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Executives

Ronald A. Williams - Chairman and Chief Executive Officer

Mark T. Bertolini - President

Joseph Zubretsky - Chief Financial Officer

Jeffrey A. Chaffkin - Head of Investor Relations

Analysts

Joshua Raskin - Barclays Capital

John Rex - J.P. Morgan

Ana Gupte - Sanford C. Bernstein & Co.

Charles Boorady - Citigroup

Michael Baker - Raymond James

Peter Costa - FTN Equity Capital Management

Matthew Borsch - Goldman Sachs

Justin Lake - UBS

Gregory Nersessian - Credit Suisse

Carl McDonald - Oppenheimer & Co.

Scott Fidel - Deutsche Bank Securities

Matthew Perry - Wachovia Capital Markets

Aetna, Inc. (AET) Q4 2008 Earnings Call February 12, 2009 8:30 AM ET

Operator

Good day everyone and welcome to Aetna's fourth quarter 2008 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jeff Chaffkin.

Jeffrey A. Chaffkin

Good morning and thank you for joining Aetna's fourth quarter 2008 earnings call and webcast. This is Jeff Chaffkin, Head of Investors Relations for Aetna and with me this morning are Aetna's Chairman and CEO, Ron Williams, Mark Bertolini, President, and Joe Zubretsky, Executive Vice President and Chief Financial Officer.

Following their prepared remarks, we’ll be pleased to respond to your questions.

During the call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from currently expected results are described in Aetna's 2007 10-K and our third quarter 2008 10-Q as well as our 2008 10-K filed with the SEC.

Pursuant to SEC's Regulation G, we provided reconciliations of metrics related to the company's performance that are non-GAAP measures in our fourth quarter 2008 earnings press release, fourth quarter 2008 financial supplement, and 2009 guidance summary. These reconciliations are available on the Investor Information portion of the aetna.com website.

Also, as you know, Regulation FD limits Aetna's ability to respond to certain enquires from investors and analysts in non-public forums. So, Aetna invites you to ask all questions of material nature on this call.

One additional item of note, and as you know, Aetna annually hosts an investor conference to provide you with additional insight into our strategy, performance, and outlook. We’d like to take this opportunity to invite you to our 2009 investor conference which will be held at the Plaza Hotel in New York City on December 15th.

With that I will turn the call over to Ron Williams.

Ronald A. Williams

Thank you all for joining us this morning. Earlier this morning, we reported fourth quarter operating earnings per share excluding other items of $0.96, an increase of 9% compared to the fourth quarter of 2007. For the full year of 2008, we reported operating earnings per share of $3.93, an increase of 13% over 2007 and in line with our most recent guidance. We are very pleased with our performance in absolute terms and compared to others in our industry, particularly in light of the financial market and economic challenges of 2008.

The 2008 industry leading results were highlighted by 5% operating earnings growth driven by strong underwriting results, 17% healthcare revenue growth due to continued pricing discipline and net medical membership growth of 848,000 members or 5%, and the ability to meet our capital generation and deployment plans while maintaining a strong balance sheet.

We achieved these results by developing a sound strategy and successfully executing along all 4 dimensions of that strategy.

Segmentation: Continuously identifying new opportunities and market niches and underserved segments to sustain profitable growth.

Integration: Producing improved outcomes and a better service experience for our customers by clinically and administratively integrating our information, products, and services.

Consumerism: Providing our members with information and tools to help them become more engaged, better healthcare consumers.

Operational excellence: Executing operationally and financially through the strength, flexibility and rigor of our operating model.

In a moment, Mark will provide some insight into the successes we’ve had this year executing our strategy.

Our 2008 results and the strategic investments we have made in our business provide us with considerable momentum as we enter 2009.

Before providing our 2009 outlook, I would like to comment on one particular area of strategic investment we have made over the last several years.

Positioning Aetna to be a leader in providing access to affordable quality healthcare coverage in America, we expect healthcare reform to be a major part of the national debate in 2009 and Aetna is at the forefront of this effort. By forging strong public and private partnerships together we can address the challenges facing our current healthcare system; those of access, cost, and quality.

The 46 million Americans who are uninsured are not one homogenous group of individuals but rather a collection of several groups, each with different needs including 11 million people eligible for but not enrolled in Medicaid or SCHIP, approximately 5 million college and university students and 9 million individuals with household incomes of $75,000 or more.

The strategic investments we have made in our portfolio of businesses over the past several years, particularly Schaller Anderson and Medicaid, Aetna Student Health, and small group and individual operating capabilities and market expansions, enable us to provide value-added solutions that meet the needs of these uninsured or undeserved populations.

We believe we are very well positioned to capitalize on opportunities that may emerge as part of our national debate on healthcare reforms in 2009 and beyond.

Our strong business momentum and the strategic investments we have made to drive future profitable growth position us well for continued success in 2009. At the same time, we are aware of the continued economic challenges we expect to face and have factored them into our planning assumptions.

Taking all this into account, we are pleased to provide the following outlook for 2009.

We project medical membership growth of 1.2 to 1.3 million members in the first quarter, driven by new customer wins in both core commercial and newer customer segments, as well as strong open enrollment gains. For the remainder of the year, we expect continued sale success offset by continued in-group attrition due to the economy. This would enable us to achieve total medical membership of approximately 19 million members as of the end of 2009.

We also expect full year operating earnings per share growth of 12% to 14% excluding the projected year-over-year increase in pension expense of $0.54 per share which is equivalent to operating earnings per share of $3.85 to $3.95 on a reported basis which includes the increase in pension expense.

Joe will provide details on our 2009 outlook later in the call.

We expect 2009 to be a water-shed year for the industry and business in general. This economic downturn is deep and employment levels and economic activity are uncertain. 2009 will also be the year in which healthcare reform proposals begin to crystallize, so we can formulate very specific strategies to capitalize on these opportunities.

Aetna is extremely well positioned for these challenges in 2009 and beyond. We are the preferred brand in the market and thus can grow profitably even when the market does not. Our diversified portfolio businesses are well positioned to benefit from opportunities afforded by potential healthcare reform and our capital resources, liquidity, and risk profile was expected to be continued stress in the markets.

In summary, I am pleased with our 2008 results and very confident in our outlook for the future. I would like to thank our employees for their unwavering dedication in meeting the needs of our customers. It is true their efforts that we believe will sustain our momentum in 2009 and beyond.

I will now turn the call over to Mark to provide some highlights regarding how we have successfully executed our strategy during 2008.

Mark T. Bertolini

Good morning. As Ron mentioned, we were able to achieve industry leading results in 2008 by successfully executing our strategy to provide a differentiated brand experience for our members through segmentation, integration, consumerism, and operational excellence.

I’d like to take a moment to provide you with examples of success in each of these dimensions of our strategy.

First, our segmentation strategy continuously identifies new opportunities for future profitable growth in both traditional and new customer market segments. Segmentation success is seen in both our full year 2008 net medical membership growth of 848,000 members as well as our first quarter membership growth outlook of 1.2 to 1.3 million members, both are quite strong particularly considering the challenging economic environment.

A specific example of segmentation success in traditional markets has been our sub-segmentation within small and middle markets on targeted industries such as accounting, higher education, health services, legal, and transportation which resulted in growth of approximately 53,000 members during this year. We expect this momentum to continue in 2009 and are placing additional focus on the area of women-lead businesses. In fact, we recently launched a pilot in the Philadelphia market which has been very well received.

Our segmentation strategy is also driving success in several of our newer customer segments including Aetna Global Benefits where we achieved medical membership growth of 125,000 members in 2008. During 2008, we also opened our representative office in China and were named as one of two companies appointed by the Dubai Health Authority to provide consultative health management programs and services to primary care practices effective January 1, 2009. We view the international market as one which affords Aetna significant opportunities for profitable growth.

Another example of success of our segmentation strategy in newer customer segments is in Aetna Student Health. As you may recall, we acquired this business in 2003 and since that time have been quite successful in providing solutions for this important population.

The year 2008 was another successful year in terms of net growth in this business, and as of year end, we served more than 500,000 members.

As Ron mentioned earlier, approximately 5 million college and university students are currently uninsured and we see Aetna Student Health as a solution in addressing a portion of America’s uninsured population.

Integration is the second dimension of our strategy. The best example of success during 2008 in this area was the Bank of America win. As of January 1st we successfully installed our Bank of America members in our new leading edge integrated product offering. This offering includes a broad range of benefits including medical, dental, behavioral health, disease management, life and disability, and is responsive to marketplace interest in the benefit of integrating multiple programs with a single carrier.

The service approach of this new health and productivity model are also resonating in the marketplace. We have seen strong positive market interest from customer, brokers, and consultants, and anticipate additional market success in this area.

Consumerism is the third dimension of our strategy. It is important to help our members become well educated and more engaged consumers. As of year end 2008, 83% of our members had access to our best in class transparency tools and information to help them make informed decisions about their healthcare. In addition, as of December more than 17.5 million Aetna and non-Aetna members benefit from our proprietary active healthcare engine.

Our consumer directed membership increased 44% during the year to 1.4 million members as of December 31st. We continue to see growing interest in consumer directed health plans across to all customer segments, increasingly among small employers and are pleased to be able to continue to provide affordable quality solutions that meet the needs of our customers.

Finally, operational excellence is the fourth dimension of our strategy and is one where we continue to demonstrate our leadership in the marketplace. We just experienced our largest membership growth as part of January 1st open enrollment in recent history, and it was handled smoothly, predictably and with the level of service our customers expect. In fact, we exceeded our normal level of open enrollment membership gains by approximately 100,000 members in January demonstrating that our strong value proposition continues to drive market out-performance.

We view operational excellence as a differentiator. We implemented more than 160 business process improvements prior to open enrollment to enhance our capabilities and the service experience for our customers. This aided us in distributing more than 9.1 million ID cards during the 2009 open enrollment season.

In summary, we are very pleased with our ability to continue to execute our strategy and feel well positioned to continue to have success in 2009 and beyond.

I will now turn the call over to Joe Zubretsky to provide insight into our 2008 financial performance and our outlook for 2009.

Joseph Zubretsky

Good morning everyone. Earlier today we reported fourth quarter and full year operating earnings per share of $0.96 and $3.93 representing year-over-year increases of 9% and 13% respectively. 2008 operating earnings per share growth was driven by industry leading operating earnings growth of 5% and by executing on our plan to deploy the significant excess capital we generated.

Our 5% growth in full year operating earnings to $1.9 billion resulted from a year-over-year increase in healthcare operating earnings of 7% partially offset by a decline in group insurance operating earnings of 4%. Although both segments achieved strong underwriting margin gains this year, those gains were tempered by decline in investment income of $60 million after tax or $0.12 per share. This decline which was caused primarily by lower returns on alternative investments and lower short-term yields reduced our 2008 operating earnings per share growth rate by 3 percentage points.

Fourth quarter operating earnings of $448 million after tax represented decrease of 1% from the prior year quarter as a 7% increase in healthcare and group insurance underwriting gains were partially offset by a significant decline in net investment income.

I will now discuss the drivers of our 2008 financial performance starting with operating margin and its key components, revenue, healthcare cost trend, and operating expenses.

The year 2008 pre-tax operating margin was 10.3%, an 80 basis point decrease from 2007. This was due primarily to the lower year-over-year investment income mentioned previously as well as the expected mix effect of growth in our Medicare business.

We continue to execute our strategy for profitable growth. Our strong 2008 top-line growth was driven by a 17% year-over-year increase in healthcare revenue. This was the result of disciplined pricing and continued membership gains in our commercial business which led to commercial premium growth of 8% and very strong performance in our Medicare and Medicaid businesses where premium grew by 85% and 143% respectively. Our Medicaid results reflected July 2007 acquisition of Schaller Anderson.

Our 2008 healthcare revenue results are testimony to our model for producing sustained double-digit health care revenue growth. Our model includes high single-digit revenue growth from commercial business through a combination of targeted membership gains and disciplined pricing increases coupled with growth in our expanding Medicare and Medicaid franchises.

Turning now to our healthcare cost experience, we are pleased to report that our full year and total medical benefit ratio of 81.5% was in line with the original outlook we provided one year ago despite the unusual challenges the industry faced during 2008. Our commercial medical benefit ratio was 80.6% for the fourth quarter and 80.3% for the full year. This full year result is 30 basis points higher than the initial estimate we provided one year ago but consistent with our most recent guidance.

During the fourth quarter, results for each medical cost category were within our expected ranges; however, we did experience outpatient and physician costs at the upper end of our expected range. Our 2009 outlook reflects these factors.

Our 2008 Medicare medical benefit ratio was 85.6%, a 120 basis point improvement from the 86.8% reported in 2007 primarily due to favorable results in Medicare advantage products.

Our reserving practices remain consistent and appropriate and we ended the year with a prudent level of reserve adequacy. Our healthcare cost reserves were $2.4 billion at December 31st, essentially in line with September 30th levels. Days claims payable were down 1.6 days during the quarter to 41.3 days at December 31st, this was primarily due to the expected seasonal decrease in claim inventories and a meaningful improvement in Medicare auto-adjudication rates resulting from planned system enhancements.

Our 2008 medical cost trend was nearly upper end of our range of 7.5% plus or minus 50 basis points. Trends within major healthcare cost categories were in line with the expectations we have shared with you previously.

Group insurance underwriting margin increased 39% in 2008. This resulted in a group insurance benefit ratio improvement of 410 basis points to 87.2% due primarily to favorable experience in our long-term disability business and continued pricing discipline. This favorable underwriting result was offset by lower year-over-year investment income.

The third key component of operating margin results is operating expense efficiency. We continue to invest in our future to generate new revenue streams through market and product expansions. We fund these growth investments with unit cost reductions and by leveraging our fixed cost while continuing to improve our cost efficiency. For the fourth quarter, we achieved an operating expense ratio of 18.1% representing a 90 basis point improvement over the prior year quarter. For the year, we achieved an operating expense ratio of 17.8% representing a 40 basis point improvement or 60 basis points when adjusted for acquisitions.

The second driver of our financial performance is investing for profitable growth. We were very pleased to achieve industry leading organic medical membership growth of 5% during 2008. We had a total of 848,000 net new medical members during the year including 33,000 members during the fourth quarter. This was accomplished despite full year in-group attrition of an estimated 225,000 members due to the deteriorating economy. As a result, we ended 2008 with 17.7 million medical members.

For the year, commercial medical membership increased by 645,000 members including gains in ASC and insured business of 440,000 and 205,000 members respectively. ASC gains were driven by strong performance in the large customer market and the upper end of the middle market. Insured membership gains resulted from strong growth in our newer customer segments including Aetna Global Benefits, Student Health, and individual. This illustrates the effectiveness of our segmentation strategy to continuously identify and invest in new opportunities for profitable growth while at the same time maintaining our pricing discipline in core commercial segments.

Medicare membership grew by 159,000 members which reflects the large private fee for service conversion and continued successful execution of our strategy at the local market level. Medicaid grew by 44,000 members including the commencement of our new State of Connecticut contract.

The third and final area of financial performance I will comment on is our investment performance and management of capital. Full year net investment income on our continuing business portfolio primarily healthcare and group insurance declined from 2007 by $90 million before tax due to reduced returns on alternative investments and lower short-term yields. For the fourth quarter alone, the year-over-year decline was $47 million before tax.

The continuing business investment portfolio declined in value by $85 million before tax during the fourth quarter including realized capital losses and the change in our unrealized loss position. Fourth quarter realized capital losses were $198 million after tax including $13 million after tax related to the write-downs of specific credits, $130 million after tax for the accounting other than temporary impairments. This relates to certain fixed income investments that decreased in market value and for which we do not assert that we will hold to recovery, and $56 million for a change in our deferred tax asset as we did not record the full benefit on all of our fourth quarter realized capital losses.

At year end, net unrealized capital loss balance on our continuing business portfolio was $353 million before tax, which is $134 million lower than our unrealized loss position of $487 million as of September 30th. As a reminder, these losses are recorded in shareholders equity and are accounting base losses only as we intend to hold these securities to recovery.

Turning now to liquidity and capital management; our financial position, capital structure, and liquidity all continue to be very strong. Our balance sheet metrics are excellent. As of December 31st we had a debt to total capitalization ratio of 32%, a risk base capital ratio of approximately 600% of the authorized control level, and $5.8 billion of adjusted statutory surplus, $4.8 billion in excess of the authorized control level.

Our capital and liquidity position is very strong. During 2008 we took several actions to further strengthen our financial profile and continue to be very well positioned in this challenging economic environment. We have no need to issue long-term debt. We continue to use short-term borrowing appropriately, and we still have at our disposal our untapped $1.5 billion bank facility. Despite market conditions, we generated more than $1 billion of excess capital in 2008.

With respect to liquidity, we began 2008 with holding company liquidity of approximately $100 million. That combined with full year dividends to the parent of more than $1.3 billion to $500 million of 10-year notes we issues in September and net commercial paper issuance of $116 million enabled us to cover fixed charges and fund almost $1.8 billion of share re-purchases. We ended the year with approximately $100 million of holding company liquidity and approximately $200 million of commercial paper outstanding. During the year, we re-purchased 43 million shares. Our basic share count was 456.3 million at December 31st, down from 496.3 million at the beginning of 2008.

We continue to have excellent operating cash flows. Healthcare and group insurance GAAP operating cash flow represented 107% and 127% of operating earnings for the fourth quarter and full year respectively.

The year 2008 was a successful year in terms of financial performance with 13% operating earnings per share growth, a result generally in line with the expectations we set forth in the fall of 2007. Certain aspects of our results emerged slightly differently than expected as a significant investment income shortfall and lower than expected commercial risk underwriting performance was offset by better than expected Medicare underwriting performance, disciplined cost management, and the realization of effective tax strategies.

Our balanced portfolio businesses and disciplined management processes have and will continue to produce sustainable profitable growth.

I would now like to provide some additional comments on our outlook for 2009. The economy continues to deteriorate and we have attempted to reflect the latest economic outlook in our projections. We expected continued challenges to emerge during the year including increase in group membership attrition consistent with a 9.5% to 10% unemployment rate, upward pressure on provider unit cost, the potential for higher inter-year volatility and medical cost trend, upward pressure on disability incidence rates, and continued pressure on short-term investment yields.

Economic uncertainties may lead to higher than normal variability in our performance drivers and financial results; however, we expect net medical membership growth of 1.2 to 1.3 million members in the first quarter driven primarily by an increase in commercial ASC business. More than half of this strong first quarter outlook is from previously announced gains including two larger customer wins, the State of Connecticut Medicaid contract, growth in our expanding Medicare business, and better than expected open enrollment gains. This is indicative of our strong value proposition that continues to resonate in the marketplace.

We then expect first quarter membership levels to remain relatively stable during the remainder of the year as new business wins largely in insured business are expected to be offset by continued in-group attrition due to the economy. As such, we expect to end the year with approximately 19 million members.

For the year, we expect approximately 25% of our total medical membership growth to be fully insured. For the full year, we also expect double-digit healthcare revenue growth with all five of our newer customer segments, Student Health, Aetna Global Benefits, Individual, Medicare, and Medicaid growing at double-digit rates that are higher than the average of our healthcare business.

Medical cost trend of 8% plus or minus 50 basis points reflecting higher unit costs with inpatient cost trending at high single digits, outpatient at a high single to low double digits, physician at mid single digits, and pharmacy at high single digits. We view the pricing environment as being competitive but stable and rational overall and continue to expect a premium yield that is in line with medical cost trend. This leads to an expected total medical benefit ratio in the range of 81.9% to 82.4% reflecting a commercial medical benefit ratio in the range of 80.2% to 80.8% and a higher year-over-year Medicare medical benefit ratio as we project Medicare Advantage underwriting performance to adjust to levels consistent with the current competitive environment.

Our outlook also includes continued improvement in our operating expense ratio excluding the increase in pension expense, net investment income on our continuing business portfolio that is higher in 2008 as increasing asset levels and improved returns on alternative investments are expected to more than offset the impact of lower yields, a target debt-to-capital ratio of approximately 30% and risk base capital of approximately 600% of the authorized control level, and continued accretive deployment of excess capital through strategic M&A opportunities and share repurchases.

Taking all of these factors into account we expect 2009 operating earnings per share growth excluding the increase in pension expense to be 12% to 14% consistent with our prior guidance. On reported basis this would result in operating earnings per share of $2.85 to $3.95. This assumes a weighted average share count for 2009 of approximately 460 million shares. We expect growth in operating earnings per share in the first quarter of 2009 with the remaining quarters being in line with or lower than 2008.

In summary, I am very pleased with our industry-leading 2008 financial performance. We are well positioned to continue to sustain our momentum in 2009, and I am confident in our ability to achieve the level of financial performance we have projected.

With that, I’ll turn the call back over to Jeff.

Jeffrey A. Chaffkin

The Aetna management team is now ready for your questions. We ask that you limit yourself to one question and one followup so that as many individuals as possible have an opportunity to ask their questions.

Question-and-Answer Session

Operator

Our first question will come from Joshua Raskin with Barclays Capital.

Joshua Raskin - Barclays Capital

A question just on cost trends; it sounds like the fourth quarter came in towards the high end of that 7.5 plus or minus 50 basis points, let’s call that 8%, seems consistent with the outlook for 2009; we’ve heard from some of your competitors that cost in the fourth quarter might have been slightly better than expected. Just curious, what you’re seeing in terms of the pressure upwards. And then, any further comments on the negative development in the third quarter, anything you saw as the claims developed further that helped corroborate that or any other evidence on it?

Joseph Zubretsky

With respect to the medical cost trend in the fourth quarter, we experienced higher than expected outpatient utilization, both in the number of services provided and their unit costs; so a higher level of service. We also had higher than expected physician costs, but a lot of preventive care, which actually in the long-term should be positive with healthcare trend. Also, if you look at our CDHP numbers, where we have 1.4 million CDHP members this year versus 900,000 last year, the seasonality trend is more backloaded now with respect to those numbers. So, that all contributed to our increased medical trend in the fourth quarter. We fully contemplated this in outlook for 2009. So, the revised view of the 2008 baseline and our revised view of trend is clearly included in our outlook for 2009.

Joshua Raskin - Barclays Capital

The PPD in the third quarter, any more color on that, it didn’t sound like there was a lot of information around that last quarter, maybe where it came from?

Joseph Zubretsky

We appear to have captured it in the third quarter, mostly off of the second, and as we said prior period development was not material in the fourth quarter.

Operator

We’ll move to our next question which will come from John Rex with J.P. Morgan.

John Rex - J.P. Morgan

I was wondering if you could just speak on your expectations on Medicare Advantage member growth. I think you said that that’s going to be growing significantly faster; what areas, retail areas versus group areas, and a general view on that, and also, where it stood as of January 1, 2009, in terms of enrollment.

Mark T. Bertolini

We had relatively balanced growth across all segments in the Medicare Advantage area including individual enrollment where we’ve seen some strong interest and in group, not as large in the group area as we had last year, but still a relatively healthy growth, and we don’t have the numbers in yet for the first quarter broken out by Medicare yet, so we’re not finalized on that, we’re just handling all those enrollment files now.

John Rex - J.P. Morgan

The expectations for full year ’09 in terms of that book, in terms of the enrollment gains? And maybe just a little color on magnitude; I think you mentioned also some deterioration in the underwriting margin, their magnitude that we should expect?

Mark T. Bertolini

We have about 150,000 members or so for last year. For the MBR for Medicare our anticipation is that because a lot of the business is group and experience rated, that we will have higher MBRs for the year returning to the marketplace.

John Rex - J.P. Morgan

Any magnitude? Any kind of order or magnitude on that?

Mark T. Bertolini

I think you should expect a Medicare benefit ratio more in the high 80s or in the mid 80s as we experienced this year.

John Rex - J.P. Morgan

Did you give me what your expectation for the year-end ’09 Medicare Advantage membership levels?

Mark T. Bertolini

We did not, but I think we’ll start the year strong in Medicare Advantage, perhaps 40,000 plus, but then for the balance of the year it really is a matter of how successful we are in changing that group private fee for service membership and we’re not projecting that at this stage.

Operator

We’ll go ahead and move to our next question which will come from Ana Gupte with Sanford C. Bernstein.

Ana Gupte - Sanford C. Bernstein & Co.

My question is about the fully insured book; can you break down where you are in terms of individual versus group membership today; where the individual MLR is running today, and any thoughts on outlook for the individual MLR going into ’09 as your book is aging and the recession maybe offsetting some of that and getting you some new growth.

Ronald A. Williams

We don’t really, on a segment basis, break out the individual per se. I would say that we’ve given some historical data points and I think with that, that the business’s growing has been described at a rate faster on average than our core historical block of business. As you know when you look at the MCRs associated with these businesses they tend to run lower and we do understand the durational effects associated with these business; we monitor them very carefully, and are comfortable that we have a very effective and sustainable both cost structure and market position as we continue to grow.

Ana Gupte - Sanford C. Bernstein & Co.

Qualitatively, are you seeing any impact from the AARP distribution relationship; are all your retirees getting into that book in this recession?

Ronald A. Williams

What I would say is that we feel very good about the relationship we have with AARP. I would say from an impact of the recession on the individual block of business, it’s a little early. We honestly have not seen any important fundamental different trends. We see still an important and growing individual business, but no big-step function directly attributable to the recession.

Ana Gupte - Sanford C. Bernstein & Co.

And then one last question; on the 1.2 million to 1.3 million, you see a lot of it is coming from ASC; how much can we assume is fully insured. Do you have a breakdown of that?

Ronald A. Williams

I think what Joe described is that the guidance we’re giving is on a full year basis, that’s approximately 25% of the growth, you should expect to be fully insured.

Operator

We’ll move to our next question from Charles Boorady with Citigroup.

Charles Boorady - Citigroup

Joe, I am wondering if you could walk through the cash at the parent at December ’08 and just step through any major sources and uses, and where you expect it to be by year-end ’09?

Joseph Zubretsky

We were very successful in executing our capital plan as contemplated which is extraordinary in this environment. We had nearly $1.4 billion of dividends from our subsidiaries which covers our $200 million plus of fixed charges. That coupled with a planned increase in our debt levels, our 10-year issue we did in the fall and an increasing commercial paper, gave us $1.8 billion of capital to deploy, which we did, in repurchasing over 40 million shares. In each of the years we had $100 million of holding company liquidity which we believe is adequate. So, again, executed as planned, and I think you should think about the capital plan for 2009 as being on the same dimension, obviously except for the increased leverage. We’re now at our target leverage ratio and so would still plan to generate in excess of a billion dollars of excess capital and absent any opportunities for inorganic growth, we’ll deploy it in very well-calculated share repurchase.

Charles Boorady - Citigroup

In terms of the investment income in the fourth quarter, I estimated around $0.07 a share lower than anticipated; how much of that was from less interest income that we should expect to continue going forward versus anything unusual like hedged from losses or other losses that might not recur to the same magnitude going forward?

Ronald A. Williams

We estimate about $0.06 to be precise and most of the year-over-year swing was in a decline in our hedge funds which declined 16% for the year, most of which actually occurred in the fourth quarter. So, there was a $47 million swing year over year in investment income on both our healthcare and group books of business. Again, not due to short-term yields, but the volatility of the hedge fund investments.

Charles Boorady - Citigroup

And that $0.06 was included in the $0.96 that wasn’t excluded as part of the gains or loss? Is that correct?

Ronald A. Williams

That’s correct.

Charles Boorady - Citigroup

Okay, and then finally, if I could just ask, given the Stimulus package which looks like it’s going to go through; just what the major impacts are from extension of COBRA and then separate from the Stimulus expansion of S-CHIP and what that means for your business?

Ronald A. Williams

There are three critical elements that we think have potential implications for us. One, you mentioned which is COBRA, that’ll be about $21 billion, which will provide this 9-month extension of COBRA with a 60% subsidy for those individual who are single and make less than $125,000 or couples who make less than $250,000. So, I think as you know with the difference between employer’s subsidy being 25% and when they go to COBRA they have to pay 75%, the fact that 60% will be available should improve the take-up rate on COBRA, but I do believe we’ll have to see exactly how it plays out. So, we don’t have anything included in our guidance associated with that. The second element is really the HIT, it’s about $19 billion, and we’re still reading the legislation and really trying to understand exactly how it’s going to flow. We believe there may be opportunities in the future associated with our active health capabilities, but it’s too early to really try to quantify that. And then needless to say the Medicaid, which is the biggest piece at about $86 billion will mean that some of the rate pressure we suspect will be diminished, at least that’s our hope, as well as the fact that there will be more maintenance of effort at the state level and possibly some expansion for people who are exiting the job market.

Charles Boorady - Citigroup

And your guidance assumes no benefit from S-CHIP expansion or the Stimulus.

Ronald A. Williams

That’s correct. There is no assumption in our guidance for the impact of these bills.

Operator

We’ll move to a question from Michael Baker with Raymond James.

Michael Baker - Raymond James

Mark, you indicated that you’ve seen growing interest in the integrated offering. I was just wondering if you could give us a sense of a matter of degree around that, and then also, what the early read is on trend relative to the book under the integrated offering.

Mark T. Bertolini

We’ve had a lot of interest since we announced the Bank of America relationship with a number of clients. We’ve met with about 40 clients who have expressed interest; that has been somewhat tempered by the current economic climate as employers look at ways to pare costs more immediately, but we’re still having a number of those conversations going on and are planning our operations and ramp to be able to handle more business by January 1, 2010. On the trend underneath those products, it’s way too early to tell. We only have a few weeks worth of claims data and couldn’t trend that at all for you at this point, but we’re paying very close attention to it.

Operator

We’ll move to a question from Peter Costa with FTN Equity Capital Management.

Peter Costa - FTN Equity Capital Management

On days claims payable; that has a seasonal decline and you talked about some of the systems improvements in Medicare and then the seasonal inventory, but can you talk about what you expect that to do going forward for next year and whereabouts will that be?

Joseph Zubretsky

It’s really hard to say. We have continual work on our operating platforms including systems work, and we’re constantly trying to increase both our rate of electronic data submission to get faster reporting times in from the providers and also faster adjudication. So, I think, quarter by quarter we’ll try to give you a leading indicator of where that’s headed, but we’re continually trying to improve the turn around times on these things, and so I think you’ll see a downward trend, but it’s very hard to predict how much at this point.

Peter Costa - FTN Equity Capital Management

And do you want to be specific about next quarter, where you think that’ll be?

Joseph Zubretsky

I wouldn’t. I think you’ll just see a seasonal pattern with no improvement or disimprovement one way or the other.

Operator

Our next question comes from Matthew Borsch with Goldman Sachs.

Matthew Borsch - Goldman Sachs

I am wondering if you could just comment on the factors impacting the commercial pricing yield in the quarter, just on a year-over-year basis, it looked like it was up about 3.2%, but I understand that that’s going to be reflect product mix.

Joseph Zubretsky

For the quarter and for the year, the way to think about the business; for the year we’ve had 8% commercial premium and the way to think about that is 5% driven by volume, 4.5% driven by rate, offset by 1.5% negative mix adjustment due to the faster growth of lower premium products, and that should net to your observed trend in the financial statements of about 3%. So, for the year, that’s the way to think about our financial statement yield.

Matthew Borsch - Goldman Sachs

Okay. Can you give us any view on how much would you expect the full year growth for the commercial fully insured versus other business.

Joseph Zubretsky

Right now we’re only willing to say that at the end of the year; if we end the year with 19 million members and 1.2 million to 1.3 million growth, 25% of it will be risk; and as we’ve experienced in the past, the non-traditional newer segments should grow faster than core commercial.

Operator

We’ll move to a question from Justin Lake with UBS.

Justin Lake - UBS

A couple of question; one, on the insured book. Joe, can you just look for 2009, you just mentioned that some of these non-traditional segments are going to grow faster than the core book. Typically, those segments have lower MLRs associated with them, certainly individual. You’ve guided up the MLR 50 basis points. So, maybe you could just talk about a mix adjusted MLR and what you’re seeing there and why you think the MLR is going up next year?

Joseph Zubretsky

If the mix should change the way it has in the recent past, then the mix affected result is 10, maybe up to 20 basis points year over year; that’s what it’s been in the recent past, and so we get growth rates commensurate with what we’ve experienced in the last two years, then the positive effect should be 10, perhaps even closer to 20.

Justin Lake - UBS

So, you would be up 10 to 20 basis points rather than 50, is that what you’re saying?

Joseph Zubretsky

No, I am saying that just for the mix effect, if those products grow at the rate they’ve historically grown vis-à-vis the commercial book, that should have a 10-basis-point impact on the MBR.

Justin Lake - UBS

So, those are higher MLR products?

Joseph Zubretsky

No, lower; 10 basis points the other way.

Justin Lake - UBS

Okay, it’s 10 basis points lower, not higher.

Joseph Zubretsky

Correct.

Justin Lake - UBS

Okay, so then, what is driving the MLR higher by 50 basis points? Can you just talk about that?

Joseph Zubretsky

If you think of the way we guided, we had 80.3% for the year in the commercial; we gave you a range of 80.2% to 80.8%, so it’s clearly we’re shooting for the low end of the range, but look, with all the pressures on unit costs with providers, uncertain utilization patterns, and those types of things, we wanted to be cautious about our outlook for next year, and so we put a range rounded at 60 basis points. So, we’re certainly hoping to come in at the lower end of the range, but we want to leave ourselves enough room.

Justin Lake - UBS

Okay, and my followup on the ’08 MCR. Obviously, the back half of the year you started seeing some year-over-year growth, that was a little bit different than what you’d seen in the first half of the year, as far as the MLR trajectory. Is there anything seasonally that we should be thinking about for 2009 as far as the first quarter being a little bit lower and the back half of the year continuing that trajectory higher?

Joseph Zubretsky

No, I think the first thing we need to do is sort of pro forma both the second and the third quarters for the unfavorable commercial development that we reported. So, you get a little bit of a different pattern that’s closer to historical seasonality and that’s what I would expect for 2009.

Operator

We’ll move to a question from Gregory Nersessian with Credit Suisse.

Gregory Nersessian - Credit Suisse

A followup on the PPRD question; your prior year reserve developments have obviously been very consistent over the last three years, but with the intra-year negative development and then the commentary around the trends at the higher end of the range this year, would you expect the commensurate amount of favorable prior year development next year or are you anticipating that that number will be lower, and I guess, to an extent built into your guidance if that’s the case?

Joseph Zubretsky

We can’t project for development one way or the other for next year. We believe we’re holding a very prudent and adequate level of reserves at our balance sheet date. We hold very consistent and accurately sound margins for adverse deviation, and I think that’s implied in our results that we published and we did have some intra-year development, but year over year our development has been negligible.

Gregory Nersessian - Credit Suisse

Okay. So, we shouldn’t expect any major changes there based on what you know now?

Joseph Zubretsky

Our reserves were adequate at December 31st, and we think we have a good reserve.

Gregory Nersessian - Credit Suisse

Okay, and then a quick followup on the investment portfolio, it looks like there is some changes in some of the asset allocation, maybe a little bit more corporate, less government, if I am reading this correctly; could you just talk about any changes in your asset allocation strategy for next year?

Joseph Zubretsky

We’ve not made any major changes to our strategic allocation. Obviously, we’re always allocating tactically around segments that we think will provide yield. So, you still see us heavily tied to corporate credit and I think most of our categories are fairly consistent with what we experienced in prior years. Now, keep in mind those numbers have been reduced by any amounts that we have marked-to-market through the other than temporary impairment line. So, any declines you see are probably due to the mark-to-market versus any reallocation.

Operator

We’ll take a question from Carl McDonald with Oppenheimer & Co.

Carl McDonald - Oppenheimer & Co.

In the commercial risk business, are we going to get to an inflection point in ’09 where the PMPM pricing is at least in line with cost trends or do you think that negative spread persists throughout the year?

Ronald A. Williams

I think we continue to price in line with our medical cost, and I think in terms of what the observed trend, it’s a function of some of the factors that have been talked about. Probably the one that hasn’t been talked about is the whole geographical issue which will reflect the local medical cost structure which may result in a lower premium than areas that have higher medical cost structures. I think the other thing which was commented on is the growth in the CDHP product and so the extent that we see that as clients renew we do see some trade-down as a result of that.

Carl McDonald - Oppenheimer & Co.

Where do you guys stand in terms of how the economy impacts cost trends, do you think the increase in cost sharing results in slowing utilization or do you think you ultimately see higher cost because of the attrition and the potential deterioration of the risk pool; any prior experience or color you have there?

Ronald A. Williams

I think there are lots of theories and then there is the data which is what we are driven by what we see. I think the other point I would make is that I believe each organization’s book of business is reflective of its client base, and so, hospitals, for example, see and experience a community effect as opposed to our experience which is our book of business. Given the fact that we do have many of our members who are in higher cost sharing products, I think this will be a little bit different than the other recessions where there were $5 co-pays and very modest cost. So, we’re watching it very carefully but I would say we haven’t seen anything that we would view as reflective of the fundamental trend at this point.

Operator

We’ll take a question from Scott Fidel with Deutsche Bank Securities.

Scott Fidel - Deutsche Bank Securities

Could you give us your guidance for the projected tax rate for 2009, looks like that was a little bit lower in the fourth quarter and also for operating cash flow?

Mark T. Bertolini

We had some tax planning strategies that when implemented and finalized manifested themselves in the fourth quarter results. So, our fourth quarter tax rate was low which drove down the full year to 33.8%. I would continue to use 34.5% as the sustainable run rate in our tax line.

Scott Fidel - Deutsche Bank Securities

And operating cash flow?

Mark T. Bertolini

I think you’ll see results consistent with this year, 125% to 130% of operating income, however, adjusted for the increase in pension expense which is a non-cash item. So, we’ll give clear guidance on that when we report the first quarter, but consistent on an operating basis, but obviously it will report differently because of the heavy amount of pension expense which is non-cash.

Scott Fidel - Deutsche Bank Securities

If I could ask if you saw anything around catastrophic claims trends in the fourth quarter, there still seems to be a bit of noise in the industry around cash claims in general, and just interested in the latest in what you’re seeing there.

Ronald A. Williams

We do not see any unusual large claim activity in the fourth quarter.

Operator

Our last question will come from Matthew Perry with Wachovia Capital Markets.

Matthew Perry - Wachovia Capital Markets

Just wanted to make sure I understood the comments around the higher MLR in the Medicare business in ’09, is that driven by the group private fee for service business or is there something contributing to that from the HMO product as well?

Mark T. Bertolini

No, it’s driven largely by the group business which is experience rated and we renew that every year, and so we’re seeing that on reviewing the experience with the client and pricing it to our target margins.

Matthew Perry - Wachovia Capital Markets

So, you’d probably expect HMO MLR to be similar in ’09 versus ’08?

Mark T. Bertolini

We see no change.

Operator

That does conclude our question and answer session for today. I’ll turn the call back over to today’s speaker.

Jeffrey A. Chaffkin

A transcript of the prepared portion of this call will be posted surely on the Investor Information section of the Aetna website on www.aetna.com. If you have any questions about matters discussed this morning, please feel free to call me or one of my colleagues in the Investor Relations office. Thank you again for joining us this morning.

Operator

That does conclude today’s teleconference. We thank you all for your participation.

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Source: Aetna, Inc., Q4 2008 Earnings Call Transcript
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