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Aetna, Inc. (NYSE:AET)

Barclays Global Healthcare Conference

March 13, 2013 10:15 am ET

Executives

Joseph M. Zubretsky - Senior Executive Vice President of National Businesses

Analysts

Joshua R. Raskin - Barclays Capital, Research Division

Joshua R. Raskin - Barclays Capital, Research Division

As we've been doing with all the companies -- maybe let's see an associate close the back door. But I guess, we'll get the doors closed in the back at some point. So we are going to ask the same series of 7 questions we've been asking everyone in healthcare services land, starting with number one and think again Aetna specific here.

Do you think health reform will be a positive for the company in '14 or a negative? Very negative 1, very positive 5 and everywhere in between. And enjoy the music while we do it. Go ahead.

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

All right. We'll go with undecided. So let's see, the next question.

Do you expect the company to contract rates on exchanges that will be closer to 1, Medicaid; 5, commercial; somewhere in between? Let's see who was paying attention to our notes.

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

That's probably the correct thing, a little bit close to, and I think people listened. Okay, next one.

Utilization trends for '13, so across their broad book of business, all of that combined, a significant increase in '13 down to a significant decrease, 1 through 5.

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

So people are more towards the increase than the decrease. All right. Next question.

How would you like to see the company deploy their capital? This was an old Zubretsky question, but we'll make sure on Guertin now, who's now responsible. So M&A, repurchases, dividends, repay the debt or invest in the core business?

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

Repurchase, please, and give us dividends and invest on the core. All right, next.

Do you think the company -- well, we've been defining this as EPS, the company can grow EPS in '14, yes or no?

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

All right. That seems, I thought, obvious, but all right, that's good. Next one -- there are 2 more questions here.

Do you own shares in Aetna, currently?

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

All right. A little opportunity there in the sentiment side of things. The next question.

Is your bias currently more positive, neutral or negative?

[Voting]

Joshua R. Raskin - Barclays Capital, Research Division

All right, so that's interesting. There's opportunity here. Joe will get you guys all over the hump in the next 23 minutes.

So it is my pleasure to introduce the Head of National Businesses now, previously CFO for Aetna. Joe Zubretsky has been with the company for a long -- presenting in our conference actually for a long time, so we've been lucky to have the pleasure of Joe's presentation. We're going to hold all the Q&A until we get to Poinciana after the presentation, so for the next 22 minutes.

I will turn it over to Mr. Zubretsky.

Joseph M. Zubretsky

Thank you. Thanks, Josh, and good morning, everyone. It's great to be here at the Barclays conference here in Miami. You can read the cautionary statement on your own, as I'm sure you've been doing for the full conference.

We start off all our presentations to investors talking about the Aetna Way. It's the value system that guides our decision-making. And while integrity excellence, caring and inspiration all are very important and have guided us to the performance we've achieved in the recent past and certainly will guide us as we move forward in a rather uncertain world due to the economy and continued Health Care Reform, we're particularly struck by excellence, which the business gets more demanding every day and more complex to manage, and I think Aetna has demonstrated its commitment to excellence, its pricing and underwriting discipline. And secondly, with our foray into Accountable Care Solutions in some of our emerging businesses, we truly have inspired ourselves to be innovative, and we think its innovation that is the distinguishing factor in our strategy versus our competitors.

So the investment thesis we think is very simple, that we have a very well-defined strategy. We gave the market a really good comprehensive look at our strategy at our Investor Day, and behind that strategy is a very well diversified portfolio of high-performing businesses. But it's all about the results. And with a 3-year track record of 13.6% earnings per share growth since 2010, it has been one of the best performing assets in the sector, all of which gives us an incredible amount of confidence to continually reaffirm our long-term earnings per share growth target, which is low-double digits over time. And we'll produce that from the core business, at least 4 percentage points; our emerging businesses which add nice fee-based income and high EBITDA, cash flows, all with the dual purpose of enhancing the core business; and lastly, our expert deployment of capital, which would at least add 6 points, all of which contribute to our low-double digit operating earnings per share growth rate over time. The strategy, a great portfolio of growth businesses, our history of producing results all give us great confidence in reaffirming that outlook.

This 6-point chart really outlines the execution of our strategy. As you know, the 3 dimensions of our strategy are transforming the network model, re-platforming the business in terms of making the experience simple and easier to understand for consumers at the heart of our strategy, but really it comes down to performance of the portfolio. And I start on the upper left-hand side of the chart. Our portfolio of businesses is extremely well diversified. We've built core platforms of administrative excellence, network management, care management, capital deployment and risk management, and around those core platforms, we have developed a portfolio of products that appeal to a very, very broad swath of the market: Medicare, Medicaid, commercial, small group, individual and large group, students, ex-pats. We think it's this diversified portfolio which allows us to do 2 things: one, keep an Aetna member for life as they age in and out of Medicare, as they move from Medicaid on to exchanges, as they move from employment to unemployment. This gives us the ability to keep an Aetna member for life, which has huge value to our growth potential; and secondly, when things inevitably goes sideways in certain businesses, either through exogenous factors or internal factors, a diversified portfolio allows the management team to navigate the company successfully through choppy waters.

Our Large Group business, and we'll show you some charts in a minute, is the franchise. It's the hallmark. It's the legacy of Aetna. The business bill of [ph] 2/3 of the Fortune 500, and our middle market business is quite robust. This business is earmarked by extremely loyal broker relationships, high persistency rates, and the anchor of this business is the ability to price the medical trend with a great deal of discipline, always putting the attainment of our margins before attracting a new member.

We also believe that the government business can be a growth engine, and we'll talk about the Medicare issues and the 45-day rate notice in a moment. But at its heart, the demographics is irrefutable. Medicaid expansion is here, and whether it's the dual-eligible populations or the high-acuity Medicaid populations, the graying of America or the ability to convert the retirees in our Public and Labor business or National Accounts business into Medicare Advantage, we believe that all of those factors contribute mightily toward telling a very robust growth story in government.

Fourthly, Small Group and Individual represents an opportunity for us. Yes, they are highly regulated, even more so on the exchanges in 2014, but representing only 7% of the EBITDA of the company. It's not a franchise-impacting event, if we were ever to choose not to play in those businesses to redeploy capital to another place. So we're going to be on the exchanges, we're going to participate in these markets, but it's a modest amount of our earnings profile but represents a significant upside opportunity.

Fifth, Accountable Care Solutions is the way we are executing against the transformation of the network. This is about helping providers convert from a volume-based reimbursement model to a value-based reimbursement model, all with the purpose of generating one fee income on our technology businesses, but mostly to transform our cost structure, our medical cost structure, to be best in market, which then gives us the ability to have the most competitively priced insurance products in the marketplace. We'll talk about that a lot in a minute. That's the fifth dimension of our strategy in how we're going to execute against our growth plan.

And lastly, a very exciting acquisition we made this year, the Coventry acquisition, a $7 billion acquisition, what I consider to be strategically compelling, financed right. And it will be integrated very well, and we will achieve the synergies we have outlined for you in the past.

So let's take a spin through the portfolio. This chart simply shows you the diversified nature of the portfolio. If you look quickly and add up the numbers, 75% -- nearly 75% of the earnings of the company are largely immune from the impact of health care reform. That fact is sometimes lost. The health could be -- the lines of business that are heavily impacted, Small Group and Individual, Medicare to some extent, all represent a modest portion of the portfolio, but our Commercial ASC businesses, our Large Group Insured businesses and our Group Insurance business are largely unaffected by reform. And as I said before, it is the hallmark of the company and the flagship business of the portfolio. Diversification mitigates risk and as I said, not completely immune from health care reform, but at least insulated from it.

We love the ASC business. We have over 8 million members in this business, so you could see it represents 25% of the EBITDA of the company. From the Fortune 500, of which we enjoy relationships with 2/3, to the high end of middle market, this is business that is sticky. It has unregulated fees as its revenue source. It has very low capital requirements and extremely strong cash flows. The opportunity to grow this business, even though we all know that employment in the United States, particularly in large businesses, isn't going to grow, has to do with the cross-sell opportunity of our specialty portfolio, behavioral, pharmacy, group business, dental. It has to do with our low-end option, Prodigy, which we bought in 2011. As clients opt for a low-cost, stripped-down, low-touch option, we now have that option on the shelf.

We think that private exchanges are not a risk to our profile but an opportunity. We are going to participate on the private exchanges, and as certain companies, and we believe this will be the exception rather than the rule, convert from a company-sponsored ASC model to "you're on your own, we'll make it available through your private exchange," we think the upside opportunity is significant because exchange-based business is likely to be fully insured business rather than ASC business, which has a higher contribution margin per member than the ASC business does. And lastly, running these members through accountable care organizations, which you'll see in a minute, has a huge growth curve associated with it, can be a game changer.

Our commercial insured business, broker relationships, very, very strong; high retention rates in this business, which adds value; a good pipeline inflow of new business accounts. You could see it represents 43% of the 2012 EBITDA contribution. This is where we show what we are known for, and that is the ability to forecast medical cost trends and price to it with a great deal of discipline. That's game set match in this business, the ability to manage trend yield spread. It's a stable and persistent book of business, has fantastic cash flows, reasonable capital requirements and earns significantly in excess of its cost of capital. Largely unimpacted by reform. A lot of people get confused in terms of all the issues you hear about guaranteed issue and minimum levels of benefit and actuarial values. The Large Group business -- those issues do not apply to the Large Group business. This is still the one-on-one negotiation with the plan sponsor that's looking for a high-quality product for its employee base, but largely immune from the impacts of the 2014 reform wave.

So Medicare, over an $8 billion revenue stream for us in 2013. Let me go back into history. We grew this business from a standing stop 6, 7 years ago to an $8.5 billion. We -- the franchise that we've built doesn't just rely on individual Medicare Advantage sales but group sales to our public and labor, to our public and labor distribution channel and our national account distribution channel, which leverages that distribution capability that we've built over decades and decades.

This chart shows the issues that you're always dealing with in managing Medicare Advantage. You're always dealing with the negative spread between trend and yield that CMS gives you. As you know, over the past few years and into the future, rates are moving down to parity with fee-for-service. We now have the minimum MLR requirements in 2014, which will largely uneffect our ability to write this business and to write it as -- at a reasonable profit since the rules were written in a very favorable way. And lastly, the health insurance fee, where Medicare premium is assessed the fee, but you don't have the explicit ability to recover it in rates you file with CMS.

On the left side of the page, you see the levers that we are always pulling in order to balance profitability and growth and the value proposition for our members. We're going to have to pull those levers a lot harder in 2014 due to the high-single digit rate decrease that was articulated in be 45-day advance notice by CMS. But there's still room. We think there's still room in plan design and premium. We think that because most of our business is in HMO-type vehicles and products, the ability to manage medical cost continues to be there. We are still reimbursing at a percentage above Medicare in many of our network contracts, so we have room to recontract.

And of course, in 2015, we have the ability to attract star bonus revenue. So 2014 is likely to be a choppy year. We're going to have to work hard and pull these levers to make sure that we can do what we always say we're going to do when it comes to any product in our portfolio, and that is, as we allocate capital to that product, we earn in excess of that cost of capital for the benefit of our shareholders. Again, a lot to deal with here in the near term, but we think that Medicare Advantage is sustainable over time, particularly since we're largely HMO and largely group. We think the growth rate from converting ASC members in our group accounts to Medicare Advantage is significant.

Our Accountable Care Solutions business, we launched 2 years ago. We recognized that the idea of volume-based reimbursement, rather than value-based reimbursement, is what was crippling the industry and contributing heavily toward the runaway medical cost trend. We also realized that many of the providers truly wanted to change their business model from episodic acute care management to patient population management. So what Aetna did, rather than vertically integrate, buying doctors, physician practices or hospitals and attempting to tell them what to do, we bought technology assets and capabilities that when packaged in a certain way and installed in a provider system, allow that provider system to behave in a much different way.

And so our Accountable Care Solutions business provides the enablement for providers to engage in patient population management, which allows them with a great deal of confidence to give us the best contract in that market, in some cases, many percentage points better than the best rate in the market, sometimes with Blue Cross, Blue Shield. It gives us the ability to package that contract into a new suite of products, individual, small group, Medicare, Medicaid, even national accounts and launch those products in that market to grow faster than the market is growing. So Accountable Care Solutions not only enables providers to behave differently, but creates the momentum and the confidence for them to give us the best cost structure in that market. We convert that cost structure into products, products into membership, all with the goal of growing faster than the market. Our Accountable Care Solutions business is a core business growth initiative.

Here are some numbers. I think we showed you these on Investor Day. We had 17 ACO deals done by the end of 2012. That will grow to 60. And when we say an ACO deal, we're not talking about Medicare collaborations and value-based arrangements. We have hundreds and hundreds of Medicare collaborations, patient center, medical homes and risk contracts. When we say an ACO, we're talking about a fully installed technology solution and a risk contract that flexes up and down symmetrically where we share in their -- we are aligned with the provider on the upside and the downside, and on which we launch specifically branded products, either Aetna-branded products or co-branded products. We expect to have 60 of these deals by the end of 2014, which should result -- at least our projection is 750,000 members running through these transactions to $2.5 billion of revenue, mostly premium, across the wide array of products, Medicare, national accounts, individual, small group and the like. So we think this is really a game changer, and we think that Aetna having invested heavily in the capabilities to allow providers to change their behavior and their business model is what's going to be the catalyst for this growth.

Coventry acquisition, as you know, is pending approval. We have 20 out of 21 state approvals, one is pending. We're confident we'll get it. But obviously, we have to get through DOJ approval. We're confident we'll get that as well. But it will be midyear by the time we close. We have not changed our forecast in terms of the operating earnings per share accretion that we'll enjoy from the transaction. These numbers are assuming it closes in midyear 2013. Modest accretion, expanding to $0.45 in '14 up to $0.90 in '15. You can see the pro forma statistics on the right side of the table.

Again, this transaction was bought right, financed well, and we'll integrate it with the same discipline that you've seen us operate under for the past few years. It's an in-market transaction. There is nothing about this company we don't understand, as the product line is truly complementary and synergistic with our own, the management team that we've met and have engaged with are fantastic. They're great local market operators, and I think this thing will simulate and integrate quite well and gives us high deal of confidence in these numbers, particularly since most of the synergies are created out of pure cost overlap, leverage of fixed cost with the additional membership and redundant IT expenditure.

Here's the pro forma -- our diversified portfolio on a pro forma basis. You can really see that it really doesn't change the profile of the company. A little bit higher on the government revenue concentration line from 20% to 30%, but really not much movement on the contributed EBITDA. Their workers' compensation business gives us a little more on the ASC fee line, but largely does not change dramatically the profile of the business. We still like the profile.

Some quick numbers on the financials. As you heard at the -- on our fourth quarter call, we have projected for the full year 18.4 million members. We produced 18.3 million members at the end -- or project at the end of the first quarter off of 18.2 million. We expect strong growth, and we had strong growth in our Medicare Advantage line, 175,000 members; 100,000 for the conversion of the Texas Retirement System account; another 50,000, group; and 25,000, individual. Very strong Medicare Advantage here, respectable year on the ASC line. In fact, if you discount the conversion of the TRS ASC members, the ASC business grew slightly. So it looks as though our fee-based businesses, particularly National Accounts, has stabilized from a couple of years of actual membership declines. And the Medicare Supplement line had a fabulous season, with growth of over 45,000. Gives us great confidence in reaffirming our revenue projection for the year at 9%, obviously enabled by the modest membership growth that you see here on the page; the ability to price to a 6.5% medical trend, which is an inherent growth rate in the business; and then, of course, the significant Medicare mix, all contributing to a 9% growth rate in 2013, while we enjoyed a 6% growth rate in 2012.

Nothing's changed with our outlook on trend at 6.5%, plus or minus 50 basis points. We included in our trend projection for the year 50-basis-point increase in core utilization. That's been offset by the lack of a leap year in 2013 and increased benefit buydowns by our customers. We have seen nothing in the early part of the year that caused us to change this trajectory. Whether it's flu, whether it's hospital utilization or any of the artifacts that generally affect trend, we're seeing nothing early here in 2013, which cause to change this outlook.

We've given you this bridge before, how do you account for the increase from $5.13 in 2012 to $5.40 this year, which we are, of course, reaffirming. You can see that there's a lot of puts and takes in there. Net investment income continues to be a drag due to the low yield environment. Our 2012 acquisitions, as the integration costs, we are often, as the synergies accrete, it's more accretive. We're going to get this artificial lift from the health care reform taxes that we'll begin collecting in 2013 in advance of their incurral in 2014. And then, of course, capital actions we took in 2012 have a huge benefit as we took our share count down by 35 million or so year-over-year. So again, very solid outlook at the $5.40 target level for 2013.

In conclusion, yes, we think that the strategy is really sound. We are very confident that we fought the trends in the marketplace through what's going on in the provider community, our customer base and with the consumer. We've positioned the portfolio well. The businesses are performing very well. Yes, there are continued effects and drags from the economy that we're dealing with, and of course, the new wave of reform initiatives in 2014. But having said all that, we're very confident in producing the $5.40 this year, and everything we've seen, again, gives us confidence in reaffirming our long-term target of double-digit earnings per share, operating earnings per share growth rate over time, which is a 5-year projecting -- projection, excluding the impacts of the Coventry acquisition.

So that's all I have for this morning. Appreciate you being here. Thanks for listening, and I think we're going to go to Q&A.

Joshua R. Raskin - Barclays Capital, Research Division

Yes, perfect. Thanks, Joe. We're going to have the [indiscernible].

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