Humana Inc (HUM) 2009 Q2 法說會逐字稿

Good morning. My name is Dara, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q2 2009 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 Ms. Regina Nethery, Vice President of Investor Relations. Ma'am, please go ahead.

Good morning, and thank you for joining us. In a moment, Mike McCallister, Humana's President and Chief Executive Officer, and Jim Blum, Senior Vice President and Chief Financial Officer, will briefly discuss highlights from our second-quarter 2009 results, 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, and Chris Todoroff, Senior Vice President and General Counsel.

We encourage the investing public and media to listen in to both managements' prepared remarks and the related Q&A with analysts. This call is being recorded for replay purposes. That replay will be available on the investor relations page of Humana's website, 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 cover a few other items. First, 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 SEC filings, and all of those 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 second-quarter 2009 earnings press release, issued this morning, August 3, 2009. This press release and other historical financial news releases are also available on our Investor Relations website.

Second, this morning's call and slide presentation include references to non-GAAP financial projections. Slide number 3 includes a discussion of reconciliations between GAAP and non-GAAP projections. Finally, any references made to earnings per share, or EPS, in this morning's call refer to diluted earnings per common share.

With that, I will turn the call over to Mike McCallister.

Thank you, and good morning. Today, Humana reported second-quarter earnings of $1.67 per share. This is within the guidance we shared with you in our first-quarter call and 35% higher than the $1.24 per share we earned in the second quarter of last year.

As in the first quarter, we also saw significant year-over-year EPS improvement. These favorable results were due primarily to improved performance in our Medicare prescription drug plans. Our government segment, as a whole, performed well in the quarter.

On the commercial side, pressures from the general economy were evident in our results, primarily in our small group business.

I will keep my remarks brief today, concentrating on the topics that we've had raised most frequently in the course of our meetings over the past three months. First, Medicare payment reform, 2010 Medicare bids and healthcare reform in general. Both Medicare payment reform and healthcare reform more broadly are still very fluid processes. While Washington debates a number of proposals and struggles to put forth any sort of Bill, we continue to focus relentlessly on reducing costs and investing in improved health outcomes for our members. We think that is the most prudent end effective preparation for whatever the future holds.

However, before going through those topics in more detail, let me briefly comment on TRICARE. As you know, we were very disappointed to learn that the third-generation contract for the South region had been awarded to another contractor. In light of our 13 years of TRICARE experience and numerous awards for superior customer service, this was not what we had expected. Following the debrief with DOD officials on July 16, we decided to file a formal protest, which we did on July 22.

As we've shared with you in the past, Humana Military Healthcare Services operates as a fully standalone business unit. Therefore, if our protest is unsuccessful, any wind-down costs will not affect our core businesses.

Turning now to Medicare payment reform, as we've said many times, the Medicare Advantage program is vital to any solution to Medicare's impending insolvency because it is the only place where seniors have access to proven cost containment measures, but also improved health outcomes. Care coordination, disease management, wellness initiatives and integrated medical and behavioral health are core elements of our own Medicare Advantage offerings. Any payment reform proposals that have the effect of pushing seniors back into original Medicare can only exacerbate the program's fiscal crisis.

In addition, Medicare Advantage is extremely popular among seniors. Less than 2% of our senior members return to original Medicare. And their voices are just beginning to be heard. Over the next few weeks, Congress and the administration will learn how deeply these seniors are attached to Medicare Advantage and how much they will resent any misguided reform efforts that by reducing payments to Medicare Advantage contractors will have the inevitable effect of raising their premiums and cutting their benefits.

Our profit margins are intentionally modest; as a result, benefits and premiums to seniors are quite sensitive to payment changes. Humana has nonetheless planned effectively for a change to Medicare payment environment. Among other initiatives, we've prepared for it by, one, building out our HMO and PPO provider networks, with 62% of our Medicare Advantage members already in network-based plans.

Two, we've developed a wide variety of clinical management programs that are effective in reducing costs and improving health outcomes for seniors. Three, we continue to improve our data mining predictive modeling and consumer insight capabilities. And four, through our ever-improving consumer research we continue to advance our product offerings, distribution approach and consumer facing activities.

For example, we recently concluded sales partnerships with CUNA Mutual and Bankers Life and Casualty. What we know is that seniors buy Medicare Advantage on a total value basis and are not price shoppers. These distribution channels build on this simple but powerful understanding.

In sum, we've experienced various changes in the course of our 20 years as a successful Medicare contractor. Now, as then, we've made and will continue to make the necessary adjustments to further our record of performance.

Turning specifically to 2010, although it is impossible to know until October how we will the stack up against our competitors, we are confident that the approach we took and the assumptions we made in our 2010 bids will enable us to remain an industry-leading competitor. Although it is too early to offer any specific guidance, we certainly don't anticipate major Medicare Advantage membership losses next year, and I wouldn't be surprised if we finish 2010 with more members than we will have at the end of 2009.

Why? First, the expansiveness of our Medicare Advantage offerings versus the competition. As most of the country's private fee-for-service products approach their 2011 sunset, we will have a final year to offer this easy entry into Medicare Advantage. Also, our PPO plans are growing, with 465 new counties for 2010, and next year our HMO plans will cover 63 more counties than they do today. A thorough understanding of the senior consumer and their tipping points for benefit changes that guide their choices.

Three, number of seniors currently covered by competitors who will look for new plans because of private fee-for-service market exit by those competitors. And finally, opportunities associated with the Group Medicare market that are gaining traction for us as others in the sector scale back their offerings and as employers become increasingly aware of the value of Medicare Advantage.

As an early validator of this last point, a large Midwestern public employee retirement system has selected Humana as the carrier for its Group Medicare contract effective January 1, 2010. This is a fully-insured account with 100,000 lives, representing $1.3 billion in estimated annual revenue.

In another positive development, CMS has awarded Humana a multiyear contract to administer a demonstration project designed to ease the transition to Medicare PDP for eligible Medicaid beneficiaries, and to provide consistency for retroactive claims for members who are late starts in the Medicare program. This two-year contract with three additional one-year renewal options also launches on January 1, 2010, and represents over $500 million in revenue for 2010.

Additionally, we've taken steps to lower our cost structure. Several months ago, we launched an intensive companywide cost reduction effort. This is already bearing fruit and is expected to gain momentum as we move through the rest of this year and into 2010. With a targeted reduction in consolidated administrative expenses of at least $200 million, or 5%, for the coming year.

Finally, with respect to healthcare reform generally, we have said for nine years now that our so-called healthcare system is not a system at all and needs a massive overhaul. We have pioneered important elements of that overhaul in a number of ways. Many of them are consistent with the Obama administration's top priorities for reform. Here are just two examples.

Through Availity, the multipayor, multiuse electronic provider portal that we cofounded in 2001, we've shown the way toward fulfilling the President's call for a workable healthcare IT superhighway, with attendant standardization, transparency and significant cost savings. More specifically, electronic prescribing like Availity CarePrescribe, has reduced preventable adverse drug events by 61%. Further study of doctors who use the Availity care profile electronic health record show a three- to six-minute reduction in patient intake and assessment time, adding critical efficiency to the system.

In less than eight years, Availity has grown to include 27 million owner-members and 100,000 owner-employers, involving 50,000 physicians' offices and 1000 hospitals, with 600 million transactions projected this year.

And through our groundbreaking SmartSummary benefit statements, we have shown that if healthcare consumers are given actionable information, they will behave rationally, as they do in other aspects of their purchasing lives, with the net effect of reducing costs and finding value for themselves and the system.

Launched in 2004, these unique-in-the-industry statements reach 10 million Humana members every quarter, helping these members save money and maximize their benefits on a personalized basis.

In summary, we continue to work closely with the administration and with Congress to increase the likelihood that measures designed to solve the real problems in the US healthcare, rising costs of care associated with the deteriorating health status of American, the lack of interconnected electronic systems and the impending Medicare funding deficit, become the focal points for national health care reform efforts.

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

Thanks, Mike, and good morning everyone. Since our second-quarter results and full-year guidance points are detailed in today's press release, I will focus my comments on four areas. First, the nature of the Military Service issues that we expect will affect our financials in the second half of this year and in 2010. Second, the effect that the general economy is having on our small group business. Third, our progress on administrative cost efficiencies. And finally, an update on our investments, capital and liquidity.

Let's start first with a summary of the issues we are analyzing with respect to the recently announced TRICARE contract change coming in 2010. As Mike said, we've protested the TRICARE award. Nevertheless, from a financial reporting standpoint, we simultaneously are required to proceed with a preparation of estimates for the following items.

First, the possible impairment of our Military Services goodwill, which totaled $50 million at June 30. Second, any potential exit costs we could incur in the wind-down of our TRICARE operations, as well as any potential offset in transition costs we could receive from the Department of Defense. And finally, any possible Military Services asset sales.

As you can imagine, these analyses are complex and interdependent. Thus, we are not able to estimate with reasonable certainty the impact or timing of these possible adjustments at this point. We anticipate further clarification on some portion of these issues and the required analyses during the third quarter, and will provide an update no later than our third-quarter earnings report on November 2.

Turning now to our Medicare and Commercial businesses, our Medicare business is performing well and continues to exceed our previous projections, primarily driven by improved performance in our standalone prescription drug plans.

Looking at our Commercial segment, while we were pleased to see a year-over-year improvement in the overall Commercial benefit ratio, we have increased our forecasted Commercial benefit expense ratio for our small business by approximately 1% for the full year. This consequently resulted in the $30 million reduction in our full-year Commercial pretax guidance at the midpoint.

This small group trend pressure comes primarily from the same issues cited by many of our competitors this quarter. They include, first, an aging of our small group membership, driven by workforce reductions and lack of new hires. Second, changing consumer behavior, resulting in higher utilization of services. Third, changing provider behavior, driving an increase in the intensity of procedures performed. And finally, a modest impact of swine flu and COBRA.

Our revised Commercial pretax earnings guidance of $190 million to $210 million gives appropriate consideration to each of these dynamics for the remainder of the year.

I also would point out that we did not experience any unfavorable reserve development for 2008, thus all of these small group trend issues have arisen in 2009.

From a pricing perspective, we have been raising our small group premiums throughout the year. Additionally, as we began to observe the dynamics that I just detailed, we adjusted our premium rates to reflect the assumption that these trends would continue throughout the year. These higher rates will be effective by the end of the third quarter.

And finally, most importantly, we are confident that we have taken sufficient pricing action for 2010 to address the majority of these current trend observations.

Now I will spend a few moments highlighting our continued focus on administrative costs. As Mike mentioned and as you would expect, we have a well-established administrative cost team which is dedicated to delivering expense efficiencies on an ongoing basis. Humana is committed to delivering at least $200 million of administrative cost reductions for 2010 as a result of our continuing focus on streamlining of processes, eliminating functional redundancies, leveraging technologies and completing integration opportunities from recent acquisitions.

Earlier this year, we implemented stringent hiring restrictions, which have resulted in a net reduction of approximately 500 FTEs during the second quarter, primarily by means of attrition.

Turning last to investments, capital and liquidity, we are pleased to note the following with respect to each item. First, investments. Despite continued low cash and cash equivalent yields, as well as the continued relative scarcity of fixed income investments which meet our investment criteria, investment income continues to track with the expectations that we shared with you last quarter. Our investment criteria continued to be high credit quality, broad diversity and ample liquidity. Net unrealized investment losses at June 30 fell to approximately $90 million from approximately $230 million at both March 31, 2009 and December 31, 2008. This reflects the continuing effectiveness of our investment criteria and further stability in interest rates.

Second, capital. We've completed our discussions with the various departments, the state departments of insurance and the credit rating agencies. These discussions included reviews of the statutory capitalization, 2008 performance and 2009 projections for each of our major units. As a result, our subsidiaries paid totaled 2009 dividends of $774 million to the parent company. This is more than 2.5 times last year's dividends of $296 million and twice the $377 million in dividends paid to the parent in 2007.

We continue to expect that 2009 capital contributions into our operating subsidiaries will be less than the $243 million contributed in 2008. $100 million of this year's subsidiary capital contributions were completed in the first half of 2009.

Also during the second quarter, we used $250 million of the total 2009 dividends to repay all amounts outstanding on our bank credit facility. The sum of all this year-to-date activity left us with $665 million of parent cash and investments at June 30 versus approximately $250 million at December 31, 2008. This constitutes the highest level of parent cash and investments in the last 10 years.

Finally, with respect to liquidity, our liquidity position is also strong, as indicated by the following two points. First, we are reaffirming our 2009 cash flows from operation guidance range of $1.2 billion to $1.4 billion. As was the case in 2008, we expect that most of our 2009 operating cash flows will occur in the second half of the year.

Second, we now have full availability of our $1 billion revolving bank credit agreement, which remains effective until July of 2011, after which the earliest issue of our Senior Notes does not mature until June of 2016. As always, we continue to review all possible uses of our parent cash and available credit, primarily focusing on potential acquisitions and share repurchases.

So to conclude, we are pleased both with our second-quarter performance and the resulting full-year non-GAAP earnings per share guidance range of $6.10 to $6.20 per share, which is consistent with our previous guidance.

We continue to build on our organizational experience, administrative cost discipline and new processes to improve the operating performance of both of our business segments. As we move into the second half of 2009, we are well-positioned to help our members and the nation face the healthcare challenges of both today and tomorrow, as well as to continue to provide our owners with solid operating returns.

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

(Operator Instructions) Tom Carroll, Stifel Nicolaus.

Good morning, just a couple quick questions. Did you rebid all of your current private fee-for-service markets for next year?

This is Jim Murray. Yes, we did, and probably added a couple in the process.

Very good. And then secondly, in terms of the Commercial deteriorating, I guess, margins a little bit, what was the offset primarily to backfill that net income? Just better Medicare operations, I guess.

It's primarily PDP.

So it's more from the PDP side. All right. Thank you.

Christine Arnold, Cowen and Company.

Good morning. Quick question on the private fee-for-service versus kind of network products. As you think about how you bid 2010 from a margin perspective and from an MLR perspective, do you expect those products to be roughly equivalent in medical loss ratio and total margin in 2010? And as you bid the products, what kind of margin assumptions did you kind of make for the overall book?

Christine, we've said for a long time we have really not gotten into a lot of granularity around individual product lines. We target our entire Medicare Advantage book for a margin in the range of 5%. We've done that again for 2010, and we will continue to do that.

Okay. And then how do we think about the fixed versus variable costs, if you add kind of net incremental Medicare Advantage members, or if over time, membership kind of gets depleted? How do I think about how that flexes on the SG&A, granted that you are cutting $200 million?

Well, as Mike and Jim pointed out today, we anticipate growing next year, in large part as a result of the group contract that Mike referenced, as well as the possibility from growth of the individual sales that we will make. So we don't anticipate that event occurring in 2010.

And then I would also reference that we've begun to address our administrative costs. As we look forward, with what is going on with the Medicare funding issue, it is clearer and clearer to us that low cost is going to be the way that we need to approach things going forward, and so we've already begun that good work, and we anticipate some good things in 2010 as a result of what we've already begun.

Christine, there is a lot of different scenarios with Medicare membership. As we sit here today, we have nothing in front of us that would have it declining dramatically. When you look at of the various proposals out there in terms of how we do funding going forward, you could come to the conclusion that growth will be harder. But whatever it is, whether what is good or challenging, it is not exactly going to happen to us overnight. We will have time to look forward, understand it, and adjust to what the future looks like. And we find it to be manageable and think it will be so.

We've been through this before, if you recall, after the BBA in the 90s. Basically, our Medicare business did quite well all through that period, because we had an opportunity and we did it to manage it effectively and to continue to make it more cost-effective, to find efficiencies. And we will be doing the same things this time if we have to confront that. But as we sit here today, I don't know that that's going to be the outcome.

Okay. Thank you.

Justin Lake, UBS.

Thanks, good morning. A couple questions, first on TRICARE. I just wanted to go through the margins here. I think you said it is 2.5% to 3%. Does that include investment income, or is that for investment income?

No, it does not include investment income.

What would we kind of say that adds to the margin as far as an all-in?

Investment income in TRICARE is very small, because TRICARE is sort of like an ASO light product. We get reimbursed relatively quickly after we make the payments.

So maybe another 50 basis points or something like that?

I wouldn't say it's that high, actually.

Okay, so it's even less. And then when you mentioned on your discussion in the introduction (inaudible), of the -- of it being a stand-alone segment, is that to say that if and when you do have to wind this down, there is not going to be any SG&A overhead that allocation loss? So it would only be taking away the 2.5% the 3% margins?

It is very small. I mean, I've been saying this for years. This is a completely self-contained business unit. It is that way because of the contractor requires it to be that way. And there has been very little overhang between the parent company and this business unit from an overhead perspective. So it is immaterial.

Great. And then second question, just on your Medicare Advantage bidding for 2010. I know you don't know where you stand competitively, but from a margin perspective, can you talk about how you bid those margins? And then specifically with that $200 million of cuts, do you expect that to offset some pressure on the MLR, or is that going to be incremental to the margins you are earning right now --?

Well, we are chasing the 200 because it is the right thing to do. We ramped this company up very fast over the last three years, so we think there is opportunity to sort of relook at where we are and the buildup we had. Because we know that we are not going to see the same growth going forward that we've had in the past. It would be impossible.

So the $200 million is being pursued for the right reasons, independent of our bidding process for 2010. We basically looked at what we knew. We knew the inflection points around benefit changes and premiums from a consumer research perspective. And we, by virtue of understanding that, that went into our whole methodology around how to structure and present these products. And at the end of the day, we targeted, again, a 5% -- approximately 5% margin for the entire book. It is not 5% everywhere and it's not 5% by productline. But that's the way we think about Medicare Advantage in total, and that is how we did it.

So the $200 million would be in addition to the 5%?

I'm not sure why you are trying to connect the two. The $200 million is going to drive the overall Company's margin, not specific to Medicare.

Just because Medicare is such a large piece of the book, that is why I was maybe just connecting the two. But I will take it off-line. Thanks.

Scott Fidel, Deutsche Bank.

Thanks. So it looks like you raised your view of cost trends to 7% from 6% to 7%. Maybe just walk through which of the components of trend you are increasing. And then how does the increase in that trend view break out between the higher utilization you cited as compared to some of the claims intensity issues?

We did raise it to 7%, in fact, Scott. And again, those four things that I mentioned basically all have roughly the same kind of weighting and they all put pressure on the 6% to 7% that it was before. The aging population probably added about a half a year to our population. The consumer behavior, we all sort of know about that. Generally speaking, people are working hard until the time that they anticipate layoffs. Sometimes there is an increase in the utilization of services there.

Providers have also -- their behavior has changed. The economy has changed. And so the intensity of the services that they have ordered has increased. I would also note in connection with that one that if you look at receipt cycle time, it is interesting to see you that that is down to 14 days. So with our technology and with the economy, the providers are billing us faster as well. And that is a good thing, given what we've said about our overall thing. But again, you can see that all these things have about the same -- and then I mentioned at the end the COBRA and the swine flu had a modest effect.

Then just on the COBRA issue, do you have an estimate for what the penetration is of COBRA extensions members for the second quarter related to first quarter?

Our fully-insured membership is 1.9 million and we have about 19,000 COBRA members, so about 1%. It is up a couple thousand folks since the beginning of the year.

Okay. And then just second question, just do you have any initial sense on how the Commercial pricing environment might be shaping up for 2010 renewals, and maybe just an update on how you are seeing price competition for the back half of the year relative to the first half?

Somewhat similar to what we've talked about in the past. The state of Texas is pretty competitive right now. Blue Cross in Texas is extremely competitive. We have quite a bit of our small group membership in Texas, and so that is part of the issue that we've faced in terms of membership reductions.

In terms of the ASO competitiveness that we've talked about in the past, we don't see any more significant change there. Some of our competitors are willing to put some of the medical costs guarantees at risk, which is a little bit unusual.

But other than the state of Texas, we don't see anything significantly different than we have in the past. And we are hopeful with some of what we've seen in terms of the trends that we've discussed as respects our book of business that Blue Cross of Texas sees some of that and does something as respects in terms of their pricing.

Thank you.

Peter Costa, FTN.

A couple questions. First, on this weekend's Market Basket update to hospitals, which went up 2.1% versus down 0.4%, can you talk about how that is in terms of being a headwind for you guys, in terms of your costs for next year --or an incremental cost headwind for you next year?

And then second, on the large Midwest public employees account that you won, did that account have group Medicare Advantage last year? And if it did, can you say if that was perhaps an Aetna account that you won it from and why you won it from them?

I'll take the first one. With respect to providers, we see continued cost pressure. But again, we are constantly negotiating contracts with them, and we are constantly using the information that we've had. I mentioned in my remarks about trend, provider behavior with respect to the intensity of services offered or services rendered. And again, we use this information every time we go out with providers. We do it on a regular basis, on an annual basis, so we feel we will be able to absorb that okay -- in a satisfactory manner.

Let me add to that -- this is Mike. We have a pretty robust capability to keep up with what is going on with providers, with a real focus on hospitals. And so we pay attention to their coding practices and how they bill us, and we reach an agreement with them, but that doesn't mean that's the end of the issue. Basically, you can spot cases, and we've seen it, where some providers in some communities will in fact change the way they do their financial work. And we pick that up pretty quickly and we turn right around and have another conversation with them about that. So that is sort of an ongoing management process in terms of keeping up with coding intensity and all those sorts of behaviors from that side of the community.

As to the Midwestern case that we won, they did have coverage last year. I won't talk about who they had coverage with. Why I think that we won the case was because we take a different approach to working with group customers. We like to work as a partner with them.

We put together a lot of analysis to help them understand where their costs are impacting them, and sit with these customers and work with them on benefit designs, premium, coding issues, so that particular customer gets funded by the government for the risk that exists in that particular book of business. We work with that customer as respects that.

We have a pretty good reputation in terms of our service capabilities, and that is fairly well-demonstrated as we went through the entire process with this particular group. So I think they came away thinking that we were going to be a partner, and I think that was probably different than the approach that they were used to.

Okay. Thanks, guys.

Matthew Borsch, Goldman Sachs.

Good morning. Could you comment on your results as you've grown the Medicare Advantage PPO book? I'm curious to -- if you can characterize do the results look a little bit more like private fee-for-service or like your network HMO product?

And maybe if I could ask related to that, what kind of out-of-network utilization are you seeing on the PPO product?

You know, we've talked with all of you in the past about a 15% advantage on what we have to accomplish as a Company so that we can deal with the Medicare funding issues that face us as an organization and an industry in general. And as you would expect, our PPO cost structures are better than our private fee-for-service costs structures. So when we step back and look at our results relative to our PPO block of business, it is an confirming to us that we -- on the four things that we've talked with you about in the past that creates a 15% advantage, that we are being successful in delivering that. And so we are pleased about that.

Out-of-network usage has not been significant. When we see out-of-network usage, we put in procedures to try to educate not only the seniors, but also the providers that work with us on how we can create a relationship around that particular event.

So we are very pleased with what is developing as respects our PPO result, because it is confirming to us that the 15% advantage is something that would provide opportunity for us going forward.

Matt, if you think about the PPO, it would be unlikely to see significant out-of-network utilization, because you got to think about the customer. Remember, this is a retail business. And so they look at this network and they -- it is not like where an employer has made some decision about what the plan looks like and what network will be delivered. These people make this decision individually.

So they've assessed the network and they decide whether or not it is the right thing for them, and they do that, and so --. And also, these are the type of patient consumers that actually pay attention. And so, the out-of-network utilization you are going to get in a PPO Medicare program is largely going to be driven by emergencies and things that are not able to be predicted or managed. Because these consumers will do a very good job of picking the right product with the right network and using the right providers. This is actually much easier than the Commercial business.

I guess it is just that when I've looked at -- and correct me if I'm wrong here -- when I've looked at the PPO product designed for at least some markets, it looks like you could do about as well as private fee-for-service going out of network under that product in terms of the out-of-pocket cost. Although obviously, you would clearly save money going in network.

Correct me on that, if I could, and just the last final thing here is when you do have it go out of network, are you then liable for full charges for the provider or how do you handle that?

It's a Medicare allowable.

Medicare allowable. So the Medicare rate is your fallback?

Correct.

Yes.

Okay, thank you.

Charles Boorady, Citi.

Thank you. Good morning. Mike, what is the Board's vision for what your business mix should look like long term? And if it is still to increase the Commercial and possibly the Medicaid mix to diversify a bit away from Medicare Advantage, how will you use your capital to get there and should we expect large-scale M&A?

Well, those are all the big questions. I would start by saying --.

I could have asked about your tax, but I think that would be a little bit boring.

(Inaudible) Let's just start at 100,000 feet. Clearly, we would like to be more diversified than we are. Although we love the Medicare business and we have forever, clearly it is risky to be this upside down relative to mix. And as you've watched the acquisitions we've made over the last few years, this is not some realization we've come to suddenly. We have acquired dental companies, vision companies, voluntary products, all sorts of specialty lines, a behavioral company. We've started our own pharmacy business from a mail-order distribution perspective.

So we continue to find ways to get into other lines of business. And a lot of those, it is really good because they integrate well with the base business, no matter whether it is Medicare or commercial or whatever. So it works across the entire book.

So we've also done a few smaller acquisitions of health plans to help us from a geographic perspective. We are quite viable and competitive in Tennessee and Illinois today, where that might not have been the case four or five years ago.

So everything is on the table relative to that. I can tell you that we are -- right now, we are in the process of looking forward in terms of what the strategy of the Company is going to be, if it is going to be any different. I think we will have a better understanding of that as we get clarity around exactly what the future of Medicare looks like to us, and that should happen over the next few months.

So we are at a point now where all of that is in front of us still. We are doing very well with the businesses we have. We've tried to diversify and have successfully done some of that, and will look to do more of it.

So I don't like being this dependent on one customer, although the relationship with the customer historically has been very, very good. And the beauty of that is the underlying end customer, the individual consumer senior, is very, very happy with what they have. I like the retail business. We've talked about it a lot. I like the consumer business. And this is a perfect platform for all of that.

So I know it's a long-winded answer, but basically, I think we are going to be looking at the best use of our capital, whatever that may be. We've been making some acquisitions with it when we had the opportunities. We haven't done a lot of big share buybacks, like others. That's actually still in front of us and something that is doable if we choose to go down that path. But given the uncertainty of healthcare reform and what this industry and market is going to look like over the next few years, we just need to be real smart about how we deploy this. And news to come is all I can tell you.

Just to stay on that point, about a year ago, you had talked about the same goal. And if we presume TRICARE is lost and given where Commercial was headed this quarter -- granted there are some unique issues with the economy this year -- but your concentration in Medicare will only increase next year without TRICARE and with your growth in Medicare Advantage.

So does that increase the sense of urgency to do something on a larger scale, to diversify? And maybe you can give us some parameters around when you would like to see real diversification anyway from Medicare Advantage. Is that a two-year plan or a five-year plan?

I can't say specifically today what that would be. We are like everyone else. We keep all things on the radar screen. We are constantly looking at opportunities. We are constantly assessing the usual suspects out there in terms of opportunities for larger scale activity. And I'm sure everyone else does the same thing.

We all know where everybody sits in terms of market positions and market cap and all of those sort of things. And I would say that also you can't actually drive it, even if you set a two-year window or five-year or whatever you want to do, the actual execution of that is not something always in our control.

So again, we stay current. We are on top of it. We know what those opportunities are. I try not to use the word urgent, because that would lead you to potentially some bad decisions. So we will be thoughtful. We will be strategic. We understand what options we have and we will take the most rational approach to what opportunities present themselves to us. There is no way I can be more specific than that.

Thank you.

Joshua Raskin, Barclays Capital.

Good morning. I was wondering, could you just update us on some of the conversions on a year-to-date basis in MA in terms of how many -- I think you mentioned in your press release some PDP members that had upgraded to MA. What is that number year-to-date look like? And then how many private fee-for-service conversions to network-based products have you seen year to date?

The folks that were in PDP products that concluded that an MAPD product added more value for them was -- it is 49,000 to date and we anticipate that will go somewhere up into the 50s by the end of the year. And folks that concluded that a network-based option was more valuable for them from a private fee-for-service offering, around 90,000.

Are most of those into PPO?

Most of those are, yes. And a lot of that success comes from our marketpoint reps sitting down across the kitchen table from the seniors, talking to them about the value that some of these other products have. And we anticipate a significant amount of that coming into 2010, and that is one of the reasons why Mike and all of us believe that we are going to grow our Medicare Advantage membership this year.

Got you. And just a follow-up on the PDP, obviously coming from a loss position last year. But I'm just curious -- it seems like you've seen some improvement sequentially first and second quarter versus expectations. Are we now at that sort of 5% target range or are PDPs -- do we still need some room for improvement next year?

We like where our PDPs are at -- presently. We are very pleased with the proposals that we've put on the table for 2010. We feel we are back in the PDP business, and we would anticipate growing PDP membership as well next year, not only voluntary members, but also low-income members in a few locations throughout the United States. We like the PDP business.

Okay. And I'm sorry -- just one thing in the press release, I think you said your guidance was predicated on potential changes to TRICARE, which we understand. And I think you mentioned potential accounting changes. Was there anything specifically that you were referring to?

Well, we still have to do, as I mentioned in my remarks, we still have to look at what would be the exit costs, what would be the transition costs that we might recover from the Department of Defense. Whether we would have asset sales, things like that. The goodwill that is on the books now with respect to the business. So the fact that we've used non-GAAP guidance is solely around that and around those items.

(Inaudible). Okay, thanks.

Carl McDonald, Oppenheimer.

Thanks. I just had a couple clarifications on the SG&A comments. First, is the $200 million reduction on top of the roughly $300 million plus in TRICARE SG&A that will go away if the protest is unsuccessful?

Yes.

Okay. And the $200 million SG&A number, is that a net number or a gross number that you are thinking about for 2010?

That would be a net number.

Okay. And then lastly, any range for cash you expect at the parent at year end?

No, we don't normally forecast that. But again, as I mentioned in my remarks, we had very good success with dividends from the subs this year.

Okay, and you said the -- so another $140 million or so in capital contributions down to the subs. And then do you have a full-year expectation on the dividend number from the subs?

Yes, that is the 774. The 2009 dividend, which of course is based on 2008 results, has been completed.

Okay, great. Thank you.

Ana Gupte, Sanford Bernstein.

Thanks. Good morning. My first question is about the physician fee fix. And I was wondering what assumptions are you building into your 2010 trend expectations for the fee fix, in light of the House proposal. Of course, they don't have the money to do this.

But in light of the tenets they espouse on the advanced medical home and raising PCP fees, but at the expense of specialists. And they've separated out Part B drugs, and I think CMS had a similar communication. Do you see any potential for any upside there?

Ana, I have not found a single person in Washington that believes the doctors are going to suffer a 21% cut in their pay, period. So everything we do and everything we assume around here is around the idea that it will be fixed under some scenario by the end of the year, whether they have the money or not. I'm not even sure that is relevant, given what is going on in Washington. So everything we've done assumes that the physicians do not suffer a 21% pay cut.

Okay. And then the second question is someone had (inaudible) some of the commentary earlier about your focus and concentration on Medicare Advantage. Given that you are growing in Individual, you do very well on your first sale to the government and second sale to the consumer, and at the end of the day, MAs, at least to a great degree, an offset for the coverage expansion to the uninsured, why haven't we heard more about your expectations on growth from these 35 plus million odd people that will enter the coverage pool, in essence, in 2013?

I think it's too early to know how that is going to work. I don't know that we know how many are going to be in there. That is -- the devil is in the details big-time on that subject. You've already seen huge variation in terms of what some of these bills will do in terms of the number of uninsured that they actually capture. The Senate bill that we've actually seen only picked up, I think, 16 million people. There are 12 million illegal immigrants in the uninsured pool. No one that I've been able to find in Washington knows what we are going to do with that.

So actually, I don't even know what the number is, frankly, and I haven't found too many that do. So we are going to need some more clarity before we really start talking about whether there is an opportunity in that or not. I do know that they are looking to pay for a lot of that through Medicare offsets, as you said. And that is where the seniors are going to make their voices heard quite loudly, I think, when we finally get down to the details and they are subjects to either oppose or support. We have nothing to support or oppose at this point until we get some more resolution.

I have one final one. And on the senior lobby, how is the reaction to the pharma doughnut hole coverage fill, and do you think that in any way would tender the support you get from the senior lobby on any MA changes?

Well, that proposal for pharma is kind of interesting in that it actually doesn't cut any expenses for the government. In fact, it makes it worse, because people speed through the doughnut hole quicker using branded drugs, and therefore the government picks up the back-end expenses in an earlier fashion than they would have otherwise.

It is clearly a positive for seniors who are taking those drugs in the gap. But what we also know is that the seniors tend to not take those drugs in the gap, because they are really confronting what -- the real cost of these medications. So our experience has been that when seniors understand their choices -- and I can tell you they get incredibly good at finding the value proposition in Part D. And so they know exactly where they are relative to deductibles and generics and brand choices among brands and the doughnut hole.

And it's one of the reasons that these smart summaries and other things we are sharing with them are so powerful, because for the very first time, they have incredible actionable transparency around medications. And you can watch what is happening in the marketplace, as generics continue to climb, the use of mail-order continues to climb, everyplace you can find productivity or more value, the seniors get there.

So I don't know the real benefit at the end of the day of having lower-priced drugs in the doughnut hole, frankly, because I think they are having trouble selling them anyway. And this is an effort to help with the marketing of those medications. It certainly doesn't help much as far as I'm concerned in terms of policymakers and what they are trying to accomplish in terms of paying for health care reform.

Matt Perry, Wells Fargo Securities.

Good morning. First, just a clarification. On the group Medicare account you've signed, is that a private fee-for-service, or is it a network-based account?

It's a private fee-for-service account today that likely will go to a PPO arrangement in the future. The group has looked at our PPO networks throughout the United States. They are very pleased with our approach to how we manage the Medicare business, and they like our direction. And so that is why I talked about the long-term partnership going forward.

Okay, great. And then a bigger picture question, maybe for Mike. We've seen a couple potential health care reform bills out there, and I'm sure the final bill will change a lot. But as you look at the provisions for Medicare Advantage and those bills, I think we all anticipate that subsidies will be phased out over time. But is there anything else in there that is surprising or you would spike out as either a positive or a negative?

I don't think there is anything surprising, because there are a number of political agendas, not surprisingly, built into some of the specifics of these proposals. I think it is a little too early to get too excited about any of them at this point, given -- you've heard me say for a very long time I'd assume at some point the subsidies would diminish over time in many places. I don't even know if we can say that across the entire book of business, but I think there's been conversations around competitive bidding.

There are ways competitive bidding could be effective. We've got administered pricing in another place. We've been under administrated pricing for a long time. There are ways that can remain quite effective as well.

So you can pick your poison on those. Ultimately, it is going to get down to -- I hate to keep saying it -- it is going to get down to details by county in terms of whether it is a viable business -- by county. Now, there is also conversations about shifting away from counties and going to some other way to gather geographies. That kind of changes the game a little bit.

All I can tell you is from our perspective, we have an incredible team of people that every day, all day, spend their time modeling, working through changes. And every time we get a little piece of news out of Washington that says, okay, it just twisted this way, we can very quickly analyze what that means and come back with some suggestions or changes or at least understand the implications to us a very, very quickly.

So we are in it every day. I got actuaries and people that are totally committed to the entire government process, along with an army of others that are involved in conversations in and out of Washington. So at this point, I could take all sorts of components of these bills and come up with any kind of Frankenstein monster, frankly. But at the end of the day, we are just going to have to wait and see how it plays out.

Okay, thanks. And then just another final big picture question. If we think about M&A, and I understand you are interest in maybe creating a more diversified business mix, but if I look where your valuation sits right now, how do you balance diversifying your revenue stream versus perhaps looking at share buybacks as your multiple is the lowest in the sector right now?

I mentioned it earlier. Share buybacks are there. It would be very accretive to do that. It's important, I think, to have a fair amount of cash around for lots of reasons.

And at the same time, we've been very active in determining if we had M&A opportunities, and we wouldn't do any of those if they weren't accretive as well.

So we are looking at all things that are kind of positive, whether it be M&A being accretive, share buybacks again can be accretive; all that is in front of us. I just think it is time right now to be a little cautious. We can always come back to share buybacks at some point. We still have an authorization out there at some level. I think it is 250, Jim. So we are prepared to do it. It is on our list. And we will just have to see what our opportunities are and how to prioritize them.

Greg Nersessian, Credit Suisse.

Good morning. First question was just on the -- you cited the changing provider behavior as a cause of the spike and cautions on the small group business. Wondering why you isolate that exclusively to small group, why you are not seeing that, I guess, in some of your other market segments and products. And is there a possibility that is happening; you just haven't identified it yet?

We did spot -- obviously, when a provider system changes the way they bill you for emergency rooms, you see that in all of our lines of business. But when you add up all of the things that are going with the small group of block of business, the other group movement that Jim referenced, some of the consumer behavior change that is occurring with the CDHP. The COBRA is impacting our small group the most significantly.

We just talked about small group as respects the negative on it related to the commercial reduction in guidance. But obviously, we are seeing the provider behavior issue throughout our lines, but those were performing well and this just made them perform a little less well.

I see. Okay, great. And then just a last question on the TRICARE. Does the fact that you have appealed [when] the other carrier appealed, does that push back the potential timing of the rollout in your opinion, assuming that you have -- you do in fact end up losing it? And then a follow-up, is there any capital tied up in TRICARE that would get freed up if that contract transitions away from you?

Second first, there is no capital tied up that gets freed up. The first one is, well, history would tell you these things rarely start on time, but we operate under the assumption that it will. There is an awful lot of work to be done for anyone to get ready for next year. So there is no way to know right now. I guess the intent is for it to start on time, and we are going to function under that assumption. So -- but it wouldn't surprise me if it got delayed.

Right. Okay, thanks.

Okay, well, thank you for joining us. I think we had a very, very good quarter. Obviously, most of the interest of folks today is centered around what is going to happen in Washington, rightfully so. We are there, we are part of it. We are focused on Medicare.

The advantage that we have and that the industry has relative to Medicare is that we have millions of the very, very satisfied people, and that the political conversation is going to become very interesting over the next six to eight weeks, and we will be part of it.

In the meantime, as a Company, we are continuing to operate and look forward and making sure that we have the right discipline around our costs. We continue to drive productivity around distribution capabilities, and I think at this point we are looking pretty optimistically toward 2010 relative to our Medicare Advantage business.

Lastly, I want to thank the associates that are on the call for making these great results possible, and with that, we will close the call. Thank you very much.

Thank you, and this concludes today's conference call. You may now disconnect.