Molina Healthcare Inc (MOH) 2017 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Molina Healthcare Third Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded, Thursday, November 2, 2017.

I would now like to turn the conference over to Juan José Orellana, SVP of Investor Relations. Please go ahead, sir.

Thank you, Alex. Hello, everyone, and thank you for joining us. The purpose of this call is to discuss Molina Healthcare's financial results for the third quarter ended September 30, 2017. The company issued its earnings release reporting these results today after the market closed, and this release is now posted for viewing on our company's website.

On the call with me today are Joseph White, our Chief Financial Officer and Interim Chief Executive Officer; and Terry Bayer, our Chief Operating Officer. After the completion of our prepared remarks, we will open up the call to take your questions. (Operator Instructions)

Our comments today will contain forward-looking statements under the safe harbor provisions of the Private Securities Litigation Reform Act. All of our forward-looking statements are based on our current expectations and assumptions, which are subject to numerous risk factors that could cause our actual results to differ materially. A description of such risk factors can be found in our earnings release and in our reports filed with the Securities and Exchange Commission, including our Form 10-K annual report, our Form 10-Q quarterly reports and our Form 8-K current reports. These reports can be accessed under the Investor Relations tab of our company's website or on the SEC's website.

All forward-looking statements made during today's call, represent our judgment as of November 2, 2017, and we disclaim any obligation to update such statements, except as required by the securities laws. This call is being recorded, and a 30-day replay of the conference call will be available at our company's website, molinahealthcare.com.

I would now like to turn the call over to our Chief Financial Officer and Interim CEO, Joseph White.

Thank you, Juan José, and thanks to all of you for joining us today. The results we reported this afternoon demonstrate that we are strengthening our business and positioning it for long-term success. While we still have much work ahead of us, our third quarter results demonstrate that we are moving in the right direction.

Today, we reported a net loss for the quarter of $1.70 per diluted share, but restructuring charges and impairment losses net of adjustments to our Marketplace premium deficiency reserve amounted to $2.83 of that loss. If we look past those items, we can see that underlying operations showed substantial improvement this quarter.

I am pleased with the progress we have made on the restructuring initiatives we outlined last quarter. Once I have discussed our financial performance, I will provide more detail on those efforts.

When I told you last quarter that we were taking aggressive, urgent and determined actions to improve our financial performance, the benefit of those actions was only potential in nature. Today, we can point to the first actual measurable reductions in both medical and administrative costs.

Let's start with medical costs. Our medical care ratio was 88.3% for the quarter or 89% after we removed the benefit of a $30 million reduction to our Marketplace premium deficiency reserve. To be clear, the medical care ratio for our core business, Medicaid and Medicare combined, remains unacceptably high at 91%. But we did see some meaningful sequential improvements in some of our most challenging markets, with Illinois, New Mexico and Puerto Rico reflecting noticeable improvements since last quarter. Also as part of our restructuring effort, we are now refining medical cost improvement work streams that we believe will benefit our overall medical cost performance between now and the end of 2018.

As with medical costs, general and administrative expenses are also moving in the right direction. Our general and administrative expense ratio of 7.6% for the third quarter of 2017, was 50 basis points lower than in the second quarter of 2017. And if we adjust for the impact of higher Marketplace enrollment, 30 basis points lower than in the third quarter of last year.

Our Marketplace performance also improved noticeably this quarter. In addition to the reduction in our Marketplace premium deficiency reserve, we benefited from other positive developments. Specifically, risk transfer is developing more favorably than we had expected and our 2017 premium increases are providing partial relief for the medical cost trend that has continued to rise faster than we expected at the start of the year.

While these developments are indeed favorable, let me spend some time on the topic of cost-sharing reduction subsidies, or CSRs, and their potential impact on 2017 and 2018 performance. First, I want to emphasize that our third quarter results do not include any impact from the recent decision by the federal government to cease payment of CSR subsidies. To be clear, this development may lead to an $85 million drag on fourth quarter pretax earnings. The key question is how CMS will perform the annual reconciliation of CSR payments. I need to explain that a little bit.

As of September 30, we owed the federal government approximately $220 million for CSR subsidies already received this year. CMS has paid us about $515 million in subsidies, but we have only incurred about $295 million in related expenses. The remaining $220 million overpayment constitutes our liability at September 30. Second, we expect in the fourth quarter alone, we will incur another $85 million in unreimbursed expenses that were formally reimbursed by the federal government. Now here is where the reconciliation process comes in. CMS reconciles the amount it pays to health plans for CSRs against the actual expenses incurred by those plans. This reconciliation is normally conducted over a full calendar year. If CMS keeps the same practice this year, our $220 million payable at September 30, will more than offset our fourth quarter expense and there will be no impact from the cessation of payments in the fourth quarter.

But if CMS changes its practices and performs a 2017 reconciliation over a 9-month period ending September 30, our payable position in that date will not offset expenses incurred in the fourth quarter, and we may experience an adverse impact of $85 million, pretax. Please note that regardless of the reconciliation process, we believe that we are owed CSR payments as a matter of law, and we are willing to pursue our rights in court if necessary. For now, all we can do is wait for further news from CMS.

Regarding the Marketplace in 2018, there are two important points. First, 2018 pricing in all of our markets is based on the assumption that CSR subsidies will not to be funded by the federal government. And second, we have already taken steps to limit our 2018 presence with the reduction of our Washington footprint and Marketplace exits in Utah and Wisconsin.

Turning back to our third quarter results. I mentioned impairment losses and restructuring costs is a large expense this quarter. We recorded $129 million or about $1.77 per diluted share in combined goodwill impairments for our Pathways behavioral health and Molina Medicaid Solutions subsidiaries. These are noncash charges. We also recorded $118 million or $1.39 per diluted share of restructuring costs. This expense includes about $50 million in additional noncash charges for the writeoff of capitalized software costs. It is important to remember that these charges are the results of bold steps we are taking as a company to improve our performance. We look forward to moving past this stage in our process and emerging as a stronger, more profitable company.

Now I would like to turn to an update on our restructuring efforts. Last quarter, we told you that we expect to reduce annualized run rate expenses by $300 million to $400 million in total by the end of 2018, and that we expected that approximately $200 million of those reductions would be achieved by the end of 2017. I am pleased to report that at the close of the third quarter, we believe that we have already reached our goal for 2017, and have lower -- and lowered annualized run rate expenses by $200 million, which will be in full effect starting January 1, 2018.

So that sums up the anticipated financial benefit of our efforts. Now I will talk about some of our specific work activities. You will recall that we are streamlining our organizational structure to improve the efficiency, speed and quality of decision making. Although we continue to adjust the organization as we learn and evolve, this task is now largely behind us. One result of this effort was a reduction in force of approximately 1,500 positions. We are redesigning core operating processes, such as provider payment, utilization management and quality improvement to achieve more effective and cost-efficient outcomes. While this effort will extend through 2018, we're already seeing improvements in some of our provider payment metrics regarding payment accuracy and inventory management.

We are also remediating high-cost provider contracts and building networks around high-quality cost-effective providers. While this initiative will not show meaningful benefits until 2018, some successes have already been achieved. We are restructuring our direct delivery operations and have closed many of our clinics outside of California. We continue to evaluate the future status of our California direct delivery operations.

Finally, we are reviewing our vendor base to ensure that we are partnering with the lowest-cost, most effective vendors. As with the remaining high-cost provider contracts, we do not expect meaningful results from this part of our plan until 2018, but progress is already being made.

All of these initiatives are operational and incremental in nature. They require changes in process and culture rather than new technology or ideas. We are on a path that has been traveled by other organizations before, which gives us confidence in our ultimate success. We do not expect to see our full restructuring plan benefit until 2019, but we're already seeing some of those benefits. We estimate that the restructuring plan increase income before taxes by approximately $10 million in the third quarter of 2017. Of course, we continue to take precautions to ensure that our actions do not impede our ability to deliver quality health care to our members, secure new managed care contracts and retain existing contracts.

Moving to other topics. At September 30, days in claims payable were up 4 days sequentially to 50 days. Cash on hand at the parent company was approximately $390 million at September 30, and we have about $200 million available through our credit facility. We took the opportunity in the third quarter to modify certain definitions of our credit facility so that we can incur the cost of our restructuring program without tripping financial covenants. We will continue to monitor our cash needs and act upon any financing needs as we deem necessary.

So to sum up our performance this quarter. While there is much left to be done, we are making good progress. We remain a company in transition, and we will emerge from this process as a stronger company, proud of our heritage, focused on our mission and eager to embrace the new future. We look forward to welcoming Joe Zubretsky to the company this coming Monday, November 6. As Joe takes Molina forward into its next chapter, he will shape the future of our company with the support of thousands of superb, dedicated and determined employees. Our future is indeed compelling and exciting.

Alex, this concludes our prepared remarks, and we can take questions now.

(Operator Instructions) Our first question comes from the line of Ana Gupte from Leerink Partners.

So the first question is -- and it's encouraging to see that you are, at least sequentially, improving your loss ratios in some of the Medicaid -- the state Medicaid books. So can you talk about some of the changes that have happened sequentially and still, you have issues in some of your books like California and all, and what's going on there? Where is it that you've seen underlying improvement and why? And where is it that you're not? And how does this become a systematically improved kind of consistent Medicaid result on the base book?

Sure, Ana. Let me -- that's a lot to talk about. I'll do my best. Let me first emphasize that we clearly understand here we have a long way to go. The process of bringing the company to a focus on successful growth and profitability, with the emphasis on profitability first, is a process which takes time. It involves some cultural shifts. It involves changes into a lot of practices we have. It involves a greater focus on things like capital allocation. Nevertheless, so much of what we have in front of us to improve our financial performance is what I would call basic blocking and tackling. I think you can see the impact of some of the basic actions and what's been happening in this previous quarter, in the third quarter, because the initial aspects of our restructuring plan have been much more about organization and staffing. What we're seeing helping the health plans I think right now in this third quarter is just the benefit of having new management teams in a handful of our most problematic health plans. In Puerto Rico, Illinois and New Mexico, we spoke too early in the year about how we had to swap out leadership teams. Those leadership teams have had some time to get established, and I think just do some basic management, which is helping us. Now again, these aren't fixing every underlying problem we had. That's going to be the -- that's for the future. And Joe Zubretsky is going to be a big help in that. But I think what we're just seeing is the benefits of just the general focus on more business-centric practices. I also think in the Medicare and Medicare Marketplace -- I'm sorry, Medicare -- Medicaid plans, we are seeing some rather pleasing utilization trends, which are helping us.

One follow-up, if I could ask. On the workforce reductions and the systems -- are there any systems changes that you're likely to undertake? Or is it within the existing systems, you can just change your processes around medical management? And what is the path or the glide path to that 1.5% to 2% margin? And how long is this going to take, with what you've done so far diagnostically?

Well, taking that in reverse, we haven't tied a year to that kind of profitability level. We obviously hope to get there and we hope eventually exceed it. But we haven't tied a year to that profitability level that you're talking about, Ana. What I will say though about the systems issues is what we are finding through this process is that many of our challenges are process related, culture related, not necessarily tool related. So for example, we operate on the QNXT HMO platform. There -- that's a fine platform, there's no need to change that. We just need to find ways to use -- utilize that more effectively. Hardware is hardware, pipes are pipes from an IT perspective. We're adequately resourced there. There are some areas, utilization management being one, where we are in the process of installing a new system. But in general, again, I would just say that issue -- the issue isn't so much our systems, it's how we use our technology to achieve a desired business outcome.

Our next question comes from the line of Justin Lake with Wolfe Research.

So first question is just on the medical cost payable. I was looking at that line versus the second quarter, it looks like it's up about 20% or about $400 million sequentially. And when you take that and you combine it with flat sequential premiums, I don't think I've ever seen anything like that in terms of magnitude of change. Just wondering if you could tell us what drove that and maybe share what's increased conservatism given the previous issues seen versus maybe actual trends seen in the quarter, what are the drivers there?

It's a good question, Justin. I would start by pointing out that we've obviously had some challenges this year in terms of adverse out-of-period claims development. That's made us a little bit more cautious than we would normally be in terms of our reserve setting. We actually had, if you look at our claims payable roll forward from December of 2016, you'll see we actually had some further adverse development this quarter. So what we -- not nearly as much as last quarter but, nevertheless, had a little bit of adverse development. So we think it's just appropriate right now to be a little bit more cautious on our reserve setting. In some respects, medical utilization trends do look like they're trending -- they're moving in the right direction, I mentioned Medicare and the MMP plans a minute ago. But we do have other states where the trends are not so favorable. So we're just trying to -- without going overboard, we're just trying to strike a cautious tone, given where we've been the last year.

Got it. And then just, you mentioned that -- I think you're up about $90 million sequentially in parent cash. First, is that correct? And then second, how should we think about the major inflows and outflows over, let's say, that next 3, 6, 9 months? And when you'd be -- when you'd have dividends available to come up from the subsidiaries and kind of stabilize that cash position?

Well, if you think of how the parent company of a collection of regulated subsidiaries operates, essentially, the parent is -- can only be supplied, other than from external funds, by its regulated subsidiaries. The flow of cash to the parent comes in 2 forms. It can come in dividends, as you mentioned; it also comes in the form of reimbursement of expenses incurred by the parent on behalf of the subsidiaries. So with a few exceptions, nearly all of our parent's cash expenses are reimbursed by the subsidiaries through management service agreements filed with the various departments of insurance. So again, most of the operating expenses, including cash interest payments of the parent, are paid for by the subsidiaries. The other source of cash for the parent, again, is dividends. We can ask for a dividend from a state at any time, in which the state had -- exceeds -- the health plan exceeds its network requirements. Generally, though, that's a process that would require regulatory approval generally through the Department of Insurance. So that's an activity we engage on during the course of the year. And generally, just as we find -- as we come to believe that subsidiaries are perhaps overfunded. The pattern of that can vary. I wouldn't tie it to any kind of seasonal pattern or anything, it's just something you go out and pursue, again, when you think a subsidiary is overfunded.

Our next question comes from the line of Peter Costa with Wells Fargo Securities.

Getting back to sort of the first question. You saw the big improvement in the medical loss ratios sequentially, about 650 basis points. We know there are some onetime things in there, like the hurricane savings perhaps or maybe clinic closings causing people to have to find new doctors or whatever. But what other things are in there that are sort of onetime in nature that maybe made that quarter, third quarter, so much better than we saw in the second quarter?

Well, to be clear, Peter, I'm not aware of any disruption to our member care as a result of the clinic closings. We make every effort to make sure that our members do, indeed, have physicians they can see as needed in a convenient manner. So I'm not aware of any disruption there. You mentioned the weather. I should say that if we think the impact of the very difficult experiences in Puerto Rico in September -- and our heart goes out to everyone on the island -- experiences in Puerto Rico in September probably reduced medical care expense for the quarter by between $4 million and $5 million. The medical cost impacts of the events in Florida and Houston, which were very sad, too, as far as we can tell, had very little impact on our medical cost trend. They were more short-term in duration and it appears as if those communities were able to recover faster. So if we look at hurricane impact between Irma, Harvey and Maria, probably $4.5 million to $5 million of reduced medical costs for the quarter. The other -- there were other aspects of the financial performance that I think we would call out in the quarter. One, we lack -- we did not have this degree of adverse claims development in Q3 that we experienced in Q2. We also had some more favorable developments in terms of Marketplace risk adjustment, which it resulted in increased revenue, which has the same effect of lower medical cost. Certain states, Puerto Rico, Illinois and New Mexico, come to mind where, again, I think our new management teams are starting to get their feet on the ground and they're starting to make a difference in performance. And then lastly, again, the Medicare and -- Medicare and Medicaid plans, there have been some favorable trends there all year that I think for the first time this quarter we saw in our financial statements.

Just as a follow-up, can you quantify the adverse claim development change from Q2 to Q3? And the risk adjustment change from Q2 to Q3?

The -- as far as the adverse development impact, if you look at our roll-forward table in the back of the -- if you look at our roll forward table in the back of the earnings release, you'll see that from the second quarter -- at second quarter, we were looking at favorable development of about $31 million. We've shifted to unfavorable development of about $9 million, so that's about a $40 million swing there. The risk adjustment piece, as far as Medicaid, is a little bit harder to tease out. I would think it's -- I'm checking my notes here as we speak -- I would think it's probably in the -- bear with me here since you asked, all right -- probably on the CSR side in the for -- forward benefit, probably in the neighborhood of $60 million to $70 million. I'm sorry, for the risk transfer, probably in the -- I'm sorry, bad number there. In terms of risk transfer, probably in the neighborhood of an $80 million pickup.

Okay. And just back to the roll forward table for a second. So risk adjustment got worse, is that what you're saying, as opposed to better?

I wouldn't say -- no, risk adjustment is not affected by the roll forward table. I would say that our -- the relative risk score of our members as we got assessments from various third-party players, Wakely Consulting comes to mind, indicates that our members' risk scores are relatively higher to the population than we had thought. So the outflow dollars...

Okay. Then maybe I misunderstood then... is the adverse claim development then that -- what got worse?

Correct.

From 2Q to 3Q? So that actually was a negative impact?

That's correct, yes. Q2 to 3Q, but... yes, but the swing itself from quarter-to-quarter was not as great in Q3 as Q2.

Our next question comes from the line of Sarah James with Piper Jaffray.

Congratulations on the quarter, reaching the initial savings 1 quarter early and improvement in many MLR lines. But against that positive backdrop, a few items stood out. First, on ABD MLR, can you tell us if there were any contracts pressuring that? And then second was DCP increase, should we think of that as related to some of the more conservative reserving strategy, changes to adjudication and time line from restructuring efforts or is there something broader going on because your peers had all posted DCP increases as well?

I think the first question on the ABD development for the quarter, the only thing that sticks in my mind as far as ABD is some adjustments we had to go back in California related to certain long-term care benefits that required a true-up on premium rates from California. So we took a little bit of a hit for that. That's all that really comes to mind on ABD unique. It's tended to run at pretty high MCR lately. And Sarah, I didn't really understand your second question. You broke up there a little bit.

Sure. Sorry about that. So...

After ABD you started...

Yes, there was a days in claims payable increase, and I'm just wondering if that's related to the more conservative reserving strategy, adjudication timing changing from restructuring or if it's broader because your peers also saw DCP increases this quarter?

I mean, I think certainly the timing of certain activity, particularly in Puerto Rico, where we have a claim shop, I think certainly there were some slower payments that added a little bit of that increase to days in claims payable. But in general, the increase in days in claims payable just reflects a more conservative posture to our reserves.

Got it. And last, if I could, just thinking about sources and uses of cash, you commented on Pathways and MMIS not providing as much benefit to health plans. Is it possible that you could consider strategic alternatives for these businesses or they're still something that you feel Molina needs to own?

A lot of that, Sarah, is going to have to shake out further engagement in terms of our restructuring plan. And frankly, Joe Zubretsky is going to have to come in here and look at the entire company and make decisions about that. I would just say for now that those are, indeed, viable companies with established revenue streams and, I would say, business propositions that are attractive. What we've struggled with, and particularly as we've engaged in our restructuring over the last 6 months, we've come to realize that some of the synergies we were hoping to realize in our health plan business from those benefits are not necessarily materializing. Again, though, that doesn't mean that they are without value as businesses. They are again, very, very successful businesses in their own right, and we'll have to assess just about every aspect of this business as we improve operations and continue with our restructuring plan.

Our next question comes from the line of Kevin Fischbeck with Bank of America.

So this quarter looks pretty good, but I guess, it really kind of forces me to go back to some of the questions I was asking last quarter about the decision around cutting G&A because when I think about this quarter, it kind of reminds me of normal Molina, where you would see a couple of quarters in a row of blowout numbers and a couple quarters of misses and then you kind of go back and forth. And what we're really looking for is not only improved MLR but also stability in MLR. So I guess, when you think about the G&A savings number that you're targeting, you have a couple of hundred million dollars, is there any way to put some sort of different spin on it as far as maybe is the number really $300 million but you're reinvesting $100 million into something else? Or I mean, how do I deal with that because, again, it is hard for me to kind of get my head around having this volatility in MLR from quarter-to-quarter and then cutting G&A and expecting to get a better result at the same time?

Well, to be clear, we definitely understand that 1 quarter doesn't set a trend. And I think we've been -- it pains me to say this is -- we're far from satisfied with this results. And this is a process to building a stable and more profitable company. Much of what we're trying to do, though, in terms of the restructuring plan even when we talk about org reorganization is to develop clearer lines of communication, clearer accountabilities and responsibilities so that we can act and react in a more fashionable manner. So I think building an organization in a culture more focused on profitability and more focused on operations is a key to the kind of stability you're talking about. One great example of that is we've spoken about challenges we've had in provider payment processing. Uncertainties in that area make it difficult to operate the company always in a predictable manner. So the restructuring effort, which has a substantial medical cost component, you just haven't seen it yet because much of that takes more time to develop, is an attempt to develop that more profitable company. I can only say though, honestly, there's no -- there's nothing -- nothing's going to prove success like success, and we're going to have to put in multiple quarters of satisfactory performance to evidence that we're the kind of company we need to be.

So I guess, it sounds like what you're saying is a lot of the things that you want to achieve don't necessarily require a specific investment as far as...

Well, there's a pretty hefty -- if you look at -- and we don't have our 10-Q out now, but if you look at our 10-Q from second quarter, there's a pretty hefty investment there, and that investment you can see carries over to our around probably $40 million -- up to $40 million of investment in Q4 -- in 2018. So there's definitely investment there. It is not though -- it is not -- again, it is not -- this process is not about bringing in all new tools that are going to miraculously help us run the business, it's about changing how we do things and our culture and our attitudes toward accountability and profitability.

Okay. And then I guess when we think about the $200 million number, when I think to get to $300 million to $400 million, that $100 million to $200 million is more on the medical cost side, if I remember correctly...

Correct. It would be... go ahead.

How do we think about the starting point for both of those numbers. I mean, is there like a core G&A number, I guess, that you're saying we're going to save $200 million off of this base number. And then I guess, maybe we can just say $100 million to $200 million would be 50 or 100 basis points MLR, I guess that might be the other way to think about it? Is that how you think about MLR and then, I guess, is there a G&A number base that we should be starting off with before -- to apply the $200 million?

Well, we haven't given guidance for 2018. But I think the best way to look at this is we talk about these in terms of run rate reductions. So I think as you try to model what you can expect in 2018 and 2019, you should probably look toward 2016 and first half of 2017 performance because we really saw our first actual savings from the restructuring plan in this quarter, third quarter. So I think, again, I think you would look to 2016 and in the first half of 2017, that's the run rate we're comparing to.

Okay. And then last question. I guess, WellCare took a PDR as far as Illinois goes? Any thoughts there for you?

Well, I can't speak to their situation. We feel good about or at least good enough about our position in the Illinois bid that we don't feel it's necessary to record a PDR at this time. We bid right around the midpoint of the rates offered.

(Operator Instructions) Our next question comes from the line of Christine Arnold with Cowen and Co.

The 2018 Marketplace footprint, you're exiting a few markets, going back in some. Overall, do you expect to grow membership next year? And how do we think about the potential profitability shifts now that you've seen where you stand relative to others? And you did bid, assuming the CSRs at the end.

Well, a couple of points on that. And again, we haven't given 2018 guidance. But I think we've been pretty clear in communicating that the exits in Wisconsin and Utah, the curtailments in Washington and the rate increases that we put out for the remaining markets, which are about 30% before, 30% before the adjustment that assumed no funding of CSR, so about a 58% blended rate increase. I would expect that our membership in Marketplace is going to drop considerably next year. As far as the CSR impact in rates and everything, as I said, all of our rates assume that CSRs are not funded. So we should have some protection there.

And given the movement in the risk adjusted, you got $80 million this year, I assume that was related to 2017, right, because it was in the third quarter (inaudible)?

No, no, no. What I was doing -- yes, it was movement from one quarter to another, yes.

Okay. So that was end of the year so...

Given 2017.

What is your expectation for individual profitabilities this year? And can I assume that it'll improve from that level next year, given the way you bid?

We think, overall, as we look pure period basis for this year, we're still not approaching what we had in pricing. We're quite a bit far, we're quite a ways from it. Hopefully, with the rate increases next year, we obviously price with the intent that we will be profitable. That doesn't, obviously, guarantee profits, as we've seen in '16 and '17. And we'll just have to see how everything plays out with that regard.

Do you have a revised 2017 public exchange or individual loss assumption for this year, given the movement you've seen?

No, we pulled guidance last quarter.

Okay. One last question. You talked about prior year development, did you have any prior quarter development in this quarter or -- that maybe makes us think that the first half was perhaps better than you'd reported?

There's always an element of development from the prior quarter. But again, I wouldn't read too much into that. I didn't see anything really surprising.

Our next question comes from the line of Josh Raskin with Nephron Research.

Just first question around the big payable boost. I guess the question would be what was the catalyst for that? Why this quarter, not last quarter? Was there some sort of external consulting review done? And then is this a sort of onetime catch-up, and you now feel as though with another $400 million going to the income statement, you're there? Or is this a process by which over time, you're going to get to sort of that new targeted level, be it more conservative?

I would describe it, Josh, as just more a reaction to the facts and circumstances of the position we found ourselves in as we closed the books on September 30. To be clear, days in claims payable, I understand, is a very valuable quick and dirty measure for outsiders to the company. We've never targeted a certain days in claims payable. I think I would just say that, in general, given the experiences we've had with the prior period development in -- earlier in this year, we just thought it was prudent to be a little bit more cautious in our reserving. I don't think I can't commit to anything in terms of philosophy beyond that. We've always tried to set an appropriate reserve level. Most times, we've succeeded. It just so happens that at 12/31/16 was one of those rare circumstances where we were indeed under reserved, as you can see in the roll forward table, and we're just reacting to that. It doesn't, though, reflect any sort of outside engagement or any sort of master plan as far as to where we want to move reserves. So we want reserves as outlined in our 10-Q. We seek to set reserves that are 8% to 10% in excess of the ultimate runout. Sometimes, you miss, though. And I guess, you can say we're catching up.

Okay. So that 8% to 10%, that was sort of my next follow-up. The 8% to 10% hasn't necessarily changed and that it wasn't some sort of consulting actuary that came in, it's just you guys have a different view of what 8% to 10% looks like now. Is that the idea?

Yes, that would be a fair statement. We set the reserves and, again, we usually run out a little bit better than that. Obviously, in 2016, with 27 activity, bluntly, we missed by a country mile. So we just need to reset reserves and try to get to the level, in effect, to restore our margin.

Okay. And then just more of a strategic question. I know the board's been undergoing strategic reviews and you now have named a CEO, and I know Joe starts next week. Should we think about more to come on that or did the board sort of do their analysis, think the restructuring and the hiring of an experienced CEO like Joe Zubretsky is the answer? Or is that process still ongoing? Where kind of are we in that strategic review?

I would express it this way. I don't think there's ever been much doubt and today I would say there is no doubt that the company is strategically positioned in the right place. We think being Medicaid focused and then playing in certain Medicaid adjacencies is a very sound strategy. We also think that the company has not always performed from an operational level the way it should have. So we think operationally, the basic blocking and tackling, we just need to be able to do better. Among many other skills, Joe has substantial skills in that area of operations. So he can provide a lot of help in that way. But I would describe -- Josh, I would describe this strategy again as play in Medicaid, play in related adjacencies, MMP plans, net plans, perhaps some degree in the Marketplace but play in Medicaid, focus on Medicaid and excel in operations. And that's the path forward for us.

Sorry, Joe, I guess I was thinking more asset based than overall corporate strategy. And I mean, there was a question earlier about Pathways and the MMS business. I don't know if there are certain health plans that may be suited better in other's hands. I meant more sort of like a repositioning of your assets, like is there more to go on that one as opposed to shift away from Medicaid or something like that?

Yes. I think the focus right now, Josh, is operations and improving operations. As I said with MMS and Pathways, they have businesses in their own right that are good businesses. We will -- we always look at that but right now, I think it's fair to say that we don't have any major strategic directions. We've always believed in being a geographically diverse HMO. We need to do that because we are so focused on Medicaid. So I don't think there's any grand restrategization of the company in mind.

Our next question comes from the line of Zack Sopcak with Morgan Stanley.

I wanted to ask first just about renewals. Given the amount of changes with the company and within the local readerships as you described, how's your renewal pipeline looking? And then with that, ERP pipeline opportunities over the next year or so?

Well, sure. I think the progress so far and the outcome so far in contract renewals have been very gratifying. In early June, we won a rebid of a substantial region in Washington. In July, we won as a new entrant in Mississippi. And then in late July, we won in a rebid in Illinois that involved a geographic expansion. So I think -- again, I think overall, I think we're feeling good about our ability to retain contracts. We focus on it, we pay attention to it everyday and we understand how important that revenue stream is. There is a table in our 10-K that -- or 10-Q from last quarter that speaks to upcoming rebids. Florida has -- we just submitted a response to an RFP there. New Mexico, we've submitted a response to an RFP there. We feel very good about our responses. We feel very good about our relationships with providers and regulators and communities and, most importantly, members in those 2 states, Florida and New Mexico. So we'll have to see how they play out, but we feel good about that. Next up is going to be RFP activity in Texas. We've also bid as a new entrant in Virginia, we should hear about that soon. Following Texas, there'll probably be activity next year in Washington. And then we hope some expansions into the LTSS, long-term services and support markets in Ohio and Michigan. So we have a pretty strong pipeline now, I think a rather rich pipeline. We've also, so far, been very successful at retaining contracts and we're optimistic about the future.

Got it. That's helpful. Speaking about the changed team and maybe a little bit more on the internal looking side, you may have gone through a lot of changes, obviously, in leadership and the way you operate, it sounds like, and the strategy going forward. Having gone through a reduction in force, which is never easy for anybody, can you just talk about morale, in general, how retention is internally? And how maybe the company is looking forward to this change?

Well, I will say one thing, one thing that I've always believed about Molina but it's certainly been brought home to me over the last 6 months: we have -- we are blessed to have a very dedicated, very committed, very focused workforce. The last 6 months have indeed been a time of great change and, frankly, a degree of pain. The combination of the staff reductions, along with what's happened in Texas and Florida and Puerto Rico, have created enormous challenges for our staff. But I think morale is very high. Our staff remains focused, they're doing their jobs. There is always -- you always have to work hard to retain your people but I don't think statistics show we're seeing any kind of major departure of people. I think, in general, the morale of the staff is high and I think they understand that focusing a little bit more on profitability, focusing on crisper operations is the path to a -- to the long-term success of our company.

Our next question comes from the line of Chris Rigg with Deutsche Bank.

Just wanted to sort of get your sense on the poor performance in the Marketplace. Because when I look at the reported MCR in the tables in the back of the press release, even if I normalize that for the PDR, it doesn't look that bad. I guess I'm just trying to get a sense for where things are trending relative to what you expected coming into the year at this point?

Well, they are certainly -- sure, Chris. They are certainly not favorable compared to the pricing we put out for 2017 in the expectations. I'd also remind you that Q4 is traditionally a very rough quarter in this business. You do have to be careful, too, understand there's a pretty substantial admin load on Marketplace so the incremental admin load from broker commission and exchange fees can be in the neighborhood of 12%, 13%. So the MCRs need to be low to be able to support the business, frankly, comparatively low to Medicaid. I guess what I would say on the favorable aspect of Marketplace right now, special enrollment is -- decreased compared to where it was last year. You recall that we -- like every health plan, we really experienced adverse selection with special enrollment last year. It's too soon to know the full cost trends, obviously, in the third and certainly the fourth quarter, but again we're seeing lower special enrollment in terms of numbers. I think that's helpful. And I think -- frankly, I think in some degrees, we have benefited a little bit from our relative size in terms of the risk adjustment pool.

Okay, great. And then just changing gears a little bit. If you do see a substantial decline in the ACA enrollment next year, do you have a health insurer fee problem, just sort of an unencumbered membership problem that this could be an unusually large drag next year, although albeit sort of onetime in nature?

I wouldn't necessarily call it a problem. I think it's a reality. Any insurer that experiences a decline in enrollment is going to pay a relatively higher ACA fee in the following year. A couple of points that are going to mitigate that for us. The first one is while enrollment, we expect to drop for us, we're also going to be raising rates. So our relative share of the market in that respect won't be dropping that much. We've built the ACA into the new rates. So we'll receive a little bit of a relief there. But yes, I think in general, there is a little bit of a headwind from just, I guess, I would say, a retroactive or a retrospective impact to the ACA fee, yes.

Our next question comes from the line of Gary Taylor with JPMorgan.

A couple of questions. I hate to come back to this reserving, but I do want to start there just to make sure I understand it. So the reserve's up about $400 million sequentially, $200 million of that's in the other category, which is pass-throughs that don't impact your P&L, as I understand it. And it looks like it's up -- the IBNR is up about a couple of hundred million sequentially. So if that's mostly conservatism, that's $2 a share, that's 500 basis points of MLR. So are you suggesting that X charges could have -- without that conservatism, the earnings this quarter could have been $2 higher?

Well, I wouldn't express it that way at all. Because for the simple reason again, as we rebuild margin, yes, we are trying to be cautious but there's no -- your question presupposes that the smaller number of reserves is indeed the right number. So I just can't -- honestly, I can't agree with that, necessarily, Gary. Again, I would say that there are -- there's a pass-through effect, there's also some issues on timing of payment. What we saw with Puerto Rico, there's some delay in payment. And I just -- I would just -- that seems to me to be a dangerous supposition you're making, I'll just say that.

Okay. And then if we look at the roll forward tables, the claims paid relative to the current year, in the current period, dropped about $150 million sequentially. I mean, should that give us some indication of what the timing element could be? Or is there just too many moving parts with the risk adjustment changes and so forth that (inaudible)?

Well, I don't think risk adjustment would impact that. I would say, though, that when I just penciled out the impact because I thought we might be asked on days in claims payable from timing differences, I thought it was probably somewhere between 1/2 and 3/4 of a day of the DCP increase, if that helps.

I'll think about it.

We can always talk later.

Yes. Just 2 more quick ones. I missed the first 5 minutes, so just refer me to the transcript if I missed this. But when we look at that TANF, CHIP, MLR trends up 250 bps in the first quarter, 210 in the 2Q and now, down 170 bps year-over-year. I mean, I've heard you talk about just, obviously, more favorable utilization trend. But is there anything else that moves that TANF, MLR trend so materially in your favor this quarter just outside of what you're seeing on utilization?

Bear with me, I'm flipping to that page. I mean, I would just point to what I spoke to when you particularly think of where we are heavy -- where we have heavy TANF and CHIP membership proportionally, it would be Puerto Rico, it would be Illinois and a fair amount in New Mexico. And again, those health plans are performing better. I think the shorthand answer to why they're performing better right now is simply better local management teams who've had time to get their feet on the ground. So certainly, though, the improvement in Puerto Rico and Illinois would be more dramatically reflected in TANF.

Okay. Last question. I want to make sure I'm thinking about the cadence of the savings correctly. So you've realized this run rate of $200 million so that's $50 million a quarter, only $10 million was realized in this quarter. So that means we see $40 million pretax just in a vacuum sequential pickup into 4Q from this (inaudible)?

No. You need to think about that. In many of those costs, the benefit's not going to be realized until January, starting January of next year. So various people are still working, wrapping up their work, transitioning assignments and things like that. So you should really think about all of our savings, the predominant number of our savings not starting until next year.

And of the $200 million, have you told us how much is G&A versus medical?

We spoke a little bit about that. The bulk of the $200 million right now is staffing reductions, and I would bet the split in those staffing reductions between medical and admin is probably 65 admin, 35 medical.

And our final question comes from the line of Dave Windley with Jefferies.

Just a few clarifications left. Joe, if I take the $30 million reduction in PDR and the $80 million risk adjuster benefit that you highlighted, and recalc MLR, I get something in the neighborhood of 210 basis points higher. I wondered if you agreed with that, that's kind of leaving aside the conversation you just had with Gary on the claims increases.

Well, I know the impact of the risk adjustment was in our script was -- I know the impact of the risk adjustment was basically 70 bps. So from 88.3% to 89% if you take out the benefit of the risk adjustment. I think we have the tables in the back. It's a little difficult to do that calculation on the fly, but I would just -- you've got the stuff in the back so we can talk later about it.

You said risk adjuster was $80 million, right? Risk adjuster was $80?

That's correct.

And then -- so then from a -- second question on exchange and the shrinkage in exchange, broadening the question out from not just the health insurer fee but just other stranded cost type thought process, and has that been contemplated in your restructuring? Are you already taking cost out in anticipation of this -- of the reduction in the individual book? Or should we think about some amount of negative leverage beyond health insurer fee calculation?

Well, there will indeed be a degree of negative leverage in a drop -- for the drop in -- of the size that is possible. Our general rule of thumb is that once you take out -- obviously, broker commissions and exchange fees fall off right away. So there's a lot of admin activity that takes care of itself. But we are aware of the possibility there's going to be some admin costs stranded as a result of that, and we're looking closely at that right now.

And that would be over and above the numbers that you're talking about in the $200 million and $400 million?

Correct. Correct, because that's going to be have pulled out of -- for profitability reasons, yes.

Yes, okay. And then final question. It sounds like you're comfortable with not taking a PDR relative to Illinois. Do you have an expectation around the change in, call it, wallet size that you will end up with in Illinois?

That's a really tough number to model right now because there's been some changes since the award was originally granted in Cook County, in particular, I think, which is creating some more competition. So we don't really know that number yet.

And we have no further questions at this time. I'll now turn the call back to you.

Well, thanks to everyone for joining and listening. We appreciate your interest in Molina Healthcare, and we'll be talking to you soon. Thank you so much.

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation, and ask that you please disconnect your line.