned in just a short period of time and especially in the last two years from a super-regional company offering traditional health benefits in pockets of the U.S., to a truly national enterprise with across-the-board capabilities and a wide variety of benefit offerings.

With that, I'll turn the call over to Jim Bloem.

Thanks, Mike, and good morning, everyone. In this morning's financial discussion, I will focus on the following six areas -- first, the drivers of our better-than-expected earnings in the fourth quarters and our raised earnings guidance for 2008; second, the major factor impacting the quarterly pattern of our 2008 Medicare benefits ratio, which again this year is expected to be the primary driver of our quarterly earnings pattern; third, the continuing reliability of our Commerical pricing and benefit expense trend analysis and their role in our increased pretax margins and profit; fourth, the rationale for and benefits from our SG&A spending; fifth, our investment portfolio strategy in these uncertain times and our commitment to maintaining a debt-to-capitalization ratio within a consistent range; and six, finally, our expectations around 2008 cash flows from operations.

Let me begin with a brief summary of what changed versus our prior expectations both for the fourth quarter of 2007 and as we move into 2008. As noted in the press release, the lower fourth quarter tax rate reflected two items which we had not anticipated. The first and more substantial of the two reflects a lower overall state tax rate. As our Company has expanded geographically, our earnings have become more allocable to more states. Many of these states have lower tax rates than the smaller group of states where our earnings previously were derived.

Last month as we completed our 2007 year-end state tax accruals, it became apparent that we had underestimated the impact of this change. Consequently, the lowering of our state tax rate added about $0.06 per share in earnings to the fourth quarter over our previous guidance. The second fourth quarter tax-related item, adding about $0.03 per share, related primarily to a better-than-expected resolution of an audit item with the Internal Revenue Service.

Finally, also in the fourth quarter, we recorded $0.03 per share related to a gain from the sale of a venture capital investment that was realized on December 31. We continue to expect little or no contributions to earnings from the sale of venture capital investments in 2008.

In the evaluating the impact of the lower 2007 tax rate on 2008, the lower state tax rate is the only item having a recurring effect. We now anticipate that our effective tax rate for 2008 will be in the range of 36.5 -- excuse me, 35.5 to 36%, versus our prior expectation of a range of 36 to 37%. Accordingly, we raised our 2008 earnings guidance this morning to reflect this change.

In terms of how our 2008 earnings per share guidance of $5.35 to $5.55 is expected to be earned among the quarters, we are forecasting a more front-weighted quarterly earnings pattern for 2008 versus 2007. In today's press release, we guided you to first quarter '08 earnings per share in the range of $0.80 to $0.85. Additionally, we expect that 71% to 75% of our annual earnings for 2008 will be achieved by the end of the third quarter. This compares with around 70% in 2007. This front-weighted pattern is primarily due to the quarterly pattern of the Medicare benefits ratio, which I'll discuss now.

As one might expect, the Part D benefit structure creates much of the variability in the Medicare benefits ratio between the quarters. However, just as 2007 was significantly different from 2006, 2008 is different from both of them. Now, what's the same is is that when we project our Medicare benefits ratio quarterly pattern for 2008, we continue to anticipate a pattern that is somewhat similar to 2007, with the ratio being the highest in the first quarter and the lowest in the fourth quarter, as dictated by the Part D benefit design. However, the 2008 quarterly benefit ratio progression will be less pronounced versus 2007 as shown by the illustration on this slide.

The primary factor driving this less-pronounced pattern is the composition of our 2008 PDP membership, which has changed from last year. We have nearly 300,000 fewer low-income senior members effective January 1, with a higher percentage of non-low-income seniors in our Enhanced plan and a lower percentage of non-low-income senior members in the Complete plan. The decline in the percentage of low-income members is particularly relevant in analyzing the quarterly patterns, because these seniors have a steeper declining slope to their quarterly benefits ratio progression versus the remaining Part D members, with the first quarter ratio much higher on low incomes than the overall average and the fourth quarter much lower. Consequently, our lower membership in the low-income block is anticipated to lower the quarterly benefits ratio pattern in the first half of the year and raise it slightly in the back half of the year compared to 2007.

Another factor in the quarterly benefits ratio pattern is the widening of the Medicare Part D risk share corridors. All things being equal, which of course they never are, this change would likely reduce the size of the Part D risk share balance at the end of each quarter. However, the magnitude of this factor on each quarter's benefit ratio is not all that significant.

So here is the twofold take away. The composition of our PDP membership will have a significant impact on the quarterly pattern of our Medicare benefits ratio without necessarily impacting the full year ratio. And then secondly, the 2008 quarterly Medicare benefits ratio pattern is expected to drive our quarterly earnings per share for this year.

Turning next to our Commerical segment, 2007 marked another year of improving pretax margins and profits. This performance continues to be driven by, first, our consumer-focused strategy; second, the sustained pricing and underwriting discipline that we've practiced; third, our continuous benefit expense trend analysis and forecasting; fourth, our integrated guidance solution and our clinical model; fifth, the achievement of a well-balanced membership portfolio in the consumer segment; and, finally, the benefits of scale that our Medicare membership has on our Commerical provider networks.

Our rigorous benefit expense trend analysis and forecasting includes regular interaction of many disciplines within our organization. This increases the reliability of our Commerical pricing and profit planning.

At the beginning of 2007, we guided toward same-store cost trends of around 7%, with trends adjusted for our business mix netting to about 5% for the full year of 2007. Now that 2007 is over, I am pleased to report that these trends fell right in line with our expectations, with same-store cost trends coming in at 6.7%, just slightly better than the 7% trend we had originally projected. While these same-store trends -- we expect these same-store trends to again run between the six and 7% in 2008.

Now with respect to secular cost trend components -- i.e., these are the annualized trends before benefit buydowns -- there were very -- there were no surprises here either. We saw in-patient utilization trends come in flat to negative for 2007 and we expect something close to flat again in 2008. For hospital rates, both in-patient and outpatient, we experienced a trend which continued in the low single digits, while physician costs averaged in the mid to high single digits. Both of these were in line with our forecasts.

Finally, also as expected, prescription drug trends were in the mid to high single digits. Based on our ongoing deep-dive analysis of benefit expense trend factors, we do not foresee any significant changes to the components of our cost trends as we move into 2008, as is stated in this morning's press release. So accordingly, we remain confident of our ability to meet our 2008 Commerical pretax earnings target of $280 million to $300 million and we look forward to sharing our progress with you each quarter.

Now let's review our SG&A spend. Consolidated administrative expenses increased from $829 million in the third quarter to just over $1 billion in the fourth quarter. About two-thirds of this sequential increase was due to additional expenses associated with the 2008 open enrollment period for Medicare. This include such expenses as marketing, advertising, commissions, postage, printing, etc. The majority of the remainder of the increase in administrative expenses from third to fourth quarter 2007 was attributable to the acquisitions of CompBenefits and KMG America.

The increase in expense associated with the 2008 open enrollment period versus the amount spent in 2007 was in proportion to our higher Medicare Advantage membership goals this year. As the slide shows, open enrollment periods of the first quarter of '06 and the fourth quarter of '06 were marked by the higher spending reflected in the SG&A expense ratio, represented by the blue bars, and with the dollar administrative spend, represented by the green line. In all cases, the result was an increase in Medicare Advantage enrollment in subsequent quarters, which is represented by the red line, demonstrating the efficacy of these expenses.

In 2008, we expect a consolidated SG&A ratio of between 13.5 and 14%, which is the same range as we projected and achieved in 2007. The 2008 consolidated SG&A ratio range includes a full year of the higher-SG&A-ratio businesses of both CompBenefits and KMG America, which, combined, if not offset by productivity gains, would add approximately 400 basis points to the expected 2008 consolidated SG&A ratio over 2007.

Focusing next on our investments and debt, our $6.6 billion investment portfolio continues to perform well and in line with our expectations despite the ongoing turmoil in the credit markets. This consistent performance is the result of our twin strategies of variable rate and high credit quality investments and debt. Keeping our investment returns and interest expense rates variable helps immunize our income statement from the volatility of the rapidly-changing short-term interest rates that all of us have experienced since August. Generally, as shown on this slide, when short-term rates fall, both our investment income and interest expense decline, but the difference between them remains relatively constant.

Now with respect credit quality, the other half of our investment strategy, we currently maintain a $4.5 billion fixed-income portfolio and a $2 billion in cash equivalents, with average credit ratings of AA-plus and A1, respectively, by Standard & Poor's. These investments also have the equivalent ratings by the other agencies. High credit ratings coupled with a relatively short duration period of around 3.5 years, which matches the corresponding short life of most of our liabilities, provide additional liquidity and financial flexibility in periods of credit concerns and interest rate volatility, like the present.

With respect to the well-publicized subprime situation, we have ceded to $8.1 million of subprime and second lien mortgages with one of our fourth quarter acquisitions. However, by the end of January, we have reduced that amount to $4.4 million and we're comfortable with the remaining securities that we now own, each of which has maintained at least a AA rating after subsequent reviews by the credit agencies. We do not have and have never had any collateralized debt obligations or structured investment vehicles in our investment portfolio.

Turning to our interest-bearing debt, our debt-to-total-capitalization ratio at December 31, 2007, was 29.5%. That compared with 29.4% at the end of 2006. During the fourth quarter, we borrowed $350 million off of our bank credit facility to partially finance the CompBenefits and KMG America acquisitions, which had an aggregate cash purchase price of approximately $560 million. This raised our debt-to-cap ratio from 25.7 at the September. We remain committed to keeping this ratio in the range of 25 to 30%.

Turning last to cash flows, as you can see on the slide, the fourth quarter payment of the $726 million for 2006 Medicare risk share payables resulted in a $1.2 billion of cash flow from operations for 2007. Based on the higher net income, as well as our higher depreciation and amortization expenses expected in 2008, we anticipate cash flows from operations of between $1.5 billion in $1.8 billion after paying back approximately $100 million of 2007 Medicare risk share payables to CMS this year.

Capital expenditures are projected to be approximately $275 million, mainly for technology and, to a lesser extent, fixed assets required to more effectively serve our growing membership and to integrate our recent acquisitions. These capital expenditures will be partially funded by an estimated $235 million of depreciation and amortization expenses.

Now with respect to cash available for possible acquisitions and other uses, we expect that to increase also in 2008. In addition to a significantly lower 2007 risk share payable versus the one we had for last year, we expect that capital contributions required to be made to our operating subsidiaries will be lower than the $307 million we made in 2007. We plan to give you an update with respect to cash available when we report our second quarter earnings on August 4.

With that, we will open the phone lines for your questions. We request that each caller ask only two questions in fairness to those who are waiting in the queue. Operator, will you please introduce the first caller?

(OPERATOR INSTRUCTIONS) Matthew Borsch, Goldman Sachs.

I was wondering if you could to about the rate outlook for Medicare Advantage for 2009. I know we will get that I guess on April 7 and you sort of mentioned four to 6% as a starting range. Can you just talk through the other items that you think may impact that outlook for the current year?

Sure, this is Jim Murray. There's a lot of actuaries who are very into this other and are a lot smarter than me, but Mike mentioned earlier that the range relative to the increase for trend would be some around four to 6% and we see that being the case, similar to what it's been over the last several years. There's probably four or five technical adjustments that the CMS is looking at, things like the budget neutrality, which you all are very familiar with, and fee-for-service normalization.

There's also an item that comes up every couple of years called recalibration of the MA risk factors. We are anticipating that there will be something relative to that, so when we put all of these pieces together, we look at what we're likely to get in terms of the gross increase from CMS and we don't think it's going to be significantly different than what it has been over the last couple of years. Then the net amount that we would enjoy after the MRA work that we do will probably be very similar to what we've seen over the last couple of years.

And so, again, we don't anticipate significant differences and depending upon where it all falls out, county versus county and our membership versus others, we will do whatever is necessary to adjust benefits to make our 5% margin requirement that we have talked with you about many times in the past come out to be 5%

Got it. Just a follow-up question on your -- you alluded to employers being on the fence and taking a wait-and-see attitude with respect to group MA sales. What is going to take for that to change? Is it really relate back to the uncertainty over reimbursement policy and so we would probably need to get well into the next administration before that changes or is there another factor at work?

This is Jim Murray, again. Flippantly, I would say it would be an act of God, but I just got kicked under the table.

We are seeing a lot of things happen. The larger the companies are, the more we see reluctance. I would say, you know, Jim referenced the subprime earlier, I would anticipate that that would have a significant impact on the government agencies that have retirees. And so over the next several months and year, I would anticipate that we will see more activity from states and local governments that need budget relief and we are working with them closely.

The smaller the company that has -- so, for example, there's many companies out there that have 200, 300,1000 retirees that seemed to be using our services and we are pleased about that, but it's the larger companies that we aren't seeing yet make the decision, although there's a lot more activity with the consultant community.

So, to your point, perhaps more certainty around rates from the federal government will get the companies that are larger more comfortable with our solution, but we will play that out. The way we are beginning to think about this now is that we want to focus on individual sales and hit it out of the park with individual sales. And if any of these group opportunities avail themselves, that's just going to be gravy, because we don't want to count on that anymore.

All right, thank you.

Charles Boorady, Citi.

In Medicare Advantage, can you break out for us the gross versus net adds and also by product, HMO/PPO versus private fee-for-service in terms of your new ads in January?

This is Jim Murray again. I think Mike had a graph which was like a pie chart which shows where our gross and net adds came from. I would suggest that probably 50% of our ads -- so 50% of the 100,000 -- or I think we had about 190,000 gross sales came from network-based plans. And the net 100,000, as you can see, probably 60% or thereabouts were network-based plans, so we are very, very pleased with the willingness of the membership to accept PPO and HMO arrangements, as is demonstrated in the pie chart.

Did that reflect any switching or can you talk about switching of existing members out of private fee-for-service to more network-based?

There was some switching, but not significant in terms of the numbers that we are seeing.

In the Commerical pricing, it seems like you're assuming an acceleration in medical trend in '08. Is that just conservatism in how you're pricing, or are you seeing cost trends tick up or --?

This is Jim Murray, again. Actually, I think we are expecting something of the deceleration. We are very, very pleased with what we see developing in the Commerical trends standpoint. I think this past year, we had a 6.7% trend, is what Jim said earlier, and this year we're expecting six to seven. So I feel very good about what we see Commerical trends doing.

Just from your guidance table, it previously had said a trend of 4.5 to 5% in your new guidance table for '08.

Charles, Regina. That equates back to the 3.5 to 4.5% in this morning's that includes business mix changes equates to the 4.5 decided before.

Okay, I've got it. You're assuming a deceleration, is there a basis for that in terms what you are seeing in recent trends?

Not materially. Again, we would cite more of the business mix. But, again, it is a 50-basis-point improvement and what we tried very hard to say today -- in my remarks, anyway -- was that we spent a lot of time on this as a Company in terms of looking for where trend is going to show and where it's going to break and then how that gets into pricing and forecasting. So we attribute the fact that we've been very consistent in a [slightward] down bias in trend to that work.

Got it, thanks.

Bill Georges, JPMorgan.

Just a follow-up question on what you are seeing in terms of trend. There have been some comments recently made around an up tick in volume of orthopedic procedures, perhaps driven by concerns of insured -- well, loss of insurance and/or benefit changes because of weakness in the economy. Are you concerned about that? I guess from your commentary, you are not seeing it, but is that a trend that you have seen with historical downturns in the economy and how are you preparing for that if that should happen in '08?

This is Jim Murray, again. We have seen not anything recently, but musculoskeletal, if I'm saying that correctly, costs are one of our largest increasing cost categories, and so because we saw that a number of years ago, we outsourced some work with a company that specializes in that and we're rolling that company out to all of our Commerical markets. And we anticipate that we will see a nice improvement as a result of that relationship.

Outside of that, though, you're not concerned about any sort of macro pressure as a result of people using medical services a higher rate?

No.

And then quickly just a question around capital deployment. Jim, I know you have talked about this a little bit in the past. With growth slowing modestly and the somewhat-less-intense capital requirements, you should probably have more free cash in the back half of the year. Can you sort of talk about when you might know about that and what your plans might be?

Yes, Bill, that's why I said in my remarks I thought that the by the August 4 call, we'll sort of know where we are on that in terms of we will have sort vetted our position with the state departments of insurance with regard to capital contributions to the subs and to the credit rating agencies with respect to what deployment strategies would be. We continue, as I mentioned my remarks, also, we continued to spend on CapEx and acquisitions, both using a criteria that they raise our -- that they beat our weighted average cost of capital and raise the value of the firm. So there's plenty of opportunities like that as well, but you are right that the composition and the expected cash flow for the year are expected the better than they were in 2007.

Okay, thank you.

Josh Raskin, Lehman Brothers.

Just a quick question on the investment income assumptions, Jim, did I hear you right in saying that you are not assuming any further rate changes and if that's the case, what would the impact of 25 basis points be, per se, in terms of -- and understanding there's some offset on the debt, but I assume still much bigger impact on the investment income.

Yes, what I said was is that we would like to have you take home that fact that the changes in the rates don't do that much to the net between investment income and interest expense, and that's because both are variable. Now, you're right, we have a lot more investment assets than we have debt, so a change, generally speaking, would make a bigger change in the investment income. When rates are falling, a bigger downward change.

But what mitigates against that, then, is the value of portfolio goes up and then when -- we also have the ability then to look at the gains that we have there. But generally speaking, because they are a little bit slightly different in how they are geared off of, investment income is geared off the Fed funds rate, the debt's geared off of LIBOR and the rates between those fluctuate, as well, and that's what really gives us confidence that we think that we effectively immunized the portfolio from changes in rates.

Now again, you can see investment income went down 10, but interest expense went down 10. And we expect to see more of that because we haven't really factored anything more into what the Fed might do. We'll deal with those as they come up.

But we feel in a really good position that those things should not affect materially the net income numbers that we're shooting for this year.

Got you. I didn't realize you would include the investment gains. I guess, obviously, it's an offset if yields did continue (inaudible).

The second question just on the Commerical earnings, how much of that, I guess tying it into the specialty acquisition, thoughts on what you're going to see from your specialty membership in 2008? Is it a year of sort of culling after the acquisition, or do you expect to continue to see growth in those businesses? And then how much of the Commerical earnings is coming from the increase in specialty?

This is Jim Murray. I'll take the first part and Jim can take the second part. We would anticipate that our membership in not only the dental and vision, but also some of the life STD, LTD, that we got with KMG, would probably be flat to slightly down over the first couple of months of the year. We are going to hire a number of individuals who will help us with some of the specialty lines and places that we aren't currently.

So we would anticipate as we go into the third and fourth quarter that there will be an acceleration in membership and premiums from these lines. We are very excited about the prospects. You know, many of you think of us as a regional Commerical carrier, nationally for Medicare, but some of the opportunity that we see from including CompBenefits and KMG is that it opens up a lot of opportunity on -- in all 50 states. The folks from KMG and CompBenefits can now go in with a package of products -- group Medicare, stop loss, dental, life, vision, STD, LTD -- in a lot of the states that we currently don't have a Commerical footprint. So we are beginning of think more around 50 states for our Commerical footprint than, you know, the 25 that we've talked about in the past. So we're really excited about what's happening in the environment and our opportunity to capture some of that. We are pretty excited about what's happened with our specialty lines.

Then to just follow that up, as we have said when we announced both acquisitions, if you put them both together, we had said we would have somewhere between $0.08 and $0.13 for this year, 2008, and we are right on track to be in that range.

Okay, and all of that goes to the Commerical pretax?

That is correct.

Thank you.

Christine Arnold, Morgan Stanley.

A couple questions. First, could you talk about how you are pricing -- are you pricing assuming a deceleration in medical trend? Could you talk about kind of how you are thinking about that, because I know there's a mix adjustment.

Then I'm calculating that the PDP loss ratio probably needs to improve year-over-year by about 13 percentage points in order to kind of get us to the first quarter guidance. Am I in the ballpark there?

This is Jim Murray. I'll take the first question and sometimes I can't understand the second question. With respect to the first question, I'm sorry, I was thinking so much about the second question I forgot the first question. Can you repeat that?

Sorry, it seems like you are guiding for a bit of a deceleration in (multiple speakers) Are you --

No, absolutely not. We are anticipating some improvement, quite frankly, in our medical expense ratio year-over-year. We're really going to try to price flat with where we're currently at in terms of trends and try to improve some of MER, much similar to what you're seeing happen last year versus this year. So I would anticipate some margin enhancements there.

You know, we have told a lot of folks that come in -- have come in over the course of the last year that we want to improve our Commerical margins. I think we're pretty close to four for 2007, with a target of ultimately getting up to 6. So we would anticipate some improvement in the medical expense ratio as well as the admin ratio going forward. That's our goal, is to get to six over the next year or so.

Then on your question, you are right, directionally, in terms of the PDP benefit ratio. What I -- what we had said, again, based on the low income fees, there is going to be quite a difference in the front end of this year versus last year and that has to do with having fewer low income. The amount, the dollars -- or the percentage, the 1300 basis points that you cited is a little bit high. It's not quite that much, but we didn't say what was going to be. Again, we are guiding to our overall Medicare benefit ratio. But you are right on track in terms of the first quarter will show a dramatic improvement in the benefit ratio.

So that implies year-over-year improvement in Medicare Advantage and Commerical if the PDP is less than I'm thinking here? You've outlined that SG&A expenses are going to be flat on a dollar basis in your slides. Is that an accurate rendition of reality?

Yes, again, you've got also take into effect we have more members, we have greater scale going through both, so that's -- I look, again, looking at the guidance that we've given of the $0.80 to $0.85.

Okay, thank you.

Greg Nersessian, Credit Suisse.

My first question was, Mike, you mentioned the synergistic impact of your Medicare business on your Commerical provider relationships. Could you just talk to that a little bit more and is it a function of just having a broader network and that favorably impacting sales or are you actually seeing better rates and better discounts from those providers?

I've talked about this some in the past. There's sort of an evolving thing going on around the country where there's two -- sort of two things converging together here. One is that -- put Medicare aside for a second -- generally in the Commerical business, hospital systems, who largely dictate the competition on the payer side, are awakening to the fact that they don't have an awful lot to gain by advantaging one payer over another one. So we're finding places around the country where we are actually, just purely on a Commerical basis, being invited into the community and being given a competitive pricing schedule with -- without the usual leverage that you would think you would need.

So that's one-piece and then you overlay the fact that we're showing up in lots of communities with all these Medicare products and a brand that's becoming pretty well-known, because we are obviously promoting Medicare pretty strongly. So we're in the community already. We're building PPO networks, which is what I've talked about a lot, so we actually are going into hospital systems and talking to them about Medicare PPO. While we're there, we're looking to find out whether any of these systems are in a position where they get relative to pricing on the Commerical side. And what we're finding is a fair number of them are.

So it's been a nice synergistic opportunity. We go in, we talk about Medicare PPOs. That's not -- that is something we've been able to get done and then we talk about market-competitive pricing on the Commerical side and, frankly, if we don't get market-competitive pricing, we don't kill any trees to produce a contract. We just don't do it. So we have a handful of states I've talked about the past where we find ourselves, even though we're relatively small compared to the embedded interests that are there, with market-leading hospital pricing and the rest of the provider community usually follows along pretty quickly.

So it's interesting development. It's going to take a long time for it to have a huge impact on Commerical growth, because you still have to introduce yourself to the employers and their distribution system and their consultants and all that, but it's all kind of coming together. It's really been rather fascinating and we're benefiting from it in a handful of places in the short-term and I think we'll do a lot better over the long term, especially when you consider the voluntary benefits that are going to start finding their way into these employers across the country, too. So all of it is kind of coming together to introduce us in a lot of places we wouldn't have been four or five years ago.

Okay, great. That's very helpful. Then my second question was just a little nuance on the Commerical cost trend. It looks like the pharmacy is now mid to upper single-digit guidance for '08. It had been, I think, high single to low double. Some of your competitors are suggesting it's going to go the other way in '08. It's actually going to be slightly higher because of the number of generic launches last year. Is there something specific to Humana that's going on there or if you could just describe that a little bit more.

I think that basically what that is we continued to increase our generic penetration. There's more mail-order on each side. I think those things are sort of countering a little bit what you are saying for us.

What is the new generic penetration rate?

In the Medicare part in 2006, it went from about in the 60s into the low 70s. On the Commerical side --

55 to 60 from '06 to '07.

55 to 60?

Yes.

Okay, thank you.

Scott Fidel, Deutsche Bank.

First question just on the Commerical enrollment guidance. It actually looks like you raised that a bit to 65 to 95,000 adds from 50 to 75. Just wondering what is driving the increase in enrollment guidance there and then also what type of assumptions you're building in to the employer-sponsored segments just relative to potentially higher attrition from the weakening economy.

The growth that we're seeing is primarily in three areas -- actually four areas. It's the individual. The individual business for us is doing extremely well. We introduced a new product during the middle of last year and its having a nice impact and also some tools for our brokers to do business with us a lot easier. And so our individual membership is growing nicely month after month.

The small group business for us is doing well, probably net adding anywhere from around 1000 or 2000 members per month, which is good, and we are also seeing some nice lift recently with our portfolio book of business. We've done a lot, as many of you who have been in here and talked with us over the course of a last year. We've worked hard to rehabilitate our portfolio book of business. That's looks like it's now paying some nice dividends. We're seeing some nice, but not great growth in our portfolio, which is a shift from it had been shrinking over the last several years. And we're seeing some nice rates coming on that, so we're pleased by all that.

Then around all of that, our consumerism offerings are also doing well. We came out with a new offering recently called SmartResults, which is a trend guarantee for ASO business that we've got about 20 customers out there that we are using as kind of a beta site test. And it's got us a lot of nice buzz in the broker community for being innovative and creative and so we're excited about that.

So a lot of the growth that we're seeing is in the smaller case sizes. There is, as you said, some fallout from some of the national accounts and some of the larger companies where they're downsizing and what have you. And we have that baked into the estimates that we've given you. So what you're going to see from us, frankly, will probably be a shift to the smaller case sizes over the next several years as we begin to focus more and more on those more profitable case sizes going forward.

Okay, then if I could just ask a follow-up around Part D, it looks like you increased the lower end of your enrollment guidance range for that for '08. Just wondering, is that coming from less attrition in the LIS auto assignment process or from better new sales that you are seeing in PDP?

This is Jim Murray. It's a little bit of all of those, but what we are happy about is that we saw a lot of seniors who decided to stick with us regardless of some of the rates that we put out there because of the LIS situation that we've talked about the past. So we're pleased with what must be a nice value proposition for those seniors and we're pleased with the complement of membership that we kept, mostly in the voluntary area is where were seeing a nice retention.

Okay, thank you.

Justin Lake, UBS.

A couple questions on enrollment in Medicare Advantage. First, and I think you did a great job of giving granularity last quarter around the components of Medicare Advantage growth this year and how they were going to be better than last year and obviously you talked about employer Part D upselling, open enrollment and then agent. And it sounded like it was going to be about a quarter, 25% of growth from each. Can you give us some -- obviously you've mentioned the employer side being a little bit weaker. Can you give us some idea of how those, all four of those components are trending and where you kind of see that 200 to 250 coming from now that you have a little more visibility?

Well, the way we're trying to focus on it is that our career agents are doing really well for us. When we talked the last time, we anticipated that they were going to provide a certain level of growth and they are doing better than we had anticipated before. We are also doing better in retention than we had envisioned, so getting more from our career agents and retaining more of the membership that we had before is serving to make up nicely for the shortfall that we are seeing in the group business. And, again, we're pleased with the number of network-based sales that we have made as a company. We think that that portends well for the future as more and more this has to move towards a network-based solution over the next several years. And we are really pleased with where we are at as a Company, not only in creating the networks, but also convincing people as to the value of moving into those network-based options.

Justin, this is Mike. I think if you take anything away from this call this morning relative to Medicare Advantage it's around the idea that the individual purchasers are opting for this in very large numbers, number one. And number two, those that are buying it stay with it. I think that is really -- you hear of us talking all the time about being a consumer business, retail, all those sorts of things. You're seeing it play out here. That's the type of the business at the end of the day we would prefer to have. If we end up with some group Medicare, that's great. Jim mentioned earlier we would consider that just icing on the cake and we would.

But our focus is on the individual, Medicare individual buying our product based on the value proposition we pitch, because we know, based on our relationship with them, they are likely to stay with us. And the big news in this quarter is you're seeing that actually play out a little bit better than we would've thought even a few months ago, so we've always believed it and its nice to get validation from the customer.

That's helpful. And I guess just the follow-up question on the first quarter guidance. Last year I think you are at about the same spot when you gave us and update for January, at plus $100,000. By the end of the quarter, you had added another 10,000 members. You were at plus 110. This year, it sounds like you're looking to be closer to plus 140 to 175, if I'm doing that math right. Can you give us some visibility on what that is giving you confidence that you're going to add so many more members in that February/March timeframe versus what you did last year?

This is Jim Murray. We track sales on a daily basis, so we're seeing what is happening in January for a February effective date and I'm already seeing how many we're selling during February for a March effective date. And we periodically get tapes from CMS that tell us how many terminations and based upon everything I've seen and what I know that our targets are for February 1 effective and March 1 effective and April 1 effective, I fell pretty good about what we are seeing and how that portrays what we've done in terms of guidance.

Sure, I'm not questioning the guidance, I'm just asking is it more gross sales or is it less attrition or is it half and half?

Probably a little bit more retention than it is gross sales.

Very hopeful, thanks.

Par of that, Justin, is you've got -- the market keeps changing, too. We're not dealing with the same competitive posture that we had a year ago relative to -- some have become less competitive. We learn every year, we continue to fine-tune the products, from the benefits, prices, all those sort of things. So I think you -- when we sit down to project what we're going to be able to do, we're looking everything relative to what our capability is, the metrics around the sales and distribution process, as well as at the end of the day, where our products and offerings stack up in the market place and that's how you get comfort that individual buyers will in fact choose you over someone else.

That's very helpful, thanks.

Carl McDonald, Oppenheimer.

In the past, you've given us some medical loss ratio differences, at least roughly, between the private fee-for-service and the more network products. So I was hoping you could update that for 2007 and also give a sense if that's going to change in '08 with the greater weighting towards the PPO?

I don't think that we've given official numbers out. I think we've said we think that they're kind of equal. I just -- I had no problem with the private fee-for-service medical expense ratio versus a PPO versus an HMO, but I will to you that our strategy as a Company is beginning to share with folks the choice that's available with network-based options. And as folks move into that, it really doesn't impact our overall 5% margin target that we have focused on for years and years and years. So that's the way we think a PPO and an HMO and a private fee-for-service all create a 5% target, but philosophically, CMS and us want more people to move into network-based options over the next several years.

All right, and just to clarify, the early part of your commentary was you still think there's -- the loss ratio between those products is fairly similar?

Fairly similar, yes.

Okay, then the second question, I'd be interested in your updated view on the TRICARE RFP and the timing of when you think that will be issued.

This is Jim again. That's one of those act of God things again. We are -- we keep hearing that it was going to be in October. Then it was going to be in November, so I frankly have no idea when it is going to come out. I know that our contract, I believe, is up 3/31 of '09 and so we're starting to get tight in terms of the ability to put out an RFP, for us to respond to it, for the government to evaluate it and then for the transition process to begin. So there's -- as we understand it, there's going to be a pharmacy RFP that comes out before the medical RFP, so, again, I have no idea as to when the final RFP is going to come out and what they're going to do in terms of timing. We've seen that from start of the RFP till the award has taken anywhere from six to 12 months, so, again, it has got to happen fairly quickly, because now we're starting to deal with a contract end date.

History would tell you there's little chance that this will happen without some sort of extension. It could be short, it could be longer, or who knows? We really are up against a timing situation now that would make it, based on history, difficult to actually do.

Thank you.

Matt Perry, Wachovia Capital Marketing.

I was just trying to understand your comments from the slides would indicate that the higher SG&A spending would kind of correlate to higher Medicare Advantage adds, yet in January of '08, you added 100,000 and in January of '07, you added 100,000. Is there a disconnect there or is some amount of that spending really only going to benefit growth later on after January?

Matt, it's really the goal we're talking about, the goal for last year was roughly -- let's say a midpoint of the goal was around 150 and this year, the midpoint of goal is around 225. So that is a 50% increase and when it occurs, as Jim says, we are constantly monitoring the activity and what's going on. And so that is really what gave rise to the proportionality and the decision to spend and what the opportunity was.

I would even go further. I got to tell you, looking at year-over-year I think is a big mistake. This is an annual sort of exercise relative to presenting products to seniors. Every year we go through a bidding process. Every year we get stacked against our competition. Every year we enter the market knowing exact where we stand and the likelihood of being able to sell. I think we have to be opportunistic and we will do that, so I think the actual spending could vary up and down year to year, depending on what's possible in the marketplace and what our goals are, as Jim would say. But to me, I think this -- and I'd just encourage everyone -- you have to think of Medicare as two things, an annual event where everything happens at the same time and, number two, a consumer business. And those two things change your mindset about how this industry works. It is not a traditional wholesale employer environment we're dealing with here. This is truly a consumer sort of marketplace and it changes everything.

So as we look at year-over-year, we may jump all over something in the fourth quarter of this year based on what we learn about where we are relative to '09. I think at the end of the day, history would tell everyone here that we have been pretty good at being opportunistic about this opportunity and we will continue to do that.

And when we spend the money, we get the results.

From your comments, it sounds like attrition is a little bit lower and then the group sales are also a little bit lower. Any kind of positive or negative surprises on the PDP upselling so far or the agent sales?

No, you know, Mike talked about this in some of his remarks. It is pretty remarkable that we can look and see much of a spend we have for a particular, for example, how much we spend for a cable ad and how many calls that will drive and then we have statistics around how many of those calls will convert to lead and how many of those leads that will convert to a sale and them how many of those sales will result in a referral of a friend or a family member. I mean, it's really remarkable and all of the different sales channels that we have -- a direct-mail versus a cable TV. And so that is pretty predictable and there's a lot of levers that we pull. Nothing has surprised us this year. We talked last year when we were together that we were surprised with some of our competitors and some of their benefit offerings. Nothing really has been a big surprise for us this year.

If I could just squeeze in one final thing, was there any kind of pulling forward of discretionary kind of marketing spend from the first quarter of '08 into 4Q '07? Based on your pretty strong underwriting results, did that cause you to maybe look at the opportunity a little bit differently and spend a little more?

No, as Jim said, we really look at activity. We really try to figure out where can we put these dollars to get the results that we really want to get? No, again, I would say if you just look at things the way it goes, it's looked at in terms of the goal and then what's available and what kind of, as Mike says, how are we positioned this year?

Peter Costa, FTN Midwest Securities.

Two questions, the first one regarding the Medicare Advantage group sales, again. You're changing expectations there. Do you think that's more tied to Humana's size on the Commerical side and is that just a 2008 kind of a view or do you think that's going to be continuing to see slow sales there overall? First is it just Humana and your size or is it 2008 and then I have a follow-up after that.

I think what you mean is because we're not nationwide and we don't have the opportunity to sell Banc of America that we might not be -- we don't see any of those large cases going out to bid right now for our group Medicare opportunity. And then if you look at some of our competitors, they don't have the private fee-for-service capability that we do and so many of the competitors who might be covering the Commerical under 65s can't compete with us. So there might be some of what you suggest in there, but I don't think that's the big driver. I think it's some of the questions that were asked earlier or some of the opinions that were voiced earlier about some of the larger, larger companies are waiting to see how the rate situation plays out, I believe.

I am also of the opinion -- and this is just an opinion -- that some of the consultant community is trying to get their arms around how this whole thing works and where monies come from and how we are able to do what we are able to do. I think they are getting more and more comfortable with that, so we'll see how that plays out. Again, Mike called it icing on the cake. I called it gravy. We're not going to count on it.

Let me say that slightly different, but probably the same, and this is kind of an upside down situation. If you looked at the Commerical market and you looked at national accounts and footprints and who is more national than others, than we would not be one of the top couple when you're thinking that way. Having said that, the Medicare opportunity for many of these very same large companies requires a national footprint and it largely requires, at this moment, a private fee-for-service offering, over the long-term probably a PPO, which flips and says Humana is the most likely to be able to meet their needs. So we are actually uniquely positioned to actually do it for them, should they ever decide to do that, much more so than some of their large Commerical payors they're accustomed to doing business with. So, once again, it is rather counterintuitive.

So sort of no one is ready right now, if you will?

-- the inside of the table I guess would be the argument.

I guess, the my second question on the Commerical, PMPMs were much lower on the specialty and what not, relative -- that's from the acquisitions. Does that trend lower from here and then the earnings in the special -- in the Commerical segment were flat or even down if you exclude the venture capital gain. Can you speak to that a little bit in terms of what we should be expecting that going forward? Is this the run rate where we should look at it or is it going to decline from here because of the acquisitions.

Peter, two things. One is when you look at the acquisitions, the acquisitions and the products that they sell have lower PMPMs, so when you look at that fourth quarter comparison, you know, take CompBenefits, they have an HMO dental, sometimes accessed the networks etc. Those PMPMs are less than our dental business was, same with the vision benefits. You can do the same thing kind of on the KMG side.

So when you look going forward, you are going to see lower PMPMs, but, again, we think that the margins here, again, we think give us a real opportunity in terms of the other products we sell, where employers are looking to move benefits to and to get people involved in. And we think that makes them a good opportunity. But on the PMPM part, that's kind of how you get to that.

Now on the earnings, the fourth quarter against the fourth quarter a year ago, the fourth quarter a year ago was a very good quarter in terms of -- if you remember, last year at the beginning of the year -- this is 2006 that I'm talking about -- we were somewhat uncertain about our medical cost trends and how they were going to unfold or evolve and that they did evolve within the year quite well and that was reflected in the fourth quarter results of last year. That is why the comparison is so close this year, 53 against 54.

And does that also have anything to do with the individual membership picking up, because that probably has a higher deductible, so there's more people going over it in the fourth quarter. Is that also a factor?

A certain amount, but, again, that's all in the mix in everything that we've talked about. Our business mix, our trend, our characteristics

The only thing that I what summarize -- and this is a little bit apart from your question -- we've told folks that have come in here over the last year or so that our target is to take our Commerical margins up to the 6% range in the next year or so. And I think you're going to continue to see us marching towards that, so as a takeaway, comparing the fourth quarter of this year versus the fourth quarter of last year, I think there was some noise with the acquisitions in the fourth quarter this year.

Again, we have some major shifts going on here, which makes all this relatively difficult to compare quarter-over quarter, because the businesses we're growing in the Commerical space are going to drive SG&A up and the Medicare keeps pulling it down because of the scale implications and the way that works. We'll shed light on every quarter, but they are offsetting as we go forward.

Okay, thank you.

John Rex, Bear Stearns.

If you were to take a look at your established network-based MA market, let's say Florida, and you assess the costs, what it costs you to deliver the equivalent of a traditional Medicare benefit, how does that compare? Where do you fall in terms of the government program cost?

Let me try it this way, we are generally paid the equivalent of the traditional government cost on a per head basis.

So I would say if you stripped down your benefit -- now strip down your benefit -- but your benefit is better than the government cost, so now strip it down to just be equivalent to the government cost or the government benefit.

I don't think I want to go there, but I will tell you that -- obviously we're doing better, because we have a little higher overhead because of all the infrastructure necessary to coordinate care how we do and the benefits are obviously better than the traditional Medicare program. That makes all this very attractive, so at the end of the day -- this goes back to my point that I make all the time -- we have a better offering than the traditional Medicare program, period. Over the long-term, our ability to coordinate it all and manage the actual cost gives us the long-term sustainability and makes us part of the answer for our federal government as they try to figure this out. Without having accomplished that, then there would be no reason for us to be here, so we've never gotten specific like that and I don't want to do that today, John.

Isn't that -- the whole question on this business is sustainability and the issue being that on there's, one side of the aisle, is a view that it costs more for you guys to do. On the other side of the aisle, it costs less. You nor the industry have never done anything to show that you can deliver the cost for less. I mean, so is that something we can expect? The core here is will there be a program in five years? And if you can do it for less, there will be.

Perhaps we have said some things in this regard. There was some questions in quarters past on our theoretical amount that we're paid above what the Medicare fee-for-service and there were many percentages that were thrown out. I think we talked back then around a network-based option, which includes high-performance networks and includes some of the utilization management programs and care coordination elements that Mike talk about it. I think we talked about a target for ourselves with all of these things coming together of somewhere around a 15 to 20% opportunity for us, and so I'm -- I think that is what you're asking.

We're going to -- those of the less developed markets, I think, that you're talking about. I guess I'm thinking about a developed market where you have much of this in place and if you were to offer just a benefit that was only equal to the traditional program, what would be your cost in that case? What I'm trying to get here is to can you prove a cost savings advantage? Do you have the data to show that to defend the business model?

I think I've suggested that there's about a 15 to 20% savings opportunity that through various studies that we've done around disease management programs and creating HRAs and doing network-based options or high-performance networks that we think that we can be more cost-effective than the Medicare fee-for-service environment by about 15 to 20%. I think that is what you're asking.

I guess so. So, I mean, are you saying -- let me make sure I'm clear on this, are you saying that in those developed markets where you have all this in place that you have a 15 to 20% cost advantage over the cost of a traditional Medicare benefit?

I'm not trying to be coy. What I am saying is that we've studied all of the things that we bring to the equation -- high-performance networks, network-based opportunities, disease management programs, case management programs, personal nurses, all of the things that are a part of our model. And we've studied each of those individually and as we put on a piece of paper what all of those bring to the equation, that's the kind of savings opportunity we think exists. Have we're sat down and studied Florida and compared our costs versus the fee-for-service world? Yes, so --

But John, also, if I may, your question really assumes constant health outcomes, because if you just look at the original Medicare and you look at us, and then you look at what we do, we do more things. That creates the opportunity in the total cost of government to the trust fund. It also creates opportunity for the members, because the members get better outcomes and they pay the same or less money. So those are the ways -- you have to take both sides in. You have to take a look the senior savings. You have to look at the health outcomes. Then you have a look at what we are paid for what we do to develop both of those and then compare that with original Medicare.

No, that's right. It just seems that there's somewhat of a lack of data out there in the managed Medicare maybe compared to managed Medicaid that demonstrates kind of the better efficacy. It seems like it could just be a factor that the industry seems to be missing and no one is really, really willing to put it out there. There are obviously reasons why you might not be wanting to do that, but it just -- when you think about sustainability, it seems important.

(multiple speakers) don't leave this one, because I haven't a political question yet. I'm stunned by it. Frankly, that's what we're talking about here. At the end the day, we have all sorts of clinical metrics around our industry and our company that would say we do a lot better than the traditional Medicare programs in terms of peoples' actual health, number one. So put that aside.

Now the question is it's just economics and I think if you put the clinical is better and the economics actually worked for us, then you have to conclude that we're able to do that. Then there are longer-term questions. All right, if you're paid exactly what it was costing to take care of the traditional Medicare folks, how would you be able to do? That's kind of where Jim was. There's a lot of folks in Washington that are real proud of their 3% overhead, whatever it is, in the traditional Medicare program. I would suggest they're overpaying, because there's no work being done there. The cost trend's going back to 1965 would have been off the charts, so that is certainly a failed model.

The question then is what it's worth to pay the private sector to manage this care and manage this program for the program? The answer is, at this point, we are being paid some additional funding, yes. That money is being used for two things -- to fill in gaps in a otherwise hole-ridden traditional Medicare program and to put the basic infrastructure in place to manage medical cost inside of this program over time. The payment rates on these, both for us and for the traditional program, over time are likely to come much closer together. That's the inevitability of it all.

But given the fact that we think there's 15 to 20 or 25% of fat in the Medicare program that we can get too, it gives you a lot of room to run and a lot of opportunity to actually have the model play out over the long term. That's why we wake up every day around here relatively comfortable that there is a long-term business, because this government must have somebody like us doing what we do. This is just a question of how we get paid for that.

Thanks, just one other thing on Medicare, then, have you assessed also the impact of if one were to remove IME from kind of the rate-setting formula, how that impacts your markets?

It's not a very big impact for us as a Company.

That's just mostly a factor of where your membership is located, a number of academic medical centers and such?

Yes, that is correct.

Great, thank you.

Doug Simpson, Merrill Lynch.

Most of my questions have been answered, but I was just wondering, Mike, could you talk a little bit about business mix targets longer-term and your thoughts on M&A with respect to diversification between Commerical and Government and just give us your latest thoughts there.

Well, let me start with M&A. You have seen a couple of small deals we've done here, we talked about them today. We always look for product expansion opportunities and that is what these represented. They're higher-margin Commerical lines of business using existing distribution capabilities and that sort of thing, so a nice leverage opportunity. Those are pretty obviously and we'll continue look at those.

There's always regional plans in this sort of thing that would help us potentially with our actual footprint for Commerical purposes. We don't need for Medicare. Those are always on the radar screen. So we will stay close to that. We continue to look things around Medicare to ask ourselves whether or not there's something close to this Medicare population that would be interesting to us.

And so I think it's steady as she goes from an M&A perspective. The bigger things out there, you all are as familiar with them as I am and I have nothing to say about any of that today.

In terms of mix, I think we've talking for those several quarters now about a real continuing and growing interest in focusing Humana at the smaller end of the marketplace more so than ever. I'm a big believer in the individual end of the business. We like the small group business. It's still a growing market despite economic uncertainty. It's also a place where a lot of what we're going to do from a consumerism perspective can play out better and the Smart product is where we focus. So we're trying to get real focused on those lines of business on the Commerical side that we think are interesting and we're not as focused on overall topline membership and basically -- so find the right product, find growing markets, then basically drive margin over time. That's our strategy.

I think that mix will continue to get better. If you look at the last three or four years, it had been constantly-improving situation for us. I think it also helps us from an SG&A perspective, getting pretty focused on those lines of business that we're most interested in.

So I think you'll see more of it. I think in the Medicare side, you're going to see more and more of our folks inside of network products for all sorts of reasons. They're better value, I think, over long-term. I think you'll see PPO and Medicare continue to grow. It's a place where I think, frankly, that we have about a two, 2.5-year lead on everyone just because of the heavy lifting required to build networks. I think -- I like where we are on the Medicare side. I like where the mix is moving there.

In terms of the PDP piece, we have always been focused on the voluntary individual purchaser of that and even though membership has been moved around and disrupted based on benchmarks and some other things on the auto assignees, that was never our target audience. We were building products and formularies around attracting individual sales because we had a long-term strategy to drive Medicare Advantage as the end product.

So I think you'll see more of the same in some ways, with a great deal of focus on particular individual, small group sort of Commerical lines of business being our future.

Okay, thank you.

I will now turn the call back over to Mr. McAllister for his final comments.

Thanks for joining us this morning. Let me just finished by saying I think our commitment to Medicare over all these years has really been good for our Company and it has really transformed us over the last couple of years, in particular. I still believe consumerism is the long-term key, that we're heading more toward individual accountability and more toward individual insurance over time and I think the political winds, in fact, are blowing that way as well.

Great, I think we have an '08 that should be terrific. We've guided to some good earnings for next year. We're proud about that.

Then for eight years, at the end of everyone of these calls, I've always thanked the associates that are on these calls -- I know there's a lot of them out there -- for the great work they've done and I'll do it again today. We are here because, as one of our candidates would say, it does take a village. That's what the Humana associates represent, so with that, I will close. Thank you for being with us.

This concludes today's conference call. You may now disconnect.