Humana Inc (HUM) 2014 Q1 法說會逐字稿

Good morning and welcome to the first-quarter 2014 earnings conference call. (Operator Instructions) Thank you.

I will now hand today's call over to Regina Nethery. Please go ahead.

Thank you and good morning. In a moment Humana's senior management team will discuss our first-quarter results and our updated earnings outlook for 2014. Participating in today's prepared remarks will be Bruce Broussard, Humana's President and Chief Executive Officer, and Steve McCulley, interim Chief Financial Officer. Following these prepared remarks, we will open up the lines for a question-and-answer session with industry analysts.

Joining Bruce and Steve for the Q&A session will be Jim Murray, Executive Vice President and Chief Operating Officer, and Christopher Todoroff, Senior Vice President and General Counsel. We encourage the investing public and media to listen to both management's prepared remarks and the related Q&A with analysts.

This call is being recorded for replay purposes. That replay will be available on 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 advise call participants of our cautionary statement. Certain of the matters discussed in this conference call are forward-looking and involve a number of risks and uncertainties. Actual results could differ materially. Investors are advised to read the detailed risk factors discussed in this morning's earnings press release as well as in our filings with the Securities and Exchange Commission. Today's press release, our historical financial news releases, and our filings with the SEC are all available on Humana's Investor Relations website.

Finally, any references made to earnings per share, or EPS in today's call refer to diluted earnings per common share. With that, I will turn the call over to Bruce Broussard.

Good morning, everyone, and thank you for joining us. This morning we reported first-quarter earnings per share of $2.35, with solid performance in our Medicare Advantage, commercial group, and government business. These results are indicative of the power of our integrated care delivery strategy: clinical excellence through coordinated care.

Medicare beneficiaries are benefiting from the progress in our clinical programs through benefit stability and plans with increasing, higher-quality ratings, all in a rate-reduction environment. Individual Medicare Advantage growth during the recent enrollment season was particularly strong, with membership up 13% from the end of last year, as we are able to offer reasonably stable levels of member premiums and benefits.

Though some investors have expressed concern over this level of growth, we believe our ability to enroll our members into clinical programs in a timely manner helps ensure we are assisting members with their health needs. We have been closely monitoring admission, program participation, and pharmacy experience for our new members; and to this point we are very pleased and satisfied across our Medicare Advantage business as a whole and for our Florida regional PPO.

Our innovative delivery model is differentiating Humana by putting customers first, with a goal of making it easy for them to achieve their best health. A key element of this is creating a trusting and engaging relationship with beneficiaries we serve as quickly as we can.

In the first quarter of 2014, we completed health risk assessments for approximately 531,000 of our Medicare members and nearly 8,000 individual commercial members. Further, our sophisticated predictive models have identified approximately 100,000 of our members as potential candidates for the Humana care chronic program or our personal nurse program.

All of this has helped to drive a 31% year-over-year increase in new members in our Humana Chronic Care Program. This program is one of our strongest examples of clinical excellence through care coordination.

Our strategy also continues to enable us to partially offset the negative impact to our members from the ongoing Medicare rate cuts from CMS.

Turning then to the Medicare rates for 2015, we had initially estimated the impact of the Final Rate Notice issued in early April to be a funding decline of 3%. After further analysis, we now anticipate funding to be down approximately 2%.

Regardless, it is still a funding cut in an environment of increasing medical costs. As always, our Medicare bids, product pricing, and benefit design are currently being developed with a goal of achieving our target margin of approximately 5% in the aggregate for all our Medicare products, while minimizing disruption for Medicare beneficiaries.

We anticipate sharing more detail around this later in the year, after our bids are filed and approved by CMS. But at this point we do expect the products we offer in 2015 will continue to integrate clinical excellence through coordinated care, thus enhancing the consumer experience while promoting wellness.

Our focus on enhancing the coordination of our clinical processes continues to provide solid returns on the investments we've made. We now expect to increase those investments by another $100 million to $150 million during 2014, helping position Humana for expanding growth opportunities in a challenging funding environment. This additional investment has been incorporated in the reaffirmation of our guidance we shared with you this morning and generally represents a scaling of the clinical capabilities we have discussed in the past.

Our Part D offerings are facing a challenge this year from the cost of specialty drugs to treat hepatitis C. Although we had anticipated some level of hepatitis C spend in the year, due to a faster approval process and accelerated level of awareness the impact of these drugs has come sooner and is more significant than we planned.

In the first quarter of 2014, we incurred approximately $20 million of expense related to these specialty drugs, net of risk share with CMS. The vast majority of this was for our Medicare Advantage and PDP membership. We believe health plans across the sector will be taking higher hepatitis C specialty drug costs into account for 2015 product pricing.

We are also watching closely the potential rollout of similar drugs later this year, since we expect that can result in another wave of utilization. Our current forecast for 2014 anticipates specialty drug costs will stay at an accelerated level throughout the year.

Turning now to healthcare exchanges, since we spoke to you last quarter we are pleased to experience a growing number of applications, which has led us to raise our HumanaOne growth expectations to a range of 350,000 to 500,000 in 2014. A large portion of this raised expectation took place as the open enrollment period was coming to an end.

This higher projected membership is allowing us to lower our estimated healthcare exchange investment spending as we leverage our operating platform across a bigger base. Steve will elaborate on this further in his comments.

With the open enrollment period now complete, we can begin to evaluate how certain original pricing assumptions are playing out, recognizing that it is still very early and our claims experience for this population has yet to develop fully. The mix of our on-exchange enrollment appears to validate our original pricing assumptions; and as we anticipate and price for, it skewed slightly to a younger population than the industry as a whole.

Our pricing assumptions around our original expected growth in the participation of previously underwritten individuals has been negatively impacted by a number of factors, including the administration's transitional policy changes. We are in the process of evaluating early pharmacy claims and other forms of medical data to evaluate the overall health conditions of our new member base.

Although our original pricing assumptions were negatively impacted by the factors I have just discussed, we continue to believe the overall health condition of our healthcare exchange membership approximates our estimate from 90 days ago. We remain cautious, not to get ahead of ourselves in our interpretation of this data, and are continuing to watch medical claims development for this population but are not seeing any deterioration from our expectations over the past 90 days.

So in summary, we believe that our integrated care delivery strategy is continuing to position us for success. We are growing membership across a number of fronts without compromising on pricing discipline.

The rollout of our state-based contracts is moving along well, and we continue to evaluate ways to apply our clinical model to this expanding book of business. While it is still early in the year, we are encouraged by the indicators we continue to monitor and feel confident in our ability to achieve earnings per share in the range of $7.25 to $7.75 for 2014.

Before I close, I want to also spend a moment on our recent CFO announcement. Let me begin by thanking Steve McCulley for his diligence and dedication while acting as interim CFO. Steve has a strong command of our operations and breadth of accounting expertise. I look forward to continuing to have Steve as part of the management team that sets strategic direction for the Company in his role as Principal Accounting Officer.

Brian Kane will be joining us as CFO June 1 and brings financial and strategic breadth to the role that will nicely complement Steve's operational depth. I look forward to having Brian join our leadership team.

With that, I will turn the call over to Steve for a review of our financials.

Thanks, Bruce. Looking briefly at our first-quarter results, we are pleased to report earnings per share of $2.35 that reflected solid results in our Medicare Advantage, commercial group, and government businesses. These results reflect in large part the impact of strong membership growth in our Medicare Advantage business, as well as favorable utilization trends and favorable prior-period development in both our Medicare Advantage and commercial group businesses, which contributed to the improved benefit ratios in both our Retail and Employer Group segments.

Additionally, we have increased our outlook for membership growth for our Medicare Advantage, PDP, and individual exchange businesses, as noted in this morning's press release.

With respect to pretax results, our Healthcare Services segment reported a meaningful increase in pretax income over last year's first quarter due to a higher contribution from the pharmacy solutions and home-based services businesses, which serve our growing Medicare Advantage membership. Our Employer Group segment also increased its pretax income relative to last year, reflecting a lower benefit ratio that was partially offset by a somewhat higher operating cost ratio, which now includes the taxes and fees associated with the Affordable Care Act, or the ACA, including the health insurer fee.

These improvements in Healthcare Services and Employer Group segment pretax income were offset by a decline in Retail segment pretax income year-over-year, as lower utilization levels were more than offset by planned investment spending associated with our state-based contract expansion and the exchanges, as well as the negative impact of higher-than-expected drug cost in our Part D benefits. These higher drug costs were driven primarily by hepatitis C treatments, which are expected to continue through the remainder of the year.

Despite these higher drug costs and the impact of the new healthcare exchange membership, our Retail segment benefit ratio still improved by 60 basis points compared to prior year, driven by better-than-expected utilization in our Medicare Advantage business during the quarter. You may also recall that prior-year pretax results in our Medicare business also had benefited from the absence of the impact of sequestration, which was implemented effective April 1 last year.

The year-over-year increase in the Retail segment operating cost ratio reflected investments in our state-based contracts and exchanges, along with the ACA taxes and fees, including the health insurer fee.

So, to summarize the first quarter, we are again pleased with the improving utilization in our Medicare Advantage business and the strong underlying performance of our Other Businesses and believe that our continued progress positions us well as we move through 2014 and beyond.

Turning to the next slide, this chart details the items that impacted our updated outlook, starting at the left of the slide. We now see four primary items impacting our initial guidance for EPS of $7.25 to $7.75 per share, which included planned investment spending of $0.50 to $0.90 per share in our state-based contract expansion and the individual exchanges.

First, given strong performance of our underlying core businesses, we now expect to recognize $0.70 to $0.85 per share of net operational improvements for the full year that we had not expected in our previous guidance. This range includes improvements in medical trends and utilization in our Medicare Advantage business, along with cost savings from our ongoing productivity efforts. We believe that our improving Medicare Advantage medical trend continues to demonstrate the value of our clinical model in creating long-term value in a challenging business environment.

Second, based on drug cost trends we are seeing, primarily around hepatitis C drug cost, and expectations for progression of these treatments among our member population, we expect to recognize $0.40 to $0.50 of net incremental expense from our previous guidance related to hepatitis C for the full year. As you would expect, we are actively managing our approach to treatment of this disease and will continue to respond appropriately to developments as clinical protocols continue to evolve and as further treatment options come to the market.

Third, our outlook around the healthcare exchanges has improved, and we now expect to recognize $0.10 to $0.15 per share of improvement relative to the original estimate of $0.50 to $0.90 of investment spending for our state-based contract expansion and individual exchange businesses. This brings our current expectation for spending in these areas to $0.40 to $0.75 per share. This improved outlook reflects the benefit of our increased membership and revenue outlook for the individual exchanges, which leverages our operating platform.

Finally, as Bruce discussed, given the ongoing and demonstrated success of our clinical model, we are investing an additional $0.40 to $0.50 per share for incremental clinical investments, which will better position us for the 2015 rate cuts.

So taken together, these items leave our overall earnings guidance unchanged in the $7.25 to $7.75 per share range which, as I discussed, includes less investment spending for our individual exchange business due to improving scale, and incremental clinical investments. As we have discussed before, we expect all of our investments to position us competitively and further strengthen our long-term growth prospects.

As usual, this range allows for some level of variability in our planned investment spending and any normal fluctuation that may occur in our core businesses. We look forward to updating you when we report our second-quarter results in late July.

Turning next to cash flow, we produced strong operating cash flow for the quarter of $671 million, which compares $412 million last year. As we discussed last quarter, the effect of the 3 Rs will impact the timing of our operating cash flows for the full year.

At the end of March, we had established a receivable of $54 million related to the 3 Rs; and by year-end we now expect to build a total receivable of $575 million to $775 million that will be collected in 2015, the majority of which is expected to be driven by the reinsurance provisions of the ACA.

This range is higher than our previous expectation due to primarily higher exchange enrollment. We have accordingly revised our 2014 operating cash flow guidance to a range of $1.1 billion to $1.4 billion to reflect this updated expectation. As I mentioned in our last earnings call, receivables or payables associated with the 3 Rs should not have a significant impact on subsidiary surplus or subsidiary dividend capacity.

As usual at this time of year, we have submitted our requests to the state departments of insurance that regulate our various insurance companies and have requested a total of approximately $930 million of subsidiary dividends. As you may be aware, the approval process for dividends is subject to additional uncertainties this year due to the treatment of the ACA's industry fees by the departments of insurance. Accordingly, we don't expect to have approval of all of our dividend requests until later this month, after we have filed our first-quarter statutory statements.

To date, we have received approval for over 40% of our total requests. As always, we will keep you apprised when our dividend requests are approved and finalized.

Finally, as announced in our separate press release last week, the Board of Directors has increased our quarterly cash dividend to $0.28 per share. Additionally, as announced today, the Board has also refreshed our $1 billion share repurchase program through June 30, 2016. Consistent with the previous authorization, the refreshed repurchase authorization permits shares to be purchased from time to time at prevailing prices in the open market by a block purchase or in privately negotiated transactions.

So with that, we will open up the lines for your questions. In fairness to those waiting in the queue, we ask that you limit yourself to one question. Operator, please introduce the first caller.

(Operator Instructions) Peter Costa, Wells Fargo.

Hi, guys. Thanks for the question. It looks to me like you're projecting that you're going to get a much greater portion of your earnings this year in the first quarter than you normally do. So does that -- why are we seeing such a different seasonal pattern for you this year?

Part D was vigorous, so that should have depressed your Q1. And instead you had very strong Q1 earnings.

Sequestration should have depressed your Q1 earnings relative to the rest of the year, year-over-year. So can you tell us why you are seeing this different seasonal pattern than you've had in the past?

Sure. Hey, Peter; this is Steve. First, I think if you looked at last year and you adjusted for the long-term care charge in the fourth quarter, we earned around a little over 30% of our earnings in the first quarter. And I think if you take this year and you do the same math you get to a comparable number.

But still you're -- I think the difference is -- what I would also throw in there is that the hepatitis C impact is largely in front of us in the remainder of the year. So a lot of that lies ahead, so that will put some pressure on the remainder of the year relative to the rest, as well as the duals and the investment in the duals that also continues to run between now and the end of the year.

Kevin Fischbeck, Bank of America Merrill Lynch.

Okay, great; thanks. I just wanted to go into the 3R number that you booked here. It just seems like a large number. Am I thinking about it right if I say that at $675 million it's half of your Retail operating income?

Is there -- that number just seems large. Can you put that into context for me?

And I know that, I think last quarter you said the same thing, that the majority is related to reinsurance. But at least from that answer last year it felt like it was more like 60% than 90%. Any sense of or better clarity you can give us about how much is actually reinsurance versus risk corridors?

Sure. Thanks, Kevin. Hey, this is Steve. It is mostly reinsurance, so more than half is the reinsurance. And that is going to move up just with the volume. So as we have added a lot of -- as we have increased our membership estimates, that number has moved up commensurate with that.

That shouldn't -- the thing about the reinsurance number is that number gets larger as we go through the year. It will accumulate. But I wouldn't expect us to be a lot different on a per-member basis around the reinsurance than the other carriers. Maybe the risk selection affects that to a degree.

But we are just -- we are trying to give as much disclosure as we can around what we see. And again, I think it is mainly reinsurance driven, so I will just leave it at that.

But I guess maybe the size of it is surprising to me, in the context of the Retail business. Wasn't sure if you could -- is that the right way to think about it?

And I guess then the implication would be, well, how do you reprice that business over time as the reinsurance numbers and coverage comes down over the next couple of years? Does that imply a big raise in pricing?

Yes; to Steve's point, it is really a math exercise. We have looked at other of our commercial blocks of business, and we have seen the level of claims experience above the reinsurance attachment point; and we have applied that here. We are pricing for 2015 for the wear-off of the reinsurance benefit that winds down over a period of time.

So inherent in our 2015 pricing is the fact that that reinsurance number is going to go down over time. So when we talk about our pricing for 2015, we can see pricing levels anywhere in the single digits to the double digits, and a big part of that double-digit drive is a result of the reinsurance wear-off.

Great, thanks.

Joshua Raskin, Barclays.

Thanks. Good morning. Question relates to Medicare Advantage growth; it seems like you guys have gotten a little more comfort on the medical cost trends becoming a little bit favorable this year. We now know the final rates for 2015. You know your bonus stars, etc.

So I guess obviously the missing piece is the competition and what others do. So I am just curious if you can give us preliminary thoughts on 2015 in terms of membership growth. Should we be thinking about something similar to what you have been able to show? Or is there a cumulative impact to some of the benefit changes that you have to make and we should start expecting a slowdown in membership?

We are just in the midst of our bid process here and estimating 2015 rates, and I think it would be premature to talk about our membership growth for 2015, Josh.

So maybe, Bruce, let me ask a different way then. Longer term, forgetting about just specifically the next year, but as you think about the benefit design changes that you have to make relative to this underfunding that you have mentioned several times, do you still think that Medicare Advantage growth rates should be significantly above population growth in the Medicare book at, say, 3% over the next couple years?

As you think about the next five or 10 years, do you think that your membership growth will continue to outpace that overall market growth?

We have said in the past that we do believe that Medicare Advantage for a host of reasons will continue to grow faster than the population. We see penetration historically growing even in times of rate reductions from CMS.

I think it is evidence of the population preferences and how they have changed over time. And then secondarily, I think Medicare Advantage, because of the improved quality, the clinical programs, and the integrated delivery model offers a much better value than fee-for-service; so we do see it growing greater than that.

I think year-to-year changes in market share and where we grow or our competitors grow faster is really, I think, a result of clinical programs. As I have said on many occasions, the differentiation in the marketplace is who has got the best clinical programs and can offer and really improve the experience and the clinical aspects of the member. We are biased, and we think Humana today is the leader in that.

Justin Lake, JPMorgan.

Thanks, good morning. This is Andrew Tom in for Justin. Can you give us a breakdown of the $100 million to $150 million incremental clinical investments, and where that spend is going specifically?

Sure. This is Jim Murray. Obviously, we grew fairly significantly, so we are going to hire a bunch of clinicians in a lot of the programs that have been beneficial for us. The one program that we talk quite a bit about is the home care services, where we put nurses in front of seniors who need our support services to maintain themselves in their home; and that has been a very effective program for the seniors to maintain themselves in their home environment, as well as for us, because what we are doing is deferring or eliminating an ultimate hospitalization or a nursing home stay. So that is a big area of focus.

Other things we are focused on doing are looking at some remote monitoring tools and techniques to help us with those kinds of chronic programs. We are also looking at the engagement levels of some of the individuals who participate in our programs, and we are working with the folks in our Centers of Excellence to try to develop ways to get more people to participate.

And so we will spend some money in that regard really, again, focused primarily on hiring clinicians in a lot of areas that are around our integrated model and having us focused on root cause, as opposed to the ultimate event around a hospitalization or a nursing home visit, and shifting the way that we think as an organization.

And I think that has been paying some dividends. When we get the opportunity to invest in those kinds of things, we are going to take it.

Ralph Jacoby, Credit Suisse.

Thanks, good morning. Going back to the 3Rs, I know you said that more than half is the reinsurance piece. But I was hoping you can give us how much of the receivable relates to your estimate of the risk corridor. And are you concerned at all with the budget-neutrality aspect and actually getting paid for that piece?

Thanks. Hey, this is Steve. Probably the smallest amount will be the risk corridor in the full year -- as we look at the full year. In the quarter, we reported $54 million for the three, and about $13 million of that was risk corridor.

With the budget neutrality, there's -- we don't see any problem with that certainly for 2014. Because CMS, number one, they believe that there are sufficient funds to pay all the risk corridors currently.

And to the -- I guess there is theoretically a possibility that down the road in 2015 or 2016 there could be -- if there is a shortfall, we would contemplate that when we think that that comes into play. But for 2014, we are very comfortable that the risk corridors are appropriate to record.

And that is a small component of the number, that --

It is.

When you say small, is it under 10%, 5%? Just any range?

Probably for the -- I would say 15% to 20%, 10% to 20%, maybe something like that.

And the way the math works is pretty simple. It's just if you didn't get paid for that it would just be 10% to 15% of that receivable brought to the bottom line would be an earnings impact. Is that the way to think about it if we wanted to take that stance?

Sure.

Okay, all right. Thanks very much.

Matthew Borsch, Goldman Sachs.

Yes, hi, good morning. Can you just maybe talk us through the factors that drive your confidence on the medical trend for Medicare Advantage this year? Recognizing, obviously, good start to the year.

I am just wondering what you are looking at that makes you feel confident that better-than-expected trend will be the theme for the full year.

Sure. The admission rates that we are seeing are very, very favorable, not only for the first quarter but they continue into the second quarter. Some people have said: well, gosh, that is because there was such a bad winter. But I would point out that most of our Medicare membership is in the Southwest, in the Southeast, and in particular Florida.

We don't have a tremendous amount of Medicare members in the Northeast. So our admission rates are very, very favorable, we believe in large part because of some of the clinical program investments that we are making. We are looking at pharmacy information and what is happening from a generic use rate perspective and a mail order use rate perspective; and that is very solid.

The number of people that are getting enrolled in all of the programs that we are constantly evaluating is increasing. The predictive modeling tools that we develop that identify folks faster and give us the opportunity to have a conversation with them are working better.

So a lot of the things that Bruce has shared with you many, many, many times in the past seem to be creating a fairly favorable utilization environment. And so we feel pretty good about that and that is why we took the step of wanting to invest more so that we set ourselves up better for the future.

Fantastic. Let me just ask one other question if I could, which is back to the commercial side and the 3Rs. Just so I understand on the risk corridors, I thought the way it was going to work was it was going to be budget neutral; so that regardless of how much money HHS has, if there was more net deficit than surplus across all of the plans in the exchanges and all of the individual market that HHS would make a proportional cut to the amount of recoveries that the plans would get. Is that a misunderstanding?

No, I think that's true over the course of the entire three years, Matt. But if there was a net deficit in 2014, then they would take proceeds from the 2015 and move it in, and settle up 2014. So you don't really get -- you wouldn't get into a collection issue until further into the program, if that persists.

Do you see what I am saying? Does that make sense?

Thank you.

Matt, just to carry on that conversation, keep in mind, one of the reasons why we're in this circumstance is as a result of the transitional policy that was decided by the administration around the underwriting and people being able to keep their own plan. So as we think about this and what it is impacting in 2014, and taking dollars from 2015 to 2014, it really is a result of that policy change that is driving some of the circumstances we're in.

Carl McDonald, Citigroup.

Great, thanks. I was looking to get at the starting point to think about for 2015 earnings. So the two questions I would have would be, would you view the $0.40 to $0.50 of new investments in clinical programs as one-time or recurring? And then secondarily, any one-time benefit, whether favorable development or anything else, that you would call out as being unusual? Similar to the -- I think it was the $0.45 that you highlighted when you gave the 2014 guidance.

Hey, Carl, this is Steve. On the clinical investments, we -- the way I think about those is they are recurring, but there will also be recurring benefits that go with those, too. So when you look at the waterfall slide that we presented, the first one was a favorable item of $0.70 to $0.85. A lot of that was due to the investments we made in the prior year in those same -- in similar programs.

So yes, we will continue to invest in the clinical programs, but there will also continue to be a benefit from that.

Great, and then anything from a favorable development perspective that you would call out?

No. It's is too early to tell. I think in the first quarter, we had a little more than we expected; we will see how the rest of the year plays out. And as we get further into the year and see how the rest of it -- see how the full year plays out and we give 2015 guidance, we will update you at that time.

Appreciate it. Thank you.

Sarah James, Wedbush.

Thank you. Retail earnings guidance was lower, but MLR was maintained, so I just want to make sure I understand the moving pieces. You just mentioned admissions were down, but MLR guidance was held flat; so I want to understand if the delta there was solely Solvadi, or if there was anything going on, the acuity side or price per admit side.

And then since MLR was flat, it implies SG&A went up. So I just want to make sure that just the investment spend and nothing else is moving around in your assumption.

I think that's right, Sarah. I think the only -- and I'm assuming you are talking about the Retail segment specifically. If that is the case, then what you would have in there is improvement in the MA trends and you would have then the hepatitis C and the higher drug costs and those things are all moving around in the benefit ratio range that we give in aggregate. So nothing really else happening there.

Got it. What about the new members coming in? Is there anything that you could spike out on how they differ from your existing book?

Are you talking about Medicare new members, or --?

Yes, the Medicare members.

The Medicare members that we have gotten, because of the significant growth that we experienced, we have been doing a lot of evaluations to make sure that nothing negative lurked out. We have talked in the past about how when a member comes in, in the first year they are probably a little bit less profitable, so to speak, than some of our existing membership; and they look fairly consistent with what we have seen in the past.

They are getting into programs a lot faster than what had been happening in the past. So that will allow the beneficial effect of some of what happens in year two and three to accelerate. But nothing significantly different with the new members that came in here in 2014.

Thank you.

A.J. Rice, UBS.

Hi, everybody. Maybe just ask -- I know on the investment spending, away from the clinical initiatives, it looks like you probably reduced that about $0.10 to $0.15 in the EPS impact. I know that was mainly targeted at exchange as the dual programs.

What is changing there? Is that run rate of $0.40 to $0.75 now more firm, or is there still movement there? And does it say anything about your 2015 exchange outlook, I guess?

Hey, A.J., this is Steve. Yes; just to reiterate your question, the improvement from prior to now, the $0.10 to $0.15, is all a result of having more membership in the exchanges and increasing our revenue there, which allows us to get more scale over our operating platform, which is a good thing. So we are pleased with that.

And I do think that is beneficial for 2015, because there is a scale issue that you have to reach in order to make this business work for us. And so I think we feel better about 2015 now than previously, in terms of that business.

In the duals and the exchanges, really not a lot has changed since last time, so I wouldn't point to anything. We continue to build that out and look forward to what happens between now and the end of the year.

And then, it is too early to give 2015 guidance, but I would say that we look for both those investments this year to benefit us going forward.

A.J., on the exchange side, just to add to Steve's comments, one of the large assumptions that is going to have to be vetted out is going to be the rate increases. Because that is really going to determine how this business transitions from the 2Rs, the risk adjustment -- I mean the risk corridors and the reinsurance, to an ongoing business. And I think it's going to be important as we work with the states and the federal government on the rate increases over the next few years, and we are just beginning that process.

So our outlook is that the membership is growing and I think the membership will continue to grow in 2015. We feel that we are gaining some ground in our platform and capabilities on the service side and being able to meet the needs of our customers.

But it's really going to come down to these rates and how the rates are determined in 2015 and then subsequently in 2016.

Okay. Thanks a lot.

Andy Schenker, Morgan Stanley.

Hi, good morning. So I just wanted to follow up actually on your hep C comments here. I just wanted to confirm that $0.40 to $0.50 is above what your previous run rate estimate was; and if you don't mind, trying share maybe what you are expecting there.

And then just related to that, it seemed a little bit high to me just based on the cost sharing on Medicare and Part D. Is there anything within your book that might be driving it higher than the total population? Anything this year you can do to mitigate the impact before pricing for next year? Thanks.

Hey, Andy, thanks. This is Steve. I will start off by saying, yes, the $0.40 to $0.50 is the incremental impact. What we thought when we -- at this time last year when we were pricing our Part D business is that we knew these drugs were in the pipeline; we expected them to happen late in the year, and they came much sooner than expected. And that is the differential.

But the numbers are pretty significant for us. So on the -- obviously CMS, when you go through the risk corridors and you get -- I'm sorry, the phases of the Part D benefit and you get into the reinsurance phase, CMS ends up picking up most of the cost for these people that get into catastrophic layer of the Part D benefit.

So we anticipate for our Medicare and Part D business having north of $1 billion of gross cost for these drugs in 2014, so it is a very big number. Obviously, the net impact to us is smaller. The net impact to CMS is very significant.

This is Jim Murray. As just a follow-up on what Steve had to say, for all of our Retail businesses these drugs weren't in our formulary; and then that changed sometime in April. They were included in our specialty tiers with a prior authorization.

But, frankly, what we are seeing is that when they go to a third-party appeal program, they are being overturned. So philosophically, for the remainder of 2014, in most of our Retail businesses we're likely going to have to pay these for the individuals who are put forward by their physicians.

When you think about it, we are talking about 1% to 1.5% of our population, and some percentage of those who will ultimately take advantage of the program. And there's varying levels of estimates in terms of how many will ultimately take that. I have seen some schedules that would suggest 20%.

So we have tried to estimate what we think will happen in 2014 and came out with the numbers that Steve talked about earlier. In addition to the initial regimen now, there is also the possibility that there will be an additional piece added towards the tail end of the year that will make it more expensive.

This is a unit cost problem, and we have to really have folks address that. We're going to put it in our pricing for 2015, and I expect most of our competitors would do the same. But for 2014, there is not a lot that we can do to offset the negative impact of this very expensive drug.

I think, just to add to that, it is a price -- it's not a utilization issue from the type of patients we are seeing; I think we are in line with the population as a whole. But as Jim is saying, this is going to have a significant impact on Part D pricing next year for a minority of the membership that is using it.

And I think it is a public policy issue here on pricing that needs to be addressed because it's only going to get worse as we look at specialty drugs coming forward.

Dave Windley, Jefferies.

Hi, good morning. If I'm looking at your individual commercial membership numbers correctly, it looks like as of April 1 your membership probably had gotten up over about 1.1 million; and your year-end numbers are a couple hundred thousand lower than that. Is that an allowance for nonpayment of premium, or is there some other reason there?

And if you could talk about the percentages that you are seeing on that front, I would appreciate it.

Yes. This is Jim. We are estimating that there will be some churn in this business. That is kind of what we thought, that maybe there will be a lot of folks who go in and out of the program, because some might go back into Medicaid; and so that is a part of our estimate.

You're right that we are probably going to bump up against 1 million members in this program. And we are estimating that there will be some level of terminations because of that churn.

We're not -- we have never had this kind of business before, so that is clearly an estimate. And we will see how that ultimately plays out.

It's Regina, Dave. Also, on your question about payment of premiums I think we are seeing 75% to 80% --

75% to 80% for those that came in in January, February, and March, correct. Sorry.

Okay, great. Thank you.

Chris Rigg, Susquehanna Financial.

Good morning. Thanks for taking my questions. Just wanted a little more color on the crosswalk on slide 12, particularly the first bucket, the $0.70 to $0.85 of net operational improvement.

Is that mostly in the first quarter, or is that spread out over the course of the year? Just trying to get a sense for what we saw right out of the gate here. Thanks.

Hey, this is Steve. There is certainly a chunk of that in the first quarter, and -- but it is also spread out over the year. I don't have any -- I can't give you any specifics on that, but it is going to be throughout the year with a chunk of it in the first quarter.

Thanks.

Christine Arnold, Cowen.

Hey there. As I look at the difference between the $0.50 to $0.90 headwind with duals and exchanges going to $0.40 to $0.75, I understand the $0.10 to $0.15 is more efficiency on the exchanges because we have so much in enrollment. But we have so much more enrollment that it seems like you are assuming potentially a better loss ratio.

Is that the right assumption? Because if I'm so much enrollments, we've got the operating efficiencies, it feels like we are expecting less on MLR losses. Am I thinking about that right?

Christine, this is Jim. All of what you are seeing there is the improving fixed-cost scale impact. When we did our pricing for 2014 long, long, long ago, there were various assumptions about the size of the pool overall and the size of the pool from the underwritten existing insurance business.

When troubles began to happen during the course of when we had set our original pricing and when we gave you our first set of guidance 90 days ago, the folks in Wisconsin -- who are extremely intelligent -- took the opportunity to try to negatively impact what we thought the overall MER position would be, given the reduction in the size of the pool and some of the transitional things that Bruce referenced earlier.

We have left that exactly the same for this update. And what we are doing now is evaluating the medical claims that we see on that business, to see how that comports with the overall models that the folks in Waukesha have put together, which are very sophisticated. And I can't say enough about those actuaries in Waukesha.

What we are evaluating regularly is how our medical claims bump up against that. And we feel very comfortable with that overall model guidance that was put together by that actuarial team versus our claims experience that we are seeing. We haven't changed our assumptions relative to our expense ratio since 90 days ago to see how that ultimately plays out for the remainder of the year.

Okay, thank you.

Ana Gupte, Leerink Partners.

Hi, thanks. Good morning. Wanted to follow up on the question -- or actually ask a separate question -- about your individual off-exchange book in the small group book. Two of your competitors reported growth and one reported a decline in the individual book, with some conflicting data around the margins are getting worse or better.

So I wanted to understand if this is dependent upon your health risk in your off-exchange books, as they are pooling risk and you can no longer medically underwrite? What is the experience that you are seeing in the off-exchange book? Are your margins improving or getting worse?

We have the legacy block of business, which represents our old underwritten business; and that is obviously shrinking as people are moving into the ACA-compliant plan. I would say that we are not seeing a significant deterioration in the overall results.

I think there has been a slight worsening in our legacy block of business. And obviously, over time the legacy block of business for us and all of our competitors is going to shrink, and that will make the overall exchange pool a lot better than what exists today.

The transitional policy changes that Bruce referenced significantly impacted the overall pool in the exchanges, because those underwritten lives are still in the older plans. When they are allowed to move into the new ACA-compliant exchange, that is when the risk pool will self-correct itself.

So we don't see significant deterioration, but some; and it is going to wind down over the next several years. It would have wound down faster except for the transitional rules.

So I don't know if I answered all your questions, but those are the factors that we are having to deal with as we estimate a lot of the 3Rs and set our pricing, is a lot of what is happening with not only our legacy business but also our competitors' legacy business.

Okay. So the pool is shrinking and the MLRs are getting worse, and it will take a few years to play out?

Yes; not significant shrinkage. I expect you also talked about small group. We are not seeing a significant deterioration in our membership in small group.

That seems to be holding fairly nice. We did have a nice growth in the back -- last quarter of 2013, because a lot of our customers chose to renew their policies early.

And we're watching to see whether or not there is what we call other group movement out of some of the smaller plans into the exchanges, and we are not seeing a significant impact from that yet. But we are trying to monitor that.

Thanks. Appreciate the color.

Brian Wright, Monness, Crespi, Hardt.

Just wanted a real quick clarification. If the 3Rs is 75 at the midpoint and 50% is reinsurance, 10% to 20% is risk corridors, does that mean about -- you are assuming you're a net receiver from risk adjustment of about $230 million, something like that?

Those were your numbers, but that's -- we are a net receiver from a risk-adjustment perspective.

The only thing I would add is the reinsurance is more than half, so a little bit more than half.

Okay. Then just -- is that net receiver position predicated mostly on the Platinum enrollment? Or can you break that out by your metallic (multiple speakers)?

That is a piece of it. I would say more -- I will use an example. I don't want to give any of the states that we are doing business in, so let's pretend we're in Montana right now. And let's pretend Montana has a very big Blue Cross plan that has lots of share and we have very little share.

You have all been reading in the papers that a lot of folks are saying that not many new participants are coming into the program, into the exchanges. What is happening is that people who had insurance before are what is populating the exchanges.

And so in a Montana, if you've got a big plan there that has a big share, what is happening likely is that plan is getting a bigger proportion of underwritten members into their new ACA-compliant exchange pool. While we had a small share and so our membership that we are going to get, because we are smaller in a Montana, would be more aligned around folks who didn't have coverage before and not as many members who were underwritten.

So that is why these sophisticated models that I talked about that the people in Waukesha put together, state-by-state they evaluate that kind of dynamic. And it is really amazing to watch, because you have to evaluate the big share carrier in a particular state, what they are likely to do, and the implication that that has on us.

And we go state-by-state and we try to evaluate that not only from a reinsurance but also a risk adjustment and ultimately the risk corridor perspective. It is really an incredibly dynamic modeling process.

But that is generally how we end up with some element of the receiver position in risk adjustment, is that dynamic that I explained about Montana.

Okay, thanks.

You bet.

Michael Baker, Raymond James.

Yes, thanks a lot. Bruce, clearly you are playing in the government space. You own Medicare, you own the public exchange, but you partner on the Medicaid side.

I was just wondering if you could give us your updated thoughts on your hesitancy in terms of owning the position there.

I think as we have discussed on many different occasions, we are excited about the ability to service the duals population, and it really aligns with our capabilities as an organization in helping people that are in need as they use, heavily use, the healthcare system. Specifically in the TANF population, we are really putting our toes in the water through joint ventures that to date have worked out well, as you can see in our projections, that we will be bringing a lot of number of members on coming over the next year.

And we are still comfortable with that relationship -- the relationships that we have, and it seems to be working well for our states, our partners, and for us. As we have said in the past, we will continue down that road. If it doesn't look like that is working the best, then we would always be open to looking to expand our capabilities in the Medicaid area, specifically in the TANF business.

But I think we have been fairly clear; the reason we would do that is to enter and be a leader in the Medicare -- in the duals business. But we would not do it on an individual basis and just to be in the TANF business.

That is what we are working through, and I think to date we have been successful with the joint venture model.

Thanks for the update.

Andrew McQuilling, UBS O'Connor.

Thank you very much. I just had one question on the exchange members and if you are able to use any of your clinical program infrastructure to ultimately help manage some of that cost. Is that part of the plan and why you are expanding the clinical programs as fast as you are?

It very much is. And I think as we articulated in the fourth-quarter conference call, the reason why we are excited about entering these new populations, such as duals and in addition to the individual exchange members, is because it closely aligns with our capabilities around our clinical programs. And I think in my comments I mentioned that we have identified about 8,000 members that are available for some of our clinical programs through our predictive modeling, and we are actually reaching out to them as we speak.

But I did want to emphasize that the $100 million to $150 million expansion that we are investing in, in our clinical programs, is really a result of our Medicare Advantage membership and the growth in that, and being able to both service that membership on an ongoing basis and continuing to prepare for 2015 and the additional membership that we would get in 2015.

Terrific. Then maybe if I could, in terms of understanding better your exchange member health status, is Q2 -- you think you're going to have a pretty good handle on it? So right now you haven't changed assumptions, but Q2 you think you will know?

Well, remember that we got about I am going to guess 200,000 or so in the first quarter, and we got a big bolus of new members in the second quarter. We will feel better about the cohort that came in in the first quarter, although we have studied the heck out of them in terms of their pharmacy costs and their utilization, and did a lot of the predictive modeling work that we do for the Medicare population with this group of folks.

And we feel reasonably comfortable with what we have seen so far on that first cohort. We will study the next cohort over the next several months. So I would -- I am going to guess that sometime in the next three months, maybe six months, we will feel very comfortable about it.

I quickly want to add, a lot of what we are doing around our 2015 pricing, which is due right now, is based upon those old assumptions that we talked about. It is not what we are seeing develop with medical claims. And so I think there is a bit of conservatism built into our 2015 pricing because we haven't done anything to adjust our medical expenses for what we are seeing in terms of medical claims.

Tom Carroll, Stifel.

Hey, good morning. Just a quick one. Was there a specific reason why you were not able to repurchase the normal -- normal in quotes -- amount of shares this quarter that we have seen recently?

Hey, Tom; this is Steve. No, there wasn't really a specific reason. We were working on the rate announcement with CMS, so that was in play a little bit; so that was something we were just keeping an eye on.

As well as I mentioned earlier around the dividends, our dividend requests, under a little bit more scrutiny from the DoIs with the implementation of the Affordable Care Act and in the way the fees are handled in the statutory financials.

So just monitoring those two items was really all we were contemplating.

Okay. Thank you very much.

So in closing, let me thank you all again for joining us today. We are pleased, obviously, with our first-quarter performance, better-than-expected membership growth both in Medicare Advantage and in our new exchange-based products, increasing ability to help our members with the timely, data-driven clinical intervention, and particularly those members with chronic conditions.

It does speak to -- and I think a lot of questions that were coming out about our clinical capabilities -- to our goal of having clinical excellence via coordinated care. Finally, I would like to thank all the Humana associates on the call. Your skill and dedication are what made these results possible.

And have a great day to everyone. Thank you.

This concludes the first-quarter 2014 earnings conference call. Thank you for joining. You may now disconnect your line.