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Humana Inc (NYSE:HUM)

F1Q09 Earnings Call

April 27, 2009 9:00 am ET

Executives

Michael B. McCallister - President, Chief Executive Officer, Director

James E. Murray - Chief Operating Officer

James H. Bloem - Chief Financial Officer, Senior Vice President, Treasurer

Christopher M. Todoroff - Senior Vice President, General Counsel

Analysts

Tom Carroll - Stifel Nicolaus Capital Markets

Charles Boorady - Citi Investment Research

Joshua Raskin - Barclays Capital

Matthew Borsch - Goldman Sachs

Justin Lake - UBS Investment Research

Greg Nersessian - Credit Suisse

Christine Arnold - Cowen & Co.

Scott Fidel - Deutsche Bank

John Rex - JP Morgan

Carl McDonald - Oppenheimer & Co. Inc.

Peter Costa - FTN Equity Capital Markets Corp.

Ana Gupte - Bernstein Research

Matt Perry - Wachovia Capital Markets

Operator

Good morning ladies and gentlemen, my name is Laurie and I will be your conference operator today. At this time I would like to welcome everyone to the Humana First Quarter 2009 Earnings Release Conference Call. (Operator Instructions) At this time, it is my pleasure to turn the conference over to Vice President of Investor Relations Regina Nethery. Please go ahead.

Regina Nethery

Good morning and thank you for joining us. In a moment Mike McCallister, Humana’s President and Chief Executive Officer and Jim Bloem, Senior Vice President and Chief Financial Officer will briefly discuss highlights from our first quarter 2009 results, as well as comments on our earnings outlook.

Following these prepared remarks, we will open up the lines for a question-and-answer session with industry analysts. Joining Mike and Jim for the Q&A session will be Jim Murray, our Chief Operating Officer, and Chris Todoroff, Senior Vice President and General Counsel.

We encourage the investing public and media to listen in to both managements prepared remarks and the related Q&A with analysts. This call is being recorded for replay purposes. That replay will be available on the Investor Relations page of Humana’s website humana.com later today. This call is also being simulcast via the internet, along with a virtual slide presentation. For those of you who have company firewall issues and cannot access the live presentation, an Adobe version of the slides has been posted to the Investor Relations section of Humana’s website.

Before we begin our discussion, I need to cover some other items. First our cautionary statement: Certain of the matters discussed in this conference call are forward-looking and involve a number of risks and uncertainties. Actual results could differ materially. Investors are advised to read the detailed risk factors discussed in our most recent filings with the Securities and Exchange Commission. All of our SEC filings are available via the Investor Relations page of Humana’s website, as well as on the SEC’s website.

Additionally, investors are advised to read Humana’s first quarter 2009 earnings press release issued this morning, April 27, 2009. This press release and other historical financial news releases are also available on our Investor Relations website. Any references made to earnings per share or EPS in this mornings call refer to diluted earnings per common share.

Finally, one point of clarification on this morning’s press release, on Page 9, the Government segment benefit ratio guidance point is that to the entire segment so includes Medicare, Medicaid, and Military Services. The Medicare benefit ratio guidance point below it is that for Medicare Advantage and stand-alone PDP combined.

With that I will turn the call over to Mike McCallister.

Mike McCallister

Good morning everyone and thank you for joining us. Today Humana reported first quarter earnings of $1.22 per share, $0.07 above the midpoint of the guidance of $1.10 to $1.20 we shared with you in our fourth quarter 2008 earnings release, and significantly higher than the $0.47 per share we earned in the first quarter of last year. These favorable results were due primarily to year-over-year improved performance in our Medicare prescription drug plans as we effectively addressed the issues we encountered in 2008.

Additionally, the quarter saw solid operating performance in both of our business segments, Government and Commercial, which we anticipate to continue through out 2009. Consequently, we also announced today an increase in our full year 2009 EPS guidance, now at $6.10 to $6.20 per share, up from our previous guidance of $5.90 to $6.10.

Given that our 2008 results were adversely impacted by the PDP event and not indicative of the strength of our operations, we’re watching the two year compounded annual growth rate as a more relevant measure of how we’re adding shareholder value. Based upon our updated guidance this morning, the two-year CAGR using the midpoint of that guidance is 12%.

In the next few minutes I will offer comments on the specific performance and outlook of our Government and Commercial segments and give you an update on how we’re making measurable progress in reducing costs and improving health outcomes for Medicare Beneficiaries through clinical initiatives associated with our Medicare Advantage offerings. I will also update you on a significant customer service milestone we achieved in the first quarter, the launch of a major Humana initiative in conjunction with 20 members of congress designed to reduce childhood obesity and on the continued development and uptake of Availity our ground breaking provider portal that is fast becoming a national model for IT connectivity in healthcare.

Let’s begin with our government segment. As many of you are aware the Centers for Medicare and Medicaid Services announced the final 2010 Medicare Advantage Rates on April 6, with an effective rate decrease for the sector of 4% to 5%. We will have to address this rate change by increasing member premiums, reducing benefits, or some combination there of, as we file our bids for 2010. At the same time, we will continue to pursue our successful cost reduction and outcomes enhancing strategies, including care coordination and disease management, to help mitigate the adverse effects of this rate reduction on our Medicare Advantage members.

As our 2010 bids are due the first Monday in June, work is already underway to make strategic changes designed to not only keep our plans competitive versus the combination of original Medicare with a Medigap policy, but also to be well positioned against the competition within our sector. With our knowledge of senior consumer behavior, together with our product design and actuarial depth, we believe we can effectively design products that address the shortfall in rates while still providing the solid value proposition for seniors.

Nevertheless, Humana and the industry, in conjunction with congressional leaders, continue to work for further consideration of the DOC fix since we believe the related CMS technical adjustment for 2010 will cause the nations seniors to experience significant disruption to their benefit structures only to have much if not all of that reversed back in 2011.

Specifically, we have been working with a bipartisan group of US senators who recently sent a letter to CMS expressing their concern about the Medicare payment cuts for 2010, along with a letter of concern from their chairman and ranking member of the Senate Finance Committee. Among other reasons the senators are concerned because of the continued inclusion in the rates of a scheduled 21% reduction in what physicians are paid to treat Medicare beneficiaries. As those senators pointed out in their letter, it is very unlikely that congress would ever allow these lower physician payments to take effect. In past years Congress has always enacted a DOC fix and we believe it will again this year.

In fact, the Senates budget resolution includes a provision with the goal of protecting Medicare Advantage enrollees from premium increase in benefit reductions in their Medicare Advantage Plans as a result of CMS not taking into account the likelihood that Congress will address the physician payment formula. If Congress does act to address this issue in a timely fashion, CMS has acknowledged they will work with Congress to consider options for addressing it as part of the 2010 Medicare payment rates.

Additionally, the senators concerns are shared with more than 800,000 Medicare Advantage members who belong to an industry wide grass roots coalition. These seniors are calling, writing, and meeting with members of Congress across the country. They also participated in numerous Medicare Advantage community meetings during the recent congressional recess.

So how might our products look in 2010? While we are still in the midst of our annual market-by-market, product-by-product benefit design review, this Slide gives an indication of what seniors in Des Moines, Iowa, for example, might see if we change only member premiums in 2010. As you look at the value when compared to the purchase of a Medigap policy, is still quite clear.

Turning to Medicare Advantage membership for 2009, we expect the addition of approximately 50,000 net new Medicare Advantage members this year. Sales of our network-based plans continue to be strong, with 61% of our membership now in either PPO or HMO products, including 87,000 of our Private Fee-For-Service members who chose to move into one of those network products for this year. With over 80 % of our Private Fee-For-Service members already in areas served by network products, a percent we expect to increase as we further build out networks, we are well positioned for the changes scheduled for 2011 that will have the effect of triggering the replacement of Private Fee-For-Service products with PPO and HMO network based products for most of the nation.

I said earlier that Humana continues to make progress reducing costs and improving health outcomes for Medicare Advantage beneficiaries. This work has positive implications, not just for our members, but for the Medicare program as a whole. As we’ve pointed out many times, original Medicare, which lacks any sort of cost controls and functions essentially as a claims bank factory, is headed rapidly for insolvency. By contrast, Medicare Advantage features care coordination, case management, disease management, predictive modeling, comprehensive wellness services, transplant coordination, and more, all of which have the measurable effect of lowering costs.

Many in congress understand the capabilities being rolled out through Medicare Advantage are critical to the viability of the program and must be applied to the total Medicare population over time. This roll out is currently being financed through the payment methodology for Medicare Advantage plans. Many know the good work done by MA plans must be fostered by health reform and not lost in a misguided concept of returning to growing reliance on an out of control old Medicare program. We continue to make measurable progress against Humana’s initial goals of having medical costs 15% below traditional Medicare. The next couple of slides illustrate a few of the opportunities.

The positive effects of coordinating care on the cost of inpatient acute admissions, including readmissions, and emergency room visits are graphically shown in this comparison of utilization for original Medicare versus that in our Medicare Advantage plans. Savings of nearly $345.00 per beneficiary on inpatient admissions and $30.00 per member on emergency room visits add up quickly when you’re serving millions of seniors. This translated to savings of $301 million for inpatient acute admissions and $26 million for emergency room visits related to the seniors served by Humana plans.

Another important aspect of our Medicare cost reduction efforts is finding, assessing, and contracting with efficient physicians, thus the cost of physician services in Humana Medicare Advantage plans is driven lower as the network focuses on only the most efficient providers. Importantly, this is accomplished while offering a robust network to our members.

At a time when the new administration will be required very soon to seek a long-term answer to the Medicare funding problem, we’re ready to help with a proven cost and care solution that members love. Satisfaction rates for Medicare Advantage plans are well over 80% with only 1% to 2% of seniors leaving Medicare Advantage to go back to original Medicare. This is further evidence of a value proposition.

We believe that we may also have some opportunity to pick up market share as participants exit the market when the product becomes more operationally challenging for them.

The combination of our Medicare cost management model, administrative productivity, and strong networks position us to have a viable Medicare Advantage offering for many years to come. At the same time, we are also strengthening our Medicare Supplement product portfolio to round out our comprehensive menu of product options for seniors.

Our view of Medicare has not changed, nor have the facts. Healthcare provided through the old Medicare program is wasteful, not coordinated, and unaffordable for many seniors. The Medicare Trust Fund will be insolvent in the not too distant future. We must as a country ensure the long-term viability of the program. Seniors aging into the program seek value and are more accustomed to coordinated care plans. Coordinated care can and does have a positive impact on health and wellness and lowers medical costs. The depth and breadth of our Medicare Operations Team will continue to position us well in this dynamic environment.

Now turning to our other government business, TRICARE, we continue to anticipate that the Department of Defense will make its TRICARE award announcement for the T3 five-year contracts sometime in the second quarter. This announcement would involve all three regions, south where we are the incumbent bidder, as well as the north and west regions. In the interim, as you know, we have signed agreements with the Department of Defense for additional option periods with the first extending through March 2010 and two more six-month extension periods to be exercised at the discretion of the Department of Defense.

Turning to our Commercial segment, we have been closely monitoring the impact the volatile economy is having on our Commercial segment operations. Reductions in force have caused corresponding membership losses in our Small Group business to be substantially higher than we previously expected, even while the employer remains our customer. However, our solid reputation in the Individual business through Humana I is resulting in some of these members who are enrolling in our individual plans. On a full-year basis we expect our Commercial Medical membership to be down $150 to $175, 000 versus the end of 2008, reflecting both the loss of a few larger ASO accounts that we reported last quarter, as well as the impact of in-group attrition I just mentioned.

With investment income also expected to be lower than we previously anticipated, a topic Jim Bloem will discuss in his remarks, we now expect Commercial pre-tax income to be in the range of $225 to $235 million. I do want to note, however, that our 2008 Commercial segment earnings are still anticipated to increase 10% to 15% over the prior year despite lower net investment income for 2009.

Before closing, let me update you on three developments that extend Humana’s industry leadership and service, health and wellness and health IT connectivity. Each gets at the heart of supplying solutions to the biggest health policy problems facing our nation, cost, and the growing numbers of Americans with preventable chronic conditions and the lack of IT connectivity.

First I will discuss customer service. In a recent polling by JD Power, Humana has become the top rated health plan in a number of regions around our geographic footprint. These results are a testament to the growing effectiveness of our company wide Perfect Service initiative which emphasizes engaging our members proactively and seeking to anticipate and then exceed their individual expectations.

Second are Health and Wellness Initiatives around childhood obesity. This fast growing epidemic accounts for $14 billion in direct medical expenses each year. Obesity is one of five preventable, chronic diseases that when taken together consume 70% of the nations healthcare bill. Now we are doing something about it. With the US Capital as a backdrop, the Humana foundation on March 31, held a news conference to launch the American HorsePower Challenge in conjunction with 20 members of Congress, 10 Democrats and 10 Republicans. 2000 elementary and middle school children in districts represented by the congressmen will compete in a unique exercise video game designed to attack the epidemic of childhood obesity. This innovative exergaming approach translates actual physical activity, steps walked, measured by a computerized pedometer into an online race amongst schools in the same congressional district and among the districts. The 20 members of congress are servings as honorary participants in the challenge. Their own steps will be counted in their states or districts total.

In a Louisville, Kentucky pilot program students burned over 470,000 calories and walked nearly 13.5 million steps, the equivalent of approximately 6,400 miles. Some important behavior changes were noted in these students, specifically 62% exercise at lunch, 45% started eating healthier, and 53% exercise with their family. The program is constant with Humana’s long held belief that supplying consumers with actionable information empowers them to take control over their own health. What HorsePower Challenge represents is the convergence of that actionable information gathered in a unique way through technology and the knowledge that kids are big consumers of gaming. The result is a contemporary approach to wellness through measurable behavior change.

Finally, Health Information Technology commonly referred to as HIT. The Obama administration has committed $19 billion in stimulus funds to foster Healthcare IT connectivity demonstrating the importance it places on such initiatives. We are proud to say that our Availity joint venture is playing an increasingly important role, serving as a model for the long-held dream of a robust, nationwide, interoperable Healthcare IT network.

Since it pioneered multi-payer IT connectivity for providers in Florida eight years ago, Availity has expanded its reach and serves more than 50,000 doctor’s offices, 1,000 hospitals, and 1,000 health plans nationwide. Active in all 50 states, Availity has enhanced its capabilities to include the creation of payer based health records and real-time claims adjudication. The Availity venue is now used by all of the major health plans, public and private, for profit and not for profit, with one of our more sizable competitors recently buying into the joint venture that Humana and Blue Cross Blue Shield of Florida began in 2001. The administrative simplicity for the provider community Availity provides is unmatched and we believe will continue to result in higher transaction volume going through this portal.

In addition, Availity was recently selected as a vendor of choice by the Virginia Health Exchange Network, an association of health plans and health systems in that state and Availity is contracted with a Florida agency for Healthcare Administration to implement a new demonstration product that will give physicians and patients access to Medicaid claims based electronic health records as well.

For 2009 Availity is expected to handle more than $600 million transactions or approximately 10% of the total transaction volume in the US. In addition the ongoing expansion of the networks real-time health information exchange now includes e-prescribing in Texas and Florida with more states scheduled to be added later this year.

Why does this matter? For years we’ve discussed with you the power of actionable information at the consumer and provider level. Availity is essentially the real-time highway for the delivery of that information. The result is speed, accuracy, higher quality, and of course, lower cost. That has been the clear impact on the rest of the economy as information technology has spread and will be in healthcare too.

As you can see, Human is active on many fronts and we expect the remainder of 2009 to extend the success we had in the first quarter with our full-year EPS now projected to be in the range of $6.10 to $6.20. Despite the uncertainties of politics and the global economy, we believe Humana is particularly well positioned for success in future years as well. Our direct to consumer approach to sales and our emphasis on the power of the consumer to choose, finance, and use health benefits with confidence positions us well in an economic climate where the impact of rising healthcare costs, reflected in insurance premiums, will grow ever starker.

The flexibility and resiliency we’ve shown over our 48-year history in anticipating and adapting to change now deeply a part of the DNA in both our company leadership and just as importantly our associates is already bearing fruit as we continue to incorporate the adjustments that the future will demand. Consistent with our legacy of successfully transforming our selves through a number of businesses with health always at the center, we are now strategically broadening our scope beyond health benefits. We are supporting the health of individuals and communities. Over the next few years our emphasis increasingly will be on providing opportunities for our members to improve their health in ways that are measurable, that offer rewards, that take advantage of new media tools like exergames and social networks, that help sustain the planet, and are just plain fun. If we can help people get and stay healthy over time, they will save money and the system will prosper. In the meantime, the operational discipline that produced our first quarter results bodes well for our own ability to continue to succeed.

With that, I will turn the call over to Jim Bloem.

Jim Bloem

Thanks Mike and good morning everyone. Let’s begin by recapping our first quarter results. As Mike mentioned we are pleased to report that our earnings per share exceeded the mid-point of our expectations for the first quarter by $0.07. The primary driver was our Medicare operating performance as both the Medicare Advantage and the stand-alone PDP businesses performed very well. As noted in the slide, the quarter also included $0.03 per share of adverse impact from the lower than anticipated investment income due to circumstances I will discuss in a few minutes.

My comments this morning will focus on the three most noteworthy factors impacting both our first quarter results and our increased full year EPS guidance range. These three items are first, better than expected Medicare performance; second, reduced investment income due to lower interest rate expectations; and third, decreased Small Group Commercial membership. I will detail each of these factors in the next several slides, but first let’s look at our full year anticipated earnings per share.

As Mike mentioned, we are pleased to raise our 2009 EPS guidance from a range of $5.90 to $6.10 to a range of $6.10 to $6.20, an increase of $0.15 using the mid points. The following three factors enable us to confidently raise our full year EPS guidance:

First, the primary reason is our improved outlook which builds on our improved outlook for Medicare, which builds on our first quarter Medicare performance. That’s reflected in both higher than previously expected revenues per member and lower than expected benefit expenses.

Second, slightly offsetting the full year Medicare improvement is a projected decrease in Commercial Small Group membership as the year progresses.

Third, we also now anticipate our full year 2009 investment income will be lower than our previous guidance by $55 million or $0.20 per share.

Let’s review each of these changes and expectations in greater detail starting with the changes to our Medicare forecast.

This morning we lowered our expected 2009 overall benefit ratio by about 75 basis points at the mid points. That ratio is now expected to be in the range of 82.5% to 83.5%. As I mentioned, we are seeing improvements in both the benefit expense and the premium components of the overall benefit ratio for Medicare. Changes in the benefit expense expectations primarily relate to the stand-alone PDP expenses, while changes in our premium expectations primarily relate to Medicare Advantage.

As we continually have monitored our PDP claims expenses we have been pleased to note that each of our three plans has performed better than expected with the Standard Plan doing particularly well. Higher uses of generics across all three plans have helped drive these lower than forecasted expenses.

Now with respect to Medicare Advantage premiums, much of the improvement stems from higher risk adjusted premiums. In last quarters call we mentioned that the risk scores of the members that we acquired for 2009 were not significantly different than those for 2008. That fact has not changed, rather though, the primary driver of changes in risk scores is an improvement in provider documentation for those Medicare Advantage members that we have had over a longer period of time. Note, that the longer the members tenure with us, the more likely it is that the risk score accurately reflects the members health status.

CMS used March as one of its two cut-off months for analyzing member risk score data to adjust planned premiums later in the year. Accordingly, we also update our risk adjustment premium accrual analyses using the provider data submitted to CMS by the cut-off date. Based on that work, we adjusted our risk adjustment premium accruals to ensure that revenue was recorded properly. Consequently, our first quarter results include these updated accruals, as does our forecast for the remainder of 2009.

Turning next to the Commercial segment, this morning we lowered our full year commercial pre-tax income guidance by approximately $50 million. As shown on the slide, about $35 million or 70% of this reduction consists of our lowered outlook for investment income, which I will detail in a moment. The other issue impacting the commercial business is our revised outlook for Small Group membership, which we now see as declining by 90,000 to 110,000 members by the end of this year. As Mike mentioned, it has become clear that the prolonged recession is having a more significant adverse impact on smaller employers than we previously estimated. Virtually all of the $15 million detailed on the operations line on the slide can be attributed to lower expected Small Group membership.

Finally, our secular trend components, which as usual are detailed in this morning’s press release, continue to track with our expectations. In the aggregate, we expect secular trends of 6% to 7%, however, if you include the impact of benefit buy downs, growth in high deductible health plans, the migration of groups to more cost effective networks, and other business mix changes, the trend decreases by another 3%, resulting in net trends of 3% to 4%, which are in line with those we shared with you in last quarters call and release.

Now, with respect to investment income, the first quarter investment income was $69.5 million versus $90 million in the first quarter of 2008. That is a decrease of $20.5 million or 22.8%. Despite our roughly $750 million or 10.7% year-over-year increase in the average invested balance, we continue to struggle with investment returns for the following three reasons: First, continued extremely low cash and cash equivalent yields; second, a relative scarcity of fixed income investments, which meet our investment criteria. This results in a greater than desired portion of our average invested balance remaining in cash and cash equivalents. Third, the Federal Reserve’s March 18 announced commitment to purchase $1.1 trillion 150 million dollars of US government securities with maturities of between two and ten years by the end of September.

It’s important to note that each of these reasons reflects a lower general level of interest rates rather than any specific credit issues. The first two reasons caused our first quarter investment income to be $8 million or $0.03 per share, less than we expected 90 days ago with an additional $11 million or $0.04 per share reduction expected over the remaining nine months of this year.

The third reason, which is termed by the Fed as quantitative easing is expected to lower our investment by an additional $36 million or $0.13 per share over the last three quarters of the year. As a result the yields on the two to ten portion of the yield curve have tightened up by 50 to 60 basis points. Accordingly, today we have reduced our 2009 investment income guidance range by a total of $55 million or $0.20 per share to $270 million to $290 million.

Our $7.4 billion investment portfolio continues to benefit from broad diversification and appropriate duration, ample liquidity, and high credit quality. At March 31 we had approximately $230 million of net unrealized losses on investments, which is the same amount we had at December 31. As of April 23 our total net unrealized loss is decreased to approximately $165 million. The $65 million or 28% improvement over March 31 reflects, among other things, the Fed’s quantitative easing that I mentioned a few minutes ago.

Now as was the case in the last two quarters, you can get further detail on our portfolio composition from the statistical pages of this morning’s press release.

Turning to the balance sheet, our days in claims payable declined 4.8 days when compared to the fourth quarter of last year. This slide, which is again taken from the statistical pages of this morning’s press release, highlights the key items which impact the change and compares them with the first quarter of 2008. In short, none of the decline was indicative of reserve releases or any changes in our consistent reserving practices.

A summary of the major components of the decline are as follows: 1.9 days of the 4.8 days relate to timing, specifically the cut off for our pharmacy payment and process claims out the door. Second, another 0.7 days relates to the faster processing of claims inventory. Note that our days claims on hand were 4.2 at the end of the quarter, a near record low, and that reduction in days claims on hand was accomplished even while we continue to add more membership volume to our core Medicare processing platform, along with rolling the Medicare and Order of St Francis Medical membership acquired in 2008 to our core platform on January 1st.

Finally, another two days was the result in the expense component of the days in claims table computations while the liability itself remained flat. This mismatch occurred twice in the first quarter days in claims payable computation. The first of these expenses versus liability mismatches occurs annually for the Part D component of our MAPD benefit. Since Part D deductibles reset on January 1st and are front-end loaded in terms of the plans responsibility, the first quarter expense is higher than the fourth quarter’s expense.

You will note that we also experienced this same affect in days in claims payable in the first quarter of 2008 and as well, in the first quarter of 2007. In the first quarter of 2009 this resulted in a sequential decline in days in claims payable of 1.1 of those two days, of those last two days I just mentioned.

A second expense versus liability mismatch in the first quarter days in claims payable computation occurred this quarter in connection with our Cariten acquisition. The expenses associated with Cariten members increased simply due to the timing of the acquisition, which was on November 1 of 2008. This timing resulted in only two months of expense in the fourth quarter while a full three months was, of course, in the first quarter of ‘09. That resulted in a sequential decline in days of claims payable of 0.9 days. The remaining 0.2 days of the decline reflects normal fluctuation in the days in claims payable metric. Again, we remain comfortable that our reserve levels are conservative and appropriate.

Turning last to capital and liquidity, as demonstrated by the following 4 points, we continue to both have and prudently conserve ample capital and liquidity in these continuing uncertain times.

First, we are reaffirming our 2009 cash flows from operations guidance range of $1.2 billion to $1.4 billion. The primary driver for the full year increase over 2008 is the expected increase in 2009 net income. As was the case in 2008, we expect most of the total 2009 operating cash flows to occur in the second half of the year.

Second, we continue to retain $750 million of availability under our $1 billion revolving bank credit agreement. Our bank credit facility remains effective until July 2011, after which the earliest issue of our senior notes matures in June of 2016.

Third, our March 31, 2009 debt to total capitalization ratio was 29.3% and our target range remains in the 25% to 30% range.

Finally, we continue to carry significant levels of aggregate excess statutory capital in surplus in our state regulated operating subsidiaries. We are pleased to note that last week all of our parent and subsidiary credit ratings were affirmed with a stable outlook by Standard & Poor’s. Our parent company rating is BBB.

Our continued expectation is that we will be able to a dividend at least $500 million from the subsidiaries to the parent in 2009 versus the $296 million that we dividended in 2008. In addition, we expect capital contributions to the operating subsidiaries to be less than the $243 million that we contributed in 2008.

As usual, we will update these amounts with our second quarter earnings conference call in early August, after our discussions with the respective State Departments of Insurance and all the credit rating agencies are completed.

To conclude, we are very pleased with our first quarter performance and the resulting increase in our full year earnings per share guidance of $6.10 to $6.20. We continue to build on our organizational experience and new processes to improve the operating performance of both our business segments. As we move toward mid-year 2009 the operating discipline and financial strength of Humana have never been greater.

With that, we will open the phone lines for questions. We request that each caller ask only two questions in fairness to those still waiting in the queue. Operator will you please introduce the first caller.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Tom Carroll with Stifel Nicolaus Capital Markets.

Tom Carroll - Stifel Nicolaus Capital Markets

I have a two-part question on Medicare as it relates to your Private Fee-For-Service to network product transition. First, Private Fee declines have been fully offset by increases in network products. Is there any correlation between your current Private Fee-For-Service enrollments switching over to, so Humana Private Fee to a Humana PPO type product? Can you give us some kind of metric on that?

Secondly, how do you think about this transition in 2010? Then maybe you could give us some high level commentary on 2011 also. So, is there going to be a big push to make the transition in 2010, or is that going to be left really more to 2011?

Jim Murray

The net plan-to-plan changes that we experienced this past open enrollment period were around 87,000 members. We purposely try to create a product continuum that encourages folks to go from the Private Fee-For-Service to the network based options, be it regional PPO, local PPO, or HMOs. We saw some good movement this past open enrollment period and we anticipate we’ll see increasing levels of movement in 2010 and 2011. We feel very well positioned for the CMS rule regarding the elimination of the Private Fee-For-Service on January 1 and we’re very pleased with how this is all beginning to set up for us.

Tom Carroll - Stifel Nicolaus Capital Markets

So increasing levels in 2010, maybe it is too early to say right now in terms of your strategy, in terms of bidding for next year, but is it going to be more so in 2010 than 2011?

Jim Murray

I would anticipate that 2010 would be slightly higher than 2011. 2011, as I sit here now, we are obviously in the process of going through the market-by-market evaluation of what your benefits and premiums are going to look like. My goal and our goal will be to try to get as much done in 2010 as possible with 2011 being the finalization of that process. Again, we saw some nice movement this past open enrollment period and as we create our product continuums market-by-market that will be a major goal.

Tom Carroll - Stifel Nicolaus Capital Markets

That’s very helpful, thank you.

Operator

Your next question comes from Charles Boorady with Citi Investment Research.

Charles Boorady - Citi Investment Research

I am wondering how much of the impact in your Medicare Advantage loss ratio expected improvement this year is coming from the revenue benefit of the risk score issue that you discussed versus an improvement in underlying cost trends or other factors?

Mike McCallister

Charles, I mentioned two things, I mentioned the PDP and that was lowering benefit expenses and of course, your question again suggesting the Medicare risk adjustment. The two things together were probably about $0.10 in the first quarter and they’re about a 3:2 ratio, so again, we kind of expect that to play out through the year.

Charles Boorady - Citi Investment Research

Okay and again, you underlying cost trend assumptions though, are they unchanged versus what you thought when you [interposing].

Mike McCallister

Yes.

Charles Boorady - Citi Investment Research

Okay, I have it. Then in terms of looking out to 2010, you mentioned the 4% to 5% cut that you hope to have mitigated, but assuming it goes through, if we were to assume it goes through and trying to assess what the impact will be in 2010, do you have any information that you can share with us to help us make our own estimates of what the impact would be? For example, maybe the sensitivity of your MA demand growth this year in light of your imposing new member paid premiums this year, how sticky the enrollment was and whether that is an experience that you can look at to assess the expected enrollment impact in 2010, presuming you have to put through additional member increases or cut benefits then?

Jim Murray

As I mentioned to the earlier questioner, we’re in the process of going market-by-market evaluating benefit designs and premiums that we’ll likely put into place. There is a benefit cut level that we’re trying to align around and trying to evaluate how many members we would likely have moving back into the Medicare program or perhaps to competitors. We feel very confident that the offerings that we’ve evaluated so far are going to be competitive and they are going to provide the members with a substantial value proposition. So, we’re not prepared right now, obviously, because we are bidding against ourselves, if you will. We’ll know more in October when we see what some of our competitors do, but we’re cautiously optimistic that when we get done our benefit plans are going to be very, very competitive and we feel, again, cautiously optimistic that next year we’ll see some growth.

Charles Boorady - Citi Investment Research

You imposed first time premium this year and seem to hang on to a preponderance of your lives. Do you have any data on people who might have left because of the premium you imposed versus the percent you kept?

Jim Murray

Help me understand what you are specifically looking for.

Charles Boorady - Citi Investment Research

Essentially, how do members respond when you impose a monthly premium on them.

Jim Murray

The membership, we broke it into the different premium increases and we saw a persistency issue at some level of premium increase. We believe that there is a premium level that people begin to evaluate their choices and that’s one of the reasons that I mentioned earlier. We are going to look at that particular premium level and evaluate what we want to do with benefit cuts and premium increases, given what we saw last year about that specific premium level where again, it looks like people look around a little bit more than other increases.

Mike McCallister

Let me add to that. There are some things we did learn relative to premiums and what we do know is that we can sell a product with a premium to seniors with our distribution capability, because there is a value proposition there that they can sell. What we had happen, as you know, is we had people out there with zero premium products. We sold a lot. We had some churn because of the zero premium competitors and we don’t know what people are going to do next year, but I would find it incredible that anyone would be out there with a zero premium product in 2010. So, we are going to be premium against premium here as opposed to the stark reality of a premium versus nothing. I think overall we have to feel pretty good about where this is going to come out.

Regina Nethery

We are going to need to move on. We have a number of people in the queue.

Operator

Your next question comes from Joshua Raskin with Barclays Capital.

Joshua Raskin - Barclays Capital

My first question, Mike you have talked for years, and year, and years about a targeted 5% overall Medicare margin. Obviously things are going slightly better than that, so I am curious as you think about 2010; one of the components you are not talking about in terms of changes would be potential margin change i.e. getting back to that 5%. I am just curious if that is in the plan as well.

Then, Jim, the favorable development, obviously a big number $169 million, but it was actually down a little bit on a year-over-year basis. Based on what was recognized last year in the first quarter I would have thought it might have been up this year. Is there anything in the favorable developments that could spike up?

Jim Bloem

Again, we used our same conservative reserving methodology that we always use. Again, it is based on all the actuarial information that we have. We continue to think that people over think this, so we give them all of the information that is in the press release regarding how it works and you’ve picked up on the piece of development to date. I would go back and say that we’ve, again, booked to a constant level of margin. We continue that margin. So, again, we feel very good about our reserves and we look at it. By the time we get to the end of the year, again, there has been a lot of consistency in the last couple years and I think we’ll see that again this year.

Jim Murray

To your first question the goal we have each and every year is to increase our profitability year-over-year so as we’re evaluating on a market-by-market basis we’re trying to determine what we think the competitive landscape looks like market-by-market and making decisions around a specific market level contract level plans that we have in some of those that it makes sense, perhaps to attempt to grow membership in others it looks like it’s more appropriate to maintain the higher margins and so when we put all of that together the end goal for us as a company is to make more money year-over-year as you might expect. So, it is a very, very evolving process and we feel very good about where we sit right now.

Jim Bloem

I will just add to that Josh. I have said 5% for a long time and that is still where we work. I mean we go into this whole process every year with the idea that for our entire Medicare book of business we think about 5% is where it ought to be. Now there are a lot of moving parts associated with that. We have to look at the total company, as Jim said, it is a huge variation based on location and geography and where we think we are relative to medical cost management and a lot of different things. I think generally we are staying in that range and it has been a little higher, it has been a little lower. Last year it was a little lower, right now it is a little higher, but we always go into it with 5% in mind.

Mike McCallister

That is important to note, we struggled to make 4% least year.

Joshua Raskin - Barclays Capital

Right, fair enough. I guess I was just asking, you guys have a little bit extra margin. You have already added premiums. You seem, relative to your competitors, probably in better shape for next year, so I was just curious if the goal was to maintain that membership or is this goal, as Jim Murray just talked about, of just increasing the profits every year?

Jim Murray

The goal is to increase profits year-over-year and as you might expect a 1% margin change up or down had some pretty significant implications on the number of members you have to gain, so we evaluate that pretty in depth and again, lots of moving parts, but again, as we sit here right now, we feel cautiously optimistic about how things are playing out so far.

Jim Bloem

The percentage margin is one thing, but the dollar margin, as Jim says, the dollars that we earn, that’s the part we’re trying to move up. The 5% is a year-over-year long-term moving average.

Operator

Your next question comes from Matthew Borsch with Goldman Sachs.

Matthew Borsch - Goldman Sachs

I have a question about the potential expected fix to the physician SGR. What do you think about the time frame in terms of when that would need to get done in order to still be able to roll through something to the 2010 rate potentially? Is there a time frame that you think this has to get done by?

Jim Murray

We’ve provide Mike and Heidi Margulis, our Senior VP of Government Relations some dates that would make the most sense. We would love to see something done before the CMS finalization of rates in August. If it happens later than that, we will obviously stand ready to do whatever it takes. That fix is worth $25.00 of benefits and premiums and from my point of view it saves some significant disruption in the senior population and it is something that a lot of people in Washington ought to be focusing on. So, we will do whatever it takes to get it in time and we would ask that the folks in Washington feel the same.

Mike McCallister

We’ve put a lot of energy as we’ve gone through building out each of these benefit and premium proposals and there are thousands of them that have to go in and prepared ourselves for scenarios around what would happen if we get a late change to this so that we could quickly react. So, we are prepared. Congress will do what it’s going to do and we can’t drive the timeline. We’ll have to see how that plays out. I know there is significant pressure out there to get something done about this, because it is kind of an outrageous concept that we’re going to put the seniors though all this, this next year and then turn around and reverse it by formula in the following years. So it is kind of an awful lot of wasted energy.

Matthew Borsch - Goldman Sachs

If I could just ask on your slide presentation you showed on page 7, you showed the PPO product compared to Med Supp plan with stand alone PDP. Is that sort of what is never going to be completely apples-to-apples, but is that pretty close? In other words that sort of implies that the product is providing effectively about $60.00 a month in additional value, if I’m reading this correctly. Would that be inclusive of the 4% to 5% rate cut that’s on the books for now?

Mike McCallister

Yes, the answer to all of your questions is yes.

Matthew Borsch - Goldman Sachs

Okay. All right, I’m good for now, thank you.

Jim Murray

And remember that is the PPO. The HMO, obviously, has significantly more value than that.

Operator

Your next question comes from Justin Lake with UBS Investment Research.

Justin Lake - UBS Investment Research

You gave us some color around the PMPM Medicare Advantage premiums that you reported. Can you give us just a little more color on the break down? It was up 10% year-over-year; that is a big number. I am just curious how much of that is 1x catch up on those risk adjusters versus what we can expect to continue as the year-over-year increase in yields going forward.

Jim Bloem

Actually it is very little. You are right that the Medicare per member per month Medicare Advantage premium is up 10%, but that is driven by a lot of factors, and the one that I mentioned that changed the guidance was a very small change. Here are the kinds of things, and I am sure you know a lot of these, but if you think about us they particularly apply. First of all you have the base rate that you get from CMS. Then, as we have talked about, we are one of the few companies that added a premium this year for 2009, so that increased it. Then we did a number of acquisitions in the last three quarters of 2008 gave us a lot more members. Then we also got a mix of business issues, again, we’ve got HMOs, Private Fee-For-Service, PPOs and then the geography of where things are changed and then finally the demographic mix, the age, the gender of our members etc. So all of those things go into that 9.9 increase for the premium per member per month and the amount that made the guidance change, again the guidance went up $0.15 and as I said that has the investment income reduction and the commercial reduction in Small Group membership, but again it just takes a very small change in that MRA thing to produce the change we did today.

Justin Lake - UBS Investment Research

My second question, I just want to follow up on Josh’s question on the 5% target. Mike, specifically, you went through a lot of time last year on the first quarter call going through the steps you were taking to get the 4% margin back to 5%. When we fast-forward to 2010, are you going to be talking to us about getting 6% back to 5% and what you’ll be doing there? Then to take that a step further, if we don’t get a change in these rates, is there any possibility that Humana would be willing to accept lower than even that 5% margin target for 2010 in order to maximize their benefit designs with the expectation that rates will bounce back in 2011 and you will kind of smooth it out?

Mike McCallister

First of all, let me tell you how we think about this. You are going to start with the entire company and we ask ourselves what can all of our product lines produce; where are our earnings, what do we think is a reasonable growth potential off of those earnings; then we start looking at all of our products, including in this case Medicare, to continue to try to find a way to continue to grow the company. None of these things are etched in stone. If I could find a way to significantly grow earnings on the back of a 3% margin would I do it, of course I would. So it is all about working with a number of moving pieces. We generally shoot at this 5% number for Medicare, because it has been fitting how it works our company for a while, and as we get further into the year we will think about that. As we know more where we’re going to stand against competitors, as we see what we think we can do with all of these various proposals and bids, all of that is going to come together. We intend to grow earnings next year; whether it is going to be 5% or 5.5% or 4.8%, at this point it is too early to say.

Justin Lake - UBS Investment Research

Great, thanks for the color.

Operator

Your next question comes from Greg Nersessian with Credit Suisse.

Greg Nersessian - Credit Suisse

My question is on the commercial business. Last quarter you pretty much brushed off the potential impact of the slowing economy on your Commercial Group membership and obviously you have changed your view on that point. So, I was wondering what specifically did you see change, since you reported the fourth quarter numbers, that has caused you to change that view.

Then if you could help us understand as to how the seasonality might change this year in your high-deductible health plan products from the impact of the slowing economy.

Jim Murray

I was the person who brushed it off, as you so aptly put it and I own that, so. Here is what happened from the time we talked last until today. We did a number of things. One of the things I talked with you about last time we spoke was that we were going to increase our pricing on our, particularly our Small Group business and we did that. That was one thing that went into the membership issue.

Another thing that we did was we chose for the Small Group is made up of 2 to 25, 26 to 50, and 51 to 99 case sizes. For the 51 to 99 we weren’t pleased with where our medical expense ratios were running and so we change our underwriting approach from an employer question approach to an employee question approach. We tried to understand more about the particular pieces of risk in those groups that we were looking at, and that went over well in probably 60% of our markets. In 40% of our markets the competitors didn’t follow suit and so that caused a little disruption, more so than we had anticipated.

Finally, when we last talked we have a thing here called Other Group Movement, which is the net, net effect of lay-offs and individuals deciding to drop coverage. For all of 2008 that Other Group Movement for the Small Group block was averaging around 1,500 to 2,000 members for month. When January hit the number was closer to 6,000. We thought okay, January has a little bit higher enrollment activity than other months. Unfortunately for us that stayed at around 5,000 to 6,000 in February and March.

All of those three pieces added together caused the change in the way that I looked at our Commercial membership. We’re obviously identifying a number of fixes to get after. Specifically it’s a Small Group issue. We did talk about some ASO cases that left us and that was okay, because some of what happened there was competitive situations that we weren’t willing to accept. So, we have some things that we’re doing on the Small Groups side to get after it.

Around new products, we have our new consumerism products in the second half of the year that we’re going to roll out. When we roll out products we do market visits and we will, we call them road shows, so that we will get in front of a lot of brokers. We are going to expand some of our value propositions. Some of our, what we call, under writing days, where we have under writers meet face to face with brokers. We are doing some things around bonus programs.

So, we anticipate that towards the tail end of the year that the Small Group losses that I just referenced will start to mitigate, but we’ve tried to be conservative with our reductions.

As it relates to the question that you asked regarding the high-deductible health plans, we saw some benefit for that in the first quarter and we’ll likely see some negative in the fourth quarter. But overall, some of the pricing that we did, that I referenced at the beginning of my response, is driving the improvement in the medical expense ratio for the overall commercial block up 100 basis points or perhaps even a little bit more so. We are pleased with the way that the commercial profitability is starting to be positioned for the year, and this Small Group enrollment issue is something that, as you might expect, has my attention.

So, sorry that we weren’t as on top of this as we should have been when we had our last call, but we are all over it now.

Greg Nersessian - Credit Suisse

Great, thank you very much.

Operator

Your next question comes from Christine Arnold with Cowen & Co.

Christine Arnold - Cowen & Co.

In regards to Medicare Advantage, could you give us a sense for the churn that you ultimately saw in the first quarter kind of gross adds, gross losses? Then how much of that increase PMPM of, I think you said 9.9%, was going to risk adjusters that you either have received first quarter or expect to receive later in the year? Finally, can you talk about the loss ratio? Given the churn, how confident are you that you’re seeing the underlying trends and what kind of metrics do you look at there?

Jim Bloem

Let me start with the last two. We are very confident that, we continue to watch weekly and daily the trends and everything, so we know that the expenses that we’re booking are the expenses that are actually being incurred.

As far as how much of how much of the 9.9 is risk adjustor, again it is not a very large amount, because think about what I said before. We introduced a member premium. We’ve got the base rate from CMS. We’ve got the acquisitions that we did and then everything else it really goes in terms of the lines of businesses, how we expand the network product over the Private Fee-For-Service, so not a very big number.

Mike McCallister

I have a couple of follow-ups to your questions. On a gross basis our sales were $367,000 which includes about $114,000 of plan-to-plan changes; so net MAPD sales were around $254,000. Our market pool agency had an absolutely incredible year and we appreciate all the good work that they do. One of the things that I would follow up with, some of Jim’s remarks that as he said in his remarks, are the risk scores for the new members that we’ve got were very similar to the risk members that we got last year and the risk members that we got the year before that. The improved risk scores are for our persisting members where we are getting paid the amount that we should be based upon the risk that we’re assuming. So, this isn’t an issue about any kind of surprises in the new membership that we received.

The increase here is a function of the documentation and again, being paid for the risks that we’re assuming. And, as you might expect, lots of metrics around here at Humana. We look at claims almost on a daily basis. Particularly the drug claims and we are very pleased with what we are seeing not only in the PDP, but also the MAPD claims.

Christine Arnold - Cowen & Co.

Okay, my final question is on cash deployment. Why so little repurchase with all this cash and the shares where they are?

Jim Bloem

We have adopted a philosophy for the last year now, really, since the recession began 15, 26 months ago, that we are going to prudently have a bias towards conserving cash, just because again, as we said, look at investment income, the ability to issue debt, things like that. We’ve got a very solid financial position, as I mentioned. Our credit facility doesn’t expire until 2011 and the first of our senior notes not until 2016. But, we are being very cautious about the use of cash right now, even though you are right, it would be wildly accretive to do. It is still a matter of a lot of companies that have done that, not in our sector necessarily, but everywhere that have used up their cash have sort of regretted doing it; so we would like to see further evidence of stability in the credit markets and in the cash markets, for that matter, before we continue repurchasing.

Christine Arnold - Cowen & Co.

Thank you.

Operator

Your next question comes from Scott Fidel of Deutsche Bank.

Scott Fidel - Deutsche Bank

Can you give us your initial impressions on this new swine flu outbreak and do you know if any of the initial 20 cases in the US have been Humana members? Can you give us a sense of what type of impact on this could have on the business if it continues to spread around the US?

Jim Murray

I read about the swine flu over the weekend for the very first time and we’ve got a lot of folks who are looking through to assess the issues, but frankly, it is early in the process.

Mike McCallister

I would say there is homework that gets done around subjects like this, whether it be this one or any other pandemic kind of issue out there and in fact natural disasters. So, it is not like we have never thought about this. We have folks who have spent a lot of time with plans and preparations for these kinds of things, but it is way to early to have any idea whether this is going to have any impact on us or any of our members.

Scott Fidel - Deutsche Bank

Then a follow up on health reform and maybe now with it looking like there will be a reconciliation provision included. I would like your thoughts around timing, will it potentially not be until Fall now, so we really have a good sense of this. Then I would like your updated, what you are hearing just the conversation around the public plan and how that could be framed and the chance of that actually coming out including something like Medicare rates as compared to it being based more on commercial competition.

Mike McCallister

It is a little hard to say at this point. Even though you are starting to see a little more clarity about what people are thinking the process might look like, I would say that the devil is still going to be in the details around all of this. I will tell you that the public plan option, which is nothing but a government run health plan is a real lightening rod and could disrupt everything, so it will be interesting to see how committed some folks are to such an idea.

Our industry has done a nice job of preparing for this both from the standpoint of having really positive, solid policy positions that we put forward that are really structurally different. It is surprising to some folks up there. We will see. We have a good grass roots capability that will be applied when and if and where necessary. So, I think we are prepared to argue the points and the policies as well as play the politics if it is necessary to get to the right place. But, I think there is a lot of time left here before we have anything to really work with.

Operator

Your next question comes from John Rex with JP Morgan.

John Rex - JP Morgan

Just back a minute towards thinking of managing through 2010 and assuming that we don’t get any benefit from the physician fee fix and the rest. I mean how willing are you to be the smoother for the senior as you go from 2010, 2011. So, think of the business kind of over that two-year cycle. And, you kept saying if we could take lower margins a long with the net earnings growth, but I guess coming back to more, would you be willing to take no earnings growth to be that smooth, as long as you could see your way to the fact that in 2011 this gets fixed and gets back into the rates?

Mike McCallister

Well what we can never count on is a long-term thing, from the standpoint of the political side of this. That idea is clearly one that’s on the table. We look at that sort of thing all the time and I think we owe it to ourselves to do that. Because, we have said all along we plan on being on Medicare over the long term. We think it is a long - term business opportunity even with some of the clouds that are out there. So yes, we have to think about that, but I would also say that there is no guarantee that it would go the other way in 2011, because someone may step in and intervene in that formulary process.

So the formula would say it comes back in 2011, but one of the real judgment calls is whether you trust it will actually happen or not. So, these are all what we get paid to think about and try to make decisions around and I can tell you our bias going in is we anticipate growing the companies earnings every single year. As like in 2010, we plan to do it again. So we will have to work through it.

Quickly, to throw in, there are other lines of business that are a part of our ability to make money. So, those are parts of the levers that we constantly evaluate. It isn’t just MA that we do here, as you know.

John Rex - JP Morgan

But, do you think it is completely unfeasible? So, say you got there and you had confidence on the 2011, it’s coming back: is it completely unfeasible to think about 2010 as being a flat to modestly down earnings year?

Mike McCallister

It is way too early, I think, to talk about that. I mean, again, the principles we operate around here is early earnings, we still have that as our bias. We have work to do on all this Medicare bit work. We have to see what our competitors have done in October, before we will even have a good yield, no matter which way we go. So we are always in this cherry because of the way this business, Medicare Advantage business, has been and the timing around it.

You know, we put our cards on the table and we don’t know how they’re going to play until we turn them all over in October and then we have a really good view of the following year. Generally we have done a pretty good job of being able to look at that point forward and have a pretty good view of it. So, I don’t see anything different at this point.

John Rex - JP Morgan

Okay, but you wouldn’t dismiss it out of hand. That is a possibility at least.

Mike McCallister

Well, I mean we have an obligation to think about what’s best for the company long term and clearly that could be one of the decisions, but I’m not here to tell you that it is. We would be irresponsible, I think, not to think past just one year.

John Rex - JP Morgan

Right sure and can you just remind us in the longer-term, again. When you look at a Medicare member, what kind of a differential do you think you have to have longer term? What kind of differential does a senior need to perceive in terms of value in MA versus being in the traditional plan? Also, how much extra benefit do you think is the break point to get, especially to get new seniors to enroll in MA? Is it 10% do you think roughly when you look at your membership and success there?

Mike McCallister

I think that is a function. We know the seniors fall into various segments. Some are going to be motivated by a different inflection point around that than others are, so there is no single way to think about that. Some are more focused on benefits versus premiums. I think it is overly simplistic to think of this as a homogenous crowd, because they are not.

We put a lot of work into trying to find out where those inflection points are among the various segments to try to get the right balance between premiums and benefits to appeal to as broad a population as we possible can. Because, we think we can meet all of them at some point in some product array. So, there is no single way to think about that.

John Rex - JP Morgan

I guess I was thinking when you think about their all end costs and traditional versus regular. Do you assume that seniors would still enroll if you couldn’t score any kind of cost save between MA and Private Medicare?

Mike McCallister

Well if it was a perfectly flat environment we would have a less compelling of a value proposition, but we do have some things just beyond the benefits. I mean we have the simplicity of having a single insurer with an umbrella coverage that covers everything from Part A, Part B, C and D. All of that is valuable. We have better information flows than a traditional line up of Medigap. I mean if any of you had parents that are sick and you have all of these separated plans, it is a nightmare just to do the paperwork. So the value proposition goes beyond just the benefits and the premium, but those are obviously the most powerful ones.

John Rex - JP Morgan

Great, thank you.

Operator

Your next question comes from Carl McDonald with Oppenheimer & Co. Inc.

Carl McDonald - Oppenheimer & Co. Inc.

Assuming status quo on the Medicare rates for 2010, do you anticipate from an industry perspective enrollment will be flat, up, or down relative to the million plus lives that have been added the past couple of years?

Jim Murray

Based upon where everything is being discussed now, I would anticipate that there would continue to be some growth. As we talked earlier, when you array us and our products against a traditional program and a Medigap policy to go with that, and a PDP product to go on top of that, the value proposition is there for the seniors and I think seniors are beginning to increasingly understand that. I think the $10 million that we talked about the last time we were together in New York is now driving closer to 11 million folks who are in an MA program. So, I continue to believe that there is value there for the seniors and it is a part of us and the rest of the competitors in the industry to share with folks.

This discussion has been all about premium levels. There are other value propositions that come with Humana and so that is one of the things that we constantly focus on is those other value propositions, rather than getting into a conversation around commoditization.

Mike McCallister

I would comment further. I was looking at a schedule the other day that outlined the market share of Medigap versus Medicare Advantage over the last few years. Medicare Advantage has really been capturing market share from Medigap markets. One of the reasons we teased out this Des Moines comparison this morning, is because that is one of the primary competitors to Medicare Advantage and you can see that even with what happens in 2010 in that particular market, and even if you put all of that new issue into premium you are still way below Medigap in terms of premium. So there is a long way to run before Medicare Advantage is not competitive against the Medigap, because you have to remember Medigap keeps going up as well.

Jim Bloem

And Carl, also the ageing are very familiar with managed care type products as opposed to the old indemnity products. So, as 2.7, 2.8 members come in next year age into being 65, that also helps.

Jim Murray

One more thing, not only to address this most recent question, but also to address some of those that we got before. Mike showed a slide, I believe, that demonstrates what we’re focusing on, on the 15% solution. Nobody has talked or asked about that and that is a big part of how we think about this and the ability over the next couple of years to drive to that 15% solutions. We’ve got 500 contractors through out the United States who are putting networks together that have a significant amount of savings associated with them. We’ve been spending significantly around some of the things that are shown on that slide around disease management programs, behavioral linkages with medical nurses in particular markets. All of those things are beginning to come together and we’re really seeing some increasing opportunities on that 15% solution. So that has got to be a part of this whole thinking. It isn’t just about this negative 5% decrease. It is about what are we doing in addition to that to get after the whole value prop.

Carl McDonald - Oppenheimer & Co. Inc

Okay, thank you.

Operator

Your next question comes from Peter Costa with FTN Equity Capital Markets Corp.

Peter Costa - FTN Equity Capital Markets Corp.

Can you give us an idea of what your days claims payables is going to do going forward? The last few years it has risen through the year. Do you expect that to continue, if you look at your explanations for the decline this quarter, you’d think it could go up at least a couple of days. Is that the right way to think about it, or how should I be looking at that?

Jim Bloem

Somewhere in between those two, because again, if you think about the reasons that we enumerated to give that it came down, those are all really good reasons in terms of operation. We paid claims faster, we do those things and receipt cycle time is less. We’re working very hard to continue to put in those operational improvements that get people paid accurately and quickly. Again, I would say somewhere in between.

We still, again, are very pleased. What we try to do is not really drive for a day figure, but just do the best we can operationally and then see where it comes out and then tell you why it is different than last time.

Peter Costa - FTN Equity Capital Markets Corp.

Okay and then back to the swine flu question. What sort of things do you think you’re going to be doing in terms of monitoring and how fast will you know whether people are prophylactically prescribing things like Tamiflu and Relenza, an things like that?

Jim Murray

We were talking about it before the call and I’m sure I’m going to get an update from the folks who are evaluating just exactly what we’re seeing in that regard. Until I get an opportunity to get off of this call and go and talk with those folks I really can’t update you. But, if we see anything that is significant, we will obviously advise accordingly.

Mike McCallister

Obviously we have good visibility into prescriptions for such things as that. We will know pretty quickly.

Peter Costa - FTN Equity Capital Markets Corp.

Okay, thanks.

Operator

Your next question comes from Ana Gupte with Bernstein Research.

Ana Gupte - Bernstein Research

I have two specific questions related to reform. The first one is around the Medicare provider payment reform debate that is ongoing in Congress. Also, could you elaborate on how you as a leading Medicare plan are participating, if you are, in that debate, particularly around the advance medical homes raising, PCP pricing and the expense of specialists and do you see that changing the distribution of your HMO and PPO offering or any benefit to that 15% or long-term trend moderation solution?

Mike McCallister

I guess I would say that those are all fine ideas they’re pursuing. I would be somewhat doubtful about the ability to execute on those in any kind of a way that would have a material impact on the marketplace. One of the great ironies as we talk about this whole Medicare reform and changing physician payment methodologies and the pay-per-performance and this endless list of things that people talk about, it is remarkable.

I am in Washington frequently. I will stop at a meeting and I will say you know what you just described with all of this, a managed care plan. At which point you could drop a pin, because nobody wants to think of it like that. So, we do all of the types of things that are being suggested as some sort of a solution. We are better organized because of the way we’re structured and the way we’re paid. So, from a pure competitive perspective I don’t find much fear in all of this at all. I think the execution difficulties surrounding some of these ideas are huge, given my 30 years at this.

I think Humana is positioned well and I think Medicare Advantage is positioned well. I think it is interesting. It is probably good for the country for those people to pursue these sorts of things for the non-Medicare Advantage membership, but I don’t think it affects our business.

Ana Gupte - Bernstein Research

My second question is around the individual market. You have a very, very strong individual and consumer franchise and if any of these universal access proposals come into play, do you see that any potential underwriting margin compression, even if there were an individual mandate? Do you see that being offset over the long-term because the rule of brokers and broker commissions may change in a different clearinghouse type model?

Mike McCallister

That will determine how that clearinghouse model works, I believe, as much as anything else. One proposal is that it is more of a clearinghouse for information. Others would like it to have a lot more direct control over the marketplace. Some would like to have the agents and brokers squeezed out of the business. Others are not targeting that. So, again, this is one of those where depending on the details, all of what you described is quite possible

I don’t know at this point whether the individual market would even be the place where that connector would have the most impact, because their decision may be to go a different way and you may end up in an effort where you are expanding Medicaid and doing other things to get people that are uninsured into the marketplace.

Again, we as an industry, as a company, have very specific proposals about how to set this up so that it works. We will be a part of the conversation through out the summer and I think the end of the day we will have a solid point of view, because we understand the implications of these various choices.

Operator

Your final question comes from Matt Perry with Wachovia Capital Markets.

Matt Perry - Wachovia Capital Markets

First going back to share buy backs, it seems prudent to me that you’re kind of building capital on the balance sheet and you have said that volatility in the market is one of the reasons why you’re not buying back shares. Can you talk a little more about how those thought processes work between management and the board? What sign would you need to see maybe to think about buying back shares?

Then how much does healthcare reform and the significant uncertainty of what might happen if a bill is passed. How much does that inform your opinion on share buy backs?

Jim Bloem

That lateral one does, but before we get to that one, normally in the first half of the year, given where the credit markets are, which you already understand that part of the discussion. But, then there is also the part where we show each of the states that we do business in, we have 34 operating subsidiaries, what we did last year and what our plans are for this year and what’s the appropriate amount of capital we think should be kept there.

So, we have those discussions and then we also have meetings with the credit rating agencies regarding what the parent ratings are and then what the claims paying ability of the subs are. We are still in that process and generally every year in the second quarter call we begin to talk about the results of that. That will inform, to use your term, some of what’s available. Then we still have, again, we have talked about it all morning, about the uncertainty of health reform and the other things and the credit markets. So, we want to continue to be prudent about it and those will be sort of the things.

The first step would be let’s see how discussions go with the states. How much is dividend able, how much needs to be retained, how much needs to be contributed. Then look at what the rating agencies say about the claims paying ability of each of the subs and our parent ratings again, we will look overall. So what we see going forward.

That is kind of how the board, the board is active, the board does act; everyone realizes that, that it would be quite accretive to do it, but again, conservation of capital right now is sort of what we’re doing. We’ll update you next time.

Matt Perry - Wachovia Capital Markets

Okay and then a separate question maybe for Mike. I have another healthcare reform question. I think there is a lot of varying opinions on what a public plan would mean to the health insurance industry. What is your take, having spent a lot of time in DC. Do you subscribe to the belief that any public plan, even if it is set up at first to be kind of a level playing field, would eventually morph into something that would pay Medicare rates and crowd out the private sector. Or do you think there is a viable way to set up a public plan that just promotes competition?

Mike McCallister

I don’t think it matters much how it starts. I think we know how it ends. All we have to do is look at our Medicare program and we know what happens. That has been around for 40 some years. So, where are we today in Medicare, which is providing healthcare to people in the same way that we do, we’re financing it. And, you have a government that does price setting with providers, therefore producing a cost shift to the private sector, which this year is in excess of $80 billion. So, the rationale that that somehow is a competitive and effective and efficient program is just outrageous.

My suggestion would be that if it starts even, and frankly I don’t know that it would, but if it starts as a level playing field, I think over time it would deteriorate to where they would go back to price setting and doing what the need to for their own budgetary reasons.

So, I think we have to fashion this market so that the private sector, and our industry has proposals on the table to do this, and solve the fundamental problems that are screaming out for this supposed public need for this plan. I think we can solve the problem so that we don’t have to have a public option under any scenario, because I think it is a slippery slope to a nationalized healthcare program.

We will be a part of that conversation. We make proposals. We can solve this program without going down that path and the idea that it will be a level playing field, to me, is a goof. It won’t be.

Matt Perry - Wachovia Capital Markets

Okay thanks for that perspective.

Mike McCallister

I will just wrap it up real quick. I think we had a really good quarter. I am really pleased that all of our Medicare projections that we made last year for this year are playing out as predicted. Our Medicare Advantage business is solid. We’re benefiting from it as are the consumers, the seniors. I think it continues to be quite solid and I think based on what we’re looking at in 2010 and beyond we have issues to deal with relative to changes. But, I think it remains a good business that we’re positive about.

Lastly, I want to thank the Humana associates, who are on this call today, for making all of this possible. With that, thank you for joining us.

Operator

Thank you very much ladies and gentlemen for joining today’s Humana conference call. This concludes our conference.

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