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WellPoint, Inc. (WLP)

March 12, 2013 1:30 pm ET

Executives

Wayne S. Deveydt - Chief Financial Officer and Executive Vice President

Analysts

Joshua R. Raskin - Barclays Capital, Research Division

Joshua R. Raskin - Barclays Capital, Research Division

So before we get started to get WellPoint in your minds, guys, we'll introduce Wayne and team in a second, but we want to get some of the audience participation going, so we've got a good sample set for all the companies. Simple question, health reform is going to be positive or negative for WellPoint starting in 2014. One very negative, 5 very positive. Go for it.

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

All right. Not hugely surprising, right? I think, it's kind of consistent with what you guys are getting in terms of methods. Number two, contracting rates, and Wayne's going to actually probably answer this question explicitly, but where do you think rates are coming out? Are they, let's call it, Medicaid, 1; let's put Medicare at 3; and Commercial at 5. And where do you sort of think they're in between there?

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

So all over the place, gosh. Although no one actually thinks you're getting commercial rates, so I guess that's good news for you.

Third question please. Utilization trends in '13. So do you think we're going to see a significant uptick increase that's 1, all the way down to a significant decrease in number 5. Go for it.

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

It sounds like slight increase, which seems consistent. That makes sense. No one looking for a decrease. All right, next question. How would you like to see Wayne do his job? All right. So would like to see him do more M&A, repurchase his dividends, repay his debt, especially after the acquisition or invest in the core business, 1 through 5, you've got to pick one.

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

Seems like repurchase is the favorite. All right, that sounds good and then maybe investing in the core. Do you think the company is going to grow earnings? Let's define this as EPS in 2014. I'm hoping this is an easy question for WellPoint specifically. One...

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

All right, 14% have not been paying attention apparently. So let's go with the last 2 questions. Do you currently own shares in the company? That's an easy one.

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

So almost 60-40 in terms of the opportunity, and then sentiment question, last one, what about your current bias? Is it more positive, more negative or somewhere in the middle?

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

Clearly a positive -- the positive minus the negative is going to get you a positive number here. So that's interesting. All right, we've taken our 3 minutes on that. I'm going to turn the podium over to Wayne Deveydt who is the CFO, previously the Chief Accounting Officer for WellPoint and probably been with company for 8 years now, I was off by one. He's obviously has been down in the conference several times. I probably don't need to explain WellPoint. They're the largest commercial health insurance player, largest Medicaid player in the country now. They're a significant player in the broader health insurance market. We're going to go through the slide presentation here. We're going to hold the Q&A until we get to Poinciana 3, which will be immediately following the presentation. So with that, my pleasure to introduce Wayne Deveydt.

Wayne S. Deveydt

Thanks, Josh. Hope you can hear me okay. Actually, I think he did that so that he could write his report for the day with the many questions that were asked. I did find it is interesting though in some of the questions, and it's one of those things where I think many of the responses we would have concurred with and obviously some we wouldn't have agreed with as much. But hopefully today, I can give you a little bit of background on WellPoint and where we're heading.

Before I start, I do want to make a few comments regarding the Safe Harbor statements. We will be making some forward-looking statements. I think it's very important that you consider the risk factors that we periodically outlined in our Form 10-Qs and our Form 10-K as we make those statements.

Let me talk about today's agenda, and I would like to be a little more conversational with this. While many of you are familiar with WellPoint and our story, there's been a lot of recent developments within the company, specifically our CEO, as well as how our quarter's progressing so far, and I would like to give you a brief update on that. In addition, I would like to talk a little bit about our 5-year strategy, how we plan to grow earnings and that, of course, a big component of that is not only around core operating earnings, but capital deployment as well. And so I'll go over our capital deployment first and then actually get into the core earnings and then speak a little more specifically on the exchanges, since that is going to be one of the largest growth areas beginning in 2014.

Let me first start with, probably, the most significant change for our company, which is the appointment of Joe Swedish as our new CEO. Joe will be starting with our company effective March 25. So we're now less than 2 weeks away from when he'll be arriving at WellPoint, and brings over 40 years of industry experience, 26 years of which he served as a Chief Executive Officer. He brings significant leadership skills, strategy and execution skills. One of the things I found most interesting with Joe, though, when you really get some time with him and get speak with him is, his background on the provider side is quite substantial. And as you think about the collaboration that is starting to occur between payers and providers, I think you'll find that this will be an invaluable asset that Joe brings to the table. So we're all very excited. It is our intention to get Joe out in front of our shareholders as quickly as we can possibly get him out, although within a week of him joining the company, we will enter blackout period for first quarter.

Let me highlight real quickly how 2013 is starting. While we do not give intra-quarter guidance, and we don't give quarterly guidance but we give annual guidance, we are comfortable and feel a very solid start of the year already in terms of our outlook. If you'll recall when we gave our 2013 outlook, we made a couple of major assumptions. One was that we were going to invest incrementally, approximately $300 million to drive growth in 2014 and beyond. And I'll talk about that briefly. We also talked about the fact that we had the challenges of integrating Amerigroup into our organization this year and we are investing over $100 million for those integration activities as we progress through 2013. Even with those investments, and with the Amerigroup integration costs, we did guide for modest growth of at least $7.60. So we did expect a very modest growth in EPS this year. We feel very confident in that outlook based on what we have seen so far this year. We still believe operating revenue to be in the $71.5 billion to $73 billion and operating cash flow of at least $2.6 billion. I would give you one data point though that we have seen so far this year, and that's around our medical membership, and our membership is trending better than our original expectations that we guided to. So with that we will provide more detail in the April call, but we feel very positive about the momentum we saw in the back half of the year continuing into the first quarter of this year.

The other item I would comment on regarding 2013 was the flu season was quite strong in January. I don't think that would be a surprise to anybody in the room. I would say it was even stronger than we could have anticipated, but it does appear that it's come down quite significantly in February and hopefully, now in March, we've seen kind of the tail end of the flu season. And even with those costs associated with flu, we still feel like we're off to a very solid start to 2013.

Let me first talk a little bit about the company's long-term strategy and then actually get into components of that strategy. And from a shareholder perspective, I'm going to talk a little more about numbers during this presentation. And one of the things we talked to our shareholders about is that we anticipated growing organically around 4% to 6%, and I'll cover that in a minute. We said through M&A, we would grow approximately 2% to 3% and then through capital deployment, we would grow about 4% to 5%. And when you average that in over a 5-year period, you're looking at a CAGR in the 10% to 14% range. And so what I'd like to do is take you through each one of those components at a high level and work backwards from that. So let me start with capital deployment and then I'll move to M&A, and then we'll spend most of our time on how we're growing organically and how we're preparing for 2014.

Let me first start with our capital deployment of 4% to 5%. We've had a strong track record of returning capital to our shareholders and our current plan assumes that we will return $1.5 billion of capital to our shareholders this year through repurchases. When you consider our current market cap just north of $20 billion, we will always obviously be able to achieve at least our 5% CAGR that we assumed within the repurchase program from a long-term perspective. Obviously, last year, we exceeded that goal, and we do model, though, that most of that repurchase would happen more at the back half of the year when we give our original plan. But we are being opportunistic as we see the stock where it's currently at and taking advantage of the markets where they reside.

The other thing we've done for capital though is we have increased our dividend to our shareholders. And there was a 30% increase that we recently announced. It's a 50% increase from when we started our dividend 2 years ago. And as you'll see here, even with the increase in the dividend, which gives us a 2.4% yield, which currently exceeds the S&P average, it still allows us to have an adequate deployment of capital for the buyback program. So in the current year, deploy about $1.5 billion in buybacks and then on top of that, have an annual dividend of approximately 2.4% yield, which represents about a 20% payout to our shareholders.

Let me move to M&A then. So we feel very comfortable with our long term guidance of 4% to 5% through capital deployment. We've got a track record of doing it. As we move to M&A, which is the 2% to 3% growth, probably the most strategic acquisition we did that you're all familiar was the Amerigroup acquisition, which we closed in December of last year. Amerigroup was very critical to where we saw a lot of growth coming for our combined organizations. They had obviously one of the most successful Medicaid assets out there and had shown over 60% growth in revenue just in 2012 as Medicaid continued to expand and more space went out for proposals. We had the fourth-largest Medicaid business, but really were not operating on such a unique platform as Amerigroup had.

When you couple that with the dual eligible opportunity of $300 billion revenue opportunity, we recognize that having their Medicaid assets coupled with our Medicaid assets and then overlaying that, our senior experience and our CareMore experience, not only positions us well for growth in Medicaid but really positions us extremely well for the growth that we saw coming in the dual eligible population, and I'll talk about those in a minute.

I highlight the Amerigroup acquisition specifically, though. This transaction is accretive in year 1. We estimated it will be mid-teens accretive, and it is accretive inclusive of all onetime costs, including $100 million of integration costs. So we clearly believe this asset will continue to positively drive our 2% to 3% EPS growth over the next several years. We indicated by 2015, we expect it to add at least $1 of accretion from its current mid-teens accretion, that's a combination of both the synergy cost that we're going to get from the transaction coupled with a onetime integration cost going away. And then as you're all very familiar, with the with the Affordable Care Act expansion beginning 1/1 of 2014, we will be a direct beneficiary of many new Medicaid lives that enter into the markets. And because we have a contracts in the combined states of both WellPoint and Amerigroup, we will directly benefit in those 20 states from that expansion.

So with that, let me move to the 4% to 6%, the organic growth. Because I think this is the piece that requires probably the most information for investors to really get comfortable with and understand. It's also the area that is probably most fluid right now, as we see the Affordable Care Act about to come out, as we see recent news from CMS regarding Medicare rates, and as we start to decide what we think the landscape will look like, not just for '14, but really for the several years thereout.

So how are we preparing for that growth? Let me first start off with the commercial market and exchanges. WellPoint holds the #1 market share in the country when you think about the retail markets, so selling directly to the consumer. And our business is very significant around selling directly to employers as well. In fact, we have the #1 market share in small group employers purchasing coverage. Yet we know that, that small group market and even the large group market over time is going to start migrating to the individual consumer making the buying decision, not necessarily the employer making the decision.

Now we have theories of what pace it will move at. We have theories and hypothesis on what will be the rationale for when movements occur. But I think the one thing that we have found internally is, even if we disagree on many or some components along the way, we all agree that in 5 years or so, the migration to the exchange in the retail environment will be significant. And for that reason we've invested in 2013 an incremental $150 million to prepare for the exchanges that go live on 1/1 2014. And I'll talk more in detail on this because this is probably the most significant change that is coming our way in the next 12 months.

For the Medicare programs, we've also invested approximately $150 million to improve our risk coding and to continue to expand our CareMore facilities. Now relative to the 5 areas we're investing in for growth, this is probably the one area that we have to hit the pause button on for a second and at least evaluate what is happening with the current rates. I'm sure I'm stating the obvious, but I will state it, that the current rates that have been published are, from our perspective, a challenge for the industry and more importantly, for our ability to grow within this sector. We don't obviously have the exposure in Medicare that would impact our EBIT very much, but we also viewed it as a significant growth opportunity. The key message I want to highlight for our investors here though, is that our Medicare program investments are flexible. And we were doing these investments with what we believe to be a future environment that with the current rate structure, we don't know whether the environment will be sustainable with these investments. And so we will flex down our investments or flex up depending on how final rates evolve.

Let me move to Medicaid. We talked about in Amerigroup we're investing over $100 million to integrate our 2 companies. We know that beginning 1/1 of 2014 we'll be a direct beneficiary in all of our Amerigroup states. But it's also important to recognize that we talked about 2% to 3% growth through M&A. We looked at that with the lens of Amerigroup only. Outside of that lens is the organic growth that we get in our WellPoint Medicaid state and the opportunities that we get there through auto-assigned as Medicaid expands, as well as our new opportunities both around the ABD and the long-term care population.

Within the dual eligibles, we do have our first contracts with the state of California already. I highlight this to say that when you think about the horizon in the next 5 years, there's currently about $300 billion spent by states to support the dual eligible population. When you look at the states that both WellPoint and Amerigroup now combine cover, that represents $180 billion of that $300 billion opportunity. If you were to bifurcate it even a little bit further between those that you think might come sooner versus later, 4 states: California, New York, Florida and Texas, represent $100 billion opportunity by themselves. This is very relevant, though, because as the states begin their pilot programs, we want to make sure we are at the table to be a participant. In California, we bid on 3 counties, we were awarded 3 counties. We are in the process of obviously moving forward and bidding in New York, and we would anticipate participating in the other states as their expansion moves forward.

And then finally, in Specialty. I highlight this because as we move to a more consumer-centric retail environment, Specialty products are going to matter even more to the individual consumer. From a retail perspective, what really matters is dental and vision. As you're buying coverage for yourself, many of us wear contacts or glasses, all of us hopefully are using dental services. And so we invested in areas that would drive growth in these 2 segments in particular. We do have our first National Dental GRID. That's being rolled out this year. What does that mean? It means that today, we can actually bid on large national accounts for all their dental needs across the U.S. even outside of our 14 states. We've partnered with our Blue brethren to be able to have that opportunity.

In addition, with the acquisition of 1-800 CONTACTS, we now have the opportunity to expand not only to our consumers that we have today, the contact lens, but we are rolling out glasses.com and that was recently featured at Ted as one of the most innovative technologies coming forward. So more to come on that, but you will start seeing later this year the glasses.com rollout.

Within these 4 area -- or 5 areas, we see significant growth as we move into '14, recognizing the time that we have today, and we have the chance for Q&A afterwards, I would like to spend a little bit of time focusing specifically on Commercial segment and exchanges because of that is probably the one area that's got the most question from our investors.

Well, let's first talk about the Commercial business. This is where we sell directly to the employer. You'll see that we have a very robust, very strong and diverse membership base. We have over 28.5 million members that are employer-based and individual. Again, I highlight this though because as you look at this pie on the screen, you'll see the yellow section, which is a very small piece of the pie, 1.9 million members. So while we have the #1 market share today, when we sell directly to consumer in a retail environment, it's really a very small piece of our commercial book, which is the yellow segment you see up there with 1.9 million members. We obviously have many other areas of our business. Both our National Accounts with over 7 million members, our large group administrative services only customers, where we do not bear underwriting risk to get a fee for access to our networks and paying claims, and then our large group fully insured.

One of the big questions we get though is, the world is changing but what does this mean for WellPoint and how do you look at this large base of 28.5 million members and evolve to where the world is going?

And so we'll talk about that. One of the things I'd like to highlight for you is what is the composition of the health insurance market in our states? While this is a busy slide, let me give you some interesting stats that we believe in, that are very relevant to where we think the world is going. If you look at 2014, so the first day the Affordable Care Act goes into place, and you look at those individuals in our states that will be eligible for Medicaid, so in this case a full subsidy from the state governments, or eligible for a full or partial subsidy on the public exchanges, how much of the population would actually qualify for that if everybody moved on 1/1? Now again while we recognize not everybody's going to move, it was important first to understand the landscape of where the world was going. And in our 14 states, 66% of the population is either Medicaid eligible beginning 1/1 '14 or fully or partially eligible for a subsidy on the exchange. That's just based on the demographics of household income. When you add into that senior and how many individuals turn age 65, that number moves well north of that. And now looking at almost 3/4 of the population being either fully subsidized or partially subsidized by either the federal or state governments.

So it's really important to recognize that our world is changing. And as that world changes from a direct to employer market over time, it's migrating to much more of a retail or direct contracting with the government. What I want to highlight here for you is what is most susceptible in the nearer-term for that migration to occur? Now who we think it's most susceptible is our small group employers. Like those employees who have 2 to 50 [ph] -- those individuals generally for WellPoint are smaller in size, usually less than 10 employees and many of our small group employers, and those are individuals that would be most incented early on to move from buying coverage directly for them and their employees to actually shifting those employees to a public exchange.

And when we look at that landscape, we actually think that, that migration will not be that fast in 2014. But we do think, when you look out over 5-year horizon that, that migration will occur. What we try to model for you though was in the next several years, assume you have a 30% migration though that actually occurs in our small group membership, what does that look like? And what it means is we would lose about 600,000 members that are currently covered under our small group employment today.

But then turnaround and migrate to the public exchanges and assume that all we win is our current market share in those exchanges in retail. And again, as we've mentioned, we know in the retail environment we have the #1 market share, and we know that, that direct to consumer, those market shares are in the 40% to 50% range. So let's assume that we average a much smaller market share. That we don't actually grow exponentially over where we're at today, but that we just average a consistent level. We think we can do better. Or even if we average a consistent level, of the new lives coming in, you're looking at roughly 1.5 million new members. Clearly, under 30%, we get margin contraction, so we're adding almost 3x the lives to offset the contraction, and we believe actually grow EBIT through that first migration.

Let me highlight a few reasons why we think this is unique and how WellPoint specifically is positioned. This is a very busy slide with different colors around it. And what we're highlighting here is what states are following. And what you'll see here is, if it's a dark blue, they're looking at the federal fallback. They're basically saying, "We're not going to build an exchange. We want the federal government to go ahead and be the fallback plan." If it's light blue, you'll see federal-state partnerships. If you're looking at green it's a state-based facilitator model, essentially like an internet access for just facilitating connecting consumers to insurers. You'll see much more of a state-based facilitator model in pink and then a darker red is an active purchaser model where the state will help make those decisions. Very similar to the way they do Medicaid in helping to drive who gets to be on the exchange and what levels you play at.

I highlight this diversity to say that one size is not going to fit all in how you address the exchanges. And understanding your local market is going to be more critical than it's ever been before, not just your local state issues and your local regulators, but the consumer and how they respond in this new world. We believe that we have proprietary research that helps us make those decisions better than anybody else. Let me highlight why. Over the last 18 months Dennis Matheis, who is sitting to the far left here, has been focused on nothing but exchange strategies. And our exchange strategy started, as I mentioned 18 months ago, with a focus on consumer behaviors. Not consumer behaviors as we know them today in retail, not commercial behaviors that we assumed would move into consumer behaviors, but real simulations with individual consumers.

We did simulations on over 55,000 consumers over 8 states, both our East Coast, West Coast and Central State regions. We focused on things like price, did it matter; brand, did it matter; network did it matter; drugs; formulary? We went through every possible scenario we could do. And we did it for the simple thing of understanding what was going to motivate a consumer within a particular state and probably more specifically within a particular county. What we found was, and this would probably no surprise to you, was that price mattered most, price mattered most, and people are willing to do trade-offs for price. What we found second was brand mattered a lot. And that we had a 3 to 5-point advantage just based on brand. And it's somewhat logical if you look at how we -- how it translates today to us having the #1 retail market share already when we sell directly to consumers, but we were able to validate it. And then we found everything else was a very distant third place of what mattered, and it was very sporadic. To some it was network, to some it was formulary, to some it was the actual drugs that were covered.

Now I'm sure that those stats that we just highlighted about what mattered aren't a surprise to any of you. They weren't necessarily a surprise. But what really is relevant about the studies we did and the research we did is we know this by county. We know how much of an advantage the brand has in a particular county. And whether it's 1 point in 1 county and 8 points in another county, we know that. We also know where price matters most or where networks do matter some or more or less, as well as what formulary matters. And so I highlight this simply to say that as we prepared for the exchanges, we really thought it was important that we had a view at not only a state level, but a county level and then we based it on data that was statistically significant and whether or not those behaviors differed too much with an area. So when we look at the West Coast, we didn't just look at California, we looked at other West Coast states. When we look at the East Coast, we didn't just look at New York. And when we looked at the Midwest, we didn't just look at Indiana. But in taking a number of states from each location, what we also found interesting is the behaviors and what mattered is very different between East, West and central states. But within those clusters, they're relatively similar, which gave us an opportunity then to then extrapolate that to our other West Coast states and our other central states.

So we think with this research, we are very well-positioned product design, in our marketing strategies and more importantly, in our pricing. One of the questions that Josh asked before the meeting was, where do you think WellPoint will ultimately price for the exchange strategy? We think affordability is a major issue for this industry. We think the consumer obviously has affordability concerns. And as we're building our networks, if we are going from very broad network, well we can narrow those networks and move to a much more narrow network and still offer a significant network beyond what many have today. And we believe that we can get closer to Medicare rates and have been successful in doing that today. We think that's relevant because it helps drive the cost of goods sold advantage that we have today even further. Couple that with the brand, we believe we can offer a more affordable product to the consumer. And since we know price mattered most, we think that is going to become very relevant as we go out to this new membership that's going to be available to the market beginning 1/1 or 2014.

Another growth opportunity that we believe is a little bit longer-term is the idea of private exchanges. You may have heard this where large employers are simply saying, "I would prefer not to move my employees across many states into many different state exchanges." And you can see some of the logic behind it. You saw from the previous slide how diverse the decision-making will be around exchanges in different states. But if you're a large employer across multiple states, you may want an opportunity to allow your individual employees to have the choices that they want to make and to make those decisions on their own.

What I would describe as similar to defined benefit plans or pension plans and how those overtime evolved to be 401(k) plans, where employers put a flat amount in and then that employee, that individual get to make choices for themselves. We highlight this opportunity though to say that we are getting interest in this model. And you've seen publicly certain large carriers start to move to this model, large employers move to this model in the last year. What's probably not always appreciated within this model, though is what we illustrated for you in the PMPMs is that when you're doing an administrative services-only contract, you may be charging $20 per member per month in revenue, and you have a very nice margin for bearing no risk, which converts to about $4 operating gain. But as you move to a fully-insured environment and individuals are making buying decisions with those individual dollars, either in a private exchange or a public exchange, you move to a fully insured environment. And for that additional risk you take while a lower margin, it's on a higher premium, which equates ultimately to better operating earnings and better cash flow. We view this as longer term, but we also view it as a natural migration that will occur over time as employers begin to move to exchanges either public or private.

With that, I know we're going to move to a Q&A room, but I do want to just leave you with a few takeaways. We're excited about Joe joining the organization. This is a unique transformational period, and we think Joe will bring unique assets and we're excited for investors to meet him. We are investing heavy in our future and the investments are around growth. As we mentioned, we got 5 key growth areas we're driving. We are watching the current Medicare environment to determine if that will continue to be a growth area, but are very optimistic on the other 4, based on what we know at this point in time. We are preparing for the marketplace transition in the Commercial business. It's real, it's here, but we think we can capture our fair share, if not more. And we think we're extremely well-positioned for those exchanges based on the research we've done today.

Thank you so much for your time and look forward to your questions.

Joshua R. Raskin - Barclays Capital, Research Division

[indiscernible]

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