Health Net's CEO Discusses Q4 2012 Results - Earnings Call Transcript

Jan.30.13 | About: Health Net, (HNT)

Health Net, Inc. (NYSE:HNT)

Q4 2012 Earnings Call

January 30, 2013 11:00 am ET

Executives

Angie McCabe – Investor Relations

Jay M. Gellert – President and Chief Executive Officer

Joseph C. Capezza – Executive Vice President, Chief Financial Officer and Treasurer

Operator

Good morning, everyone, and welcome to this Health Net, Incorporated Fourth Quarter and Year End 2012 Conference Call. Today's call is being recorded. At this time, I would like to turn the call over to Angie McCabe, Vice President of Investor Relations. Please go ahead.

Angie McCabe

Thank you, Marly. And thank you for joining us for a discussion of Health Net's fourth quarter and full year 2012 results. During this call, we will make forward-looking statements that are subject to certain risks and uncertainties. Risk factors that may impact those statements and could cause actual future results to differ materially from currently expected results are described in our filings with the SEC as well as the cautionary statements in our press release issued in advance of this call.

In today's call, we will refer to adjusted days claims payable. This adjusted metric is not being presented in accordance with generally accepted accounting principles or GAAP. Please refer to today's press release, which is available on the Company's website for a reconciliation of this non-GAAP financial measure with the most directly comparable GAAP financial measure days claims payable.

I will now turn the call over to Jay Gellert, Health Net's CEO. Jay?

Jay M. Gellert

Thank you, Angie, and good morning everyone. Today we’re pleased to report fourth quarter results that demonstrate continued progress on the plan we outlined on our second quarter call. There are three key areas we focused on in Q2. One, we have successfully repositioned the large case commercial account. We’ve either gotten more favorable pricing or the accounts have left. On January 1, we renewed approximately 60,000 of these members with necessary premium increases. Accounts representing approximately 40,000 members did not renew.

Second, we recorded no additional adverse prior period development in the second half of 2012 and foresee none in 2013. Combined with mixed changes and large group re-pricing, this supports the 350 basis point yield cost spread we guided to for 2013.

Third, our state sponsored health program business improved significantly from the third quarter to the fourth quarter of 2012. Overall our MCR improved by 270 basis points sequentially as a result of various rate actions that took effect on October 1, 2012 that included addressing the shortfall in FPD rate. Our discussion on further changes in the program including rates, benefits continue. It's important to remember that our new state agreement will help provide P&L predictability and the time to settle the remaining issues. We are pleased that we successfully address each of these issues and met expectations in the second half of 2012.

Before going into more detail about our expectations for 2013 and our future prospects, let me address some fourth quarter results. GAAP EPS was $0.06 per diluted share while diluted EPS from the combined Western Region and Government Contract segment was $0.36. This brought the full year diluted GAAP EPS to $1.46 and the full-year diluted EPS from the combined segment to $1.02 consistent with our previous 2012 guidance range.

The overall health plan MCR in the fourth quarter of 2012 improved sequentially from the third quarter of 2012 by 40 basis points. This expected improvement was driven by both Medicare and Medicaid while the commercial MCR rose from the third quarter of 2012.

Our commercial cost in the fourth quarter were affected by our assumption of higher utilization among members in departing large case accounts, a prudent assumption given historical patterns in similar situation. In addition, risk sharing adjustments with certain providers impacted the commercial MCR. This higher level of risk sharing is a direct result of better-than-expected performance in our tailored network products in 2012.

Underlying commercial cost trends were moderate. We continue to benefit from our pharmacy agreement with CVS, favorable utilization in the tailored network products and lower than expected unit costs.

Our G&A ratio rose sequentially by 40 basis points in the fourth quarter of 2012 versus the third quarter of 2012. This was consistent with our expectations and reflects marketing cost in the fourth quarter.

Adjusted days claims payable rose by half a day sequential in the fourth quarter, though total reserves did decline somewhat. This was the result of a $45 million pass-through payment included in reserves related to state health plans that occurred in the third quarter, otherwise total reserves would have increased sequentially.

Operating cash flow in the fourth quarter exceeded net income plus depreciation and amortization. Operating cash flow for the full-year was impacted by the sale of our Medicare PDP business. The cash benefit of the transaction is reflected in cash flows from investing activities while the costs related to it were recorded in cash flows from operations.

Excluding this effect, operating cash flow for the full year of 2012 would have exceeded net income plus G&A. Our 2013 outlook for operating cash flow is that it will be at least equal to net income plus G&A. Let me add that with the $106 million in cash at the parent as of December 31 2012 and with meaningful incremental debt capacity, we continue to possess substantial capital flexibility.

Let me now turn to the rest of our outlook for 2013 and some initial developments in January. First, we are encouraged by the early results from open enrollment in our small group segment driven by continued interest in our tailored network products in 2013. We expect that these products will comprise approximately 40% of our commercial enrollment by the end of 2013 compared with approximately 35% at the end of 2012.

Our performance in Medicare Advantage annual enrollment period was consistent with our full-year outlook. Along with positive revenue developments in Medicaid, we're beginning to see some encouraging signs in health care cost trend among FPD members, who have been with us long enough to gain the benefit of enhanced case management capabilities. We are, however, are waiting more performance data, before actually reflecting this trend.

We believe that our Medicaid MCR will demonstrate significant improvement in 2013 versus 2012. We believe this because of the October 1 effective rate actions, improved medical management and anticipated further rate and benefit changes going forward. The state agreement affords us the time to complete the process with the state. We expect our government contract business to remain stable in 2013 when compared to 2012.

We believe the average quarterly pre-tax income contribution from this segment will be approximately $20 million in 2013. However, we do anticipate quarterly deviations based on the timing of the work fees and other incentives with a lower first-quarter and better performance in the balance of the year.

The G&A expense ratio in 2013 will higher than 2012, as we expect to spend approximately $30 million to prepare for exchanges and other aspects of health care reform. These expenses are included in our guidance and our necessary investments as we position ourselves for health care reforms. We have not included cost related to the California Coordinated Care Initiative in our guidance. That care initiative includes the dual and non-dual LTSS population. The LTSS population, consist of Medicaid only recipients who receive long-term care and other support services.

It is our understanding that the state expects to have an agreement with CMF in February. The state then expects rate and implementation plan for the initiative to be completed by the end of April for September implementation. Based on that tight line, we would anticipate providing guidance on CCI on our first quarter 2013 earnings call.

Going forward, we believe we have the right products and expertise to meet the needs of our government and commercial customers as the industry continues to evolve. We look forward to a successful future together and to now answering your questions.

Let's open up for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Christine Arnold.

Jay M. Gellert

Christine?

Unidentified Analyst

Yes, I am here.

Jay M. Gellert

Are you there?

Unidentified Analyst

Can you hear me?

Jay M. Gellert

Yes.

Unidentified Analyst

Hey, how are you?

Jay M. Gellert

Good, good.

Unidentified Analyst

So are both the duals and LTSS going to start in September, or are they on separate tracks? And how I think about the LTSS opportunity in terms of warm bodies that aren't in the FPD or dual programs or other Medicaid programs already?

Jay M. Gellert

The anticipation of the state is that they would start at the same time. So September implementation for both is what we’ve been guided to. There is…

Unidentified Analyst

And – I'm sorry, go ahead.

Jay M. Gellert

Do you have a question?

Unidentified Analyst

Yeah. On the LTSS, is it going to be the same as the duals, an 18-month implementation in LA? And I think about LTSS for you is primarily LA?

Jay M. Gellert

Well, first of all, I think the exact timing in terms of months is still being finalized. I think 18 is the max, and maybe down slightly differently, but that's what we are waiting to here on. It's conceivable that the LTS as could occur more rapidly, we've not gotten final information on that. We are waiting to hear that the LTSS population is of a significant size. Our sense is roughly the same size as the dual population, but its Medicaid only. But all of that is kind of up in the air; I think right now we are in discussions with the state. They are actually taking the budget that Governor Brown produced and now beginning to pull all their stuff together, so that we actually can come up with a very specific execution and economic plan to get this thing completed. So giving specifics at this point it's impossible if we don’t know them, but we are involved in very direct discussions now to meet that timeline that I articulated.

Unidentified Analyst

So, if I think about that the duals I can double the expected enrollment to incorporate LTSS.

Jay M. Gellert

Christine, I'm not sure that the enrollment I think what I was indicating more was a sense of the dollars. We don’t exactly have the number of enrollments. Some of those people will be in adult day health centers, some of those people would be receiving IHSS only, some of them will be in long-term-care and I just gave you kind of a sense of numbers. We don't have the data from the state yet to answer your questions completely. We would anticipate that the LTSS part of the Coordinated Care Initiative would occur more broadly then just Los Angeles, but we are waiting to get all those details.

Unidentified Analyst

So your rough guess at this point is the dollar revenue opportunity to you is roughly equal to the duals?

Jay M. Gellert

Order of magnitude, but I don't want to be health accountable even to that. I think we'll have much better data. We actually haven’t even really studied the Governor's budget document. We’ve just begun this process with the state. So I will think better of giving you more information on when we get it in a more detailed way.

Unidentified Analyst

Okay. And it looks like the premium yield for Medicaid and dual and SPDs combined increased like $25 per member per month. I know some of that’s the October 1 rate action, where there any one timers in there or is it just a good run rate from which we can hope for more relief in the state on payment levels.

Jay M. Gellert

First of all, it confuse somewhat because we also have a new program there, the Adult Day Health Center program included in that. I think that we are still in discussions with the state, but the kind of margin assumption is a beginning and then we are looking at some medical management improvements and benefit changes and the like as I articulate it. So I think we feel comfortable with the guidance, I guess I’d say in growth, but exactly the geography of it is still to be decided over the course of the next three to six months.

Unidentified Analyst

Okay. And that’s the margin you are expecting 300 basis points to 400 basis points in MLR improvement on all these stuff combined state sponsored true?

Jay M. Gellert

We are assuming in that range. Yes.

Unidentified Analyst

Okay. Thanks.

Operator

And your next question comes from the line of Ralph Giacobbe.

Unidentified Analyst

Thanks. Good morning. Can you may be talk about your TRICARE contract negotiation with providers that are going, obviously in the headlines you came into green with Tenin after a bit of a standstill. Just help us as there are a lot of pushback in general and just what your thought process is for rates going forward particularly in 2014 in terms of your commercial business as well as potentially on the exchanges.

Jay M. Gellert

I believe that different providers are making some different kind of arrangements. In general we're seeing providers interested in developing alternatives that work in the exchange, that work in the narrow network contact, and I think we're seeing somewhat less receptivity on the broad network contact. So we are actually seeing in the provider community a real interest in producing products that hit different price points as we've done over the course of the last three of four years.

Unidentified Analyst

Okay. And then maybe can help with the – the risk sharing adjustment that you’ve talked about in terms of just the drag component of that, how much of that 70 bip sequential bump came from that and whether that's an ongoing and impactful the 2013 all and then just the expectation for improvement in the commercial MLR for 2013 and so the existing book?

Jay M. Gellert

Our guidance includes that risk sharing assumption in 2013. So the guidance we gave which is 350 bip yield improvement includes that in it. As we indicated basically what we've assumed in it is an OPPIA which is about 210 bips, about 60 bips 70 bips improvement from the large group re-pricing, about 80 bips improvement from the fact of moving more lies into small group narrow network and some individual growth. And then some assumption to give some room for some utilization increase and then some of the efficiency assumptions that have already occurred as a result of what's going on. So that's the framework of our guidance.

Unidentified Analyst

Okay. And then just my last one, can you help us with the level of share repo you have built in the guidance, just how we should think about sourcing uses of apparent cash basically through the year? Thanks.

Jay M. Gellert

Yeah, I think that the end of your share account is 83.1 the plan is built on 80. And I think that that’s step one. And step two really is, as I said earlier by April getting a conclusion on how the Coordinated Care Initiative, Medicaid expansion is going to occur so that we can assess regulated cash requirements in order to accommodate that. And then I think we’d go from there to determine our additional policies in that regard, but we don’t expect other than capital improvements, other capital deployment then our purchase plans as we’ve done before.

Unidentified Analyst

Okay. Great. Thank you.

Operator

Your next question comes from the line of Josh Raskin.

Jay M. Gellert

Hello, Josh.

Unidentified Analyst

Hello. First question, I was wondering if you could give us a sense of your earnings by segment. We have a pretty good line of site obviously into the TRICARE or the government contracts business. But may be if you could give us a sense of how much of your earnings, based on your forecast for 2013, because I know 2012 is kind of a strange year, so let’s not look at that. But based on 2013, how much of its large group commercial, how much small group, how much Medicare, how much Medicaid?

Jay M. Gellert

Let me get back to you on that, but let me give you some color and then we can get more data. At this point in time, if we look at it, I guess I could better look at it from more of a gross margin standpoint, because I have that right in front of me.

Unidentified Analyst

Okay.

Jay M. Gellert

Particularly Medicare and Medicaid are roughly equal and the order of equal. And they together, probably represent about 42%, 43% of our earnings in the gross margin standpoint excluding TRICARE, so they probably represent 42% to 43% of non-TRICARE gross margin. On the commercial side, the vast majority of the gross margin comes from mid small group products relatively little from individual and not that much from full network large group.

Unidentified Analyst

Okay. So and you're looking at the gross margin and then maybe if you could just help us little bit from a G&A perspective, I assume that the Medicare and Medicaid G&A loads are probably lower and I assume that the individual commercial probably the highest G&A is that fair?

Jay M. Gellert

Because of selling cost, yeah, that's fair.

Unidentified Analyst

Okay. So that's okay. And then...

Jay M. Gellert

We can get more data.

Unidentified Analyst

No, that's helpful. So I mean, so if you're looking ex-TRICARE, let's call it somewhere in the ballpark of 55% to 60% is commercial and that's almost all what you are defining to be mid-to-small group?

Jay M. Gellert

Yeah, there is some gross margin in the larger – because as we said before, we are pricing nothing negative, but it more covers overhead and have some limited profits.

Unidentified Analyst

Okay. Okay I got it. And then Jay you’ve mentioned some comments earlier around your assessment of the business and the scale that you have in the commercial world, and what that means for your future, the future of Health Net et cetera, any sort of updated thoughts on what you're thinking there?

Jay M. Gellert

We indicated when we raised this before, we saw kind of a three-step process one was the result of 12 issues which I think we had and we walked through that. Second was to tie down the state relationship and I think we are well on the way to that. What I think we have now been doing is really assessing the alternatives in terms of scale and we anticipate coming back later in the year with some specifics on how and what we are going to do in that regard. It’s premature to really comment at this time particularly given that the next couple of months I think we get a real clarity on the demands of the state expansion business.

Unidentified Analyst

Right. Okay. I think that’s fair. And then if I could sneak in a last question around…

Jay M. Gellert

Sure.

Unidentified Analyst

I’m sorry.

Jay M. Gellert

I said sure, keep going.

Unidentified Analyst

Okay. The risk sharing agreement in the tailored network, was there a true up function in the fourth quarter that has a bigger impact i.e. we weren’t necessarily accruing all of this and had to catch up. And if so, how much of this was prior period in that regard?

Jay M. Gellert

No, no. There was a limited amount of risk sharing because we saw improved MLR in some of the narrow network products and so it would be – when you look back it probably wasn’t a large number but it was partially prior period.

Unidentified Analyst

How would you think…

Jay M. Gellert

Over the course of a year.

Unidentified Analyst

Right. So but I was just thinking you had a 70 basis point change in your commercial MLR, so it’s impactful in the quarter.

Jay M. Gellert

Yeah. I think that when you look at 70 bips that’s about $10 million as an order of magnitude isn’t it right guys. And probably half of it was related to the – just we assume run out number and probably half was related to this, and probably this you’d probably spread mostly in the second half back to the first half, but in the second half so probably you take half of that and say that’s maybe in Q3 and before.

Unidentified Analyst

Okay that's perfect. Thanks Jay.

Operator

Your next question comes from the line of Mat Borsch.

Unidentified Analyst

Yeah thank you. Can you guys just talk about AB 92 and any impact you might or might not see on that front?

Jay M. Gellert

AB 97.

Matthew Borsch – Goldman Sachs

Sorry 97, right? Yeah don't talk about AB 92.

Jay M. Gellert

I know, I just didn’t know what it was, I’ll point about that. With regard to 97, we’ve included it, our expectation on its effect in our going forward guidance. There is no retrospective effect to it. And we’re acting as though what’s included in the Governor’s budget related to 97 will be implemented.

Unidentified Analyst

Okay got it. And can you also, I think I’ve heard you guys observe on that the Medicare advantage landscape that you see that as particularly competitive influencing your limited view of growth coming into 2013. Could you just elaborate, is that California, is that a dynamic of the big integrated plan and the benefits they are offering?

Jay M. Gellert

Well I think our view is that in the markets we are in there, very high existing penetration, and simultaneously there’s very high dual population. So when you add existing penetration dual population and people who are covered with employer sponsored plans, that there isn’t near the opportunity that exists in some other places. Our focus therefore has been as we said on the duals where you really do have in California something like 13% or 14% of all the duals in the United States, and that’s an area where we think that there is real opportunity to really fundamentally change service for people and better in the economics. So what we’ve basically been saying in the markets we are in that seems to be a greater opportunity.

Unidentified Analyst

Okay. And last question, can you just talk about your view of – your plan for your non-California markets and do you sort of hold steady there? Are there differences between Pacific Northwest and how you look at Arizona?

Jay M. Gellert

Well, Arizona is improving. We actually see some opportunities in Arizona, and we see some fairly significant permanent anticipated in 2013. So we – I think are staying with our basic thesis, which is that those markets are kind of moving in alignment with California and that they makes sense to kind of retain them as a unit.

Unidentified Analyst

Okay. All right. Thank you.

Operator

Your next question comes from the line of Sarah James.

Unidentified Analyst

Thank you. Your enrollment guidance implies commercial losses of $100,000 to $110,000 and in the prepared remarks you mentioned so far repricing has led to about $40,000 in losses. So that leaves another $60,000 or $70,000. So I just wanted to understand if that was driven by continued repricing of the book or just typical attrition in account losses. Because If I remember correctly the completion factor issue was brought up on the first quarter call last year, so I think that from that point forward all subsequent 2012 contracts already have that priced in.

Jay M. Gellert

Yeah. We have seen some evidence of some aggressive pricing in some segments. We’ve said from the start that particularly given the large book of business, which we have in terms of these new government program, we don't want to follow it.

So we're going to be, we’ve built our plan on the assumption that we're going to be pricing for the long haul, not pricing for the short-term. So that combined with some provider dislocation in some instance in Oregon and together I think that all has put us into a situation where we've made an assessment that this allows us to basically tie down the guidance we gave in terms of the significant improvement we've given in terms of commercial NOI. So we feel pretty good about that.

Unidentified Analyst

And how much of your book is currently contracted for 2013?

Jay M. Gellert

You mean accounts or...

Unidentified Analyst

Enrollment.

Jay M. Gellert

For enrollment I think 52% is the first quarter.

Unidentified Analyst

Okay, thanks. And then California continues to be ahead of the rest of the country with moving forward with the exchange timeline, as we've seen with the special session this week. So as you move forward with your discussions to prepare, are you finding negotiations where provider rates are baseline offer of Medicaid or Medicare rates and when do you anticipate that negotiation will be finalized?

Jay M. Gellert

One of the factors going on in California, there's some discussion of a Medicaid bridge for the portion of the population, people are approaching that somewhat differently then the rest of the exchange situation. We are also in some cases using narrow networks where the pricing differential isn’t very great. So we are not seeing general pricing at the Medicaid level by any means. But we're seeing opportunities for narrow network and bridge products that allow us to hit different price points within the exchange.

Unidentified Analyst

Okay. That makes sense. And in your discussions with the state on exchanges, is there any interest on their part in breaking up the state into multiple exchanges based on geographic area? Is there any discussion of that going on?

Jay M. Gellert

They’ve established 19 regions already within one exchange, but the state will be – the exchange has already established 19 regions as the basis for exchange activity.

Unidentified Analyst

Have you talked about how many of those regions you might be interested in?

Jay M. Gellert

We haven’t talked about that as of yet. We are waiting really to get more information on some of the rules and structure of the exchange.

Unidentified Analyst

Thank you.

Operator

Your next question comes from the line of Scott Fidel.

Unidentified Analyst

Thanks. First question just may be you can talk a little bit about expected seasonality of earnings over the course of the year and you did highlight expected lower profitability in the TRICARE business in the first quarter and then that ramps up. Any other factors that we should be thinking about obviously Part D isn’t really a factor in seasonality anymore but things like the pacing of the investment spending for healthcare reform or any other items that would influence quarterly progressions.

Jay M. Gellert

Yeah. I think that we will have some health reform front-end spending. I think we will have – we’ve historically because of the capitated business ended up in a situation where we give most of the capitation rate increases ahead of getting the premium increases. So we have a different experience in many since we have relatively little high deductible business but a lot of capitated business. So we have historically been, in the low-40s in the first half and the rest in the second half, that’s the exact range with may be a little TRICARE variability.

Unidentified Analyst

Okay. Then just on share repurchases, didn’t look like you did much or any in the fourth quarter. Any particular factors that influenced that that decision not to do buybacks and then again in terms of pacing of buybacks, would you expected those would ramp up again in the first quarter, or first half of this year?

Jay M. Gellert

Well, we’ve indicated that we wanted to make sure that all the initiatives we took had actually worked. And we wanted to get a sense of the timing of the Coordinated Care Initiative in terms of its demands for capital. We feel pretty comfortable now that that’s in front, that’s behind us, so we know it. And my assumption although we don’t give guidance on this, my assumption is that you have to buy some fairly early in order to meet our target, and that’s our target.

Unidentified Analyst

Okay. And then just one last question just on premium yields sequentially looks like those dip down around 40 bips from the third quarter, with that just all a function of mixed changes in terms of more narrow network or were there any other factors that drove the lower premium yield sequentially in the 4Q relative to 3Q?

Jay M. Gellert

Yeah it’s mix. If we went back and kind of did our apples-to-apples comparison, and when we look apples-to-apples, we’re seeing the premium trends in the seven plus range, in the pure apples-to-apples basis, so that the variations are going to be the result of mix.

Unidentified Analyst

Okay, got it. Thank you.

Operator

Your next question comes from Carl McDonald.

Unidentified Analyst

Looking back to Christine’s question, when you talked about the LTSS being roughly speaking similar kind of revenue to the duals, just we are all working up the same base, what’s your latest rough number of the potential dual revenue?

Jay M. Gellert

I was kind of talking order of magnitude, and I think, I was kind of trying to give kind of bread box assumption not a specific numbers, I think we’ll have that better in the next month or so.

Unidentified Analyst

Do you have a sense relative to some of the earlier numbers that you’ve given so I think you’ve talked before certainly may be somewhere in the $2 billion to $2.5 billion range is that still, as you said bread box?

Jay M. Gellert

Yeah, I think that’s bread box.

Unidentified Analyst

Okay. And then the second question if you could go through the rate changes that you mentioned in Medicaid any specificity that you have between what kind of rate changes are for the SPD population versus the traditional population?

Jay M. Gellert

I think the present – even more because of the SPDs, but it's really hard to come to any conclusion on specifics now fully, because we are still in negotiations and I think it enhances our chances of coming to a satisfactory resolution if we don't talk too much at this point in time.

Unidentified Analyst

And then last question I have, just on the commercial positioning in the scale in the large group. As you said you make money on the mid to small group not so much on large group. Do you think there is a way that you could run a business in California just with small and mid group? I guess ask differently if the profitability in small and mid group dependent on also having the lives and the leverage that the large group gives you?

Jay M. Gellert

No, I don't think the full net, we have one more time to conclude quite frankly the full network large group gives you negative leverage, because it puts you in a position where you can as effectively design low-cost networks, because you would dependent upon having everyone in. So I actually believe that large group is neutral to negative leverage, particularly depending on how the exchange is designed, and what goes on in terms of quick products, the volume in the exchange and its effect on the overall small and individual market, I think it clearly can do very well, particularly when you get to the point where you have the majority of your business in narrow network products.

Unidentified Analyst

Thank you.

Operator

Your next question comes from Peter Costa.

Unidentified Analyst

Thanks for the question. First question, some of your competitors talking about raising prices in small group from 10% to 20% or 10% to 30%. What are your expectations in terms of raising price in small group for 2014? Do you think if you can take that bigger rate hike and if your competitors start raising prices by those amounts what would you do to your business kind of talk through what you think is going to happen in small group in 2014?

Jay M. Gellert

Part of it is, part of it depends on in small group. The pricing range allowable before 2014, so California has a relatively small band, other state have wider band, so the implications will be different. I believe that it will be a product-by-product consideration, it will be different in different geographies and it will also relate to network choices people are willing to make. For us I think, we think the insurer fee is a real issue that have to be confronted in this market, but I think it's premature to give those kind of projections.

Unidentified Analyst

And so no expectation whether you are going to participate in those small group exchanges or not?

Jay M. Gellert

I think we have expectations to participate, but we have to see the final rules, and we have to look at it geography-by-geography. As we said an earlier – to an earlier question there are like 19 different geographies in California. I’m confident we’ll participate in some of them. But the number will participate will depend on provider arrangements, the exchange rules, our relative existing customers debts in those markets, and the likes. So I think the answer is yes, if the question is how much.

Unidentified Analyst

Okay and then, can you tell us a little bit about the fourth quarter, what happened in the Western Region tax rate and investment income, those two line items specifically?

Joseph C. Capezza

Yeah, Pete its Joe, the tax rate has been fluctuating throughout the year, due to the capital loss carry forward utilization that we’ve been experiencing. So as capital gains go up more capital loss carry forwards get applied to the current GAPP earnings. And the balance gets allocated to the gain on the sale of the PDP business. So that’s what you’ve been seen the fluctuation and that’s what you have much lower tax rate. And the capital gains that we’ve been experiencing, is just due to market conditions that we’ve been seeing in the bond market. We’ve got a very strong bond portfolio and it’s been reacting very favorably to market conditions.

Unidentified Analyst

Okay, and so the capital loss carry forwards those used up at this point.

Joseph C. Capezza

Yeah definitely. That totally used up as of the end of December.

Unidentified Analyst

Okay. And then, are there any effects in this quarter from the contract that you have with State of California on sort of the margins in quarters in Medicaid business, no affects from that at all?

Jay M. Gellert

No. Not at all.

Unidentified Analyst

Okay. And then lastly, CVS have been banned in marketing their Part D product. Will that have any carryover to you guys at all or is that completely separated now that, that business is sold to them?

Jay M. Gellert

Completely separated.

Unidentified Analyst

So there is no carryover to any of your plan existing businesses?

Jay M. Gellert

No.

Unidentified Analyst

Terrific. Thank you very much.

Operator

Your next question comes from the line of Chris Rigg.

Unidentified Analyst

Just wanted to come back to the guidance in the cost, you said excludes costs related to the participation in the duals. Can you help me think about those potential costs in the contact to the agreement you signed with the state. I guess I’m just really still trying to figure out how that profit band will work; meaning is it definitely a drag this year and under any circumstance when the duals come on or is there some offset that we may not be aware of?

Jay M. Gellert

The duals would be covered by that agreement. So to the degree that the start-up costs in the duals resulting some in kind of drag 2013 the risk sharing would set into compensate for that.

Unidentified Analyst

And that risk sharing arrangement you wouldn’t see that, it would lag, so which shop in the first quarter of 2014, is that the right way to say...

Jay M. Gellert

It would be confident with the costs.

Unidentified Analyst

Okay. So basically there can’t really be a drag to earnings because of the duals.

Jay M. Gellert

Yes, there is 25% risk but there can’t be it. There can’t be a drag to earnings from the duals of any significance.

Unidentified Analyst

Okay. And then a follow-up on that, I don’t know if this is possible, but if you think about the contract that you have started with the agreement with California in January 1. If we think about that in the context, let's say the fourth quarter would that have moved the needle much on the Medicaid MLR?

Jay M. Gellert

It would have moved it limitedly, but not significantly.

Unidentified Analyst

Okay. And then changing gears, so last week you announced a new agreement with the National Hospital chain obviously to the California facilities, I guess the multi-year deal because of the changes in 2014, is there anything materially different in that contract structure that’s worth sort of noting with paid and price the business in 2014 or any color on that would be helpful? Thanks.

Jay M. Gellert

No, I think in terms of our business there relatively small player. So I saw people I think they probably say the same thing that we probably have disputes like this every year, there just not with a public players, so that doesn't capture your attention, but we went back and looked and we probably had this kind of haggle over every for the last couple of years with no significant effect.

Unidentified Analyst

Okay, thanks a lot.

Jay M. Gellert

If I could, there are no trend to it.

Unidentified Analyst

Sure.

Operator

Your next question comes from David Windley.

Unidentified Analyst

So last year's clarification, so when you say on the CCI program that your excluding cost, is that from point of go live, but preparatory stuff is running through the model or are you excluding ring sensing at all and excluding everything related to that program from your current guidance?

Jay M. Gellert

I think it's been totally ring fenced.

Unidentified Analyst

Okay. And then would it be your expectations so excluding the state agreement, would it be your expectation that the early months of the launch of this program would run MLRs 100, less than 100, more than 100, I mean, what are you expecting in just kind of the raw underlying performance before you apply the protection in the state agreement?

Jay M. Gellert

Well, it’s premature for me to comment until we get through the process that I earlier articulated.

Unidentified Analyst

Okay.

Jay M. Gellert

I don’t expect negative gross margins in this program from the start. But to be more specific we’d be premature.

Unidentified Analyst

Okay fair enough. And so then the start up cost for this program, is it equally premature to size those I guess, I’m wondering if they would compare in size to the $30 million you are setting aside that’s been on exchanges?

Jay M. Gellert

I think that until we get the exact specs of what’s been anticipated, particularly though we understand the planning process in terms of LTSS, because there is, I think it’s too early to say we’ll able to say next quarter. We’re less concerned about it all right now, because of the agreements, reason we got the agreement set up, so that this wouldn’t be an issue until we could get into the program and make the necessary investments to do it right, when you look at the size of the revenue of this program that’s really important. So I think we’ll be able to be specific when we talk to you next. But with – there’s less kind of pressure for us to speculate, given the agreement we signed.

Unidentified Analyst

Got it. Okay. And one last quick one, what’s assumed from an investment income standpoint for 2013?

Jay M. Gellert

I believe it's roughly the same as last year, correct. It's the same as last year.

Unidentified Analyst

Okay, great. Thank you very much.

Operator

Your last question comes from the line of Scott Schneeberger.

Unidentified Analyst

Hi, thanks for the questions. I'm calling in for Kevin. I had a clarification question on AB97. I thought the budget proposal as it related to the HMOs would implement the cuts in July 2012 instead of June 2011. So if you’d been accruing for that why would that not be a favorable cheer up?

Jay M. Gellert

I'm not sure. We had a lot of gives and takes in terms of the consideration. Our understanding is that its perspective AB97. It's not retro it all.

Unidentified Analyst

Okay. So AB97 originally was proposed way back when for June 2011, but your understanding is that it ultimately would only be implemented prospectively?

Jay M. Gellert

Right, right.

Unidentified Analyst

And have you been, I thought you’d been accruing for some sort of AB97 cut in the last year?

Jay M. Gellert

No, we've basically, the effect on us is fairly de minimis because of our provider arrangements. So we’ve been affect – it's not that significant thing and we've been kind of handling it as part of just overall costs related to our business.

Unidentified Analyst

Okay. Do you have any estimate for how many people could potentially be covered in the California Bridge program?

Jay M. Gellert

No, because I don't think we've even gotten the specifications of the Bridge determined. We would be able to do that when we get more information on what it entails?

Unidentified Analyst

All right. And then one question on your large group commercial membership, now that you’re pricing all of those members in 2013 to a positive margins that you could price equal the trend going forward, do you expect that block of business to be more stable on a membership standpoint going forward?

Jay M. Gellert

More stable, but we’re going to continue to keep our pricing discipline. So since as we and Josh Raskin asked the question since it’s really not all that margin significant. The goal we have there is just to maintain a process of adequately pricing it. And so I think we’ll just have to see where that leads us.

Unidentified Analyst

Okay. Thank you.

Operator

And there are no further questions at this time. And that does conclude today's conference call everyone. You may now disconnect.

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