Molina Healthcare Inc (MOH) 2014 Q2 法說會逐字稿

Welcome to the Molina Healthcare second quarter 2014 earnings conference call.

(Operator Instructions)

As a reminder, this conference is being recorded, Wednesday, July 30, 2014. I would now like to turn the conference over to Juan Jose Orellana, Senior Vice President of Investor Relations. Please go ahead, sir.

Thank you, Melody. Hello, everyone, and thank you for joining us. The purpose of this call is to discuss Molina Healthcare's financial results for the second quarter ended June 30, 2014. The Company's earnings release reporting its results was issued today after the market closed and is now posted for viewing on our Company website. On the call with me today are Dr. Mario Molina, our CEO, John Molina, our CFO, Terry Bayer, our COO, and Joseph White, our Chief Accounting Officer. After the completion of our prepared remarks, we will open the call to take your questions. If you have multiple questions, we ask that you get back in the queue so that others can have an opportunity to ask their questions.

Our comments today will contain forward-looking statements under the Safe Harbor provisions of the Private Securities Litigation Reform Act, including but not limited to forward-looking statements about the reimbursement of the ACA Insurer Fee and the recognition of quality based revenue by our Texas health plan. 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 website or on the SEC's website.

All forward-looking statements made during today's call represent our judgment as of July 30, 2014, and we disclaim any obligation to update such statements except as required by 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 Dr. Mario Molina.

Thank you, Juan Jose. Hello, everyone, and thank you for joining us today as we report our second quarter results. We are pleased that the results for 2014 are unfolding as we anticipated when we provided guidance in February. The three key elements that we shared with you in February remain critical for our success in 2014, and they have not changed. These elements are the growth of membership and revenue, the provision of high-quality, cost effective care to our members, and improving administrative efficiency.

Membership continues to increase, and we finished the second quarter with approximately 2.3 million members, up from 1.85 million members at the end of the second quarter of 2013, an increase of 22%. In fact, we added over 100,000 members since last quarter alone. Much of this growth is due to the expansion of Medicaid that has added over 230,000 members since last year, and has exceeded the 160,000 new expansion members that we had projected in guidance at our February Investor Day.

Several states, including California, Michigan, and Illinois, where we have health plan operations have reported backlogs affecting the processing of applications for Medicaid. For example, California reported a backlog of 600,000 applications, but they expect to cut the backlog to 350,000 by September. In Illinois, the backlog has decreased from 500,000 in April to 250,000 in June. As the states process the backlog of applications, we expect to see our Medicaid enrollment continue to grow.

The new members that are enrolling as a result of the Medicaid expansion tend to be slightly older, compared to our TANF members. The Urban Institute estimated that nearly 50% of the uninsured are over 35 years of age. Consistent with this estimate, about 60% of our Medicaid expansion members are over 35 years old. It is too soon for us to know exactly what the final costs and characteristics of these members will ultimately be.

Total revenue is tracking in line with our expectations, and is up 44% as compared to the second quarter of 2013. This is consistent with the growth in membership and the shift to members that are older and have more complex medical needs. These members come with higher premiums. At 89.3% of premium, medical costs are higher than the same quarter a year ago when they were 86.2%. However, it is difficult to make meaningful comparisons to last year, because of the change in our member demographics. What is more important is that medical costs are in line with the 89% that we projected in guidance for 2014.

Let me speak for a moment on Florida. First, it's important to note that we have limited exposure in Florida due to our relatively small enrollment in that state, and that our participation in the managed medical assistance, or MMA program, did not begin until July 1. Once the program is fully implemented, Molina Healthcare will be operating in only three regions 7, 9, and 11, which geographically speaking represents Central Florida, the Florida Treasure Coast, and South Florida.

As part of the implementation of the new Medicaid contract awards in that state, we have had to exit some markets and start operations in others. This has resulted in temporary declines in enrollment in June and July as we exited Tampa and Broward Counties. However, the membership decline will be offset with new membership in Miami-Dade which started on July 1, as well as Orlando and Palm Beach starting August 1. We will closely monitor the implementation to determine how it is tracking with our expectations.

The rise in pharmacy cost reflects the higher costs of drugs in general, the increased prescription drug needs of some of our new members, and the costs of new drugs such as Sovaldi. While the utilization of Sovaldi appears to have plateaued in the second quarter, we remain concerned about the high cost of Gilead Sovaldi and the impact it could have on state Medicaid budgets. We are even more concerned about the future impact of specialty drugs of which Sovaldi is just a single example.

Competition generally brings with it lower costs. However, the specialty drug market may be an exception. Senator Wyden from Oregon and Senator Grassley from Iowa recently wrote, and I quote, in order for a marketplace to function properly, it must be competitive, fair, and transparent. It is unclear how Gilead set the price for Sovaldi. That price appears to be higher than expected given the cost of development and production and the steep discounts offered in other countries. An efficient market needs informed consumers to keep cost down. End quote. We at Molina hope that in the future the pricing of specialty drugs by pharmaceutical companies will be competitive, fair, and transparent.

Another important strategic objective for this year and next year is the implementation of six demonstration contracts for the coordination of care for patients eligible for both Medicare and Medicaid. These so-called duals represent much higher medical costs than typical for Medicare or Medicaid beneficiaries. They tend to have multiple chronic medical conditions, and they face obstacles associated with poverty that further complicate their care. We're very proud to have been selected to participate in the Medicare-Medicaid plans demonstration programs.

In addition to the 44,000 duals we currently serve through our dual eligible special-needs plans, we began enrolling members in the MMP demonstration contracts in Illinois, California, and Ohio. Recall that these dual eligible beneficiaries are first given the opportunity to enroll with a health plan that will coordinate both their Medicaid and Medicare benefits. Those that fail to do so will be assigned to a health plan through the process of passive enrollment. However, the beneficiaries have the right to elect to continue to receive their Medicare benefits on a fee-for-service basis by opting out of the demonstration plan.

We projected that 50% of the duals would opt out. Our experience so far leads us to believe that this is still a realistic estimate. There's been no change to the timeline for the implementation of our duals contracts for other states. We expect that these contracts will be implemented in Michigan, South Carolina, and Texas in 2015. In keeping with our commitment to have all of our health plans accredited by NCQA for Medicaid, we are proud to announce that our health plan in Wisconsin received accreditation from NCQA in April of this year.

Finally, we continue to see progress in administrative efficiency. Our general and administrative expense ratio declined sequentially to 8.4% in the second quarter of 2014. We expect this trend to continue as we guided to approximately 8% for the whole year. The quarter was negatively affected by three issues. The first is reimbursement of the health insurance fee or excise tax that is part of the Affordable Care Act. The second is the non-deductibility of this fee that increases our effective tax rate. And the third is the decision by the Company to delay the recognition of some of the quality incentive revenue under our contract with the state of Texas.

These are the same issues that affected our earnings last quarter as well. John will discuss these three issues in greater detail in a moment. The second quarter of 2014, much like the first quarter, was consistent with our expectations and the guidance that we provided in February. We continue to make progress towards our goals for the year. Now, I will turn the call over to John.

Thank you, Mario, and hello, everyone. As we previously discussed, we are focusing on adjusted net income as our reporting metric as we feel it better reflects how we manage our business. For the second quarter, adjusted EPS from continuing operations was $0.71 per diluted share. Overall membership grew by 22% compared with the second quarter of 2013, and sequentially by 5%. Premium revenue has grown again this quarter to $2.2 billion, up 12% compared with the first quarter of 2014. General and administrative expense ratio declined sequentially by 70 basis points to 8.4% in the second quarter of 2014, from 9.1% in the first quarter of 2014.

The positive developments I just outlined occurred despite some adverse factors which carried over from the first quarter of 2014. These include the delays in some of our states in securing agreements for the reimbursement of the Affordable Care Act's Health Insurer Fee, as well as a gross up to cover the non-deductibility of that fee, and delays in the recognition of quality related revenue at our Texas health plan. These delays reduced earnings by a combined total of approximately $23 million or $0.20 per diluted share for the second quarter, and $45 million or $0.41 per diluted share for the six months ended June 30, 2014. In other words, had we caught up in the second quarter with all of these timing differences, our year-to-date results would have been higher by $0.41.

Total revenue this quarter increased by about $240 million, a 12% increase over the first quarter of 2014. The increase was driven mainly by a higher Medicaid expansion enrollment. Since the first quarter of 2014, our Medicaid expansion membership experienced a significant jump of almost 100,000 members, a 75% increase. As Mario mentioned, our current Medicaid expansion enrollment now exceeds the guidance of 160,000 that we laid out in February.

As we previously discussed, we decided to delay recognition of a portion of the Texas quality revenue. To refresh your memory, the state implemented several new quality measures in 2014. Health plans earned this revenue by demonstrating improved performance for certain metrics in 2014 over 2013. The calculation of these new measures is extraordinarily complex and is performed on the state's behalf by a third party using proprietary software. It is the state's intent to distribute 2013 baseline data to health plans sometime in the second half of this year.

We are calculated in our performance against the measures today using our best estimates. But without seeing the state's methodology, we believe it is prudent to see that our performance in 2014 is better than what the state has measured for 2013 performance, before we recognize any revenue for these measures. In the first half of the year, we had about $13 million in quality revenue in Texas that we decided not to recognize.

Medical costs this quarter experienced a modest increase, partially offsetting the benefit from the increased revenue. We don't consider the change in medical-care ratio between the first quarter and the second quarter to be significant. We believe that the rapid growth in our membership in the first half of the year coupled with the introduction of new benefits like long-term care services and new programs like Medicaid expansion make the fluctuations in medical care ratio between the first and second quarter less meaningful. Our anticipation is that our medical care ratios will remain in flux during 2014, driven by factors such as pent-up demand, retroactive eligibility changes, member confusion regarding when and how to access care, and delays in our receipt of claims for services provided. However, we expect that the overall trend will remain in line with our guidance for the year.

We are pleased to improve our administrative costs leverage this quarter. General and administrative expenses were 8.4% for the second quarter of 2014, a decrease from 9.1% in the first quarter of 2014. Our expectation remains that as new programs are implemented and their associated revenues finally start hitting our books, we will gain further administrative leverage resulting in a lower administrative expense ratio. So far, the decline in G&A ratio is tracking closely to the quarterly estimates we provided at Investor Day, positioning us well towards achieving our 7.5% target for the fourth quarter of 2014, and an overall 8% for the entire year.

Finally, an update on our effective tax rate. The non-deductibility of the ACA Health Insurer Fee continues to affect our financial results through higher effective tax rates. We have recorded an effective tax rate of around 58% this quarter. Days in claims payable was flat at 46, and as of June 30, 2014, the Company had cash and investments of around $1.9 billion, including approximately $300 million at our parent Company.

The Company's guidance for FY14 remains unchanged and is as follows. Adjusted net income per diluted share in the range of $4 to $4.50, and net income per diluted share in the range of $1.65 to $2.15. Our operations are tracking as anticipated, as Mario suggested, but the timing of the ACA Health Insurer Fee and the Texas quality revenue may not be resolved until the fourth quarter. We believe these are timing differences, not operating issues.

This concludes our prepared remarks. Operator, we'll now take questions.

Thank you.

(Operator Instructions)

Justin Lake, JPMorgan. Please proceed with your questions.

Hi, this is Mike [Meesha] in for Justin actually.

With the reiteration of guidance, last quarter you said your bias was toward the upper end of the range. Is there any change there in terms of how the quarter came in?

I think that we're tracking just as we said in the script and in the press release.

You're not reiterating the upper end of the guidance range. It's going to fall within the whole range?

That's right.

Specifically on the MLR, it sounded like it was an uptick that maybe may have fluctuated above what you're expecting from the quarter, but still within line for the full year. Is it in line with what you're expecting for the quarter? Or it's not so high that it is still within guidance range?

This is Mario.

If you look at our medical care ratio for the first six months of the year, it comes in right at 89%, and that's right in line with guidance.

Got you. Specifically on the Medicaid expansion members, are they still tracking around 88%?

Again, everything right now is tracking in line with guidance.

Okay. Great, thank you.

Our next question comes from the line of Sarah James with Wedbush. Please proceed.

Thank you.

It looks like California MLR it just keeps improving. Things are going very well there. Are you paying back under the EBIT agreement by now? What should we think about as a run rate MLR under that agreement?

Sarah, this is John.

No, we have not started paying back. We still have a reserve, a receivable from the state. I think the run rate for California, again, there's a lot of changes in California, especially now with the duals coming on, but as Mario said, I think overall the picture is we're tracking with guidance.

Okay. I hate to circle back on this. When I think about specific to this quarter, and the expansion membership, if I'm doing the math on where run rate has been for a couple of markets and where MLR ended up, it just looked like a little bit higher of a number in some of the expansion states like Illinois, Michigan, Utah, Washington. I get that you're still on track for the year, but just specific to this quarter, are they at 88%? Or maybe that was never meant to be a quarterly specific number. Maybe that was a year number. If you could just talk about that a little bit.

Sarah, here's the challenge. It's John again. While Illinois, Ohio, and Michigan are expansion, they didn't have much expansion enrollment in the quarter. It's really hard to get that granular and give you folks a picture of the overall health of the Company. Rather than try to figure out what the MLR is for the expansion population in X state or Y state, the message is everything combined is tracking per guidance, just like we've been talking about.

Sarah, this is Mario. Let me just add, if you look at the six biggest states that we have, California, Michigan, New Mexico, Ohio, Texas, and Washington, four of those states are tracking with MLRs below 89% and two of them are above. Again, I think overall it's tracking within expectations. I don't place a lot of emphasis on a small state like Illinois. It doesn't really impact the numbers that much, so we tend to focus more on the bigger states.

Okay. Thank you.

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

If you look at most of your states, they grew in membership a little bit sequentially, and yet your loss ratios mostly rose as well. That suggest that the new membership is coming on at higher loss ratios, which wouldn't be atypical. If that continues and you talked about the members coming on from the backups of the states, do you think that your loss ratio should actually rise generally speaking through the rest of the year? And how confident are you that they're not going to rise at a more accelerated rate that you're already looking at right now?

Peter, we always have higher costs when the new programs come on. As Mario said, for the first half of the year the MCR is about 89%. We are expecting to end the year at about 89%. I think that addresses your question.

Yes, I know, but if you look at the trend that you've seen, it seems like it would be driving it in a slightly different direction. What do you see the confidence that it's not going to continue to go with higher loss ratios as you go forward?

Take California as an example. California's the state that's had the most growth, and their medical loss ratio is actually coming down. I don't think you can just make a blanket statement that the medical loss ratio is trending up, and that we're not going to hit that 89%. We still believe that the guidance number 89% is the right number.

I'm just looking at generally the state patterns other than California. California's a little bit of an exception with an improving loss ratio sequentially. Most of the others, it didn't improve particularly where you had membership growth.

We still maintain that the 89% that we putting guidance is the correct number for the year.

Peter, remember, we've always discussed that as the population ages in, as we have more time to get people under care management, et cetera, we can bring the medical care ratio down. So, while it may have gone up sequentially. It will start to track down.

Okay.

Peter, it's Joe White speaking. Hi. As you can imagine, I'm speaking because we're going to get into a technical discussion right now, which we try to avoid.

You also thought have to look at when you measure the quarter-over-quarter development, you have to look at the way our estimate of our December 31, 2013, claims liability played out. If you recall back to the first quarter, we anticipated picking up about $51 million of favorable prior-period development from December 31, 2013. That dropped to $37 million in the second quarter, about a $14 million swing, and within individual states, I don't want to go into that much detail state-by-state. Prior-period development of that size can move individual states pretty significantly.

That's helpful. Thank you very much.

Sure.

Our next question comes from the line of Josh Raskin from Barclays. Please proceed.

Thank you.

I just want to follow up on Joe's response there real quick. Relative to historical norms or normal course of business, prior-period reserve development, was there any abnormal, or was there any negative development in the second quarter?

Again, Josh, I'm talking about the development to be clear, the reserve we established at December 31, 2013. It didn't come in as robustly as we usually anticipate. I think a couple of states may have actually been below the margin, but many states were essentially beneath the target margin. I think we can't attribute that to any specific thing, other than I just think with the new membership we got starting January 1, I think our claims payment was delayed a little bit, which extended our lag factors a bit.

Okay. Then not to pick on Illinois, but Illinois looks like it's mostly new membership. It's duals and expansion. The MLR is 106%. My understanding, I would be surprised if you had enough claims data to make a call one way or another, so I would assume that's an underwritten margin. Is that what you were expecting? Were you expecting based on the rates that you were seeing that you'd be in that 106% range? Or, do you actually have some claims data already that's putting you towards a level that's higher than expected?

Again, it's Joe speaking.

We are venturing into accounting technicalities here. One of the real challenge is with recording the MCR in Illinois is that with anticipation of the expanded enrollment and with anticipation of the dual eligibles coming on, we had to front load a lot of our medical management staff. If you think a typical health plan, if you think consolidated basis, normally what we call quality assurance costs, medical management, runs about 2.5% of revenue.

In Illinois, it's running about 10% of revenue. Certainly, it's one of our higher cost medical markets, but if you normalize for the administrative cost burden, the medical management burden, you knock about 10% off of the MLR for Illinois.

Got it. You put all those quality expenses in the medical costs line?

Correct.

Okay, consistent with the NEIC guidelines, et cetera. One more question for you, the opt out rate, I'm just looking at the second quarter, it looks like you're at about 62%. I think you have been talking about a 50% opt out rate. Can you walk us through the timing of the dual rollouts? Is this an issue where you've got a timing issue and that this will migrate more toward 50%? Or is that 62% in line with your expectations?

Josh, it's Joe, and Terry's going to get into the more substantive business explanation of this in a minute, but as far as how we've reported this, it's not the numbers. The major factor here is Ohio. Unlike our other MMPs states, in Ohio the state is rolling in everyone for their Medicaid benefits, and the individual until January 1 to receive the Medicare piece of the MMP has to opt in.

The result of that is, we're starting to get members in Ohio who are defaulted just to the Medicaid piece of the MMP benefit, and have chosen not to opt in to the Medicare piece. The result of that is what you see right there in terms of the way we've disclosed enrollment in the earnings release.

Josh, I will just add two more factors. At this point we're telling you that we're tracking toward that 50% opt out number, which is what we put in guidance. We don't have any indication it will not be there. Some people opt out before they ever come into the program. Some opt out in the first month they're in the program.

What Joe just explained, Ohio is a different situation, where the passive enrollment will not begin until next January. You've got Medicaid coming in, and then a voluntary opt in on the others.

There are so many factors. I think we've discussed it at length and looked at Illinois, California, and Ohio, all whom are at different points in the voluntary and passive process. Our conclusion is that we are not seeing that we will exceed that 50% opt out rate. The bottom line is, it's too early to tell.

Right.

We're waiting for that information to finally come in.

Just to clarify in Ohio then, all of these individuals have been assigned Medicaid passively.

Yes.

Then, they will get their Medicare assignment on January 1 passively as well, and then there's probably an opt out period after that, as well?

Correct. They can opt out of Medicare at any time. I just want to also clarify for you the entire Ohio enrollment has not been assigned yet. That's coming in and segments, and you're seeing in the June 30 numbers only the first pass in selected regions. That will continue to occur over the next month or two.

Right. You'll get a big bump in the full duals assignment for January 1, and then it will come down a little bit as people opt out after that.

Yes, but even the Medicaid is coming in over the course of a couple of months, not all at once.

Got it. Okay. Thanks.

Our next question comes from the line of Kevin Fischbeck with Bank of America Merrill Lynch. Please proceed.

Great, thanks.

I'm struggling to fully understand some of the commentary that you made so far. When I look at the 10-Q, it looks like in the quarter California got a bunch of payments that were out of period revenue payments related to Q1 in 2013, which I believe made the MLR look lower. If I back those out, I coming up with MLR up 160 basis points sequentially. Is that the right way think about? If so, I want to go back to the question earlier about revenue growth and a rising trend in MLR.

Sure, it's Joe speaking.

Yes, I think the way you've laid out is the way I would lay out. California benefited from an out-of-period revenue adjustment in the quarter that more or less offset consolidated prior-period development. We didn't see a need to call it out on a consolidated basis, Kevin.

When everyone started to talk about individual health plan performance, I was just making the point that that unfavorable prior-period development on a comparative basis from the previous quarter easily skews other health plans' MLRs. I think the way to look at it is without going into too much detail, California's MCR helped by the $15 million of out-of-period revenue, the other health plans hurt by prior-period development.

Yes, okay. I think the number was $20 million, so you're saying the $5 million in Q1, that's obviously a 2014 number, so you include that in your 2014 thoughts, just the $15 million to $13 million, not exact, that you would back.

Exactly. It's about $15 million versus $15 million for last year.

Okay. It does seem then like if you look on a normalized basis that -- generally speaking I understand that the concept that your relating that it is hard to get a clean number because we don't have prior-period development by state. It still directionally feels like the comment before about new enrollment coming in a higher costs, generally speaking, is the right way think about it. I think you have also talked about that historically, that when you don't have visibility on claims you take little bit more conservative approach on MLR.

It's interesting that we have that enrollment coming on. Normally, we would think that it should be a higher MLR. The bridge and the ramp in guidance is pretty dramatic. Obviously, you're expecting to get the healthcare insurance fee and the Texas incentive payments.

I'm just trying to think about the bridge there. Is it all about the G&A reduction and hitting that? Is that the other big reason for the dramatic increase in the earnings when MLR might not be the answer?

It's Joe speaking again. That's a big chunk of it. I don't want to model for everybody, but if you look at where guidance is at on the revenue side versus where we are today for the first half, and then take the impact of the admin ratio we talked about for the year, which we still believe we're going to get, it's a pretty substantial number dropping to the bottom line.

Okay. Then just last question on the Texas incentive payments, I just want to get an update from you, any color you can provide about conversations you've with the State about where you are versus those numbers. Obviously, there may be a restriction when you can actually book it, but just any color you have about the degree of confidence of actually hitting those numbers?

This is John. We've done our own internal calculations that we feel pretty comfortable with that our performance is improving, but until we see what the baseline is, and we have to get that from the state, and they have to get that from the third-party vendor, it's impossible for us to know.

Is there timing on that? Is that a Q3 event? Is that a Q4 event?

They've told us Q3, but let's face it, we recognize that oftentimes when states are rolling out new data that there are delays.

Okay. Great. Thanks.

Our next question comes from the line of Chris Carter with Credit Suisse. Please proceed.

Thanks, good afternoon. Just a quick one. When I go back to your Investor Day book, I think I come up with a target of around 60,000 duals I think you were targeting for the year. Are you on pace for that, given where you are today?

That's a good question.

It's Joe speaking again. I think that point, since then, we've talked about delays in the rollouts in Michigan.

South Carolina.

And South Carolina. We don't want to go in that level of detail, but I think it's fair to say we'll come up little bit less than that.

Got it. Okay. Then just on the Texas MLR, that looked elevated in the quarter. Is that just simply related to the revenue recognition? Or anything else going on there?

It's Joe speaking again. Yes, it's the revenue recognition. If you look at it compared to last year, it also has to do with some timing of recognition of profit-sharing due back to the state.

Okay. All right. Thank you.

Our next question comes from the line of Dave Windley with Jefferies. Please proceed.

Hi. Thanks for taking the question.

A follow-up on the dual Medicare opt out, I'm wondering beyond the obvious that you don't get the Medicare premium portion, are there other implications to that opt out in terms of your ability to manage the members' care? Perhaps the savings assumptions that are baked into the premium that you are getting?

I think that we're still going to be responsible for managing the long-term care benefits. The savings that are baked in are baked in only for the MMP program, so if they're not fully enrolled, there's no savings expectation. They are essentially like our Texas Star Plus members, where we're responsible for the long-term care benefits but there's no associated savings.

The savings idea was that if you could coordinate the care for both Medicare and Medicaid, there will be some synergy and cost savings. To the extent that the members don't participate in both programs, they're outside of that contract.

That's how we modeled in our guidance.

Okay. You feel like the premium that you will get in an opt out situation is appropriate for the benefits and the savings or lack thereof that you're responsible for?

That's right.

Yes, okay.

Yes, and I also think that there's an opportunity later on for those patients to voluntarily enroll in the demo if they choose to. I think that if we do a good job of managing their other Medicaid benefits, they may gain confidence in the health plan and decide that they want to fully participate. It's not as if these members are permanently gone on the Medicare side. They could come back to us later.

Sure. On that point, are there other steps that you can take that would change the proportion of opt outs, change the network and things like that?

Certainly one of the reasons that people opt out of the Medicare side is if we don't have their provider in the network. It becomes more difficult on the Medicare side because these beneficiaries have multiple physicians, whereas typically on the Medicaid side, their real contact with health care is through their primary care doctor.

On the Medicare side, it's often the specialist. If you've got four or five specialists and one of them is not in our network, you may opt out. As time goes on, I think we will shore up the network. We do get information about who the providers are.

Got you. Last question, coming back to the MLR, there's a lot of focus on the new members that are coming in or will come in over the balance of the year and impact on MLR. What about your expectations for MLR or underwriting margin for the members that we're looking at today, the decline as they mature into your plans, and the medical management resources that you have in place? Maybe you could talk us through the proactive steps that you are taking to make sure these folks get into plans and their cost experience declines as they season?

This is Terry. We're executing on our model of care that we have been working on and focused on the last few years. We use a model of care when they're aged, blind, or disabled patient or Medicare D-SNP, and we've extended it now to the new enrollment. The patients are all -- a risk assessment is completed upon their entry to the program, and they are dependent upon our modeling tools, and our tiering of the severity and the need for immediate intervention. Folks are getting assigned to case managers.

I think we have shared with you in the past, we're focused on community connectors and care transition workers so that we're working with members in their homes, and when they leave the hospital just as much as we're managing them during their inpatient stay. Our full care management model which is very focused on coordinating medical, behavioral, and social needs is in play on these members, not 100% on day one. That's where our triage mechanisms come in place, so that we can focus on those in greatest need.

There's also medication therapy management programs that come, so all of the members who have a high number of medical diagnoses and prescription drugs are each in dialogue with a registered pharmacist to coordinate their drug program. That's another way that we focused on those of most greatest need in the beginning.

All right. Thank you.

Our next question comes from the line of Tom Carroll with Stifel. Please proceed.

Good afternoon. I wonder if you could talk about the process that you are taking with your states to get the ACA fee totally covered and wrapped up with a bow? I thought by this time of the year you might have a bit more visibility on it. Are you more conservative in your process? Any additional color would be helpful there.

Sure, Tom. This is John.

I think one of the important things is we're waiting for our contract language. While there are a couple of states, Utah and Michigan, where the legislature has passed budget appropriations to cover the fee and the gross up, we are not going to recognize that revenue until we get a contract amendment.

Okay. Then just to clarify one other thing, does your prior guidance also exclude Sovaldi spending?

Yes.

It did. When was that? I was just trying to figure out when you excluded that? Was that your Investor Day?

That was on Investor Day.

Okay, very good. Then is there any comment? You were hesitant to comment on first quarter about Sovaldi spending. I appreciate the comments about it plateauing. Is there any order of magnitude description you could give to us first quarter into second quarter?

Yes, this is Mario.

I don't know that I want to quantify that. Certainly, the spending in the second quarter was greater than the first quarter. Requests for the drug seem to have plateaued, so we think that that's going to flatten out. I think that part of that is an expectation that there are new drugs in the pipeline. Some physicians may be waiting for those new treatments.

Okay. Thanks for that.

Our next question comes from the line of Andy Schenker from Morgan Stanley. Please proceed.

Hi, it's Andy Schenker. Thanks for the question.

Just following up on the Sovaldi comments there, you previously highlighted obviously got the KCK team. You have acknowledged, at least Texas acknowledged, that the drug wasn't in rates. How are those conversations going with Texas about reimbursement there specifically going forward?

How your conversations with other states? Any other states potentially going to pay retroactively? Is your expectation it will be in rates when they renew?

That's a whole lot of questions there, Andy.

I'm not aware that anyone's planning to pay us retroactively. I think that states are talking about what they can do on a prospective basis, and I think that what I would say is, it's all over the map. Every state is taking a slightly different approach to this, and I think they are building that into the rates for next year.

As I stated in my remarks earlier, a big part of our concern is not just Sovaldi, but all the other specialty drugs. I think that the government needs to step in here and make sure that the market is rational. If we as a health plan want a rate increase, we have to go to our regulators and get it approved. There's no such thing going on in the pharmaceutical market. Right now, pharmaceutical companies can charge whatever they want, and I think there needs to be a rational basis for all of this.

If we're going to cover all of these people, all of these uninsured people, the only way to do that is by bringing down health care costs, and we can't do that if we see a large number of specialty drugs accelerate the medical trends. It's a problem not only for Medicaid companies, but it's going to be a problem for Medicare, for the VA, and for commercial plans. This is truly a national problem that is going to affect everyone.

Okay. Just following up on your states that are off-calendar, fiscal year rate increases, any updates on how those rate discussions are progressing?

We generally don't talk about how rates are progressing until we actually get rate manuals, rate sheets, et cetera, but as Mario said it does run the gambit from folks like Florida doing KCK payment to others that are going to increase the rates a certain percentage specifically for Sovaldi or specialty drugs like Sovaldi.

I was thinking also just beyond Sovaldi, just in general on discussions are trending.

I think that with the discussions on the ACA fee and Sovaldi, those have taken the forefront. There hasn't been a lot of discussion yet about baseline trends other than for Sovaldi, et cetera. I think that now that we're getting the populations in the MMPs, getting in the Medicaid expansion, and getting some data, we'll move some of those discussions on trends to the forefront.

Okay, thanks.

(Operator Instructions)

Our next question comes from the line of Ana Gupte with Leerink Partners. Please proceed.

Yes, thanks. Good evening, I appreciate you taking my question.

I wanted to just get some qualitative color if you can offer it at this point on the Medicaid expansion lives, as far as the venue or the site that they're presenting themselves? What types of services are they seeking? Then when you think about the premiums of about 50% to 200% higher depending upon which state you're in, do think there's adequate rates in there to cover maybe the upfront outpatient, pharmacy, imaging, and any of those types of costs for potentially untreated, unmanaged patients?

Ana, this is Mario.

As I said before, the patients are older than our typical TANF members, but I still think it's early for us to be making statements about the rates or the place of service or the kinds of services that they are getting. For example, we picked up 100,000 members from the first quarter to the second quarter, and so I don't feel that we have enough claims data yet to be making those kinds of statements. We'd be getting into a lot of the member characteristics or health care patterns yet. I think it's developing, and we're just going to have to watch it, and maybe we can update you on that in future quarters. Right now, it's probably too soon.

In the hospitals, I think some of them are talking about expecting that outpatient care might trend down and it will eventually transition into the inpatient setting. Are you as a health plan taking any steps to get primary care interventions or anything of that nature? Is this just going to happen relatively unmanaged, and they end up in the ER, and so the plans don't really have that much control over what happens?

We certainly hope that this is not going to be unmanaged care. That's what we're here for. We are trying to manage the patients as best we can. As Terry mentioned for a lot of the patients we're doing initial health assessments. We've got all kinds of care managers.

Joe talked about the investment we made in Illinois. Across the board, and this is reflective in our admin costs, we've staffed up, and you saw a lot of that infrastructure growth last year. I wouldn't say that this is just going to develop in an unmanaged fashion. We're learning as we go. We will try to continue to improve on the method of care for these members, but I'm hoping that the tools we have will help us to manage them.

Then with the state, at the point when you and the states together can make a decision as to whether the rates were adequate or in excess or too little, let's assume they were excessive, do you think the states will manage the margins to where they think they should be through a risk corridor, an MLR floor type mechanism? On top of that, do think there will be some rate adjustments? If there were rate adjustments, do think the states will use the expansion population in the federal subsidies to manage against their budgetary constraints in other areas with Sovaldi and Health Insurer Fee and that type of thing?

Ana, this is John. I'm not sure how a state could do what you're discussing in terms of the last point. Those are federal dollars so I don't know how the state could use it for their budget issues.

There are a number of states that have caps and floors with respect to the expansion populations, but the rates for the expansion populations have to be actuarially sound. As we get data in on demographics and utilization, we will have discussions with the states on what the appropriate rates are.

Ana, I think that's an important point that John just made. In addition, because of these rate quarters that we have in a lot of the contracts, there's some additional mitigation that you don't see. We set aside money for claims that have been incurred but not received yet, but there is also these risk corridor mitigation factors that will help us as well.

When we last talked I think there was something about a rate change in July. Did that actually materialize in California? I might've just missed that altogether.

California is looking at rates for certain counties in July, but I don't know. I haven't seen them all yet and don't know what the impact on the expansion, if any, is.

Yes, I'd be surprised.

Finally, just on duals with the opt outs, are you seeing any selection in that opt out equation, where the more acute care utilizers for the Medicare portion of this are more likely to opt out because they get more unmanaged usage, if that's what they're seeking? In some ways, it actually helps you they're opting out?

We really don't know. What I would say is this, the members opt out. It's a voluntary choice on their part. We don't have a lot of insight into things like what their prior care or what their health status is at the time they're opting out. We really don't even get information as to why they opt out. It's really anecdotal information that we get.

We suspect based on our experience with the dual eligible special needs plans that a big driver of this are the providers and the provider network that we have. I can't give you that kind of detail as to who's opting out or why, and what their patterns of utilization are. That's just something we don't have any insight into.

If I could sneak one last follow-up on that point you made, will you do any outreach to these auto-assigned people, so that you know who you're reaching out to, and trying to keep and retain within the system, either through the provider base or any other channel?

The moment that we are allowed to reach out to these new members, we do so.

Okay. Thank you. I appreciate the color.

Our next question comes from the line of Chris Rigg with Susquehanna International Group. Please proceed.

Hi. Thanks for taking my questions.

I just want to dumb down the guidance for the year and make sure I understand what exactly the message is. The year-to-date EPS is $0.26. The normalized for the HIF, annualized, it's about $0.60, and then the Texas issue annualized, about $0.24. That gets you to roughly $1.20 which leaves you $0.45 to $0.95 from your guidance. Is the message on the low end, do you think you think you can get there just on G&A improvement? Then to get to the upper end, we need to see the MLRs come down a bit?

This is John.

I'd hate to make it that succinct because as we've discussed there's a lot of moving parts. I think if you want to characterize it that way, I would think the just bringing the G&A down though gets us beyond the low end.

Okay. Then the DCP remained at an elevated level here from the first quarter, and I guess I'm just trying to get a sense for what's the right level to think about as we move into the back half of the year, maybe just giving a little bit longer term?

It's Joe speaking. Are you asking about what the right level for DCP is?

Yes. It looks like there's some conservatism baked into that, and you're not alone in the industry at this point. I'm just trying to figure out where you think that shakes out over time.

We don't put a lot of stock in DCP, but I think you can expect it to come down a day or two as the populations mature, and we work for our claims backlogs, and we get more confidence with where we are in terms of our cost estimation.

Okay. Then my last question, or questions, the health insurance fee and the remuneration for that, is that still a split, like an FMAP split, between the states and the feds? Or are the feds taking most of that on behalf of the states?

It is a split. Part of it's contributed by the state. Part of it's contributed by the feds.

Right. Then this is kind of crazy, but then we think about Texas and where they are politically, particularly their governor, who seems to loathe everything about the ACA, is there any political element in your mind with regard to them not agreeing yet to remunerate that because they may just say, we don't care. It's a federal tax, and we don't want any part of it?

What I would say about that is that we have a fairly good relationship with the Health and Human Services Commission, and we have dialogue with them as do the other health plans. I would not ascribe a lot of political motive to anything at this point.

Okay. Great. Thanks a lot.

Our final question comes from the line of Brian Wright with Sterne Agee. Please proceed.

Thanks, and I apologize. I may have missed this, but could you talk a little bit about the sequential move in Michigan on the MLR, just to give us some understanding of what happened there?

Hi, Brian. It's Joe speaking. That's one of those mainly mechanical developments in terms of how --

The December 31, 2013 change?

And that combined, and again, the numbers are small consolidated but there were all just some revenue adjustments on Medicare there.

Okay. Thank you.

Not significant enough to move the needle consolidated but they can have an impact on a health plan.

Okay. Thank you.

Dr. Molina, there are no further questions at this time. I'll turn the call back over to you.

Thank you all for joining us today, and we look forward to talking to you with our next quarter results.

Ladies and gentlemen, that does conclude today's conference call. We thank you for your participation and ask that you please disconnect your lines. Thank you, and have a great day.