Humana Inc (HUM) 2010 Q2 法說會逐字稿

Good morning. My name is Maria and I will be your conference operator today. At this time I would like to welcome everyone to the Q2 2010 earnings 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)

Ms. Regina Nethery, Vice President of Investor Relations, you may now go ahead.

Good morning and thank you for joining us. In a moment 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 second-quarter 2010 results as well as comments 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 this morning's press release as well as in our most recent filings with the Securities and Exchange Commission. Today's press release and other historical financial news releases are available on our Investor Relations website. All of our SEC filings are also available on the Investor Relations page of Humana's website as well as on the SEC's website.

Humana's results for the second quarter and year to date in this presentation include financial measures that are not in accordance with Generally Accepted Accounting Principles. Management's explanation for the use of these non-GAAP measures is included in both today's press release and the slide presentation. This slide shows the reconciliations of GAAP to non-GAAP financial measures being used today.

Finally, any references to earnings per share or EPS made during 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, everyone. In my remarks this morning I will speak not only to Humana's operational progress, which was the primary driver of our favorable second-quarter results, but also to how Humana continues to invest in innovative delivery and care management support systems to help our members in the post-health insurance reform environment. I will begin with our financial results for the quarter.

For the second quarter Humana earned $2.11 per share on a non-GAAP basis, $0.44 above the midpoint of our guidance. This compares to the $1.67 per share we reported in last year's second quarter. We are very pleased that our underlying operating earnings and cash flows demonstrate solid operational progress in both our business segments for the first half of this year.

As we look ahead to the remainder of 2010, we now expect full-year earnings per share in the range of $5.65 to $5.75, reflecting our improving operating results, higher-than-expected favorable prior period claims development, and the write down of deferred acquisition costs as well as some offsetting newly anticipated expense items for the back half of 2010, all of which Jim will discuss more fully in his remarks.

We continue to experience strong operating performance in both our business segments and believe we are positioned to ensure that momentum carries on in the long term. To that end, continuing to gain traction with our Medicare Advantage 15% solution becomes all the more critical.

As we shared with you in the past, there are four primary elements to the 15% solution. One is the early identification of members most in need of integrated care. Two, ensuring that our members benefit from the integration of clinician-based support, pharmacy solutions, physician guidance, and wellness and productivity initiatives that all comprise our clinical guidance model.

And three, managing claims costs through diligent, timely reviews of provider coding and admission status as well as industry-leading fraud detection. And lastly, analysis of our physician outcomes versus utilization to ensure we develop an efficient and effective network for our members.

I will spend the bulk of my remarks this morning discussing how our progress on the 15% solution increasingly creates a value proposition that we believe will continue to be appealing to seniors for many years to come. I will also highlight Humana Cares, one of the many 15% solution clinical programs that provide a great return on investment for both our senior members and Humana.

Let's start with our provider network development activities. Approximately four years ago we began to expand our Medicare network to ensure long-term access for our senior members. We have long believed that Medicare Advantage payment rates would eventually be at parity with original Medicare and recognized the importance of network solutions in helping to address medical costs. This map demonstrates the results of that work to date.

It clearly shows the broad extent of our networks. The key factor in ensuring our Medicare members have the access to doctors and hospitals they need and want, while at the same time providing a more cost-effective alternative thus enhancing our value proposition.

Our networking initiatives are also expected to result in a smooth transition for our private fee-for-service members in 2011. We have filed for network plans around much of the nation and anticipate approximately 95% of our current PFFS members will have the option of either remaining in their current plans or transitioning to a network plan next year.

Now let's look at how our clinical guidance positively affects health outcomes. I would like to briefly describe Humana Cares, a good example of how we put the 15% solution into action. Humana Cares is a new holistic approach to consumer engagement whereby a multi-disciplinary team coordinates a Medicare Advantage member's care in close cooperation with the member, the member's doctors, pharmacy, family, and community-based resources.

This complex, chronic care management program focuses on the member in his or her experience, not just the case or the disease. The program employs predictive models to identify individuals before critical events occur.

A primary nurse is assigned to the member and becomes that individual's personal contact and advocate across the healthcare system. This primary nurse works with a team, including physicians, who continue to own the treatment plan, family, community-based support, and behavioral and social service experts. The member also becomes an active participant by developing individualized self-care goals which support behavior change through proven psychological techniques while maintaining the critical support system I just mentioned.

This program is especially effective with our most fragile members, many with multiple chronic conditions and restrictions on activities of daily living. More than 75,000 Humana members are projected to participate in the Humana Cares program this year. For those who have been in the program at least a year, clinical outcomes include reductions in hospitalizations, which are down 36%, emergency room visits down 22%, outpatient procedures down 14%, and physician visits down 23%.

The improvements in quality of life are equally impressive. As detailed on the chart, Humana Cares members report life-enhancing progress across a number of factors including health status, pain level, sleep disruption, and depression. Further, an independent survey revealed that 77% of Humana Cares participants are more confident and comfortable proactively addressing their medical conditions.

Humana Cares is only one component of our broad-based 15% solution. Let's step back and take a look at how the four major elements -- early identification, clinical integration and guidance, claims cost management, and provider contracting -- come together in an integrated fashion to provide comprehensive results.

A comparison of Humana's utilization to traditional Medicare provides an overall snapshot of the effectiveness of the 15% solution. Inpatient acute admissions were more than 7% less for Humana's Medicare Advantage members compared to traditional Medicare, while the hospital readmission rate within 30 days of a discharge was approximately 9% less. As expected, outpatient surgery visits were 30% higher. Emergency room visits declined nearly 16% with only a nominal change in physician office visits.

I often speak about productivity gains in Medicare spending. Increasing outpatient surgery volume traded against lower inpatient utilization is a good example to why such productivity gains are good for the patient and for Humana.

While these utilization reductions are impressive, we equally value the quality improvements in the lives of our members and strive for progress across numerous measures. Comparisons to original Medicare measures have been historically difficult to do -- difficult due to a lack of data transparency, but our industry is now beginning to gain access to more expansive data from CMS. We consider data like that shown on the right side of this slide as further evidence of the value our coordinating clinical efforts add to the good work of physicians around the country.

This work represents a growing body of evidence that healthcare for seniors can be organized and improved, and that our government needs the good work of companies like Humana to help with the solvency of the Medicare program over the long-term. Ultimately, the 15% solution must help position Humana for long-term success in an environment where payment rates are changing. As you can see from this slide, our efforts, though not complete, continue to bear fruit.

This chart shows our current medical cost positioning versus the adjusted Medicare payment rates we ultimately expect to receive as the new Medicare payment quartiles are phased in over the next several years. We are very pleased with the good work that leaders and associates across the Company have done and continue to do here. Were it not for our 15% solution work our Medicare Advantage members would likely have been -- have seen substantial benefit reductions in 2011.

This graph shows the medical cost trend used by CMS in determining Medicare payment rates each year broken down between the current year forecast and the catch-up adjustment as prior-year actual experience becomes known. Clearly there is a disconnect that we believe will get better over time as original Medicare claims history for the most recent payment years completes. The funding formula must, by law, reflect actual cost in out-years as data mature so that the payment rates more accurately reflect long-term cost trends in the Medicare program.

In the interim we have invested the payments we received which were above original Medicare in recent years quite wisely. Using these dollars to not only improve coverage for seniors across the nation, but also to -- one, build expanded provider network systems, some of which have tested and proven innovative payment models, and, two, to build technology-supported care management systems that drive innovative delivery system models. This investment has positioned us to reduce the unfavorable impact on our senior members of the temporary imbalance in 2010 and 2011 between Medicare payment rates and what actually is happening with medical costs.

Turning briefly to health insurance reform. Although it might appear that major aspects of the new laws won't take effect for several years, a number of them are already in place. As you can imagine, ensuring that all elements of health insurance reform are incorporated into our businesses seamlessly is no small task.

We have well over 100 leaders across the organization actively involved in health insurance reform project teams on a daily basis. These leaders represent all lines of business and functional areas. They lead more than 10 strategic teams and more than 30 tactical project teams.

Product filings and rate filings are at or on their way to state DOIs in approximately 40 states. About 20 Humana leaders from a number of functional areas are actively involved in regulatory committees at the NAIC, AHIP, and the American Academy of Actuaries. A number of external experts linked to reform are also providing us additional perspective.

By quickly establishing appropriate processes we are moving down the path to ensure what we believe will be a smooth and effective ongoing transition for our members over the next few years. With initial commercial business implementation deadlines of September 23 of this year we believe we are well positioned. In fact, within a month of the bill's passage we demonstrated our commitment to rapid progress by becoming one of the first companies in our sector to offer coverage for dependent children up to age 26.

With respect to our TRICARE business, the Department of Defense has issued several RFP amendments since our last earnings call, each superseding the previous one. However, just this past week we submitted our final proposal revision to the TRICARE management activity. Our team has shown its metal in dealing with the many starts and stops that are inherent in this process.

Given this uncertainty, our projections continue to assume the contract will transition to another carrier after the first quarter of 2011 though we continue to be hopeful that we will retain the contract.

Turning now to our Commercial segment. Our underlying operating results have improved substantially versus the prior year. Non-GAAP second-quarter pretax earnings for this segment were $115 million compared to the $35 million we reported for Commercial segment pretax earnings in the second quarter of 2009. This improvement reflects a combination of pricing discipline, lower levels of healthcare services utilization, and our focus on lowering administrative costs.

With respect to membership, we continue to adjust our commercial footprint to focus on those geographies where we can compete and win. We are also working to increase the value of each commercial member through cross-buying opportunities for our specialty, financial protection, behavioral health, and mail order pharmacy products.

Nationwide reform is likely to increase the individual market over the long term by between 23 million and 40 million new eligibles, according to a recent McKinsey study. While it is clear the individual market represents a significant growth opportunity, we will need to learn more about the regulatory implications of states' approaches to product offerings and exchanges to fully assess this opportunity.

What we do expect is that the knowledge we have accumulated through our more than 25-year focus on the retail senior population will serve us well in this market, which clearly is going to evolve toward a more individual consumer focus.

In summary, some have expressed concern over future growth opportunities in Medicare Advantage. In fact, a congressional budget office has projected significant disenrollment across the sector as payment rates move towards original Medicare. Against this backdrop we believe the higher quality and lower costs embedded in our 15% solution will enable us to continue to grow.

This is particularly good news, not only for seniors enrolled in Humana's Medicare Advantage plans, but also for the millions of baby boomers nationwide who will age into the Medicare program in coming years.

With the continued success of our consumer-oriented approach to health benefits and now to lifelong well being, Humana faces the post-reform future with confidence. Our aggressive approach to preparing for and implementing reform is already paying off. Our traditional strength in Medicare Advantage and in the one-to-one approach is directly in line with two post-reform megatrends -- the coming vast expansion of the individual market and the age wave of baby boomers moving into Medicare.

Through it all we continue our relentless and successful focus on four operating principles that have served us well and we expect will continue to do so for years to come -- consumer-focused products, industry-leading costs, robust actionable data, and constant innovation to help our members improve their health and well being. We look forward to expanding upon these concepts with you at our Investor Day on November 18 here in Louisville. Regina can provide details regarding that event off-line.

We are pleased with this quarter's operational progress and believe our forecast for the full year of 2010 demonstrates the success our associates and leaders can achieve despite the numerous changes faced by our sector today. With that I will turn the call over to Jim Bloem.

Thanks, Mike, and good morning, everyone. I would like to begin by detailing the changes in our earnings per share since we reported the first-quarter results on April 26.

As Mike alluded to in his remarks and as indicated on the slide, there were several significant items that affected our earnings per share for both the second quarter and our full-year 2010 outlook. First, during the second quarter we recorded $148 million or $0.55 per share of expense to recognize the substantial impairment of deferred acquisition costs, or DAC, associated with our individual medical product line. These costs, which include first-year broker commissions as well as underwriting and other policy issuance costs, had been capitalized and then amortized over the life of our individual medical policies.

We account for this line of business as a long-duration insurance product due to the guaranteed renewability provisions of the various contracts. Plus, our fundamental approach to underwriting these plans. This results in pricing this book of business with a policy lifetime target medical expense ratio.

From an accounting perspective, the amount of DAC on the balance sheet is continually compared to the ongoing actuarial assessment of the financial performance of these policies in order to determine whether the DAC asset is recoverable or impaired. In the second quarter our assessment of the impact of health insurance reform, including among other things the 80% minimum medical expense ratio, resulted in the DAC impairment charge.

Additionally, in order to meet our new lifetime policy target medical expense ratio we expect to record an additional $38 million or $0.14 per share of individual medical policy reserves in the second half of 2010. Thus as the slide shows, a total of $186 million or $0.69 a share of expenses will be recorded this year to conform our existing individual book of business to the mandates of the new health insurance reform legislation. Neither the DAC impairment charge nor the additional policy reserves affects 2010 operating cash flows.

Second, we experienced an additional $38 million or $0.14 per share of higher-than-expected favorable medical claims development from prior years during the second quarter. As you may recall, we experienced $100 million of greater-than-anticipated favorable development during the first quarter. So with the additional $0.14 per share we experienced during the second quarter, we now have included $138 million of benefit from favorable development in our year-to-date earnings.

The additional $38 million of prior-period development recorded during the quarter consisted of $25 million associated with the Government segment and the remaining $13 million being derived from our Commercial segment.

Third, and turning now to our 2010 operating performance, we also experienced approximately $79 million or $0.30 per share of greater-than-anticipated favorable development from the first quarter's medical expense estimates. This amount was recorded during the second quarter.

Approximately $52 million of this $79 million related to the Government segment with the remaining $27 million coming from the Commercial segment. Much of this favorable development was due to a lower level of healthcare services utilization which has continued through the second quarter. Accordingly, first half year to date affects -- the first half year-to-date effect of these lower medical costs trends drove the majority of our over-performance in the second quarter.

I will elaborate on these trend improvements by business segments in just a minute, but as the slide shows we have been cautious about reprojecting these lower utilization levels in our outlook for the second half of the year.

Continuing with operations, the second quarter also benefited from favorable performance in most of our ancillary and specialty lines of business, as well as better-than-expected selling, general, and administrative cost reductions. In the first half of 2010 we have made significant progress in realigning our cost structure and organizational competencies for the future.

Finally, and still with respect to 2010 operations, as we move into the second half of the year we now anticipate investing $75 million or $0.28 a share on two things. First, certain targeted growth initiatives for our senior products business and second, enhanced infrastructure.

For our senior business growth initiatives we have identified specific opportunities that we believe will enhance our ability to continue to grow membership in 2011. We look forward to sharing more of the details around these efforts in our third-quarter earnings call when we anticipate giving initial 2011 earnings guidance. That call is scheduled for November 1.

With respect to the enhanced infrastructure costs, we foresee investment spending on such items as increasing our capabilities with respect to the CMS five-star quality rating system as well as continuing to build out our data capture and recording capabilities as required by the new health insurance reform law.

To conclude this section, there were several significant items moving in opposite directions with respect to our second-quarter results and our increased 2010 earnings guidance. Also, it's important to note that while we hope to retain the contract, our earnings guidance continues to include $50 million to $75 million or $0.19 to $0.28 per share of TRICARE charges associated with the loss of the south region contract.

Turning next to the Government segment. As I previously mentioned, our second-quarter results included $77 million of greater-than-anticipated favorable development, $52 million of which was derived from the first quarter and the remaining $25 million coming from the prior years. Looking at our strong overall government segment first-half results, we experienced better-than-expected performance primarily in our network Medicare Advantage offerings, especially in our PPO plans.

As we have discussed before, we have added approximately 190,000 group Medicare members to our regional PPO plans in January. We have been pleased with the performance of these new groups, which experienced lower first-quarter medical cost trends than previously estimated. We invested significant time and upfront effort when we enrolled these members in order to ensure that they were quickly integrated into our care coordination processes and clinical outreach programs. Accordingly, we have experienced lower-than-expected utilization of outpatient and physician services as well as a higher generic substitution rate for these members.

As I mentioned in my opening remarks regarding our full-year earnings outlook, we have been cautious in projecting medical costs in the second half of the year. We have not assumed that the first-half utilization improvement will continue at its current levels through the second half of this year.

In addition, since we experienced a significant increase in new group Medicare members on January 1 we also remain cautious due to the possibility of a durational effect. A durational affect results in lower-than-normal claims costs during the initial month of membership with claims reaching normal levels after the transition period is complete.

Moving on now to the Commercial segment. Second-quarter results included a charge of $148 million from writing down our DAC asset, as I previously described. Additionally, we experienced $40 million of greater-than-anticipated favorable claims development, $27 million of which was derived from the first quarter with the remaining $13 million coming from prior years.

On an operating basis, we are also pleased with the improvement in both our retail and group offerings. You will recall that last year we began experiencing higher-than-anticipated trends during the second quarter as a result of a number of issues but primarily the deteriorating economy and the job markets.

Thus comparing our year-to-date this year to year-to-date last year we have experienced lower-than-anticipated medical costs trends, and in particular we have seen nearly flat overall physician costs combined with negative inpatient admission trends and only a modest uptick in our outpatient utilization in the first half of the year. These trends also have been widely reported in the media. Once again, however, we remain cautious about reforecasting these trend improvements through the full year and would also note that we will have some newly-mandated benefits from health insurance reform beginning in the fourth quarter.

In summary, we are pleased with the turnaround and overall improvement in our commercial business this year, especially after a very challenging 2009.

Turning last two operating cash flows and capital deployment, we also are pleased to note solid progress on both these items. First, with respect to operating cash flows, we continued to generate strong second-quarter operating cash flows of $325 million versus $162 million in the second quarter 2009. This brings our total 2010 first half to $1.080 billion versus $207 million in the same period a year ago.

As we detailed in our first-quarter earnings conference call, this year's first-half cash flows from operations benefited both from the nearly $190,000 increase in Medicare Advantage members since year-end versus the first six months of last year, as well as the accompanying normal initial claims payment lag. Conversely, in 2009 the first half was unfavorably impacted by significantly greater PDP membership losses and corresponding claims run-off when compared to the first half of this year. Consistent with our improved but yet cautious earnings guidance for this year, we have raised our 2010 operating cash flows guidance range to $1.3 billion to $1.5 billion.

Second, with respect to capital deployment, we completed our annual discussions with the various state departments of insurance and the credit rating agencies during the second quarter. These discussions included reviews of our current statutory and surplus levels, our 2009 performance, and our 2010 projections for each of the major operating subsidiaries. Based on these discussions, we have remitted $747 million of dividends from the various operating units to the parent company this year. These dividends were the principal factors in the increase in our parent cash and investments to just over $1 billion at June 30, 2010.

We continue to both have and conserve ample liquidity and capital, which in turn continues to provide us with the financial flexibility needed to compete effectively in the new environment as it is unfolding.

We were pleased to repurchase $50 million worth of our shares late in the quarter following the conclusion of our discussions with the states and the rating agencies. Our capital deployment efforts remain focused on effectiveness-building capital expenditures, potential acquisitions, and strategic investments, as well as additional share repurchases.

To conclude, we are pleased with both our overall and operating results for the second quarter. We are confident that our updated 2010 earnings guidance range of $5.65 to $5.75 per share reflects the organizational experience and confidence that we have, as well as our continued discipline and intentional approach to the current and coming operating environment.

As we move into the second half of 2010 we believe that we are both able to help our members face the uncertainty of the coming health insurance reform changes, as well as to remain financially strong and flexible as a company. Accordingly, we believe we are well positioned for continued success in providing high satisfaction to our members and solid operating results to our owners.

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

Joshua Raskin, Barclays Capital.

Good morning. First question just relates to Government segment and maybe more specifically your Medicare margins running a little bit above your 5% target. So curious just in terms of the timing of the recognition of that positive trend and maybe juxtapose that with your June, first week of June bidding and how we should think about margins for 2011. Did you know about all the good news or do you think some of this trends into next year?

Josh, I will start by again setting the context. We always have said we are targeting a 5% overall and we did that again in the bid process. The only question is where were we in terms of these trends.

There is no question that costs have softened up some this year, but we don't make any long-term assumptions off of relatively short-term data. So I think what we -- we did what we normally do. We bid based on what we knew at the time and put a 5% target for our overall business in place.

I guess my thought is sort of understanding every year you target that 5%, but if you see favorable trends running post the submission of your bid it's fair to assume that that continues because your bids were just too conservative now with more hindsight?

That is the only way that can work. But even the 5% -- as you know we always continue to work on that. I target my bids at five; I always want to run better if I can because it means I am getting further down the path of solving my 15% problem.

So again the 5% is a target. We bid it that way; we try to always improve it. We reset it and if what you are describing, which is happening to some extent here, we get a little bit better news it's something that you can't do much about it, the bids are already in.

Right, okay. And then just sort of related to that, could you talk a little bit about the change in benefit design for 2011 maybe versus some of the changes that you made in 2010? Would you say it's not as dramatic, more dramatic? How did you guys think about it from a bidding perspective?

This is Jim Murray. Mike went into a lot of detail around the 15% solution and also talked a little bit about the trend environment that we were beginning to see as we did our bids, and so I would suggest that next year's not only benefit design but also the premiums will be very positively received by the senior members that we currently have or that we hope to acquire next year.

I think that one of the things that we had as a going-in desire was to reduce member angst or disruption, and we feel very, very pleased with the way we were able to accomplish that in the bid process.

I am actually anxious to see where the rest of the industry comes out on this, because I know in Washington there is a fair amount of fear that premiums are going to shoot up or benefits are going to go down or some combination of both as a result of no premium increase, given what we know the trend to be. So it will be interesting to see what happens for the industry.

I think we are in a little different spot because we have been working at this a little bit longer and we are starting to see some good traction around some of our medical management work.

Got you. And then last part of that, what date do you send your letters out to our current members on the new benefits?

I believe it's sometime in early October.

Late September.

Late September.

Okay, thanks.

(Operator Instructions) Justin Lake, UBS Investment Bank.

Thanks, good morning. First, just given the introduction of new government-mandated benefits via reform, I was hoping you could talk about what you think the impact of these benefits will be to cost trend and pricing starting in the fourth quarter and into 2011.

This is Jim Murray. On the Commercial block we have looked at the benefit changes that were mandated and for our small group and large group we don't think it will have a significant impact. The line of business that it does impact primarily is our individual, our Humana One block of business.

I have heard or read about ranges that have been thrown out there of 2% to 4%, and I would suggest that the impact that we are seeing would be on the higher end of those ranges that I have read about. But we feel very comfortable with our ability to absorb that cost increase given where we are running on an MER basis and the 80% target that is in place for 2011.

That is helpful, thanks. And then just a follow-up on the Medicare Advantage side. The table that you put in the slide deck here that looks at your costs versus fee-for-service is interesting.

I am just curious, can you give us some color there given -- clearly you have done a great job in the HMO and that has proven to be sustainable. Can you talk a little bit about how the private fee-for-service book and the PPO book look versus fee-for-service costs and how you are able to take costs out there?

Justin, we have been talking about this for a long time; we have been working at it for a long time. I mentioned in my comments that we have been receiving, obviously, payments above old Medicare. We have done two things with those. We have improved the benefits for the seniors just on a pure benefit design perspective, but we have also been investing in taking what we can of what we know about managing and organizing and coordinating healthcare and trying to take it to those looser models, which are the PPOs and the private fee-for-service.

So we have been expanding that across the country. We have been growing those capabilities. We have been adding people, technologies, and platforms, and everything we can do to take best-known methods over to those more loosely operated plans and we are seeing some decent traction. That is why we have some work to do over the next few years though. We have some work to do to get those type of plan as productive as we can possibly get them in terms of medical spend and that is where the focus is.

So are we optimistic that we can take good management across all these products? Yes. The most effective organization structure is a well-run HMO, that is a fact, but HMOs are not attractive to everyone. They are new ideas as you take them through much of the Midwest and parts of the western part of the US. So we have to take a product that people are interested in in the short term as they get comfortable with being in the private sector.

And so I would characterize the whole thing as it has gone well. We have a lot of upside still. It's one of the reasons we have a fair amount of confidence over ultimately meeting the targets that are necessary for Medicare Advantage to have a long-term, big footprint.

Mike, that makes perfect sense. Is there a number you could put on even the PPO side? Is it 2%, 5%, 10% that you have taken out?

The chart that was included in Mike's slide deck included obviously the HMO, the PPO, and the private fee-for-service. I would suggest that the PPO is performing better than the private fee-for-service and not as well as the HMO, but we are well on our way toward the 15% solution in all of the lines of business.

And as you know, private fee-for-service ultimately goes away and becomes a network-based plan over the course of the next several years. But we are making very good progress on the not only regional but local PPOs.

Justin, I would also remind you that if you look at the bill in terms of how the payments ultimately come down, there is a little bit of breathing room in some of these more rural areas because the rates don't drop as far giving us a little more breathing room, a little more time to go into those areas where it is harder to introduce an HMO.

Absolutely, makes sense. Thanks, guys.

Kevin Fischbeck, Bank of America Merrill Lynch.

Okay, great. Thanks. You guys have talked about targeted cost saves on the D&A side of $100 million this year and $200 million over a little bit longer time period. And I want to get a sense of whether the cost saves that you are seeing here are an acceleration of that or whether you feel better about maybe exceeding that cost save outlook.

What we have done this morning is basically, if you look in the comparison of the second quarter of last year, you can see that in absolute dollars spent we only spent $10 million more in the quarter than we did last year. That is 1% and we had a 9% increase in our admin or in our revenues this time, so we are getting real operating leverage.

And then what that translated into is, if you look in the SG&A ratio guidance and you look at the things that we called out special, the spending and the other things, you will see that we actually are taking that ratio down by 10 basis points for the year. So we think that we are ahead of schedule. If you look at our employment levels, all the commitments we made at the beginning of the year, we are making very good progress on the $100 million we expect to save this share and the $200 million run rate.

Okay, so those two numbers still stand then?

Yes.

And I guess the -- I appreciate maybe giving me some more color on some of these initiatives in Q3, but I guess wanted to get a little bit of a sense now for the extra spending on the Medicare initiatives. What drove the process now versus a quarter ago at the beginning of year? And then is this something that should be an ongoing (inaudible) above the baseline or is this something that is kind of one-time spend heading into a difficult rate cut year?

This is Jim Murray. As we looked around to some of our competition and what might likely happen with some of the private fee-for-service membership that they currently hold, we saw a tremendous opportunity to make our name more well known to those 500,000 to 600,000 private fee-for-service members that are with our competitors now. And there is other products that we would like to introduce this 2011 that we want to get some media recognition for that came together very nicely as we were doing our bid process. And so that is why we didn't talk about them last time.

So we are very, as Mike said earlier, very focused on growing our Medicare business. We think that the spend that we are talking about here, some of which is probably ongoing and it has been for the last several years, but because of some of the wonderful opportunities that we see out there for 2011 probably some of it is, as you described, one time in nature.

Okay, great. Thanks.

John Rex, JPMorgan.

Thanks. Could you just compare or maybe actually contrast for us what you are seeing in terms of the lower utilization you are noting? When I say contrast I mean within the government book as against the commercial book. Is it just trending directionally the same? Are you seeing anything unique in terms of the patterns of the lower utilization trends there?

This is Jim Murray again. We are seeing a slowdown in the utilization across all the book. However, I would suggest that where last year we saw a pretty big acceleration in costs in our commercial lines of business and not so much in the Medicare, the impact of the favorable is not as strong in the Medicare as it is in the commercial this year.

It just seems like folks who are in the commercial environment who get their coverage either by paying for it themselves or through their company, it appears like that utilization is more impactful this year than I would say that the Medicare business has been. We have tried to evaluate all of the things that might have caused that.

I think Jim was very clear in all of the things that we have looked at. We looked at last year's economy versus what might be impacting things this year. Obviously some of you have proposed that there is a high deductible health plan impact that is going on and there is probably some of that. The light flu season is contributing, and then that naively we would like to take some credit for the good work that we do here, not only in the Medicare space but also in the commercial space in terms of our care coordination activities.

So there is a lot of things that come together, we think, to create what we are seeing this year.

John, let me add to the end of that, we have talked about it for years that Medicare is not real cyclical in nature. Occasionally you can get a flu season or something that will change things a little bit, but generally it's relatively stable. If you look at the economics and the structure that sits with these folks that are in Medicare, that actually makes a lot of sense because they don't have the same economic impact from changes in the economy and this sort of thing.

So again it looks like that is holding to be true again. Medicare is a more stable business. It can be event driven as we saw last year, but when it comes down to cyclical in nature it doesn't seem to have much of it.

So while lower magnitude than the commercial book, I mean you are seeing the same -- would it be fair to say you are seeing a decline in utilization in all four of the major cost buckets in Medicare also, like you are in the commercial?

That would be a fair comment, yes.

And are you attributing that to the economy also when you think about -- I know you talked about some of the group business you picked up. But when you think about your same-store membership, however you want to characterize it, are you attributing that to more of the economic impact?

No, we are not. What we said this year was we have gotten new members and those members -- we are looking at somewhat of a durational effect. But remember I said also, we spend a lot of time with our new members getting them enrolled, getting them introduced to our clinical integration, our outreach programs. We think of the Medicare side that has been very helpful.

Sorry, I was thinking about kind of ex those new members, that impact that you described in your comments. When you think about kind of your same-store membership, when you look at that is that just trending then same as -- you haven't seen a change in utilization in those legacy books then?

Yes, not as much. And again that sort of goes to Mike's comment that Medicare year in and year out sort of is much more constant.

Okay, great. And just the last thing, you did make -- you made one interesting comment, you were seeing lower unit costs on the inpatient side also. Could you describe what you are seeing, what is driving that?

Lower utilization, not rates.

Okay. I saw in your prepared commentary also a comment that unit cost was also down on inpatient. Did I misinterpret that?

I believe so.

Okay, thank you.

Carl McDonald, Citigroup.

Thanks. I was wondering how much you guys intend to rely on network fee-for-service plans next year. I guess maybe it's -- basically what I am getting at is how much of your private fee-for-service membership has a fairly seamless transition over to a new product versus how much of it will actually have to disenroll and then reenroll in say like a PPO?

As we talked I think last quarter, there is about 25,000 members that we are not going to be able to have a network-based solution for and we are going to proactively go out to those folks I talk to them about our Medicare supplement products. But generally speaking, all the rest of our members have a network option that we can talk with them about via a network private fee-for-service or a local PPO, a regional PPO.

So we feel very good about our transitioning from the private fee-for-service to the network options that has been a large part of our strategy for years and years and years.

Right, what I am getting to is -- maybe I am misinterpreting this, but my understanding was if you are moving someone from a fee-for-service today to a network fee-for-service it's a fairly easy transition. A senior doesn't have to do anything when they move over to the new product, whereas if you have got to move someone from fee-for-service to a PPO there is actually some interaction that has to take place on the part of the senior.

Of our 430,000 I think or so private fee-for-service members we think that about, as I said earlier, 20,000 of those are not going to have a network-based option. I believe another 65,000 of those folks have a network solution, private -- I am sorry, a local PPO that we will have to sell them into. Then the rest will have a network-based private fee-for-service that the transition is very smooth.

Okay. And then second, on the TRICARE given that we have no final decision and the contract is supposed to transition eight months from now, is it possible that that contract doesn't get extended maybe some period of time beyond the March 31?

They would have to change their historic pattern around transition periods, because historically they have dealt with a 10-month period. Obviously we are already into that. So it's possible they can do whatever they want relative to transitions, but if they stick to the past practices they will have to extend it.

Great, thank you.

Ana Gupte.

Thanks, good morning. My question is about your competitive advantage for Medicare Advantage and how sustainable that is. I think last week one of your commercially-focused competitors made a comment that MA is a very attractive space. So would you be able to elaborate on to what extent from networks product distribution, med management, and the 15% solution and servicing it's very unique to the senior market versus you can leverage your strength in commercial elsewhere?

Well, I read that comment. Actually I have been surprised over the last 15 years, frankly, that we haven't had more people get serious about entering the Medicare market because you have heard me, I talk about this 100 times, it's a tremendous opportunity. Because of the incredible waste and abuse and nonsense that goes on in the Medicare program, the traditional Medicare program is a mess and so it represents a huge opportunity to drive productivity, organization, and all that which makes the economics work. And that has been Humana's position in for a long time and it stays that way.

So do I expect others to try to get into this market and do well? Yes, of course. And I think the answer is going to be is it possible. It's difficult to do; it has taken us a long time. We have been at it for 25 years to build out the level of understanding, data systems, infrastructure, the knowledge of the individual retail sale. All those things require some learnings and you can't go buy them off the shelf anywhere in the marketplace.

So do I expect more competition? You bet. And are we concerned about it? Not really. I think we are going to enter a period over the next -- a short period, the next two or three years, where we are going to have people leaving the market.

Jim talked about it earlier, this next year around we are going to be dealing with hundreds of thousands of people that are in private fee-for-service where we know that the companies are going to put them back in the marketplace. And so it's always a work in progress, there is always something happening. We have been successfully competing in this space against others for a very long time, so I don't know that anything is going to change. I like us.

And new term when you look at the product bids are you receiving any market intelligence as to what might be going on and who will be players that might exit and come in more strongly?

Well, we always have the rumors that you probably have from the marketplace and we try to keep our ear to the ground. But we won't know specifically what anybody has done until the cards are all turned over later in the year.

And then a related question, but not exactly on MA. Do you have any thoughts or commentary on this coding adjustment announcement that came out on the inpatient rates and what the implications are for Medicare Advantage and just broadly from a policy perspective and Medicare?

No, we don't.

Okay. Thank you.

Doug Simpson, Morgan Stanley.

Thanks. Good morning, everyone. Could you just talk about your understanding of how reserve development related to 2010 will ultimately factor into 2011 rebates under the new rules? Just trying to understand the thought process around the specific $0.14 reserve boost in the second half of the year.

Obviously we are waiting for clarity around how the MLRs are going to be calculated exactly, so just wondering sort of your level of confidence around that $0.14. And then again just how do you think PPD will be treated for periods prior to 1/1/2011?

Yes, this is Jim Murray. As I understand it, the runout will be sufficiently long enough that as we have talked on an incurred basis development of the MER and the rebate calculations, so there will be a lot of time for those claims to ultimately resolve themselves and get paid. So I wouldn't anticipate that there would be a problem with the implementation of this too early only to find out that [prior-period] development impacted it one way or another.

So I think the way it's being structured will eliminate the impact of that.

Okay. But if you did a look-back, let's just say, six months after the fact, so in June or July of 2012 they look back to 2011 certainly you would have a read on how 2011 developed. But in the event that you had development in the early part of 2011 related to the latter part of 2010, for periods thereafter it would be I think pretty clear. But just curious, do you think that they will include the latter part of 2010 in that development?

I don't believe so as we are reading the regulations.

So you don't think that late 2010 development would impact the rebate calc?

Not as we are studying and trying to understand the mechanics.

Okay. And is it your sense that -- is that something that is still work in process or --?

I think the whole calculation methodology is still in process, but as to that specific element I would be surprised to see that anything would get changed in that regard.

Okay. And then just, you guys came up with a $0.14 number was that, should we think about that as being within a reasonable range of expectations depending on how the guidelines ultimately come out? Just trying to understand a little bit the thought process around the specificity there.

That $0.14 really isn't related to that particular question. That is just the -- that $0.14 is what is going to happen for the remainder of this year to move to next year.

Coming back to your earlier question, we believe that each year stands on its own with respect to the claims runoff.

Okay. And then I think you may have given these so I apologize if I just missed them, but could you remind us your stat capital and RBC ratio at quarter's end?

Basically we are at about -- we are just around 400% of RBC. We have about $3.8 billion of total surplus and the requirement is about $1.9 billion to $2 billion.

Okay. And then just obviously it's still early here, but any read on the local market pricing backdrop or the chit chat ahead of reform implementation? Anything you can contrast between the different buckets, individual versus small group versus large group, in terms of your conversations with distribution channels? Any read, sort of game theory looking out to next year and how competitors may be positioning?

One of the things that Mike referenced was a lot of the work that we are doing here at Humana around this whole initiative. We have got hundreds of folks that are working on this. One of the things that we are evaluating is how do we want to handle our pricing relative to the 80% minimum MER in the Humana One or small group markets.

I will tell you that as we speak today and what we have seen over the last six months of 2010 is that the pricing environment seems as rational as I have seen it in a long time. I haven't seen anybody trying to accumulate membership. We have been watching for that very closely. It just seems like people are passing their trends along in the form of the premiums that they have come up with.

We haven't seen any dramatic change or anybody trying to do anything to strategize around healthcare reform, and so that is something that we are watching extremely closely. It's something that we talk about every Monday when we have our healthcare reform update meeting, but I haven't seen any significant change in the marketplace.

Peter Costa, Wells Fargo.

Two questions; one on the Commercial side, one on the Medicare side. On the Commercial side your low MLR and your high SG&A almost a foregone conclusion, I assume, that you have to do something here before we get to the MLR minimums in terms of the individual business. Can you talk about cutting broker commissions and the timing on when you would have to let them know, and what your expectation is from what that is going to do to your business when you do that?

And then a second question on Medicare. Do you believe you can get to four or more quality stars in your PPO business, and how will you do that? What sort of timeframe, what sort of things should we look for you to do between now and 2012?

Sure, this is Jim Murray again. As it respects to the commissions, we have a long-standing, positive relationship with the brokers that are a part of our distribution channel. Some of our competitors have come out and said that they are likely to change their commission levels starting in January and we are likely to come out with something here shortly that would suggest that as well.

One of the other teams that we have that is working on the healthcare reform is evaluating what we think the commission levels need to be going forward to make the, primarily the Humana One or individual book of business, the model around that a lot more economically profitable for us as a company. Lots of evaluations being done. We have got some outside help in trying to figure out what might ultimately happen.

One of the advantages we have that others might have is that we have a significant array of different products that we can try to think through in terms of the brokers' relationships with us as an organization. We have got Medicare products, we have got medical products, we have got all of the supplemental and specialty products that we have talked about in the past. We are rethinking our commission structures relative to all those lines of business and seeing whether or we can, to the extent we have to lower commissions on the medical Humana One, perhaps we can do something differently in the others.

All of those things are being discussed we are being -- and evaluated. I will tell you that there is -- with our Humana One business with a minimum medical expense ratio of 80% that we feel comfortable that we can change our administrative cost structure to get to a point where we are breaking even or producing a nice medical or a small medical margin. And that is why we have talked a lot in the past about cross-buying and all those other lines of business that we would include with our medical relationships with those individuals.

So we feel very comfortable over the next several years that our profitability in the Humana One space can be solid. And as Mike said on his call, we are looking forward to the 40 million or so eligibles that would participate in that marketplace. I have talked so much right now that I have forgot your second question.

Second part is Medicare Advantage, can we get to four stars?

In the PPOs in particular.

It's harder because what I said earlier. It's not as well organized; it's not as tightly managed. And so we think we can make good progress there and I think we have got an awful lot of resources and commitment and investment going into that particular thing right now.

Some of it is capturing data. What we know about this sort of thing throughout all of our space is that the data assets can always be better. There is an awful lot of information that resides in physician practices and elsewhere that we are not aware of that would reflect actually better performance.

So we will work really hard to learn what we can about what they are doing with patients. We will apply our clinical activities to improving those results and at the end of the day I think we will do fine in the PPO. But it is harder; it's a bigger lift than it is in an HMO, that is for sure.

The only thing that I would add to what Mike said is that we are working with the regulators to try to refine some of what they are doing around the quality initiatives. If we had a dream, some of the ways that they measure and what they measure would be changed to focus more on quality and outcomes. So that good work is continuing.

If you go through all those measurements for those star ratings, you would find very quickly that they were never designed for this particular purpose. There are some things in there that although they are really interesting and probably nice things to measure, you would never use those to drive payment rates in a program like this because a bunch of them are not really healthcare quality type of things. They are much more consumer experience stuff, which is interesting.

We all work hard on that stuff; that is not what this policy should be driving. But for the moment it is what it is and we will see if it changes.

Okay, thanks.

Matthew Borsch, Goldman Sachs.

Good morning. This is actually Daryn Miller sitting in for Matt. One question, can you just confirm what rate you pay in Medicare on out-of-network hospitals and doctors? Does that just default to the Medicare fee schedules?

For -- most of our out-of-network is Medicare allowable so yes.

Okay. Thank you.

Sarah James, Wedbush.

Thank you. Two questions on the Commercial side. Can you walk us through some of the drivers in the individual reserve boost? What were the big pieces there?

And then second, on the deferred acquisition charge, what is the underlying change in renewal rates that is implied there or maybe what is the lifespan of a contract now versus where do you see it going?

Your question basically highlights a couple of things. One is there are an awful lot of variables that go into the determination of whether or not there was a DAC impairment and then now what those individual incremental policy reserves will be.

We don't get into what each of those are, but you have named a couple of them. A couple of more would be the mandated benefits as I mentioned in my remarks, the minimum MER; the fact that there is going to be rate reviews on how much the review is -- how much rates are going to be allowed. So those are the types of things.

No one of those things -- if you knew one of them you would still be at a loss to figure out the whole thing because of the fact that there are so many of those that actuarially go into the determination of what the policy reserves will be and whether or not there has been a DAC impairment.

Got it. Okay, thank you.

I turn the call back over to Mr. McAllister as there is no more questions.

Thanks for joining us this morning. I want to thank the Humana associates that are on this call for the great work they have done to bring us to where we are this year. We are optimistic about the remainder of 2010. We are anxious to enter the Medicare selling season later this year and pretty optimistic about what our future looks like there as well.

Thanks for joining us. See you next quarter.

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