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Aetna, Inc. (NYSE:AET)

F1Q09 Earnings Call Transcript

April 29, 2009 at 8:30 am ET

Executives

Ronald A. Williams - Chairman and Chief Executive Officer

Mark T. Bertolini - President

Joseph Zubretsky - Chief Financial Officer

Jeffrey A. Chaffkin - Head of Investor Relations

Analysts

Josh Raskin - Barclays Capital

Charles Boorady - Citigroup

Matthew Borsch - Goldman Sachs

Justin Lake - UBS

Greg Nersessian - Credit Suisse

Christine Arnold - Cowen & Co.

Scott Fidel - Deutsche Bank

Carl McDonald - Oppenheimer

John Rex - JPMorgan

Ana Gupte - Sanford Bernstein

Operator

Good day and welcome to the Aetna's first quarter 2009 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Jeff Chaffkin. Please go ahead sir.

Jeffrey A. Chaffkin

Good morning and thank you for joining Aetna's first quarter 2009 earnings call and webcast. This is Jeff Chaffkin, Head of Investors Relations for Aetna, and with me this morning are Aetna's Chairman and CEO, Ron Williams, Mark Bertolini, President, and Joe Zubretsky, Executive Vice President and Chief Financial Officer.

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

During this call, we will make forward-looking statements. Risk factors that may impact those statements and could cause actual future results to differ materially from the currently expected results are described in Aetna's 2008 10-K and our first quarter 2009 10-Q when filed with the SEC.

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

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

Aetna’s first quarter results include the impact of the increase in pension expense we have described previously. To provide additional transparency into the underlying performance of the business, we have incorporated a business segment deal of operating performance consisting of healthcare, group insurance and large case pension segment results, which include the service cost components of pension and other postretirement benefit expenses.

Additionally, we have incorporated a corporate financing segment which includes interest expense as well as the financing components of our pension and other postretirement benefit expenses, which are the primary driver of the incremental pension expense for 2009.

We will speak to this during today’s call and this information including a reconciliation of our total pension expense can be found in our financial supplement.

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

Ronald A. Williams

Good morning. Thank you, Jeff, and thank you all for joining us this morning. Earlier this morning, we reported first quarter operating earnings per share of $0.96, an increase of 4% over the first quarter of 2008. Excluding the previously announced increase in pension expense, operating earnings per share increased 19% over the prior year quarter.

Our business segment operating earnings increased 8% year-over-year. Our in line performance is the results of developing and executing our strategy, which is based on four dimensions: segmentation, integration, consumerism, and operational excellence. We are pleased to admit our first quarter operating objectives in the areas of membership growth, revenue growth, expense sufficiency, investment performance and capital management.

We did, however, incur higher than projected medical costs in our commercial products, including prior period reserved development. We believe we are experiencing two impacts from the recessionary economy.

First, the impact of layoffs and increased COBRA membership; and second, a higher intensity of facility services without attendant increases in key utilization metrics. We have adopted our already strong medical quality and cost management processes to reflect changing market conditions.

In addition to exceeding the consensus operating earnings per share estimate for the first quarter we have many other accomplishments along the other dimensions of our strategy. We continue to focus on creating value for our customers and maintaining Aetna as a preferred brand in the market. Among these accomplishments is industry leading, medical membership growth of more than 1.3 million members. The vast majority of which is ASC, demonstrating the success of our segmentation strategy. A very successful launch of our new fully integrated Bank of America platform, now marketed at Aetna one, which we have now commercialized for 2010 effective dates; and almost 1.8 million members in consumer directed health plan. Relatedly our recent six-year study of healthcare claims in utilization for Aetna Health Fund Members clearly demonstrates that these plans provide tangible benefits for both members and plan sponsors.

Turning now to our full year outlook, we are confident in the operating earnings per share outlook we have guided you previously. For the full year, we project year end medical membership of approximately 19 million members. As continued sales success is driven by our segmentation strategy offset continued high rates of in group attrition due to the economy.

We also continue to project full year operating earnings per share growth of 12% to 14%, excluding the projected year-over-year increase in pension expense. This is equivalent to operating earnings per share of $3.85 to $3.95 on a reported basis, including the increase in pension expense.

I am pleased with our first quarter operating earnings per share results. Our diversified business portfolio continues to produce strong margins while we continue to grow the top line and we invest in new product and markets. I believe we are well positioned to achieve our full year outlook.

I would now like to spend a moment on a topic of great importance to our Company and to our nation. Addressing the accessibility and affordability of healthcare in America, I have been reaching out across our customer base to understand the needs of our employer groups, the employees and individual purchasers of health insurance as Congress contemplates healthcare reform.

We have also been very directly involved in healthcare reform discussions. I recently testified twice before committees of the US Senate. At the Senate Health Committee in March in the Senate Finance Committee last week to support our core goals in healthcare reform and maintain utmost leadership role as a Company that is helping to create a workable solution for a better American Healthcare System.

My senior staff and I meet regularly with congressional leaders, advocacy groups, and a variety of other key stakeholders to address challenges facing us so that healthcare reform can be accomplished in a manner that works best for the American people. This direct involvement will enable us to be a part of a solution that focuses the nation on get everyone covered, improving the quality of healthcare services and finally bending the cost curve of healthcare spending in America.

We welcomed a sensible approach healthcare reform. Indeed, we believe that healthcare reform efforts in Washington could deal positive market base change that enables Aetna to leverage the strategic investments we have made in the past to deliver positive outcomes for our customers and our shareholders in the future.

Finally, I would like to thank our employees for their unwavering dedication in meeting the needs of our customers. It is through their efforts that we believe we will continue to be successful in 2009 and beyond.

I will now turn the call over to Mark to provide an overview of our operating performance during the first quarter. Mark?

Mark T. Bertolini

Thank you, Ron and good morning. As Ron mentioned, we achieved results by executing our strategy to provide a differentiated brand experience for our members through segmentation, integration, consumerism and operational excellence.

We had many successes this quarter related to all dimensions of our strategy. However, I will focus my comments this morning on key operational aspects of our business, including medical quality and costs.

During the quarter, we incurred higher than projected medical cost in our commercial products, which included $38 million before tax of unfavorable prior period reserved development. We believe the higher than expected medical cost experience for both our revised view of 2008 as well as the first quarter of 2009 had been influenced by the current economic environment. Specifically, we experienced increase intensity of facility services and higher than expected impacts from COBRA.

We have fully considered the impact of these two factors in our projections for 2009. We have very robust management processes to forecasting control medical quality in costs and factor them into our pricing. We have previously refined these processes in light of expected macroeconomic conditions and had now adopted them to reflect our most recent experience.

Recent actions include updated pricing, increased facility audits with focus on billing practices encoding, increased utilization management including concurrent review, and an intensified focus and monitoring COBRA enrollment and medical costs.

Of note we have not seen any significant change in key utilization metrics such as hospital admissions or bed days, which continue to remain flat slightly downward.

Turning now to our segmentation strategy, we continuously identify the new opportunities for future profitable growth in both traditional and new customer market segments. Our government sponsored businesses continue to provide a source of revenue diversification while maintaining a balance risk profile for our Company.

Medicare membership growth was 53,000 members bringing total Medicare membership to 419,000 as of March 31st. Our business has demonstrated profitable growth based upon a targeted strategy that focuses on the network base individual in group Medicare market. Less than 10% of our Medicare membership is in the individual private fee for service market, which is more vulnerable to anticipated changes in the Medicare marketplace.

Going forward in a lower reimbursement rate environment keys to success from this business will be strong network development and medical management capabilities which are core competencies for us. We continue to fortify our Medicare networks in support of group private fee for service membership and today we have added more than 20,000 new physicians and 125 hospitals, providing an 86% overlap for our current group private fee for service membership base.

We are confident that through well designed benefit plans affected medical management, disappoint pricing, provider contracting and SG&A leverage, we will continue to maintain a Medicare margin profile that is consistent with our targeted rates of return.

Another example of the success of our segmentation strategy is Medicaid. During the fist quarter, we achieved the Medicaid membership growth of 84,000 members due largely to the state of Connecticut contract. With the Schaller Anderson acquisition now fully integrated, we are very well positioned to provide affordable value added solutions to this important market.

With the new FMAP funding, the recent chip reauthorization and a large opportunity regarding aged, blind and disabled and long term care populations, we view the Medicaid market as one which affords Aetna significant opportunity for profitable growth.

In summary, we continue to successfully execute our strategy. Given the importance of medical quality and cost management to our nearer and longer term business success, we are constantly adopting our actions to address medical quality and cost challenges resulting from this unique economic environment. We believe these actions which are informed and supported by our robust management processes and analytical capabilities positioned as well to achieve our 2009 outlook.

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

Joseph Zubretsky

Thanks Mark and good morning everyone. Earlier today, we reported first quarter operating earnings per share of $0.96, an increase of 4% compared to the prior year quarter. Business segment operating earnings increased 8% year-over-year to $520.7 million driven primarily by strong revenue growth tampered by higher than expected medical costs.

Total Company operating earnings decreased 6% to $442.6 million due to the year-over-year increase in pension expense. Other key metrics for the quarter include medical membership growth of 1,365,000 members a year-over-year increase of 9%. Healthcare revenue growth of 11%, a commercial medical benefit ratio of 81.7% or 81% excluding prior period development and very strong cash flows and strong investment performance.

I will now discuss the drivers of our first quarter financial performance, starting with operating margin and its key components. First quarter reported pretax operating margin was 8.8% or 9.5% on a business segment basis. This represents a year-over-year decrease of 30 basis points on a comparable basis as the increase in our first quarter commercial medical benefit ratio was partially offset by an improvement in our underlying operating expense ratio.

Our products continued to generate strong margins and return on capital. Our strong first quarter revenue growth was driven by an 11% year-over-year increase in healthcare revenue. This was the result of 12% growth in healthcare premium and an 8% increase in healthcare fees.

Healthcare premium growth reflects commercial premium growth of 9%, 19% to Medicare premium growth and strong Medicaid performance where premium grew by more than 47% due to the exception of the state of Connecticut contract.

We are confident in our ability to manage medical costs going forward, despite higher than projected first quarter medical costs. Our first quarter total medical benefit ratio was 83%, which includes $38 million before tax of unfavorable prior period development in our commercial products.

Our commercial medical benefit ratio was 81.7%, 190 basis points higher than the prior year quarter. Excluding prior year period development, the commercial MBR was 81%, which is 120 basis points higher than a year ago quarter. Approximately half of this increase was contemplated in the upper end of our original guidance range with the remainder due to the increase in medical costs that we have described previously on this call.

Our Medicare medical benefit ratio was 86.8% in line with our expectations despite a small amount of prior period development due to a higher risk profile of the book of business which was largely offset by higher risk adjusted premiums.

Our Medicaid medical benefit ratio was 90.7% in line with our projections. Higher than expected medical claim costs became fully apparent as part of our quarterly close process in April and are reflected in our March 31st reserves. We ended the quarter with a prudent level of reserved adequacy.

Our healthcare cost reserves increased 12% during the quarter to $2.7 billion at March 31st relative to a 7% sequential increase in healthcare premiums, and days claims payable increased 0.3 days during the quarter from 41.3 days at year end to 41.6 days at March 31st.

Group insurance first quarter operating earnings increased 23% year-over-year. We achieved a 250 basis point improvement in the group insurance benefit ratio to 86.3%. As expected higher disability claim costs were more than offset by favorable underwriting experience in our group life business.

The third key component of operating margin results is operating expense sufficiency. We continued to invest for future profitable growth. We fund the growth investments with unit cost reductions and by leveraging fix costs. For the first quarter, we achieved a total company operating expense ratio of 18% and a business segment operating expense ratio of 17.3%. This represents a 110 basis point improvement over the prior year quarter on a comparable basis, supporting our position that there is additional cost leverage as we grow the business.

Prior growth investments we have made are yielding positive results. Our first quarter medical membership growth of 1,365,000 members was accomplished despite higher than expected in group attrition of an estimated 200,000 members due to the deteriorating economy.

Commercial membership grew by 1,228,000 members including 1,167,000 ASC members and 61,000 insured members. Commercial ASC growth was driven by strong gains and large group customers and the upper end of the middle market and commercial insured growth was driven by gains and newer segments, the traditional segment membership in line with the year end levels.

Medicare membership grew by 53,000 members consistent with previous guidance and Medicaid membership grew by 84,000 members driven primarily by our newly implemented state of Connecticut contract.

The final area of financial performance I will comment on is our investment performance and management of capital. First quarter net investment income on our continuing business portfolio primarily healthcare group insurance was $169 million, $12 million higher than the prior year quarter due primarily to increase the asset levels and improved performance on alternative investments.

The continuing business investment portfolio declined in value during the quarter by $105 million before tax. This was comprised of $5 million before tax of net realized capital losses as a small decline in value due to mark-to-market accounting was offset by gains on sales of previously written down securities; and $100 million change in the unrealized loss position on our continuing business portfolio, which increased from $353 million before tax as of year end to $453 million as of March 31st, as bond yields rose modestly during the quarter.

As a reminder these losses are recorded in shareholders equity and our accounting base losses only as we intend to hold these securities to recovery.

Turning now to liquidity and capital management, our financial position, capital structure and liquidity all continue to be very strong. The recent reaffirmation of our ratings by Standard & Poor’s and Moody’s are testimony to our financial strength and capital management strategy despite current economic and financial market conditions.

Our balance sheet metrics are excellent. As of March 31st we had a debt to total capitalization ratio of 31% and $5.9 billion of adjusted statutory surplus, $4.9 billion in excess of our reported regulatory requirements. We also continue to have a target risk base capital ratio of approximately 600% of the authorized control level.

Our liquidity is strong. We began the quarter with holding company liquidity of approximately $100 million. First quarter dividends to the parent and other sources of cash were approximately $425 million. We funded more than $275 million of share repurchases retired over $100 million of commercial paper, encumbered fix charges of approximately $50 million.

We ended the quarter with approximately $100 million of holding company liquidity and $100 million of commercial paper outstanding. During the quarter, we repurchased 10.4 million shares. Our basic share count was 446.9 million at March 31st down from 456.3 million at the beginning of the year.

We also continue to have very strong operating cash flow. Healthcare and group insurance GAAP operating cash flow for the quarter represented 186% of operating earnings excluding pension expense. On the same basis, we would project operating cash flow to be approximately 130% for the full year.

I will now provide some additional comments on our 2009 guidance. We are confident in our 2009 outlook. The risks to this outlook are primarily economy related, including unemployment levels higher than we are projected in a higher than anticipated volatility of medical costs.

With respect to growth, for the full year we project year end medical membership of approximately 19 million members as new business wins during the remainder of the year are expected to be offset by continued in group attrition due to the economy. This is consistent with a 9.5% to 10% year end unemployment rate. Approximately 15% to 20% of our total medical membership growth will be fully insured, and we project double digit healthcare revenue growth.

With respect to underwriting margins for the full year we project a commercial medical benefit ratio of 81% to 81.6%. Approximately half of the increase in our commercial medical benefit ratio outlook is due to the prior period development and at associated impact on our baseline, with the remainder due primarily to a further increase in COBRA membership.

We also project Medicare results to be better than previously expected with the medical benefit ratio in the mid to high 80s. Therefore, we projected total medical benefit ratio in a range of 82.3% to 82.8%. Our medical cost trend outlook remains 8% plus/minus 50 basis points with some upward pressure.

Our outlook also reflects continued cost management discipline leading to a projected business segment operating expense ratio of 17.7% to 17.9%, which represents up to a 30 to 50 basis point improvement over prior year and our previous 2009 outlook.

Net investment income on our continuing business portfolio that is generally consistent with out first quarter run rate which would be to approximately a 10% increase over 2008 and capital ratios consistent with our original guidance.

Taking all of these into account, we project 2009 operating earnings per share growth excluding the increase in pension expense to be 12% to 14% consistent with our prior guidance. On a reported basis, this would result in operating earnings per share of $3.85 to $3.95.

This outlook assumes a weighted average share account for 2009 of approximately 455 million shares. We continue to project the operating earnings per share in the remainder quarters of the year that are in line with or lower than 2008.

Our continued confidence in our operating earnings per share guidance is based upon our improved outlook for our Medicare business, our operating expense ratio, net investment income, and capital management.

In summary our sound strategy, the flexibility of our operating model and well diversified business portfolio enabled us to successfully manage for this challenging economic environment and deliver on our commitments.

With that I will turn the call back over to Jeff. Jeff?

Jeffrey A. Chaffkin

Thank you, Joe. The Aetna management team is now ready for your questions. We ask that you limit yourself to one question and one follow up so that as many individuals as possible have an opportunity to ask their questions. Operator, the first question please.

Question-and-Answer Session

Operator

Your first question comes from the line of Josh Raskin - Barclays Capital.

Josh Raskin - Barclays Capital

I am just wondering if we could dig in to a little bit more commercial cost trend pressures. Maybe it will be helpful if you could just walk us through how exactly COBRA is impacting your MLRs. I am just curious how this was sort of filtering through so quickly and then maybe just a little bit more information on what exactly intensity is related to the facility side and maybe the details of what that means.

Ronald A. Williams

Well, good morning Josh. Let me start out and ask Joe to pick up the second part of your question. I think when we think about COBRA, we have to think about several components to it. I think the first component is to think about the whole question of the recession and the broad economy and individuals who are in companies that are in a layoff or reduction in workforce mode, and so we believe that there is some impact from individuals who are watching the reductions and may conceitedly be accelerating services in regard to that.

The second element is really individuals who may have been laid off or they may actually be in a severance or continuation of benefits period pre COBRA but may also accelerates services depending upon what they envision actually taking COBRA or not.

And then the third element is really the COBRA component itself where as you know the COBRA cohort has a significantly greater medical benefit expense ratio. There is really a fourth element which is in so much COBRA related but it is related to what we are seeing in the benefit buy-down category which is a somewhat relative increase where we are seeing benefit buy-downs essentially in the 200 to 250 basis point range where people knowing they are going to have less which benefits in the coming year accelerates in services.

So, those are the kinds of the broad framings and I will have Joe, he will take you through the rest.

Joseph Zubretsky

Josh, as we progressed through the fourth quarter and into the first quarter, we believe that on balance the COBRA election rates and our membership population are about the industry average of about 15%, which means that at any point in time about 2% of our membership is directly on COBRA. We believe that percentage has increased in the fourth quarter and on into the first which is putting upward pressure on our medical benefit ratio and with the legislated subsidy we have every reason to believe that it will continue throughout the balance of 2009.

In addition to the increase COBRA membership, we also think that the subsidy will cost a longer duration of COBRA durations and also a medical benefit ratio that is still meaningfully higher than the commercial average. So, all of that is putting some upward pressure on the medical benefit ratio throughout 2009.

Josh Raskin - Barclays Capital

So, just in your quick answer, you are actually seeing members on COBRA signed up having made that election already in the first quarter? Or is this still just those first two buckets of we think we are going to get laid off so we are going to use all the services or have been laid off that got 60 days of benefit before I have to pick COBRA?

Ronald A. Williams

Josh, I would say you have to remember that I mean many companies their reductions really started in the fourth quarter of last year and so we are seeing depending on the company’s benefit structure. Some of those people are on COBRA; some are on a continuation of benefits and about to go in the COBRA.

So, we are seeing some of each and I will also remind you that we have included some of this in our projections going forward for ’09, and I would like to ask as to finish the second party of question is really no question on the intensity of services.

Mark T. Bertolini

Josh, this is Mark. We are seeing across the facility spectrum in both inpatient and outpatient a higher level of intensity without an increasing utilization. We are not quite sure if this is related to the first two buckets that run outline around the economy but people are using services before they get laid off or before salary separation and also we are seeing it in the category that is below what we will consider to be cash of declaims throughout the higher end to be between $50,000 and $10,000 worth of our claims. So, higher intensity, this is caused to do a number of things.

We have taken the numbers apart in looking at utilization, found no definite increase in utilization but secondly I am looking at facility audits and billing audits as we try and understand why we are seeing this increase intensity in the claims where we are receiving.

Josh Raskin - Barclays Capital

Okay. And then just may be related I guess to…

Jeffrey A. Chaffkin

Josh, you are on question four.

Operator

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

Charles Boorady - Citigroup

I just sort want to understand relative to the companies we already saw report earnings this quarter whether you are leading or lagging a bit. In other words, we saw the weak economy coming last year really enough to take price for ’09 and do you have been around a long time in this business to look at history. You think there is a missed opportunity to sort of foresee some of this and factor into your pricing, recognizing the historically bad economy and so in our lifetimes it probably was not as bad as it is now?

And in hindsight, were your assumptions do you think somewhat optimistic or do you think you are more of a leading indicator and seeing something much worse than your competitors maybe aware of at this point?

Ronald A. Williams

Well, first, good morning. I would say that we will focus on explaining our book, our experience and what we are seeing and would leave it to our competitors to explain what they are seeing.

I would say that we feel that ’09 is clearly unlike ’08 and all the years that have gone before it, and we believe that in the pricing and in the planning and forecasting that we have done that we did as comprehensive and rigorous as job as we could we think we are seeing some things that we obviously did not anticipate by virtue of the prior period development but I think that I would remind that we did begin to bring up our medical cost trend guidance last year and actually begin to take pricing actions last year in light of this.

I think in the context of where we are we feel very good about where we are. We feel like this is a relatively minor adjustment.

Charles Boorady - Citigroup

Alright, thanks. As a follow up, can you give us rough specifics on the premium yields that you saw on the renewed customers in the press release you talked about higher yields of the renewing customers versus the average yield on the new business?

Joseph Zubretsky

I am not sure which statement of the press release you are actually referring to Charles. Can you elaborate?

Charles Boorady - Citigroup

Yes, sure. In your press release, you talked about as a contributor to the revenue growth higher premiums on renewed business. So, I wonder if you could just sort to quantify what the PMPM yields might be on the renewals versus what the average impact to your overall yield would be on new business, in other words are most of your new premium based sales on higher deductible plans with lower premiums and is that bringing down the overall Company PMPM growth?

Joseph Zubretsky

No. I think if you look at the financials, the math is, if you look at the first quarter we had a trend at about 6.5% and a yield of about 4% about a 250 basis point negative spread between trend and yield. You adjust for the prior period development that was approximately 100 to 150 basis points.

So clearly there is a negative spread between trend and yield, but we believe that the council writing our profitable I think that is evident in the 9.5% pretax margin and we posted for the quarter and as we said we continue to believe that with pricing actions we took in late 2008 continue pricing actions were taking in 2009. Now, that we fully understand our 2008 medical costs, we have a good one way for success and producing that commercial medical benefit ratio outlook for the year.

So, I think pricing was very rationale and well there is a slight negative spread between trend and yield. We are confident that we can produce the margin that we have articulated.

Operator

Your next question comes from the line of Matthew Borsch - Goldman Sachs.

Matthew Borsch - Goldman Sachs

A question about your outlook on the commercial risk MCR, it looks like you are looking forward to be approximately flatted from the first quarter if we exclude the negative PPD from the first quarter. I am just curious that the issue that surprised a number of us this quarter from some of the other companies is that they have pointed to a very much steeper slope in the progression of MCR related to uptake of higher deductible products and actually you have got yourself referred to accelerated utilization at the backend of the year.

How do you see that moving, in light of that how you do look at the potential for upward pressure over the course of the year and may be the progression quarter-to-quarter?

Ronald A. Williams

Well, first, let me give you the map and how look at the commercial medical benefit ratio for the balance of the year. You are right. The map is that 81.7% translates to 81% without the prior period development. We believe that ratio will be higher in the second quarter than it was in the first and that the medical benefit ratio for the last half of the year will be lower than it was in the first half and that is a result of, as Mark described, continued actions on medical quality and total cost and also the impact of those late 2008 and early 2009 pricing actions that are articulated earlier. Bear in mind that about 10% of our member months remaining in 2009 can still be influenced by pricing actions. So we are pretty confident in that seasonality pattern.

Matthew Borsch - Goldman Sachs

And just somewhat a related question which is you touched on the COBRA dynamic and what you think is some behavior around the layoff presumed or in progress. Have you been able to look though, aside from those factors at risk pool deterioration, do you see any dynamic where younger, healthier people in this economic climate are not taking up coverage and that on the fully-insured book, that might be leading to some upward pressure as well?

Ronald A. Williams

We have taken a very comprehensive look to this and we really see no deterioration in the risk pool in any form or fashion.

Matthew Borsch - Goldman Sachs

Okay, thank you.

Operator

Your next question comes from the line of Justin Lake - UBS.

Justin Lake - UBS

Thanks. Good morning. Question on the reserving methodology. Given 2 out of the last 3 quarters, you have shown negative development in the commercial book. I just think it might be worthwhile to understand whether there’s been any changes you made to increase the precision in setting reserves and possibly as a result of that are generating greater volatility on prior period development, that could be more systemic rather than just kind of a supply. This course, have you taken some of the conservatives or out of reserves to just be more precise and be able to set your price more precise but that might be generating some of this prior period development.

Ronald A. Williams

Justin, obviously we take the reserve calculation very seriously because so much rides on in terms of looking on your pricing, etc. We have had 2 out of 3 of the last quarters or some commercial prior period development and each time we capture the data mined and we analyzed it. We update our actual assumptions to include the most recent experience. As you know, as we reported last year, our pricing was chasing an upward moving trend. It was 7.5% at the beginning of the year and moved to the upper end of the range, became 8% by the end of the year and now, we are seeing its upward pressure. So when your pricing is chasing an upward trend, it’s hard to capture that but each quarter we close, have new information with new experience, we update our actual assumptions and we believe that our March 31 claim pick is a very, very good and solid pick. Testimony to that is the fact that the reserves are up on a sequential basis like 12% while premium is up 7%.

Justin Lake - UBS

But no change the underlying accrual?

Ronald A. Williams

We use a variety of actual methodologies that are very, very good actuarial community here in the company and we’re very confident that our methodology is appropriate.

Justin Lake - UBS

Second question, just on the MLR. I am just following up on the trajectory for the year. The first quarter is up 120 basis points year over year. It sounds like you are projecting the red flag. You mentioned the re-pricing actions and the medical clause actions is benefiting the back half. Give you give us some more color on that as far as how much of a benefit are you giving yourselves, let’s just call it for the full year MLR guide from repricing actions and separately for medical clause, it’s measured in basis points.

Ronald A. Williams

Well, if you think about it, it’s the 10% of the member months are yet to be priced. You can figure out that 100 basis point improvement on the pricing would be 10 basis points for the year. We have ranges of outcomes that we are expecting but that would be the way to do the math.

Justin Lake - UBS

Right. So can you get us the 20 basis points for each of the full year or is it 10 basis points or 40. Just trying to get an idea of how much is on the comps so to speak.

Ronald A. Williams

We are not going to part to it on that level of detail but with the medical clause actions in the re-pricing, we are confident in that outlook that we have given the adjustment.

Operator

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

Greg Nersessian - Credit Suisse

Hey, good morning. My first question is just on the acuity that you post up. Could you just bring out what segment that was in, was that mostly in like in small and mid-size segment or did you just see some of that on the stop-loss business that are self funded

Ronald A. Williams

Greg, we are seeing at a cross the book of business so there isn’t any one specific product, there isn’t one specific geography. This is generally across the book of business that we’re seeing this increase in intensity and facility claims, facility request for payment. The other, the part I would notice though again, this is the lower stop-loss limits so we’re not seeing that activity in our stop-loss results. It’s actually coming in below the $50,000 level.

Greg Nersessian - Credit Suisse

Okay, great. I guess just a question again on the pricing strategy going forward, you guys are now pricing to a higher level of costing for the rest of the year. Some of your peers are saying stabilizing cost trends, do you anticipate that pricing environment is going to become more competitive to you, should we think about the membership mix maybe shifting a little bit more AEC than risk for the rest of the year, offset to the competitive thing?

Ronald A. Williams

I think as you can see from the results we reported for the first quarter and as we projected the rest of the year, we are seeing less risk membership and more and more AEC membership throughout the year. We do expect to have as much in sales and growth as we expecting attrition through the remainder of the year as a result of the economy. The pricing environment is very stable and rational, our competitors are coming from a different place than we’re coming from and as a result, we continue to monitor our results against both our trend our target margins and our competitors in each market place by segment, by geography, by product.

Operator

Your next question comes from the line of Christine Arnold - Cowen.

Christine Arnold - Cowen & Co.

Hey, there. Can you help me understand the data that you have that lead you to believe that this is a COBRA issue? You have a number of COBRA claims, number, dollar amounts of COBRA. Secondly on the intensity, would not a change kind of [anniversarizing] your hospital contract structures going from a 2044 to 999, would that not appear as an increase in intensity because the price per unit will rise as you kind walk through that. So can you help us on both COBRA and intensity to get a sense of what you’re looking at behind the top-line numbers?

Ronald A. Williams

Good morning. I think in terms of the COBRA, what we done is look at both the aggregate data that we have and then also do some deep guides on selected cases where we have very good data associated with things like the benefit change, the severance benefits in terms of continuation of benefits and then looking at the COBRA. Each company and each organization has a slightly different curve and obviously as we are talking about full year. We have done some projections based on what we believe the impact of the COBRA continuation and the COBRA subsidy will have. So we are looking at a data as well as some projections. I’ll ask Mark to talk…

Christine Arnold - Cowen & Co.

Supposed somebody has COBRA, I mean when I had COBRA, I paid the premium to my former employer, I carried the same card, I would imagine to the carrier there was no change. So how do you know it is COBRA so I can have an understanding of the extent to which this is company versus industry.

Ronald A. Williams

Well, I think, we know that it is COBRA from several different ways, types of and the analytics that we do. In some instances, companies do in fact, do different levels of analytics, companies know who is on COBRA and who is not. We administer it for some companies where we actually do collect the premium on behalf of the employer. So there are multiple approaches that they have given us the ability to tiangulate. Mark…

Mark T. Bertolini

Christine, on the intensity of services, we obviously have detailed models on our pricing which we factor into our rates and into our trends. So we haven’t seen any abnormal pricing behavior, we do see some upward pressure on the part of facilities as we renegotiate our contracts. We have about 30% or our 2009 contracts still open for re-negotiation. As they try and get to a revenue neutral position in the market while they are seeing decreases in utilization and occupancy. So we are seeing some pressure there but we believe our pricing, our unit pricing at the facility level is well inculcated into our trends and to our medical cost.

Ronald A. Williams

Christine, the other point that I wanted to underscore is that broadly speaking, I think about this as the recessionary effect and while COBRA is one element, I believe that this notion that employees are concerned about reduction and layoffs in companies that have announced reductions but haven’t provide clarity on exactly on who’s going, places people in a different state of mind regarding acceleration. I think in the last call we had someone asked that question and it wasn’t clear whether there would be an increase in acceleration of services or whether people would defer services because they wanted to be at their desks demonstrating their productivity. I think we’re getting assumptions to that. I think the other thing again on benefit changes that may in fact be a contributing factor as well.

Operator

Your next question comes from the line of Scott Fidel - Deutsche Bank.

Scott Fidel - Deutsche Bank

Thanks. Just thinking on the medical cost, can you talk about, if there any particular product segments or geography where you are seeing a particular fault in the clause pressure and maybe just highlight 3 of the growth segments, individual, student and global benefits in terms of what you’re seeing with that clause right there.

Ronald A. Williams

In terms of the question of where we are seeing it, it is across the board and would view it not as something that is coming out of the product or product design but much more from the provider’s perspective. Just as the world change for us, the world is changed for the provider community. This is nothing new. We normally see changes in how providers bill and do other things and what we try to do is we understand that and then make certain that we are adjusting appropriately. Mark will do the second part.

Mark T. Bertolini

I think what we have seen, at some employer levels again this is COBRA effect and as employers get to understand what this COBRA subsidy means to them, we will see depending on how the employers offer benefits whether or not they will have this COBRA effect impacting the medical cost. The only geographic thing that we have seen is with the changes in New York where they are putting some taxes on the claims and that will impact people’s premiums going forward as the state goes back to collect those but beyond that, there isn’t any geographically that is of note and then history choose a small one.

Scott Fidel - Deutsche Bank

Okay. I’ll just follow up on one non-medical cost question. Just on the commercial mortgage portfolio. If so, can you give me an update on how that’s performing with the loan-to-value ratios or whether these ones are not fully performing at this point?

Mark T. Bertolini

Approximately $1.6 billion in gross values as you know. The loan-to-value ratio is still approximately 64% with the cash coverage ratio of 1.4. We did have one loan, a $7 million loan in Texas foreclosed during the first quarter. We own the property. It is actively being marketed and we fully expect to recover our principal. All the other loans are performing. As you know, we avoided the 2006 and 2007 Vintage years which were the aggressive underwriting years and we have very minor amounts of principal coming due here over the next 18 to 24 months which will be refinancing challenges. So we’re feeling pretty good but we did take one property.

Operator

Your next question comes from the line of Carl McDonald - Oppenheimer.

Carl McDonald - Oppenheimer

Thank you. Do you have any statistics you could give us on what a loss ratio for a COBRA member typically runs and also the 2% enrollment that you mentioned, is that consistent across both the risk and the SO business?

Mark T. Bertolini

Yeah. Our loss ratio experience is consistent with the industry and you have seen published reports that would say that the loss ratio could be 150% to 200% on the COBRA member and we are certainly experiencing in that range and as you can imagine that as new members were added to the pool that loss ratio ought to decline as healthier members actually elect COBRA and that is something we expect as well.

The second about the average numbers of members on COBRA?

Carl McDonald - Oppenheimer

Yes, the 2% you mentioned is just a consistent. Is that across the entire book or is that a good number to use for to say all right 2% of the commercial risk membership is COBRA?

Ronald A. Williams

I think that is a fair assumption to use across the book of business.

Carl McDonald - Oppenheimer

And then just separately do you think it is possible to have an integrated benefit offering to employers if you PBM is outsourced to somebody else?

Ronald A. Williams

Yes. I think that one of the things that we have looked at broadly in the context of our PBM strategy is the value of integration and we have talked a lot about integration as a core part of our business strategy. I think unlike some of our competitors we have essentially one set of integrated business systems that gives us an ability to integrate all of our products and create value from that. So, I think I would say we have a different strategy that relates to our PBM and some of our competitors and we believe that it contributes to a lower total cost and better value for our customers.

With that said we are always looking at actions we can take to enhance about customer value as well as shareholder value.

Operator

Your next question comes from the line of John Rex - JPMorgan.

John Rex - JPMorgan

I apologize if I missed this, but could we just go back. So, what cost trend level kind of more precisely did your forward pricing now anticipate and if you can compare that versus what are your heads were at the beginning of the year? So, just give us an order of magnitude on how that would have changed versus the beginning of the year?

Ronald A. Williams

At the beginning of the year, we said 8% plus/minus 50 basis points and now we are seeing there is upward pressure on that ratio and obviously with the prior period development we have reestablished our 2008 baseline medical costs which will then influence year 2009 medical costs.

So, we are definitely saying there is upward pressure on that 8% plus/minus 50.

John Rex - JPMorgan

I am just trying to get an order of magnitudes. So, is it 50 bits? Is that more than that? I am just trying to, if you were 8 to the beginning of the year, are you now 0.5 or is it a little bit edge above that and how would the yield on your forward pricing, again? I understand there is a negative spread right now. But how the yield in your forward pricing compared to that? If you could put some numbers around that would be great.

Ronald A. Williams

I think John it is safe to say that we are operating within that range, the plus/minus 50 and that is about the level of precision we want to give on a metric like that.

We clearly do believe that first of all our philosophy is still to maintain a pricing discipline or a pricing to cost trend. Now, whether or not we can convert that negative spread to positive spread of the future is going to be up to Mark and his team as they go by market-by-market looking at competitive forces or looking at the prices that are in the market.

Keeping in mind that, we have been able to grow the business profitably maintain a high single digit margin in the wake of this higher commercial MCR. So I think you need to look at the entire picture of the fix cost leverage we get from our administrative cost platform, an MBR and a resulting margin and that if we can just maintain the discipline we have in price to trend we will have a satisfactory margin.

John Rex - JPMorgan

I guess part of the reason I am asking is because kind of from your metrics now this quarter you are missing, you used to talk premium yield and you said in line with medical cost trend and that is going to missing from the new guidance points. So, is it still like as you look forward you are still in line with whatever the higher cost trend level is you believe your pricing in line with that now? Is that fair?

Ronald A. Williams

Yes. The expectation of the year is the price in line with the new view of trend.

John Rex - JPMorgan

Okay. And could you just give some metrics around how the average deductible for commercial risk has changed ’09 over ’08 kind of order of magnitude, maybe this is a got rough percentage?

Ronald A. Williams

What we said is that in total benefit buy-downs would be in the 200 to 250 basis point range and if you would contrast that to the prior year we would have said basically 150 to as high as 200 depending on the customer. So, there is clearly a step function that we are seeing.

John Rex - JPMorgan

And Ron, do you think that is enough to meaningfully alter kind of utilization patterns or is that not enough to really change it?

Ronald A. Williams

Well, I think it currently depends upon the individual and how that buy-down reflects itself in the plan design and benefit design and then the individuals anticipated need for services, so far some people it may not for others it may be an important reason to do it now as suppose to do it next year, to do it in ’08 as opposed on ’09.

Mark T. Bertolini

And John, I would add that what we are seeing is that we are seeing much more significant buy-downs in small group area versus the larger clients. So, as a result, in the small group area where you generally have people they are compensated the different level, you are going to see the impact of buy-downs have much more dramatic impact on the personal disposable income and much different behavior than you would in large accounts.

Operator

Your last question comes from the line of Ana Gupte - Sanford Bernstein.

Ana Gupte - Sanford Bernstein

I wanted to get on understanding of the evolving risk profile of your individual book of business, typically you do not disclose this but given the cost trend increase, would you be able to tell us what percentage of your fully insured book is individual how that MLR has been evolving and is the durational impact in terms of how many people are the under one-year or two-year timeframe changing as you are getting in to the recession?

Ronald A. Williams

Well, good morning, Ana. I would say that that one individual continues to be in attractive market for us. We are very mindful of the durational aspect of the business, are managing it very consistent with that durational impact. We see no sudden precipitous changes there in any way and feel pretty good about our growth prospects in that segment if they continuous to be one of the areas. We think there is significant opportunity now as well as to the extent of healthcare reform in the individual market with these additional opportunities.

Ana Gupte - Sanford Bernstein

Okay, thanks Ron. Just a follow up on the individual underlines of reform, what is the likelihood in your mind that the individual mandate will actually go through in the clearing house and then can you comment on the evolving individual market outside the clearing house, in other words would they have a guarantee issue community rating for the broader market as well?

Ronald A. Williams

Well, I would say that that I really would have a hard time handicapping it given all the challenges that are going on. I would say that we are actively at the table. We have been very engaged in trying to structure changes in that market that are sustainable in work. We have been very clear that the only way you can guarantee issue is that if you do have an enforceable sustainable mandate or individual coverage requirement and I would have to say that that seems to be penetrated many of the policymakers. But the politics have it maybe another manner as they try to struggle with what can be done to generate that support for bill that could in fact pass.

So, I would say that the main point is we are very early in the process. We are actively engaged on all fronts and what we are trying to do is help people come up with solutions that that can really help us getting more people covered in a way that sustainable and an increase at the market.

Ana Gupte - Sanford Bernstein

One final one on that is this likely to be a national system or will this be more like group regional and regional state cooperatives? I have got those questions a lot from investors.

Ronald A. Williams

Yes. My sense is that this is likely to be a national framework with some role for state or regional. If I were betting I would say much more states because this existing apparatus is all at the state level.

So, I think there will be a national framework, national guidelines so that we do not end up with inconsistent systems, but perhaps consumer enforcement and other local issues left to the states.

Operator

And I will turn the call back over to your host for closing remarks.

Ronald A. Williams

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

Operator

Once again that does conclude your conference. Thank you for you participation.

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Source: Aetna, Inc. Q1 2009 Earnings Call Transcript
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