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Executives

Allen Wise - Chief Executive Officer

Shawn M. Guertin - Chief Financial Officer

Drew Asher - Senior Vice President, Corporate Finance

Analysts

Thomas Carroll – Stifel Nicolaus

Scott Fidel – Deutsche Bank

Anna Gupta – Sanford and Bernstein

Carl McDonald – Oppenheimer

Greg Nersessian – Credit Suisse

Charles Boorady – Citigroup

Matt Perry – Wachovia

Michael Baker – Raymond James

Coventry Health Care, Inc., (CVH) Q4 2008 Earnings Call February 10, 2009 8:00 AM ET

Operator

Welcome to Coventry Health Care Fourth Quarter 2008 Earnings Conference Call. (Operator Instructions) Today’s call will begin with opening remarks by the Chief Executive Officer of Coventry Health Care, Mr. Allen wise, after a brief forward-looking statement read by Mr. Drew Asher. Please go ahead, Drew.

Drew Asher

Ladies and gentlemen, during this call we will make forward-looking statements. Certain risks and uncertainties as described in the company’s filings with the SEC on Form 10-K for the year ended December 31, 2007 and Form 10-Q for the quarter ended September 30, 2008, may materially impact those statements and could cause actual future results to differ materially from those anticipated and discussed.

Allen Wise

A few comments by me, and that will be followed by our CFO, Shawn Guertin, and maybe a brief time for some questions. Today is only my twelfth business day after being named as CEO, so this is going to be brief and hopefully my comments will reflect what I know at this point and not what I think.

By way of introduction, I was the CEO of Coventry from the fall of 1996 until December 2004, and subsequent to my retirement I was the non-executive chairman of the board until December 5, 2008, when I became executive chairman and began a comprehensive review of our businesses and operations. While not the intent of this review, the review resulted in a change of our company leadership as announced on January 23, 2009. My appointment is permanent rather than any interim or transitional role. With regard to change in Chief Executive Officers, it’s really as simple as two reasonable parties disagreeing. In light of 2008 results in my review of the business, the Board of Directors believed that continuing substantial oversight involvement by the board was necessary, and Dale Wolf, who led the company during the last four years, disagreed.

With a doubt, 2008 was a disappointing year, both financially and from our inability to anticipate and predict results much sooner. After Coventry’s reforecast in the fall of 2008, the board considered several courses of actions and decided that I should undertake a thorough and comprehensive review of our businesses and operations after such an unsatisfactory year. Clearly, the board needed additional information about the operations of the company. This review, which began on December 10, 2008, did not result in the discovery of any additional material or financial information not previously disclosed.

Our chief financial officer, Shawn Guertin, has expressed the company’s status as, “the wheels are not coming off.” Well, I agree with this characterization. However, in my opinion, the review did review both organizational and operational areas of stress in several parts of the company, which is the result of multiple years of very substantial revenue growth, both from acquisitions and from major internal initiatives in our government programs area. There were also issues in the area of focus in attempting to operate in an organizational structure with executive accountability not as clear as I would like for it to be or as clear as it needs to be in some areas.

I also found many positives. Good businesses and very experienced, capable, and caring employees. What I took away from all of this is that after some organizational refinement, our senior management team will have a clear and definitive path along with the tools they need to improve our business. I think these refinements of structure will take about 30 days, and as you might expect, it will involve both strategic and operational adjustment. I believe the best summary I can provide is that I would not have accepted the CEO position if I was not convinced that we know how to make this a better performing company.

So, what about 2009? During my review in December and early January, the company’s management was working on 2009 guidance, which was announced on January 14, 2009, at the JP Morgan Conference. I believe the management process for guidance was very thorough, comprehensive, and in my opinion done correctly. I am comfortable or as comfortable as anybody can be given our 2008 history and continued Medicare growth in 2009 with our guidance of a range of $1.70 to $1.90 for 2009. I am extraordinarily comfortable that we will have the focus, effort, organizational alignment, accountability, and tools needed to achieve our 2009 forecast and even more important, to build and improve the foundation for margin expansion and expense control to improve our company in 2010 and beyond.

So, how are things on a day to day basis? I believe not bad at all. We have a good senior management team. In fact, we have many of the same people that fostered such outstanding earnings growth record for almost a decade. My job is obviously to get the organization right and align people with their experience and talent. We will also build some bench strength. Harvey DeMovick, who was a part of our very senior team from 1997 until his retirement in July 2007, rejoined our company on February 2, 2009. Harv has a long history of experience and success in many areas of our business. His permanent assignment will be established at a later date when I am far more certain about our organizational needs.

Prior to my arrival, the company hired Allen Karp who was previously from the Aetna organization and he has begun a comprehensive review of our medical cost structure and at this early day, I am very pleased with the experience and skills that Allen brings to our company. As we identify needs and additional executive talents, I am sure there might be others who would join us.

So what are we going to do? Number one, while revenue is obviously important, we will not seek revenue at the expense of margin. We will improve the margins in our business. Number two, every dollar spent from today on will have to pass an ROI test. With that thought, it is likely that we will spend less than the previously disclosed $45 million for network initiatives. Three, we are going to test all of our businesses against the benchmark of critical success factors.

In other words, we are going to once again identify crucial and critical resources, skills, activities, and benchmarks that are essential to be successful in our businesses. We have traditionally done this very well on our commercial, Medicare-coordinated care, and medicated health care network businesses and we will bring this same approach to the rest of the activities within the company. We are going to do whatever is necessary to be the best or close to the best in these businesses or we will do something else. Hopefully by our Q1 conference call, I will be able to provide a much more comprehensive accounting of the initiatives that are underway from this period through Q1 and through the remainder of the year.

With that, I would like to have Shawn provide his report.

Shawn M. Guertin

As you have seen this morning, we have reported earnings per share of $0.60 for the fourth quarter of 2008. This is the same number that we shared with you in mid January when we provided our initial earnings guidance for 2009 and to no surprise, the underlying components and drivers are largely unchanged. From a financial perspective, I am pleased to report that it was a relatively quiet and stable quarter with the consolidated MLR coming in as expected along with stable claims payable.

I will start off with some comments on commercial pricing and medical costs. Starting with the top line where I believe you can see some of the early results of the pricing action we took in early and mid 2008. As indicated in the press release, our commercial yield in the fourth quarter was up 4.1% versus the same quarter a year ago, a sequential increase of 30 basis points from 3.8% in the third quarter on a same store basis.

To make the numbers comparable, Vista is completely excluded from this calculation as we did not own Vista for most of the third quarter of 2007. As an aside, if you included Vista in the fourth quarter, the fourth quarter increase is slightly higher at 4.3%. It is important to keep in mind while processing the 30 basis point increase from Q3 that only 15% of our book renews in the fourth quarter.

Looking forward, it feels like we are succeeding with our price increases. As we expected and communicated in January, we continued to expect our risk membership to decline about 4% in January and 6% to 8% for the full year of 2009. This is no surprise when you combine the current macroeconomic environment with higher street prices, but we do continue to sell new business and renew existing customers consistent with historic levels of persistency. In fact, we’ve continued to grow small groups slightly in January. Clearly, benefit buy-downs will increase as a means for employers to manage the overall rate of increase and the mix of our customers will inevitably change over time. Both of these factors will ultimately have an impact on our realized premium yields for 2009.

On the medical cost front, all was stable in the fourth quarter as evidenced by the medical loss ratio coming in as expected. Looking more closely at medical cost trend, the full year of 2008 is coming in more or less right on the 9% level. Just a reminder that this figure is a measurement of cost trend after benefit buy-downs but before any mix change in the population. We can now see that the inflection point on trend appears to have occurred sometime in the middle of 2008 with the more recent period showing no sign of any further acceleration. While this is directionally encouraging, it is clearly premature to declare victory at this point.

The pricing actions we have taken in our 2009 guidance assume that trend in 2009 is at the same level as that observed for 2008. While we have maintained our guidance in this area, this should not be confused with complacency on this topic. On the contrary, Coventry has long embraced a low-cost wins mantra and we are 100% focused on improving not only the trend result but ensuring that we maintain a competitive cost position. As Allen mentioned, we have added executive-level leadership in this area and as an organization are focused on improving aspects of how we contract for and manage medical expense.

Let me update you on where we are in Medicare for 2009. This is an important issue for the company in 2009 and I know an item of interest to many of you. At this point, we are comfortable that we will achieve the membership targets that underlie our guidance. The early 2009 growth continues in the same product offerings we shared with you in mid January and the risk or the new businesses generally less than our average renewing number. However, none of these are proof positive either way at this point in the year. We will only know that once we have analyzed a more mature set of revenue and paid claim data. Equally important to our future is the submission of the 2010 bids in a few months where we have not only the financial analysis of this experience to incorporate but also some important strategic decisions to be made around product offerings and network strategy.

Regarding the balance sheet, I am pleased to report that the overall position of our investment portfolio at 12/31 is excellent. One simplistic measure of this is that the portfolio is in a net unrealized gain position as of year end. We remain conservatively invested in high-quality securities with approximately $1.6 billion in cash, cash equivalents, and treasury securities. During the fourth quarter, we were able to utilize existing cash to appropriately capitalize our operating subsidiaries and maintain all of our existing ratings.

As of the end of the year, we have approximately $440 million of corporate deployable cash. We will continue to be prudent in this area and reassess market conditions regularly. Our first priority as always will be to support the regulatory capital needs of our subsidiaries as required to support their growth. Beyond that and assuming market conditions do not deteriorate any further, look for a measured and balanced application of free cash to de-lever and purchase shares consistent with the level assumed in our guidance.

Turning to guidance, as you saw on the press release, we are reiterating our 2009 guidance. The detailed elements are exactly the same as those we shared with you in mid January. In addition, as you may have noticed by its absence in our mid January guidance release as well as our press release today and similar to others in our industry, we will now be providing annual guidance only. We feel that this is more consistent with the natural cycle of this business and a longer term view we have on managing the business.

In closing, I would like to point out that while there are many positive aspects to this business, for example, strong cash flows and recurring revenue streams just to name two, one of the more difficult aspects can be the time it takes for pricing corrections to show up in results. This really is the story for 2009; however, this should not be confused with any sort of permanent loss to our longer term earnings power. Our franchise and core attributes are still strong, and our employees are energized. As you have heard from us before and you heard reiterated by Allen today, we are 100% committed to delivering on our 2009 guidance and expanding margins in 2010 and beyond.

Operator, we will now open up the call for questions.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from the line of Thomas Carroll with Stifel Nicolaus.

Thomas Carroll – Stifel Nicolaus

Just a quick question on your comments regarding the network expansion dollars that you are going to be spending, you mentioned that they might be a little less. I was wondering if you could give us some order of magnitude as to how much less, and then more importantly, does that suggest some kind of change in Medicare strategy, maybe shrinking the footprint a little bit going into the 2010 bids?

Allen Wise

We have preliminarily, and I think that decision was even before my arrival, decided to step back and take a closer look at the 40 some million dollars spend and at the very least be more strategic about it in terms of where we do that. My guess is it will be considerably less than the 45, and I don’t know what that number means other than considerably less, and far more strategic than maybe was anticipated at sometime in the past. As Shawn indicated, we have some important decisions to make in that arena on how to proceed from this point forward, and we are in the middle of that decision process now and obviously needs to be done here in 45 days or something like that, and we will be in a much better position to stop it at that at the end of Q1.

Operator

We will go next to John Rex with JP Morgan

John Rex – JP Morgan

Allen, the way you used to describe philosophically your approach to the business that you wanted your revenue stream to essentially match the general healthcare spend in the country. Is that kind of still philosophically how you are focused, with Medicare being about 50% of premium revenues in 2009 and obviously heavier weight than you looked at, is there anything over the last couple of years that would have changed your approach to that and how you want the company to look?

Allen Wise

My approach has always been, and I am really dated here in trying desperately to get up the speed with my approach, if you think about the historical folks of the company, which was small and mid-size insured business, I think that the strong point of the company because we knew the 20 things or 22 things that were necessary to do very well to succeed in that business. As we had an abundance of success in growing revenues here on all fronts from especially businesses to a huge increase in government programs, Medicare, I think that we really ended up with more on our plate here at sometime, this is my opinion only, than we had the ability to manage well. We had so much going on at the same time that we departed from the incredible focus, by necessity. We still had the same sized companies and same group of people for the most part. We departed from the things that made us successful for a decade in terms of increasing earnings and being able to predict where we were going.

We need to return to some of that focus and that is what we are doing, so it is dangerous to ask me to be philosophical, but we are looking at every business and say ‘where are we, what does it really produce, what can we make of it for the future, what do we have to do to be the best in this business’ and that process will take too long. We really began that informally in December, the senior management team is working on that, and what we are going to have in a few months here is a similar list of critical success factors in all of these business, and we are going to return to making certain they work even if it is at the expense of some revenue. We have just have businesses that need to perform better.

John Rex – JP Morgan

Maybe we shouldn’t be surprised to think about you coming out of this when you are done. We see a top line that is maybe $3 to $4 billion lower than you are at right now. Is that within the realm of possibilities?

Allen Wise

I can’t answer that. I would not agree with that. I just don’t know. I think if you talk about revenue the decisions that Shawn outlined in his report a few minutes ago about careful decisions that we need to make. The government program, that is really around the fee for service arena. Part D is going extraordinarily well and that business is treating us well. The coordinated care product, which is a part of our history since early 90s is growing really well, and I have always believed and continue to believe that it’s the only way you are going to be able to deliver effective care in the future, so that is not an issue. The fee for service, which is obviously huge revenue piece and one that is not providing any returns for us now, has to be done better, and it’s going to take the next 45 days to make decisions and what that’s going to result in at this point in time I just really don’t know.

John Rex – JP Morgan

Any early thoughts on the Workers Comp business? Has it become pretty big for you guys now?

Allen Wise

Early thoughts is correct. We are going through the same process there, and I am looking with Jim McGarry who has managed that business with us and with some of his people looking at two different ways to organize the business and improve it a step. You are right, it is a big business for us and it is doing well, but it is kind of difficult since we grew so rapidly and at the expense of having some good cost accounting in terms of the $2 billion of SG&A spend here, some of it is easy to define and easy to track. It is somewhat harder because of how rapidly we grow for me to understand what some of the businesses are really doing on a pre-tax basis. It is a prejudice, but I prefer to look at things as pre-tax. I have got to get the SG&A aligned, so I understand it and get it 90% right as opposed to planned contribution. I think it is doing well. I think it needs to do better and it’s back to my earlier comments.

We are in the middle of deciding how to make it a better business and how you organize that in such a way where it is a bit more freestanding but not necessarily. It is not an independent company. It is going to use our IT resources and things of that nature, but the necessity there is for them to understand and all the businesses better with their request for IT really is what result that is on a pre-tax number, and I think the organizational alignment of that here in a few weeks will give them more tools and resources, make them more accountable for a pre-tax number and hopefully, as the year progresses, we would be able to provide an accurate pre-tax contribution on all the business that we are in, not just lump them together as specialty businesses. It’s a good business, but I think that we need to understand better how much SG&A they are really using in the organization and get that aligned, and it will help them make better decisions and the company too.

Operator

We will go next Josh Raskin with Barclays Capital.

Josh Raskin – Barclays Capital

You mentioned the role of CEO is not temporary. A couple of questions around that. First, if you could just help us understand the process by which the board went through. Obviously, it sounded like the news around Dale was 13 business days so previously, was there sort of a search in place or was this a board decision that there was no need to do that and have the internal resources coming in off the board, and then, how do we think about your role as permanent CEO in light of your announced retirement about 4-1/2 years ago and at that time talking about a transition to the next phase in your life?

Allen Wise

I think on the first part, for better or worse since I had a decent knowledge of the company and put a decent crew together with a good track record, the succession planning of the board was a process that we undertook with Dale, and in light of nothing obvious being provided by Dale or anyone else, the successful plan of the board always was that on some basis that if necessary, I would step back in, so there was not the developments in the company. It was after the third quarter re-forecast that the board became much more aware of their need for additional information. So, there wasn’t any process underway and when I began the examination of the company’s businesses on December 10, 2008, it was just that. It was a need to better understand the events in the company because the board was perplexed. It was two of the best financial people in our view in the business in Dale and Shawn, but it produced a very disappointing 2008. So, during the evaluation process, it was just that. I had a need to understand some of the new businesses better and had a need to understand the events that resulted in the 2008 numbers. I think the board and certainly that included me from experience in other companies over a long period of time understand that interim CEOs really are not helpful to an organization. You cannot really make the strategic, the human resource, and the organizational changes that are necessary.

With regard to my personal life, I stay very active on four to five boards and investments in our sector, and my health is good. I have a high energy level, and I have not thought beyond coming in and getting the business with the senior management running better, we’ll see where that goes, and it’s sort of inarticulate to speculate on what that course of action is. I would say that my history in the business has always been, I don’t remember for all the senior staff at Coventry that I ever paid a search for them. I don’t believe I ever did, so what I am attempting to say is that I have always spent a significant amount of time with people in this sector and with people from my background that I respect and some part of my life every month is always listening and learning from people and thinking about how the organization would be better, and I will be doing that for my successor in the same way that I always have, and whether that results in a change in a year or three years, I don’t have any idea.

Operator

We will go next to Scott Fidel with Deutsche Bank.

Scott Fidel – Deutsche Bank

Allen, I am interested in if you can talk a bit about how you think the industry itself might have changed over the last 4 years, since the last time we were able to talk with you in terms of from an overall competitive level and in terms of capacity in the industry. Do you think the industry is more competitive at this point or pretty much the same, and then in terms of capacity, do you think this industry needs to consolidate further at this point and how do you think the change in political environment might impact the ability of the industry to consolidate?

Allen Wise

A lot of questions, and I will start at the back. I have little or no control over what they are going to do on the Hill, and so I’ve always felt like if we run our company in the very best way, things are going to be alright. The first part of your question is really interesting. In getting more familiar with current events, it’s obvious that loss of 20,000 jobs a day is affecting all of us, and it’s serious and that we need to manage our company not for a worse case basis, but for an 80% worse case, so we’ll get real serious about controlling our expenses around here and having only the very best people around. I think with regard to the commercial business, the pool out there, as Shawn indicated we continue to have really fine resources and focus on the small and mid-size group basis, and I think that pool I would characterize it as a smaller pool of fish and more sharks swimming out there. Obviously, the size of the market place is diminishing for the reasons that you know as well as I do. The thing that I found in my review with the field people that was pretty encouraging, I found a bunch of people that run these local businesses that had very good insights about the challenges they had in 2008, and I think about 70% of the answers, not that some markets aren’t tough, were about things that they had identified as shortfalls in their own organization or self-inflicted wounds, and they had a little bit of clutter and loss of focus. Their life got a lot more complicated. They used to sell at commercial and mid-sized group and a little bit of ASO. There were national accounts, and there was Medicare and there was Workers’ Comp network. There was life and dental. There was a behavior business. A lot of things made their life busier, and I was encouraged by the focus that they had on what they had done not as well as they should in 2008 and their focus on 2009, so it’s a competitive difficult business, but I came back feeling really good that we hadn’t lost our edge there and that the people in the field were not internally focused like we tend to be in a corporate setting and had a real good view of who the competitors are, what they were doing, what they needed to do, and our success in the small group area is evidence that we have the critical success factors to continue to succeed there. There is a man in our organization that had a lot to do with the small group business that’s now enlarged his responsibility, from 2 to 50 to 2 to 500, so it’s a tough business, but I felt pretty darn good about the insights that people had to get better in the business.

Scott Fidel – Deutsche Bank

If I could ask a followup too on how the FEHBA and Vista businesses performed in the quarter from a margin perspective sequentially and then update on your margin expectations for FEHBA and Vista for 2009, pretty much the same as your prior update or any additional nuance you can provide around ’09?

Allen Wise

I’ll let Shawn answer that question. My first business of Vista is going to be the 16th, so I’ll know more on the 17th, but Shawn should answer those questions.

Shawn M. Guertin

No, Scott. I wouldn’t say we have anything new on either front. The commercial experience as I mentioned in my remarks for the fourth quarter was right in line with our expectations, and I wouldn’t have any new comments either pertaining to Vista or the FEHBA business. Going forward, as you know, the FEHBA bids are submitted early in ’08, so our first real chance to influence that is in ’09 for ’10, but I don’t have any additional color on that, nor do I have any update on Vista for ’09.

Operator

Your next question comes from the line of Anna Gupta with Sanford and Bernstein.

Anna Gupta – Sanford and Bernstein

I was wondering if you could comment on your expectations for the long-term structural MLR and commercial risk. It used to run in the 70s. You’re now in the 80s, and as you’re doing this review of medical cost structure inside and then looking outside as employers are buying down more, but those products are higher margin and spreads are potentially improving going into ’09 and ’10, where do you think you’ll net out on that?

Shawn M. Guertin

Anna, as I mentioned, for ’09 we are not getting too far ahead of ourselves, and we are sort of talking about a loss ration between 82.5 and 83 on our guidance. In fairness, I’ve told people that the pricing formula we’re using today is the same pricing formula that in the past has produced loss ratios in the upper 70s. Now, the timing of the calendar for ’09 obviously impacts that, but all other things being equal, that’s the same old formula. Now, there’s a lot between now and 2010 in terms of what happens with your book, what happens with your med cost trend, but I would tell you that from a pricing philosophy standpoint, the way we stand today is the same as we did back then. I actually think the variable to this might be more about what happens to your book from a membership standpoint, and it’s more complicated I think than just the absolute change in membership. In the short run, you can tend to push price and achieve an outcome, and then the question will be what happens to your volume, and I think the more difficult aspect of that is do you start to see something where all of a sudden you stop writing new business and you see something happen to your persistence, and you actually start worrying about whether potentially you’re being adversely selected in the block. So I think one of the litmus tests that we have used as we’ve pushed price in ’08 and ’09 is to sort of watch our level of new business sales. I certainly think that it’s reasonable to assume that it could be lower, and where are we going to be ’09, to be honest, I don’t know when I start thinking about all the other variables, whether we’ll see 78 again, but it can certainly be better than it is today in the near term.

Anna Gupta – Sanford and Bernstein

Based on the recent data you’ve seen into ’08, are you seeing any drop in coverage from healthy actives? Any change in the risk profile on your book, particularly in small group?

Shawn M. Guertin

You would have thought, Anna, given what we’re doing and just some of the macroeconomic factors that we would have seen this, but I have to tell you we have gone through the book in multiple ways looking just for that. Something as simple as our active people just waiving coverage now because of higher employee out of pocket, and you cannot find any systemic evidence that that’s happening in our book, other than the FEHBP slice accounts that Scott was asking about for. What we are seeing clearly is an uptick in in-group losses of membership, i.e., it’s employers downsizing, but right now, there does not look to be a bias to that on the unfavorable side despite my hypothesis going in that that’s exactly what we would see. We really have not seen that in the data yet.

Operator

Your next question comes from the line of Greg Nersessian with Credit Suisse.

Greg Nersessian – Credit Suisse

On the private fee for service, within the 2009 guidance, is that business excluding the network spend? Is that business a positive contributor to the ’09 guidance?

Shawn M. Guertin

I would say it’s right about breakeven.

Greg Nersessian – Credit Suisse

So the network spend that you originally planned would take it to a net loss?

Shawn M. Guertin

If you wanted to look at it that way, you could, but remember the network spend in whatever form it ultimately takes is about constructing coordinated care networks, and so it’s really broader than private fee for service in its long-term application.

Greg Nersessian – Credit Suisse

Now that you have the full year look back at ’08, any change in your view on what the drivers of the cost trend acceleration on the commercial business were, and then maybe some preliminary thoughts on the impact of the slowing economy on utilization of services? Are you seeing any change there?

Shawn M. Guertin

We’ve not seen that change yet, and it has not played out where I could say I have seen evidence of that, and the answer from the highest level is no. When you look at the trend data, the problems are very much in facility. Physician and pharmacy are right in line with where we thought, and in facility, it is tending to be more on the unit cost side in the in-patient arena, and then it’s a little bit more mixed between both utilization and unit cost in the outpatient category, but facility is clearly the area of focus in terms of medical cost management.

Greg Nersessian – Credit Suisse

Could you remind us what percentage of your facility contracts you have a chance to renew this year in 2009?

Shawn M. Guertin

I actually don’t know that off the top of my head. I’ll have to get that to you.

Allen Wise

I think back to moving forward after Q1, whatever than medical spend is here, $7 or $8 billion that’s what now Allen Carp is taking a much more comprehensive and fresh look at. That is one of the subjects that we would probably on a regular basis report back both successes and failures because I can’t prove it at this point but my guess is that the unit cost has slipped half a notch and I believe we’re going to get that back on the right track.

Shawn M. Guertin

Greg, on your point, we can get the exact number if it’s important, but we tend to enter into multiyear contracts, so I would just from 50,000 feet guess it might be a quarter to a third. I don’t know that we have an abnormally high number coming up, but to some extent, in this instance that’s even less important because one of the things we try to do in provider contracting is to some extent make sure we have a meeting of the minds with the provider on what the negotiated increase is, and we do retrospective reviews of all of our contracts, and if we see something that’s really aberrant, we are not bashful about going back to the table and trying to change that early. We’ve had success at doing that in the past, and again it’s all premised on did the parties have a meeting of the minds and what has really turned out to be happening, so even if a contract isn’t up for renegotiation, if it’s a problematic contract, we will take it on and go after it.

Greg Nersessian – Credit Suisse

I know you guys aren’t giving quarterly guidance anymore, but just in terms of the percentage of the earnings because of seasonality progression, during 2009, is it fair to use 2007 percentage earnings by quarter as a proxy or has seasonality materially changed for 2009?

Shawn M. Guertin

What I would say about that, Greg, is I would just sort of think about the Part D slope and the Part D volume and where those loss ratios have typically been in the first quarter, and that is typically the biggest driver of the seasonal pattern of earnings that we have.

Operator

Your next question comes from the line of Charles Boorady with Citigroup.

Charles Boorady – Citigroup

Can you tell us what the prior period reserve developments were related to last year and related to previous periods this year?

Shawn M. Guertin

Charles, as you know, we don’t do it from quarter to quarter. We never have. The prior period development, I think we disclosed that in our Q2 10-Q, and it’s really not meaningfully different. We certainly didn’t have any meaningful in the fourth quarter that goes back to ’07.

Charles Boorady – Citigroup

So qualitatively, you talked about an inflection point on cost mid year. Should we have seen some benefit from prior period developments in the same year to the extent that you might have overshot in estimating medical expenses for Q2 or Q3?

Shawn M. Guertin

Again, I wouldn’t go there.

Charles Boorady – Citigroup

If I could ask Allen a question, is there anything that you can share with us, anything relevant, in your employment agreement related to either key dates or key operating goals or other things that might be relevant to equity investors?

Allen Wise

Unfortunately, I don’t have an agreement. The course of developments there is just as we’ve disclosed. The chair of comp committee is in Australia or whatever, so we’re going to work it out. I can comment back to it philosophically. All of the senior management group here is going to under the same plan as we do in 2009, the management incentive program, we’re a bit late because we weren’t unable to give guidance until it was the 12th or 14th, and so we’re in the middle of it. One of the priorities is to have compensation systems where management is well paid based on EPS. It’s a simple thing. Shareholders have to be paid first. We try to keep base salaries low, and I’d include myself in that category and have big incentives when we get big results, and a pretty simple plan, probably not anything based on strategic objectives or goals. Way more heavily weighted to earnings than revenue and the same type of plans that we’ve historically had. It’s going to be EPS driven.

Charles Boorady – Citigroup

Could you update us on the transition of PBMs and any future plans and also on the timeliness of the data that you’re getting from you PBM to the extent that that’s a predictor of your cost trends in ’09?

Shawn M. Guertin

From a service perspective, my sense is that the switch to Medco for Part D has gone pretty well, especially in light of the big volume that we put through the system. As Allen mentioned on the network spend, the decision as to where we go with the commercial PBM is one that will be on the table for us to think hard about pretty quickly here.

Allen Wise

It’ll be based when we have facts and information on how the Part D plan has gone. I don’t know how long it’s going to take. We won’t do anything until we see if the projections are real.

Charles Boorady – Citigroup

How timely are you getting scrip data, and can you comment on the effectiveness of that data in predicting overall medical trends for the year? Can you tell from people’s prescribing patterns how healthy or sick they are and what other medical costs you may be incurring as a result of their scrip trends?

Shawn M. Guertin

Obviously, they are feeding us data regularly, but I’m not in a position today to comment on what I can infer from the January results.

Operator

Your next question comes from the line of Matt Perry with Wachovia.

Matt Perry – Wachovia

Two questions—first for Shawn, and maybe your last answer tells me how comfortable you feel into going to more detail on this, but last month when you issued your ’09 outlook, you said that the new Medicare members you had received in both private fee for service and PDP had risk scores as good or better than renewal members, so from that perspective, you felt comfortable with your margin outlook. Have you seen anything in ’09, scrip trends either in PDP or private fee for service that confirms or changes that view?

Shawn M. Guertin

I think what I wanted to share with you all is just what we knew, and what we knew about the new membership and what their risk score was and what products they were buying. The inference from that is if you think you’ve attracted a lot of sick people, at least that’s not showing up in the risk score. As I mentioned in my remarks, that’s not proof positive, and as I just told Charles, with the growth that we’ve had, I’m just not in a position to comment either way on Part D today for January.

Matt Perry – Wachovia

A question for Allen, when guidance was given and Shawn confirmed that at least a preliminary review of the commercial medical cost structure from a unit cost perspective, they thought the company was positioned pretty well, but just a few moments ago, you said maybe unit costs have slipped half a notch, so maybe you could go into a little more detail there as to what has happened and maybe how do you get it back up half a notch, and Coventry had always priced the commercial book very well to maintain or grow margins. I am wondering if as you look at the company now versus 4 years ago, if anything has anything changed on medical management or utilization management. Are you where you need to be there or is getting commercial margins back in place mostly a function of re-pricing?

Allen Wise

When I was conducting a review of the company, I was trying to determine the cause of the 300 or 350-basis point deterioration in the commercial medical loss ratio, and I think it is impossible for me to determine precisely what happened there. You heard a little bit about the flow and you heard a little bit about MSDRGs, and you heard a little bit about unit costs, and I think it’s a probably a little bit of every thing, but there was not any question there was stress at the local health plan of a contractual nature by some of our other businesses, and by that I mean the network rental business, the Workers’ Comp business. I am not sure on the Medicare front, but when you interviewed people here and in the field, look at our litigation count on litigations for network-related issues, there was stress enough there, and enough of frequency to people recounting stops among major providers they started off with that until you solve X or Y problem, none of which were connected to the commercial health risk thing that your rates are going to go up or something. I didn’t overreact to that. I think there was and has been a little bit of stress at that level, and at the most basic level, I think the revenue increase, and I’m not sure this is benefit plan adjusted, but the 24-month rate increases for all the commercial business was about 4%, so I think revenue was a bit short. I think there was a bit of pressure on unit cost. I expected to find some deterioration in local patient management activities. I did not find that. The core competency of the company, while there is plenty of clutter with new activities and a feeling of a lot of things going on at one time, I did not find a loss of focus at the local health plan levels. Many of those medical directors have been with us for a decade, and I didn’t see much change there. If you take the unit cost level, I just think in meeting with our new guy Allen Karp and best practices in each of the plans and having more quantitative information on what really happens on a month to month basis out there, I think there’s just room for improvement there.

Shawn M. Guertin

Matt, let met just sort of talk a little bit about what those comments were because they were a little bit subtly different. There is no doubt that the facility unit cost experience was worse than it had historically been and worse than we had expected in ’08, so what then followed from that was does that mean something has fundamentally changed about our competitive cost position, so the first was this sort of a rate of change issue. The second then is where am I now in terms of absolute cost, and so the comments that I made were based on some external data we went out to look at, which said that from a perspective in an absolute sense, we still seemed to be in good position. As I mentioned and that was based on ’07 data, and in the next couple of months, we’ll get the ’08 data and do the same thing, but it really sort of goes to us asking ourselves the more important question and that is how do you feel about your cost structure going forward.

Operator

Your next question comes from the line of Michael Baker with Raymond James.

Michael Baker – Raymond James

Just wanted to get your thoughts, Allen, on the industry’s move towards one-stop shopping, integrated offering, particularly in light of the change is competitive dynamics and your reevaluation of the company.

Allen Wise

Actually nothing new about that. You win and lose and those cycles pass. I don’t think I see any change in that from 4 years ago. You lose sometime, and it comes back around. Remembering that our focus area is really the, what’s our average size, 40 or something Shawn, our focus historically has been small and mid size and insured, and I think we certainly take a large one if it’s okay, so it’s in our delivery system. We are never going be very competitive on a national account basis. I think in the sweet spot of the business, it’s essentially smaller size local business that’s been in the area where we’ve made our margin, and so I don’t see any change. We have always had times when there had been national rollups and stuff where it affects us locally. I think we could do a better job in what I would characterize multiregional. We have very strong business that are on state lines, and if you take our Midwestern business there between Omaha, Kansa City, and St. Louis, if we had a better, more seamless product, and this issue goes back a long time too that there are opportunities there but our focus is going to be the smaller stuff and insured as opposed to ASO.

Michael Baker – Raymond James

Are you finding that there are certain components that you believe are critical to managing at that level, for instance say behavioral, which I know you are familiar with, and it sounds like that’s an area that you are brining in-house over time.

Allen Wise

The decision to bring it in house was made a long time before I came back, but it’s about cost control and better control over your destiny. We have not had a great deal of success in writing new states on the Medicaid front. I can tell you that that is going to be an area of emphasis. We are going to get better at that. I think sometimes having your own behavioral network and delivery system helps on those Medicaid RFPs, so I think we will look at that market place too, but the things that you need to do to be successful in that small to mid size case is the strength of our company and has been historically and haven’t seen any real deterioration, and we will renew our focus there. By renewing our focus, we are doing really well in the under 50 case. We need to do better in the 50 to 250, and we will.

Operator

This does conclude our question-and-answer session. At this time, I’d like to turn the conference back over to Mr. Allen Wise for any additional or closing comments.

Allen Wise

I don’t have any closing comments. Thanks for your interest in our company, and thanks for your attention, and we will attempt to define the activities that we have talked about as under consideration in a much more definitive basis on the Q1 call.

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Source: Coventry Health Care, Inc. Q4 2008 Earnings Call Transcript
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