CIGNA Corporation (NYSE:CI)
Q1 2009 Earnings Call
April 30, 2009 8:30 am ET
Ed Hanway - Chairman and CEO
David Cordani - President and COO
Mike Bell - CFO
Ted Detrick - Vice President, IR
Josh Raskin - Barclays Capital
John Rex - JPMorgan
Justin Lake - UBS
Matthew Borsch - Goldman Sachs
Charles Boorady - Citi
Christine Arnold - Cowen
Greg Nersessian - Credit Suisse
Scott Fidel - Deutsche Bank
Ana Gupte - Sanford Bernstein
Ladies and gentlemen, thank you for standing by for CIGNA's first quarter 2009 results review. At this time all callers are in a listen-only mode. (Operator Instructions). As a reminder, ladies and gentlemen, this conference, including the question-and-answer session, is being recorded.
We'll begin by turning the conference over to Mr. Ted Detrick. Please go ahead, Mr. Detrick.
Good morning, everyone, and thank you for joining today's call. I'm Ted Detrick, Vice President of Investor Relations, and with me this morning are Ed Hanway, CIGNA's Chairman and CEO; David Cordani, President and Chief Operating Officer; and Mike Bell, CIGNA's Chief Financial Officer, and Bob Hughes, Financial Officer for CIGNA Health Care.
In our remarks today, Ed will begin by briefly commenting on CIGNA's first quarter results. David Cordani will provide his perspective on the first quarter results and the full year outlook for CIGNA's ongoing businesses. He will also discuss our medical membership results and outlook, and provide a current assessment of the health benefits marketplace. Mike Bell will then review the financial details for the quarter and provide the financial outlook for full year 2009. Ed will then share some thoughts on the topic of health care reform before we open the lines for your questions.
Now, as noted in our earnings release, CIGNA uses certain financial measures, which are not determined in accordance with generally accepting accounting principles or GAAP, when describing its financial results. Specifically, we use the term labeled "adjusted income from operations" as the principle measure of performance for CIGNA in our operating segments. Adjusted income from operations is defined as income from continuing operations, excluding realized investment results, special items and the results of our guaranteed minimum income benefits business.
A reconciliation of adjusted income from operations to shareholders' income from continuing operations, which is the most directly comparable GAAP measure, is contained in today's earnings release, which was filed this morning on Form 8-K with the Securities and Exchange Commission and is also posted in the Investor Relations section of cigna.com.
Now, in our remarks today, we will be making some forward-looking comments. We would remind you that there are risk factors that could cause actual results to differ materially from our current expectations. Those risk factors are discussed in today's earnings release.
Now, before turning the call over to Ed, I will cover a few items pertaining to our disclosures and first quarter results.
Effective this quarter, CIGNA adopted two new accounting standards. First, we adopted Statement of Financial Accounting Standards No. 160. This statement requires us to separately disclose the financial effects attributable to CIGNA's investment in non-controlling interests. The adoption of the statement had no material effect on shareholders' net income or shareholders' equity.
Second, we adopted the Financial Accounting Standards Board Staff Position that requires unvested restricted stock awards that contain rights to non-forfeitable dividends to be included in the calculations of both basic and diluted earnings per share. Adoption of the statement did not have a material impact on our earnings per share calculations for our first quarter 2009 results and we have also restated prior period EPS information to reflect the adoption of the standard.
I would note, however, that adoption of the statement had the effect of reducing our full year 2009 earnings per share outlook by about $0.05 per share.
Finally, the Financial Accounting Standards Board recently amended Statement of Financial Accounting Standards No. 157, which provides additional guidance regarding fair value measurements. CIGNA will adopt this standard in the second quarter of 2009, and we do not expect a material impact to our financial condition or disclosures upon adoption of the statement.
Now regarding earnings, our first quarter results included an after-tax benefit of $20 million related to the completion of an IRS examination. This benefit was reported as a special item, and therefore is excluded from adjusted income from operations in today’s discussion of results.
Related to our run-off operations, I note that CIGNA’s first quarter shareholders' net income included after-tax income of $23 million or $0.08 per share related to the guaranteed minimum income benefits business, otherwise known as GMIB.
I remind you that the impact of Statement 157 reporting on our GMIB results is for GAAP accounting purposes only. We believe that the application of the statement does not represent management’s expectation of the ultimate liability payout. Because of Statement 157, CIGNA's future results for the GMIB business will be more volatile as any future change in the exit value of the GMIB's assets and liabilities will be recorded in shareholders' net income.
CIGNA’s 2009 earnings outlook, which Mike will discuss in a few moments, excludes the results of the GMIB business, and therefore, any potential volatility related to the perspective application of Statement 157.
And with that, I’ll turn it over to Ed.
Thanks Ted. Good morning, everyone. First quarter 2009 adjusted income from operations was $188 million or $0.69 a share, and this including losses of $0.18 a share from the run-off VADBe operations, driven primarily by unfavorable equity market performance.
In the quarter, earnings from our ongoing businesses that is our health care, group disability and life, and international operations reflect sound execution of business fundamentals, as well as the current challenging economic times.
For health care, first quarter earnings reflect improved margins due to the effect of pricing action on guaranteed costs and experience rated books of business, coupled with favorable medical management results. These positives were tempered by declines in membership and lower net investment income.
It is important to note that the first quarter health care results, is on track with the earnings pattern, which supports our financial year outlook. The health care earnings pattern reflects a significant ramp up in earnings throughout the year. David and Mike will provide specifics regarding the earnings levers, particularly around operating expenses that drives this outlook.
Group insurance revenue and margins remained competitively strong. However, first quarter results were below expectations due to unfavorable disability and life claims experience as well as lower net investment income.
International first quarter results reflect continued attractive top-line growth offset by the adverse of currency movements.
Overall, our investment portfolio continues to perform well despite challenging market conditions. We believe that this is a direct result of maintaining our investment discipline. In addition, we have a strong balance sheet and the financial flexibility to weather the current challenges in the capital market, and I would note that both Moody's and S&P recently reaffirmed the financial strength of our operating subsidiaries. We view this as providing further support that our capital position is strong.
Now regarding our 2009 outlook, we now expect our full year 2009 EPS estimate to be in a range of $3.70 to $3.90, which assumes breakeven results for VADBe for the remainder of the year. This outlook is lower than our previous estimates, principally due to the first quarter VADBe charge as well as a decrease in the outlook for our group insurance business.
The outlook for our health care business is unchanged. We continue to place a strong emphasis on identifying additional opportunities to further improve our earnings for 2009 with a specific focus on reducing operating expenses. David will address our progress in this area in a few minutes.
Now, after David and Mike discuss the quarter and full year outlook in more detail, I will then comment on the very important topic of health care reform and its potential impact to CIGNA. The headline message is that, while the ultimate outcome of reform is difficult to predict, we feel that CIGNA is positioned to adapt to and capitalize on any potential opportunities from the evolution of health care in U.S.
So with that, I'll turn it over to David.
Thanks, Ed, and good morning, everyone. Today I'm going to review some brief highlights relative to our first quarter results and comment on our full year 2009 outlook for our ongoing businesses. I'll then offer some perspective on the current conditions in the health benefits marketplace, and finally I'll provide an update on the actions we are taking to further enhance our competitiveness as we continue to build for sustained profitable growth.
Let me start with the results looking at health care. First quarter 2009 health care earnings reflected favorable margins on risk-related products, due to effective pricing actions coupled with strong medical management results, partially offset by lower risk-based membership and lower net investment income. We maintained our pricing discipline and generated premium yields in excess of medical cost trends for both guaranteed cost and our experience rated books.
Our aggregate medical membership decline of 2.7% was generally in line with our expectations, reflecting higher levels of disenrollment. Importantly, our client retention rates remained strong in aggregate, validating our capabilities and value proposition continue to resonate well in the marketplace. Our service delivery was strong and consistent as we managed good results for employers, individuals, doctors and hospitals and producers.
Overall, our first quarter health care results reflected solid execution of the fundamentals, and we remain confident that we will achieve our full year expected earnings.
Turning to group insurance, results were mixed. Earnings in the quarter reflected unfavorable disability and life claims experience, lower net investment income and the unfavorable impact related to a catastrophic claim. Disability premiums and fees grew by 9% year-over-year despite a very competitive marketplace and challenging economic environment. This result demonstrates that our disability management value proposition, which focuses on helping people return to work more quickly, continues to be received very well in the marketplace.
Overall, our group insurance results continue to be competitively attractive.
Our international business results, includes the net unfavorable impact of foreign currency movements, primarily due to the South Korean won. In local currency terms, earnings in the quarter reflected strong margins in life, accident, supplemental health insurance business as well as the continuation of solid expatriate benefit results.
We continue to see good demand for our supplemental health insurance products as the growing middle class in Asian markets look toward alternate solutions to fill gaps in coverage that are left by local government programs.
Now let me provide some perspective on the current conditions in the health benefit marketplace and the potential impact of those conditions on our business. The challenging economic times have employers looking for solutions to help further manage their medical costs. These solutions are best delivered by matching competitive physician networks with base level clinical management programs. Then employers can either continue to shift more cost to their employees, reduce benefits or align benefits and supporting capabilities to encourage health improvement and informed purchasing by their employees.
We've seen some powerful results for employers and individuals when effective health improvement programs are designed and delivered. Recently we've seen increased interest in supporting capabilities, including on-site clinical delivery for employers as well as web-based coaching and care delivery. In this environment CIGNA is well positioned to meet employers' needs. Our approach is one of leveraging our knowledge of our customers and their employees to design benefit plans that align incentives and drive engagement of individuals to improve their health, which ultimately leads to cost savings for both the individual and the employer.
In addition, for small employers who do not want to be part of a risk pool, we have the ability to meet their needs through our unique product offering, which combines ASO and stop-loss programs with innovative reporting and insights for employers.
Finally, while the pricing environment remains competitive, our strategy is to continue our discipline of balanced growth and profitability.
I'll now provide an overview of our full year 2009 outlook for each of our ongoing businesses, starting with health care. The headline is our outlook remains unchanged for earnings. We continue to expect full year 2009 health care earnings to be in a range of $700 million to $760 million.
From a membership perspective we now expect health care medical membership to decline by 3% to 4% in 2009, a modest uptick from our prior outlook of minus 3%, reflecting the continued challenging economic environment. We remain on track to deliver a strong medical cost result for our overall book of business, including a material improvement for the Great-West book of business.
Before the Great-West book, as targeted, about two-thirds of the total medical cost improvement was completed by the end of the first quarter, and we continue to anticipate greater than 90% to be completed by year end 2009.
As we look to the full year outlook, we continue to expect health care earnings to increase meaningfully throughout the year due to a number of expense-related actions and other profit drivers, which Mike will discuss in more detail in a moment. In addition, we're taking actions to further improve our health care performance.
I'll next provide an update into the five areas I mentioned last quarter. First is new product development. We recently developed a number of leaner risk product offerings that we expect will accelerate growth in the second half of 2009. In many markets these products, which are more competitively positioned, will be available in the third quarter.
These improvements are driven by benefit designs that incent and encourage healthy behavior. In addition, they include features such as higher coinsurance amounts and leaner pharmacy benefits. We've also made changes to simplify our experience rated offering, which is unique in the marketplace as it provides our customers with the opportunity to participate in the claims experience and obtain cash flow benefits while retaining full insurance protection.
Second, we continue to make progress toward improving our total medical cost. In 2009, we've further invested in resources to favorably impact specific medical cost drivers. We expect to deliver meaningful improvements through lower utilization and unit costs in the following areas: outpatient professional fees, specialty injectables and implantable devices. Part of this improvement will be accomplished by offering targeted information and coaching channel members to high-quality, more efficient providers.
Third, we have identified our state and local government as well as Taft-Hartley segments as opportunities for additional cross-selling in 2009. Customers in these segments typically have long-term relationships, and have historically only purchased core medical coverage during the initial sale, thus creating significant specialty penetration opportunity upon renewal.
Our fourth area of focus is market expansion. We remain committed to growing our segments with particular focus on the Individual and Select segments, with select representing employers with 51 to 250 employees.
In regards to the Individual segment, we are currently selling in five markets and plan to enter an additional five markets by year end. To date, the response from brokers regarding our individual capabilities has been very positive, indicating there is strong market demand for our solutions.
In the Select segment we have the unique ability to grow through our differentiated product offering that we acquired through Great-West, which combines features of risk along with fee-based funding options. We expect these capabilities, along with our new, leaner product offering, will drive new business growth in this segment.
Finally, I'll provide an update on operating expense reduction initiatives. In regards to our fourth quarter charge, we are on track to realize our targeted savings in 2009. We've made good progress in executing the actions necessary to achieve these savings and expect to benefit from these actions to improve our quarterly earnings pattern throughout the balance of the year.
In addition, we're planning on taking additional actions during 2009 to further reduce our operating expense run rate and improve our competitive position in the marketplace. We expect to be in a position to dimension these actions and their related costs and benefits on our second quarter earnings call. Areas that will drive further expense reduction include improving our purchasing through vendor consolidation and lower service utilization, further opportunities for employment-related cost reductions, ongoing efficiencies achieved through effectively applying technology, and leveraging a fixed cost infrastructure, specifically real estate.
Let me emphasize while we are aggressively seeking opportunities to reduce expenses, we remain committed to maintaining our service levels for the benefit of our customers, our commitment to clinical excellence for the benefit of our customers and our commitment to invest prudently in technology for sustainable automation and efficiency gains.
In summary, the fourth quarter reduction charge was a first installment, and we are continuing our process of driving further operating expense reductions.
Turning to group insurance, as I referenced earlier, our first quarter results were impacted by loss ratio pressure and lower investment income. While the fundamentals of our book remain competitively strong, this reduces our full year outlook by $15 million.
Overall, we expect the impact from the economic downturn on our group insurance results to be manageable as our book papers recession-resistant sectors such as government, education and the health care industry. In addition, we continue to add clinical resources to address the impact of the economic slowdown.
For international, excluding the impact of foreign currency change, our outlook remains unchanged. We continue to expect full year 2009 earnings to grow by double digits on a local currency basis. We continue to see attractive growth opportunities in our life, accident and supplemental health business, especially in Asia.
In this business we offer individuals simple, affordable, risk-based insurance products such as hospital cash, critical illness and personal accident coverage that provide a fairly low-cost way for individuals to obtain health and financial security. Relative to expatriate benefits, we anticipate good growth opportunities now and into the foreseeable future as more companies seek to expand and diversify their market position throughout the globe.
To wrap up my prepared comments, in the face of a very challenging global economic environment, we remain on track to deliver good results. We are doing so by remaining committed to consistent and effective service and clinical results as we seek to provide cost-effective solutions for our employer customers and the individuals we serve.
Our client and individual retention rates remain attractive, and we're beginning to see some growth emerge in targeted areas. We are taking the steps necessary to ensure our ongoing competitiveness for the near and long term. And lastly, we remain committed to deliver our 2009 outlook.
At this point I'll turn the call over to Mike.
Thanks, David. Good morning, everyone. In my remarks today, I will review CIGNA's first quarter 2009 results and also provide an update on our full year outlook. In my review of consolidated and segment results, I'll comment on adjusted income from operations. This is shareholders' income from continuing operations, excluding realized investment results, GMIB results and special items. This is also the basis on which I'll provide our earnings outlook.
Our first quarter consolidated earnings were $188 million or $0.69 a share, compared to $265 million or $0.93 a share in 2008. By way of summary, our first quarter health care results include the favorable impact of our acquisition of the Great-West book and improved guaranteed cost and experience rated margins. While earnings for the group disability and life and international segments were below our expectations, both businesses continued to deliver competitively strong results.
Now I'll review each of the segment results, beginning with health care. First quarter health care earnings were $154 million. Year-over-year earnings growth reflects our acquisition of the Great-West book and improved margins on risk-related products due to effective pricing actions and favorable medical costs. These positive contributors were partially offset by lower medical membership and lower net investment income.
Our guaranteed cost MLR was 82.8%, excluding our voluntary business, and this result was better than we expected, primarily due to favorable medical costs and strong pricing and underwriting execution. Experience rated earnings also demonstrated year-over-year margin improvement, driven by strong execution of our underwriting actions, which generated pricing yields that exceeded medical trend. This year-over-year improvement also reflects the absence of the loss on the non-medical case that we discussed last year.
Our ASO book of business benefited from strong stop-loss results, including the acquired Great-West book.
Health care membership declined by 2.7% in the quarter, and the losses were more heavily weighted towards our risk-related products. Health care premiums and fees for the quarter increased 8%, primarily due to the Great-West acquisition and rate increases, partially offset by a decline in guaranteed cost and experience rated membership.
So, to recap, health care earnings were higher than the first quarter of last year, due to the acquisition of Great-West and improved margins on our guaranteed costs and experience rated products, tempered by lower membership and lower net investment income.
Now I'll discuss the results of our other segments. First quarter 2009 earnings in the group disability and life segment were $58 million. Excluding the benefit of the reserve reviews, Group's results were unfavorable disability and life claim experience, lower net investment income and the unfavorable impact of one catastrophic aviation claim. While we experienced an uptick in the disability and life loss ratios in the first quarter, we do not expect the first quarter results to be our run rate for the remainder of the year.
In our International segment, first quarter 2009 earnings of $41 million, include an unfavorable $9 million after-tax impact from foreign currency changes compared to the same period last year. This is primarily due to significant currency movement in South Korea, CIGNA's largest non-U.S. market. Excluding the adverse impact of foreign currency, international experienced attractive top-line growth, although there was some pressure on persistency in Korea and Taiwan, which is likely to be the result of economic conditions. The diversification of our earnings streams from our group and international businesses continues to be an important positive for our consolidated results.
Earnings for our remaining operations, including run-off reinsurance, other operations and corporate, totaled a loss of $65 million for the first quarter, and this includes a $47 million after-tax impact related to reserve strengthening of variable annuity death benefit, or VADBe product.
Of the $47 million charge, approximately $25 million was due to the decline in equity markets, primarily reflecting an increase in our provision for future partial [vendors]. The impact from volatility was relatively insignificant in the quarter at only $7 million after-tax, and this was obviously much improved compared to the $83 million after-tax impact in the fourth quarter of 2008.
In addition, the impact of lower short-term interest rates and unfavorable bond fund performance, both of which are unhedged, contributed approximately $15 million after-tax to the loss in the quarter.
I'll now comment on our investment portfolio and results. Overall, our investment portfolio continues to perform well. Our first quarter net realized investment losses totaled $24 million after-tax including $7 million of losses related to credit impairments. We view this as a strong outcome, given the challenging market conditions. Net investment income in the quarter was $21 million after-tax, below the fourth quarter 2008 actual results, and this decline largely reflect in the adverse impact of widening credit spreads on our investments in certain funds which invest in private company and real estate mezzanine debt.
Now, these investments represent less than 2% of our total portfolio and are reported as other long-term investments on our balance sheet. The decline in their carrying value reduced net investment income by $15 million after-tax in the first quarter as compared to the fourth quarter of 2008.
Overall, we do not consider the first quarter net investment income to be the run rate for the remainder of the year, since we do not expect additional material carrying value declines in these mezzanine funds over the balance of 2009. However, we are now projecting lower overall investment income for full year 2009, given the first quarter actual result.
Now, regarding our current commercial mortgage portfolio of $3.6 billion, first quarter performance remained strong. Overall, our mortgage portfolio continues to be well diversified by property type with the highest concentration in office buildings and the lowest concentration in retail. Consistent with last quarter, we have one $59 million problem loan in the commercial mortgage portfolio. All of the other loans in this portfolio are fully performing. To date we have not written off any proportion of this one problem loan as we continue to believe that the market value of this particular property is greater than our loan value. So overall, we continue to be pleased with our investment [management] results relative to current market conditions.
Now to discuss the CIGNA's capital management position and outlook, including a summary of our subsidiary capital and our parent company liquidity. By way of summary, we continue to have a strong balance sheet and good financial flexibility. Recently, both Moody's and S&P reaffirmed the financial strength ratings of our main operating subsidiaries, and we view this as further evidence of our strong capital position.
We ended 2008 with approximately $3.5 billion of statutory surplus in our domestic subsidiaries and a consolidated RBC ratio of approximately 550% of the authorized control level. Both the RBC ratio and the overall level of surplus are far in excess of regulatory minimums. Consistent with our previous discussion, we expect to manage our 2009 subsidiary dividends to increase our subsidiary capital to a level that's closer to our long-term targets.
Now I'll review our parent company liquidity. We ended first quarter with cash and short-term investments at the parent of approximately $50 million and commercial paper borrowing of approximately $375 million. During the first quarter, we made a $300 million pre-tax contribution to the pension plan and we'll receive the tax benefits associated with the first quarter contribution during the remainder of the year.
With respect to the full year outlook, I would first note there's no change to our expectations for full year 2009 subsidiary dividends or the expected year-end 2009 parent cash balance. We began the year with approximately $90 million in parent company cash, and for the full year we continue to expect subsidiary dividends of approximately $520 million, consistent with our February estimate.
This reflects our plan to retain more earnings in the subs to increase capital to a level that's closer to our long-term targets. Also consistent with our February estimate, we expect the pension plan funding to result in a net after-tax use of parent company cash of approximately $130 million for the full year. All other sources and uses of cash for the full year other than pension funding requirements are currently expected to be a use of $250 million to $300 million.
I will remind you that we do not anticipate having capacity for share repurchase in 2009, and as a result we currently expect our year-end 2009 parent company cash balance to be approximately $200 million. This assumes no material change in the company's total debt levels. And assuming credit market conditions are stable, we expect to issue long-term debt to repay our outstanding commercial paper. I'd also remind you that we have no long-term debt maturing until 2011. So overall, our current capital outlook remains positive.
I'll now review our earnings outlook. For full year 2009, we currently expect consolidated adjusted income from operations of $1.02 billion to $1.08 billion, which is lower than our previous range of $1.08 billion to $1.15 billion. We now expect full year EPS in a range of $3.70 to $3.90 a share, compared to our previous estimate of $3.95 to $4.25 per share. This updated outlook includes the first quarter VADBe charge and assumes that VADBe is breakeven for the remainder of the year, since we believe our current reserve assumptions are appropriate.
While run-off reinsurance results can differ materially from our estimates, we do not believe that 2008 results are indicative of a future run rate. The consolidated outlook also includes lower earnings for our disability and life segment, reflecting the lower-than-expected first quarter earnings and a reduced level of net investment income for the balance of the year.
Now I'll discuss the components of our 2009 outlook, beginning with health care. We continue to expect full year health care earnings in the range of $700 million to $760 million. While this range is consistent with our previous estimates, the components have been updated to recognize further pressure on membership mix, reflecting the challenging economic and competitive conditions, offset by better insured margins.
I'll now discuss the drivers of the expected health care results. We now expect total medical membership to decline by 3% to 4% for full year 2009. Regarding medical costs, we continue to expect trend on our total book of business to be in a range of 7% to 8% for the full year.
Relative to overall risk earnings, our outlook is not modestly lower than our previous estimates, and this partly reflects lower expected membership in our seniors' segment expansion. In addition, we now have a lower membership outlook for our core guaranteed cost business, partially offset by an improvement in the expected MLR. We now expect the full year MLR to be in the range of 84% to 84.5%, reflecting the favorable results in the first quarter and our continued strong execution on achieving pricing yields in excess of medical cost trend for the balance of the year.
Regarding our experience rated book, we continue to expect approximately flat earnings in 2009, excluding the first quarter 2008 charge related to the non-medical account. We expect the improved profit margins on this product to approximately offset the impact of lower membership.
Relative to ASO and specialty earnings, our 2009 outlook is now somewhat stronger than our February estimates. We now expect more favorable stop-loss and specialty contributions.
Regarding earnings progression throughout 2009, we continue to expect a considerable increase in earnings over the course of the year, driven by several key factors. First, due to the nature of the Medicare Part D product, we experienced an after-tax loss of approximately $7 million in the first quarter, but expect the full year result to be a small gain.
Second, we expect the net investment income decline in first quarter of approximately $10 million after-tax to improve in the latter three quarters of the year. So, if we normalize first quarter results to adjust for the impacts of Medicare Part D and net investment income, we get a full year run rate of approximately $680 million. Now, we expect an overall improvement relative to the $680 million run rate in the balance of the year.
On the one hand, we acknowledge pressure due to lower membership and a higher guaranteed cost loss ratio relative to the first quarter actual result. However, we expect this pressure to be more than offset by two major items. First, we expect further operating expense improvements in the balance of the year, and this includes the impact of lower transformation amortization expenses of approximately $25 million after-tax in the second half of 2009.
And second, we expect additional earnings growth over the balance of the year from our specialty businesses, including stop-loss. Specifically, we expect the stop-loss MLR to continue to improve as we realize the benefit of our total medical cost improvement initiatives associated with the Great-West book. So overall, we continue to expect full year 2009 health care earnings in a range of $700 million to $760 million.
I'll now discuss the outlook for our other businesses. We now expect our 2009 group disability and life earnings to be approximately $15 million after-tax, lower than our previous expectation of flat earnings. This decrease in the outlook is primarily driven by the lower first quarter earnings and a lower outlook for net investment income.
Our international earnings outlook is unchanged. We continue to expect to grow in the low single digits in 2009, driven by strong revenue growth in margins, largely offset by the expected negative impact of foreign currency exchange rates, particularly in South Korea.
So all in, we expect 2009 consolidated EPS in a range of $3.70 to $3.90 a share, and this assumes that VADBe is breakeven for the balance of the year.
So, to recap, or first quarter 2009 health care results reflect the impact of the Great-West acquisition and improved guaranteed cost and experience rated margins.
Overall, we continue to expect to achieve our full year 2009 health care outlook. Our group disability and life and international businesses continue to deliver competitively strong margins, and we expect both businesses to grow earnings in the balance of the year. Our current capital outlook is strong, and our investment management results continue to be competitively attractive.
With that, I'll turn it back to Ed.
Thanks, Mike. I now want to comment on health care reform and then conclude with a few overall observations. Regarding health care reform, I'll start by noting that CIGNA is actively invested both in the debate around the future of our health care system as well as the pursuit of new and enhanced capabilities required to succeed going forward.
At CIGNA, we believe that every American should have access to affordable quality health care. That goal cannot be achieved without first understanding and addressing the true drivers of health care cost. We believe the employer-based system, through which more than 150 million Americans gain access to a choice of innovative health plans and benefits, should remain the primary source of coverage for working individuals and their families. We also believe that a coordinated public and private partnership of all health care stakeholders is critical to creating a value-driven market.
Now, relative to the outlook for reform, a few thoughts; while it's not possible to definitively predict what reform will look like, some potential themes are emerging. First, future Medicare Advantage reimbursement rate cuts are probable. The recent announcement of final 2010 rates, I think, is a good indication that this is an area of focus for the administration.
Second, we are likely to see reform that will provide access to affordable health care for some portion of the 45 million uninsured, potentially, through individual and small group product offerings.
Third, there is the potential to have a national insurance exchange, which could possibly include a government-run plan to compete with the private market. Any proposed government plan faces considerable obstacles, and the construct of such a plan is very uncertain.
Fourth, we believe that America's Health Insurance Plans or AHIP, and related industry-sponsored reform proposals, which address topics like guaranteed issue, modified community rating and enforceable individual mandates, can be effectively delivered through the employer-based system and this would call into question the value of a new government plan.
While the ultimate outcome of reform is difficult to predict, we feel that CIGNA is positioned to adapt to and capitalize on any potential opportunities from the evolution of health care in the U.S. Specifically, our risk relative to the recent Medicare Advantage rate reduction is limited, due to our small exposure to Medicare membership. In addition, we believe our growing capabilities to provide individual coverage makes some aspects of reform, such as improved access for the 45-plus million uninsured an attractive growth opportunity for us in 2010 and beyond.
Finally, specific to reform that may focus on health outcomes, I would add the notion of improving health and wellness to blend the medical cost curve aligns very well with CIGNA's strategy and our business model.
CIGNA will continue to play an active role in the discussion on health care reform as part of a coordinated industry effort to develop market-based solutions that leverage the capabilities of the employer-based market. We are encouraged that our efforts to engage and inform the members of Congress are gaining traction and that there is an improved recognition that legislators and other stakeholders need to address not just the issue of access, but the cost and quality of health care as well. It is clear that our efforts to date have helped ensure that the industry has a seat at the table, and we are pleased to be part of a coordinated industry effort to work towards an improved health care delivery system.
Before we take your questions, I want to underscore several points. First, health care results in the quarter are consistent with our full year outlook and reflect sound execution of the fundamentals.
Second, we are focused on identifying further operating expense reductions.
Finally, our capital position is strong and we expect to have the financial flexibility to deal with the current challenges in the capital markets. In addition, our investment portfolio is of high quality and is well managed.
In conclusion, we are confident in our ability to achieve our full year earnings guidance for our ongoing businesses and continue to improve our competitive position, thereby creating value for the benefit of our customers and our shareholders.
That completes our formal remarks, and we will be glad to take your questions.
(Operator Instructions). We will go first to Josh Raskin of Barclays Capital.
Josh Raskin - Barclays Capital
First question just on the COBRA, there was no real mention of that and understanding the large majority of your business is in the service, your thoughts around any potential impact this year?
Josh, this is David. Relative to COBRA, first off, we did not see a major impact of COBRA in the first quarter. We do see some uptick in acceptance rate based on the federal subsidy, and we are tracking a little bit of erosion in disenrollment offset by a little bit of an uptick in the COBRA results. But we don't see a material swing to date relative to the overall performance of COBRA thus far.
Josh Raskin - Barclays Capital
And I guess as you review the cost trends even for your self-funded accounts, are you seeing any changes in utilization patterns or even severity of utilization in those cases in periods prior to layoffs or sort of even before the COBRA kicks in for some of these members?
This is Mike. At this point we are not experiencing any sea change in our underlying medical cost trends, and hence we're maintaining our full year outlook for the total book of business in that range of 7% to 8%. And I would emphasize that the first quarter data is very immature and the economic impacts that you are referencing are still uncertainties, but to date, we have not seen evidence of an uptick in trend from the factors that you are describing.
Josh Raskin - Barclays Capital
Just a quick follow-up on the pension funding. I'm sorry; did you say you made a voluntary contribution of $300 million, but the net impact on full year parent cash was going to be $130 million? I was just trying to reconcile or maybe did I mishear something?
Sure, Josh. First of all, the contribution in the first quarter was $300 million of cash. So that's a gross number. It's pre-tax, and it's pre-contributions from the subsidiaries. So the full year number that I was referencing of $130 million is after-tax, and it's after the contribution from the subsidiaries.
So in other words, just to round out the pieces, the gross contribution for the full year is expected to be around $400 million, and we would expect a tax benefit on that gross contribution of approximately $160 million, and the remainder would be the amount that we would collect from the subs that would help fund the $400 million overall full year contribution, which, again, would be pre-tax and would be pre-subsidiary contribution.
Josh Raskin - Barclays Capital
Is it a good way to look at it $240 million going out of the overall entity?
$240 million after-tax is our current estimate for the full year going out of the entire entity, but I think it's important to note that only $130 million of that is funded by the parent. The remainder is funded from collections from the subs that would be part of the normal operating company subsidiary cash flow as opposed to having to be funded out of the subsidiary dividends.
Josh Raskin - Barclays Capital
That puts you in a better funding status that you would anticipate further contributions in years to come, is that fair to say?
That's correct, Josh.
Our next question comes from John Rex of JPMorgan.
John Rex - JPMorgan
I wonder if you could just provide us some perspective on the performance of Great-West as you look at it now versus kind of your early expectations when you were closing the deal, may be along metrics of both of the earnings contribution that you've realized from it and the retention, and give some comments again as you're looking at it in '09? I know you're not breaking it out specifically still, but it's a pretty important piece.
John, it's Mike. I'll start and I'll ask David if he wants to add. The overall headlines for Great-West, is that we are tracking in aggregate for Great-West relative to our most recent earnings projections. Although, as we've talked about before, increasingly this has become integrated into our health care operation, so our ability to get a precise, auditable Great-West P&L is becoming more and more limited.
What I can tell you is that our outlook now for full year 2009 is for an improved medical loss ratio on the stop-loss book, even relative to what we expect in three months ago and this reflects the factors that both David and I talked about, and that is specifically we made very good progress on giving a Great-West access to the benefit of our total medical cost improvements and we are seeing that show up in favorable loss ratio result in the first quarter and we now have even better visibility into a stronger loss ratio for the balance of the year.
Now it is fair to say that there is pressure on the membership in Great-West and so round numbers we're now expecting the full year Great-West membership to decline by approximately 14%. Again like I said that's sort of a number that's more art than science. It's now part of the more integrated ASO book, but again round numbers that would be modestly worse than what we had expected before mainly because of pressure on the new business sales as opposed to (inaudible). David, do you want to add?
John, good morning guys. Just to add a couple of points around the fringe of that. You asked in terms of the overall view now that we got the company for better part of the year, strong positives on people, distribution relationships as well as the relationships with the delivery systems, hospitals, the physician community as well as the product features are strong positives that have come through.
Mike referenced earnings and reinforced the growth point. Our expectation was to improve the overall proposition that Great-West has by delivering the medical cost improvement that is largely in flight now, improve the product features by offering some of our specialty capabilities, and we believe that will help to drive some of the emerging growth, that we need to bring out in the Great-West book of business, as we look forward.
John Rex - JPMorgan
When you look at the membership kind of compared to when you brought, I mean where would you be down now like at roughly 35% or so or?
John, its Mike. First of all, it would not be that high. Second, again all members will not treated equally so that we have lost a number of members in their TPA arrangements where they had negotiated with other managed care organizations, particularly TPAs to allow those other entities to use the Great-West network. We have lost a significant amount of those particular members; those were not particularly helpful in terms of contributing to earnings and were much more focused on retaining the full service ASO members that have stop-loss.
So I don’t have the precise number again, I’m back to my earlier point. This has become more and more part of the integrated organization as opposed to a standalone set of financials, but again, in fairness, back to your original point, I think it's fair to say the big positive, from an earnings standpoint, has been the positive loss ratio. There has been pressure on the membership. We were very excited about the people in the distribution relationships that that would be added as well.
John Rex - JPMorgan
Just a follow up on COBRA so, how did you bring COBRA into that? Do you assume it’s kind of that adoption rates stay about where they were or kind of how did you think about that in developing your health segment outlook for ’09?
John, its Mike. The COBRA overall is a relatively insignificant part of our overall book. Keep in mind, a couple of things. First of all, overall COBRA membership is only approximately 1% of our total book. We have a little over a 100,000 COBRA members and exactly how sticky they will be in this kind of environment versus those members finding individual coverage, for example, is really unclear, but it’s a relatively small number in terms of our overall book.
Importantly as well, John, over 80% of our COBRA members are ASO so that we don’t have the kind of medical cost impact that others with a much larger fully insured book would have so. It really is not a big deal, it's not a big earnings driver for us.
John Rex - JPMorgan
This split fairly even like of 80%. So it kind of represents your overall membership mix in terms of the split. Do you look for that to be higher? So at the end of the year would you expect that 1% to be 1.5% or you kind of expect it to still be in that range as you end '09?
John, its David. We expect it to grow a little bit, but modestly. We expect it to grow a little bit as we look at the disenrollment pattern driven by unemployment. If unemployment goes from 9% to 10% in the year at least what we're seeing right now the COBRA uptick that could potentially offset a portion of the unemployment impact. So it will uptick slightly as Mike said it will pattern relative for a book of business on heavily ASO oriented.
Our next question comes from Justin Lake of UBS.
Justin Lake - UBS
A couple of questions. First on, just wanted to get your view given the PBM news at WellPoint recently on your in-house PBM capabilities, may be you can give us some color around the way you think you're buying versus the market and where you kind of saw the buying power with that combination and maybe outline the operating profit contribution from PBM there and kind of your thoughts on how structurally you view that as a part of the business?
Justin, this is Ed. First of all we say consistently and it continues to be true today that the PBM is an integral part of our value proposition, particularly our integrated value proposition and particularly attractive in the middle market where we see lots of packaged buying.
Now we have historically looked at the PBM on a regular basis, benchmarked our performance of the PBM to the standalone PBM and kind of consistently concluded that it was best value for shareholders to retain that. We will continue to do those reviews and continue to benchmark the performance of our PBM. But in areas like generic substitution, the performance of our mail order, the penetration of our mail order, our statistics there, Justin, are very strong. So it continues to be a very strong earnings contributor for us as well as a very strong part of our integrated value proposition.
Having said all of that, we will continue to look at that and evaluate based on what’s happening in the market broadly, whether continuing to own in ourselves is ultimately the best outcome for shareholders. So at this point in time, it's been very clear to watch that that has been.
Justin Lake - UBS
Could you just outline the operating profit and the mail order penetration numbers that you talked about?
Justin, it's David, we typically don’t break out the operating profit in detail. Let me give you a little bit of some of the supporting statistics you are looking for though. So, for mail order penetration, you know the business while it's difficult to do comparables especially since our guaranteed cost book is so small and our ASO book is large.
But our penetration rates are in the mid to upper 20s in terms of overall generic substitution rate is in the very high '60s, which you can compare relative to any threshold. Our medication compliance rate are in the upper 80 percentage rate in terms of the clinical quality. With that reference, it’s a highly integrated proposition. So when we look at the benchmark competitors, we [react] quite strongly from some of the clinical indicators there.
Justin Lake - UBS
Just one other question on the impact of the economy to the business, you’ve outlined a membership here. Are you seeing any impact to your ability to upsell whether it's Great-West or in your middle market books, national accounts books to the secondary products because of what’s going on in the economy?
Justin, its David. I am going to give you a yes and no answer. So, we’ve seen impact. In some cases there is a negative impacting your ability to upsell as employers are you know looking at every opportunity to offset total cost in a given year. Conversely as employers are looking for means to offset their medical costs, take disease management, take some clinical integration programs for middle or large employer, usually benchmark is their own experience.
So you could demonstrate to them whether or not there is an ROI in 12 months and that aids the selling proposition. So absolutely an impact, a more acute focus on not only the ROI, but the payback period, which makes it a very consultative rich sale out in the market place today more than ever. Ed, do you have a point?
I was just going to add, David, that the other thing I think we've seen consistently is as opposed to what we might have experienced two or three years ago with standalone products, what we had seen in this movement towards more integrated programs. And so they are more efficient, they are likely more cost effective and they have better outcomes for people. It also advantages somebody like us who can bring that integration up there. That's also a trend and I think its probably been accelerated a bit by the economic challenges.
Our next question comes from Matthew Borsch of Goldman Sachs
Matthew Borsch - Goldman Sachs
I just wanted to get your outlook on the what you see in the credit markets now, specifically as it relates to your commercial paper access and crafts if you can comment the timing of your thoughts on rolling out long-term debt to replace that and generally the current credit market impact on your investment portfolios?
Matt, it's Mike. First, in terms of our commercial paper, we continue to be real pleased with the trends that we've seen really since late 2008 in terms of availability of paper and also the rates that we have related to that paper specifically in terms of paper that we had outstanding as of March 31st. Our average rate on the total amount outstanding was approximately 2.1%, and obviously that significantly improved from some of the dark days in fourth quarter of 2008.
I see no evidence that would get worse anytime or soon. Obviously, I don’t have the crystal ball, but I don’t see any trends that would make you feel concerned about that.
In terms of issuing long-term debt that something obviously we're evaluating as we speak obviously we will have a window once we issue the first quarter financial statements.
So we would look very carefully at the window hearing in early May. I think it is more likely than not like I had characterized it as probable, but in fact we will do that in early May. But again that something that we'll evaluate over the next couple of weeks and make a final decision at that point, and obviously, we would announce if in fact we were going forward with that. We would obviously announce that at that point in time.
In terms of the overall credit markets and the impact on our $18 billion investment management portfolio. Again things have been reasonably stable since the beginning of the year. There've obviously been some pockets of softness. But, again as a general rule, I would characterized it as more stable certainly than some of the negative trends that we saw late last year.
Matthew Borsch - Goldman Sachs
And could you comment on any VADBe impact that you've seen so far this quarter?
Sure. Obviously it's early in the quarter. But I think it's fair to characterize the VADBe results here in April as favorable. Obviously we've benefited from the favorable stock market performance in April, a volatility has been reasonably well behaved as well. So, again way too early to give any specific point of view for the second quarter, but certainly to-date April has been helpful.
Matthew Borsch - Goldman Sachs
And may be if I could sneak in one last question. In terms, on the health care business in terms of what you see incrementally as compared to your last quarter updating early February in terms of the intensity of price competition on the risk side and also on your ASO book?
Matthew, good morning. It's David. We continue to see the pricing environment as competitive. I would not say the intensity has changed markedly in either direction over the recent past as you should know in your loss ratio relative to our premium yields.
So, we’ve stuck to our underwriting and pricing discipline, and feel good about the rates we’re able to secure. Some impact on the retention rates within the book of business as you might imagine, some impact in terms of somewhat lower close ratios. So overall, still competitive marketplace and that we’ve not seen any marked change for either ASO or risk over the last quarter.
Our next question comes from Charles Boorady of Citi.
Charles Boorady - Citi
Can you update us perhaps on your progress in growing the individual and small employer business, maybe how the enrollment is trending. Any regional successes or failures that you had loss ratio experience in that new book. Any investments you’ve made on admin side to try to grow that business?
Charles, this is David. So overall, we are early into the process, relative to the two segments you referenced individual and small. Our primary focus, given market conditions is disproportionate to the individual block of business right now. As I referenced in my prepared remarks, we are in five markets as we sit today and with some sharp focus, we will enter an additional five markets throughout the course of the year. Early signs within the markets we’re playing in. Our growth trajectory is on track with what we want out of the individual market. Volume is actually pretty high. Broker activity and inbound volume is pretty high. Close ratios are reasonable and new business growth is in line with our 2009 trajectory for that block of business.
As it relates to loss ratios, given the early part of the year and the newness of that block, it would be premature, but early indicators in terms of rate ups and rate downs. We feel pretty good with what’s on the books, but we’re all cautious around that. As it relates to your reference relative to administrative investments as you might imagine, as you’re doing market entries, there is additional investments in people. There is additional investments in marketing, support, et cetera. So we’re being targeted in those key geographies; the five we are in and five additional that we’ll drive in the marketplace.
As a final note, this is led by a dedicated segment, within the organization and so we’ve the focus because the distribution channel is different, the product is different and that’s part of our ongoing investment.
Charles Boorady - Citi
That’s very helpful. As you look at your overall enrollment declining, can you paint a trajectory or sort of where’s the individual and small business? How is it compounding and is there a point at which the growth in individual and small will be great enough to offset the fairly sharp declines that you’ve seen recently in enrollment or do you feel like you’re going to need to resort to M&A again as a source of longer term enrollment gains?
Charles, I’ll start, relative to individual and small, so let’s parse the segments. We talk about a select segment which is 51 to 250 life employers, small, 2 to 50 in individual, we expect net-net about 30,000 additional lives in the individual segment this year. That’s consistent with our expectation. So will that swing the bar for us this year on an overall membership base? No. But 30,000 life contribution is meaningful and we expect that we will actually still shrink our 2 to 50 book as we reposition in two geographies and (inaudible) harvest that book and have a few targeted entries.
As we look forward in 2010 and beyond, we're actually quite excited about the growth opportunity in the individual, both the volume as well as the revenue and earnings contribution that goes along with that book of business, which is why we're taking the gated approach.
My final comment would be, we would expect to see more contribution from the select segments. You heard Mike reference before relative to Great-West as well as myself, that 51 to 250 life employer with the benefit of both the ASO product from Great-West and our leaner guarantee cost product we expect will be a contributor as we look to 2010 and beyond.
Charles Boorady - Citi
Just one balance sheet question and I'll drop on, page six of the stats, in reference to the valuations on the mortgage loan portfolio references the deterioration, the economic conditions. This is the third quarter of '08 and for more information refer to the 10-Q for March '09, which I haven’t found filed yet, but I’m wondering is there something in there that would lead us to a materially different valuation than the $3.6 billion that you've got on your balance sheet for the commercial loan portfolio.
Well, this is Mike. The short answer is no. There is nothing in the disclosures that would cause us to want to write down further of the $3.6 billion. All we were attempting to reference there is that the values, which were calculated as part of the third quarter 2008 review and have only been updated subsequent to that for specific properties that are either probable unlike the one that we have or potential probable that we recognize that those owned values are some what stale and we'll likely then get updated as part of the third quarter 2009 review.
As I've discussed in my prepared comments, we only have one loan that is delinquent. We expect on that particular loan since the fair market value of the property is stronger, is higher than our loan value that we expect that at the end of the day to be money good, even if we have to foreclose and take it ourselves.
We will go next to Christine Arnold of Cowen.
Christine Arnold - Cowen
Hi, couple of questions. First, was there any positive development in the quarter related to ’08 in your healthcare division and ay of the major line items?
Christine, it's Mike. The short answer is nothing material overall prior year development for the quarter was literally a unfavorable $2 million after-tax; there was $1 million guaranteed cost, there was $1 million in Medicare, there was $1 million voluntary unfavorable. The piece of favorable news, we had $1.5 million after-tax favorable in the behavioral business. But again, I would consider all those immaterial.
Christine Arnold - Cowen
And then, I think it was down a little bit, but I just want to understand your assumptions. Can you tell me if my assumptions are wrong with the way kind of COBRA works. So my understanding is that, in groups of over 50, people who’ve been laid off between September of '08 and today, are going to get a letter saying you can join COBRA and you can do it 60 days retroactively. Is that your understanding?
Christine Arnold - Cowen
So, help me understand, if an individual got run over by a truck last week. If the member you didn’t have and yet you are going to be viable for those costs, true?
Christine, it's David. First, we reference before the size of our current COBRA book, Mike referenced about 100,000 lives to. I will just re-highlight the profile of our book of business as we are greater than 80% ASO and working hand in glove with managing our employers' relationships.
Is what you describe possible? Sure, that's possible. Thus far through the first three months of the year, we have not seen any acute movement in the COBRA book. We've seen some growth, for sure. We've not seen any patterns, client specific, loss ratio specific, etc., that have bounced out of proportion yet, relative to those type of events.
Christine Arnold - Cowen
Couple of questions on this. When did the letters go out for your employers, inviting people to join? And I guess my issue is with reinsurance. Since the consultants are urging employers to make sure that the reinsurance covers these retroactive events, I'm trying to figure out there's exposure there, so if you could specifically address those questions. I think that would be helpful.
Christine, it's David. I'll start. I don't have the level of detail that you're referencing at my fingertips in terms of when the letters have gone out, what's transpired. As for a clarifying point, when you say reinsurance, are you referencing stop-loss programs that might be [hatched]? And our stop-loss programs as a reference if it's an ASO employer?
Christine Arnold - Cowen
So, relative to the latter point, again, if we are managing it hand in glove relative to an ASO employer, to the extent we are dealing with a middle-market employer that has an ASO relationship or if we are in the select segment with an ASO relationship, we will be managing that overall cost profile, just as we would with any other individual for that employer. Remember to the logic pattern you use, there's also a finite life relative to the design of the program as well as how long an individual could be on this with this subsidy. The point I would come back to is, thus far we've seen an uptick of COBRA lives, not a sea change within our portfolio.
Secondly, we have not seen or ASO employers or within our guaranteed cost medical cost trends, any discernible movement, stop-loss, guaranteed cost or ASO trends. And as a final note, Christine, for our largest employers, we have a team of medical economists that actually go through their individual case level on medical trends and provide quarterly, if not monthly consultation. Ed?
Christine, the only other thing I would offer, and obviously, we don't know this yet, but the subsidies are pretty significant here and so one of the things that we don't know yet is how the risk pool will change. COBRA has historically been not very attractive, as we all know. And that has largely been because there has been a tremendous adverse selection, given the cost associated with it. One of the things we don't know is what the risk pool will do when you have people who suddenly have a 65% subsidy. You may actually get an improvement in the risk pool. Again, way too early to know that, but that's something we'll watch as well.
Our next question comes from Greg Nersessian of Credit Suisse.
Greg Nersessian - Credit Suisse
First question on the disability and life outlook, I guess, relative to our estimates, it doesn't look like the miss in the first quarter is being projected forward. Is that sort of consistent with your internal view? Why wouldn't the unfavorable claims experience persist through the rest of the year?
Hi, Greg. It's Mike. First, your overall headline is right. Second, in terms of your question on why would we not expect it to persist, remember, there were a lot of factors that hurt first quarter, and most of those factors we don't expect to be run rate items for the balance of the year. So just talk through a few of those. First, net investment income declined sequentially for the CIGNA Group insurance business by approximately $4 million after-tax. As I referenced in the prepared remarks, over half of that relates to these mezzanine investments that we took a hit that we don't expect to be the run rate for the remainder of the year. So that piece we view as a first quarter-only item.
Second, we did have a number of people insured as part of the plane accident here in Buffalo, New York. That cost us $3 million after-tax in the quarter. Again, we don't expect that to be the run rate going forward. The life loss ratio bounces around quarter-to-quarter. Specifically, it bounced unfavorably here in first quarter. It's bounced favorably in the past. Just as I've said in the past, I'd suggest that you not overweight the good news, I'd suggest you not overweight the bad news on the life business in the quarter. That was worth approximately $4 million after-tax.
And then the disability loss ratio also increased in the quarter relative to full year 2008. That was worth approximately $4 million after-tax. We do hypothesize that it is probably related to the softer economy. On the other hand, we have a good history here of when we staff up the disability management organizations, they do a particularly good job of helping people get back to work. Therefore, I don't believe that the first quarter run rate for 2009, that was worth the $4 million, is again the new run rate going forward.
Greg Nersessian - Credit Suisse
Second question is just on the VADBe. I guess back in March you had indicated you thought the charge is going to be as much as $80 million after-tax, a little bit less than that. If you could talk to what changed from that initial view? And then on the partial surrenders, how should we think about that going forward? Do you think that you've captured the threat of partial surrenders right now with the current reserves, obviously depending on market conditions, but do you think we could see some additional charges as we move through the year?
Greg, it's Mike. In terms of your first question on why was the VADBe charge in first quarter lower than our last 8-K, specifically the big driver there was the improvement in the equity markets over the remainder of March. Actually, again, the good news is that that's continued into April as well. Now, who knows what it's going to be going forward, but specifically, the equity market decline was less than what we had built into the last 8-K. As a result, the reserve strengthening that we had to do for future partial surrenders was less at March 31st than we had estimated earlier in the month.
In terms of your question on partials experience and probability of any kind of future reserve strengthening, a couple things I would note there. First of all, the first quarter 2009 experience was in line with our reserve assumptions. Now, specifically remember that our reserves automatically pick up the drop in the equity markets. So when the equity markets drop, we increase the reserve formulas, automatically assume an increase in expected future partial surrender rates because of the higher balances that the annuitants have.
Also, remember the reserve formula is based on rolling 12-month actual experience. So the good news there is that the first quarter '09 actual experience that's now part of that 12-month rolling formula was in line with the reserve assumptions.
So at this point, no negative news here in first quarter relative to new partial surrender experience data. In terms of what it's going to look like over the course of the year, again, I've told you everything I know at this point. I think the fact that our reserve balance reflects the lower stock market and the fact that in the past the lower stock market has led to higher future partial surrenders. The fact that we've got in there in the reserve balance, the present value of all of these future partial surrenders in the future, based on the current reserve assumptions tells me that I believe that our current reserve balances are appropriate. Again, there's a lot of uncertainty here and we'll obviously give additional updates in the future.
Our next question comes from Scott Fidel of Deutsche Bank.
Scott Fidel - Deutsche Bank
First question, if you can update us on the performance of the experience rated book in the first quarter, how pricing tracked, underwriting margins relative to expectations? And then the percentage of accounts that are in deficits and how just recovery efforts are tracking just relative to the economy?
Scott, it's Mike. First, the overall headline is that the first quarter experience rated results in fact were better than we had anticipated on most of the measures that you're asking about here. So for example, the medical loss ratio on the ER book improved sequentially. It improved relative to first quarter of 2008. So from a loss ratio or a margin standpoint, first quarter was better than expected. Specifically in terms of the pricing actions, we did secure strong renewal price increases. Specifically, we secured an average renewal price increase on the 64% that renewed in first quarter of 10.1%. Obviously, that 10.1% is, round numbers, approximately 250 basis points better than we expect the underlying medical cost trend to be.
In addition, good news, the first quarter medical costs were actually modestly better than we had expected as well and so, hence, better profit margins in the quarter than we had anticipated.
In terms of your question on margins and deficits, as we ended first quarter, 68% of the accounts were in surplus, 32% in deficit. The cumulative deficits at this point are $130 million. Again, that $130 million has already been fully charged to earnings to the extent that we can recover more of that in the future. That would be positive good news. The only couple of pieces that I would mention that were headwinds, the persistency ended up being a little bit weaker than we had expected. The persistency ended up being 84% for the first quarter renewals. It was specifically 67% for the deficit cases.
Again, my hypothesis there, not yet fully proven, but would be that with the soft economy it's been tougher to get deficit recovery. Again, 67% is certainly not a terrible result, and actually pretty close to in line with what we saw, for example, in first quarter of 2008, but that would be an area that's a little softer than historical averages.
And then the other point is we've referenced before the new business volumes for the experience rated book have been a little bit light. And so as a result, first quarter membership was down 7% relative to year end '08.
Scott Fidel - Deutsche Bank
Then just a follow-up, are you building into the commercial MLR, the guaranteed cost MLR, any changes in seasonality this year just relative to pickups in high-deductible membership? Clearly some of your competitors have already cited building in higher MLR views around a ramp in the back half of the year for that. Just your thoughts around seasonality in the GC MLR?
Just also, if you could update us on what percentage of your members are in high deductible plans, may be in 2009 at this point relative to 2008? Then also, just related to that, where your CDHP membership stands now in the first quarter compared to 4Q?
Scott, it's Mile. I'll start and I'll ask David to add. Specifically, on the guaranteed cost MLR, yes, you are right. We are not assuming that first quarter is the run rate for the full year, and part of that reflects the fact that we do expect there will be additional upward trend pressure in the second half of the year, particularly fourth quarter, related to the high deductible plans. So, as an example, in first quarter our loss ratio for the guaranteed cost book was 82.8%.
As I referenced, we are modeling out a full year number in a range of 84% to 84.5%. Specifically, we are modeling a 100 basis point uptick in fourth quarter of '09, specifically related to the high deductible plans that are more popular to date than they have been in the past. David, do you want to add?
Relative to your questions, the percent of the book that's in CDHP, and we define it as fund-based, not just high-deductible but fund-based programs. Think about, by the end of 2009, about 10% of the book, just slightly less than 10% right now, highly concentrated in ASO, because our focus as we built that book of business was ASO funding mechanism. Year-over-year growth, Q4 to Q1, were up about 11%.
Then lastly, just by way of color, we continue to see very good demand and interest for employers around CDHP as they are looking for alternatives as a means to engage their employees and control cost.
Scott Fidel - Deutsche Bank
One last follow-up, just a question on high dollar claims and what you were seeing in the first quarter. You saw some of those in 2008. It looks like MLR came in nicely though in the first quarter. Then just particularly relative to that, are you seeing any pickup in terms of intensity in facility claims in the $10,000 to $50,000 range, so essentially just right below stop-loss range or the catastrophic range?
Scott, it's Mike. I'll start. On your specific question on cat claims, it is fair to say that first quarter '09 was a favorable quarter for us in terms of cat claims. We saw that specifically show up as a benefit in the favorable guaranteed cost loss ratio. We also saw that show up as favorable stop-loss results, favorable stop-loss results in the ER book and the ASO book, etc. Now, I would point out that in our full year guaranteed cost loss ratio, we are anticipating a more normal trend. So we have not assumed that that favorability will continue in Q2 through Q4. David, did you want to add?
Scott, relative to your intensity question, in the first quarter, general answer is no. We saw a little uptick in inpatient, offset by a little downtick in outpatient. So overall facility claims relative to the book of business were in line with our expectations.
Our final question will go to Ana Gupte, Sanford Bernstein.
Ana Gupte - Sanford Bernstein
Outside of the layoffs, I wanted to explore the commercial membership patterns and the sources of the losses that you're seeing in the recession. So the first one is, given you have a down market self-funded product, are you seeing any change in the employer behavior in terms of moving from fully insured to self-funded? Is that part of the reason you're seeing a decline in Great-West?
Second, related question was you've talked about low-cost, guaranteed cost products that are being adopted and I swear you had an uptick in your voluntary product. We've been hearing that employers are reaching a point, the small employers, where there is not much more opportunity to buy down. Do you see that any inhibition can still keep them in the game, or would they move to may be a defined contribution option or just get out of health benefits altogether?
Ana, it's David. I'll start. You have several questions there just relative to purchasing patterns and what's happening down market. So first general thing we see, we continue to see the ASO or self-funded mechanism moving down in average employer size, and that's why we were so interested in the Great-West capability for the 51 to 250 life employer. So we continue to see that. We do see some conversions. We track them as conversions, between guaranteed costs, so if we are not renewing a piece of business as guaranteed cost, do we lose it or does it converge to an ASO with a stop-loss? So we do track that and we do see some activity there.
The second part of your question goes towards the leaner benefits and what's transpiring. First, from our book of business, since we have historically not played heavily down market, it's relatively a new space for us, and we need to make sure we have appropriate lean benefits for that market, and those benefits could be designed good 10 points leaner in terms of benefit design than what historically a 1000-life employer might be looking at. So when I referenced in my prepared remarks leaner benefits, it was speaking to that portfolio.
We do see an uptick in interest in voluntary benefits and moving the voluntary benefits from what you all just might know as traditional [mini-med] to more complete benefits. You could think about a benefit program that might be positioned between a [mini-med] program and a traditional program. We see employers interested in that and having dialogue today, but it's early to call whether or not that's a trend. We are pleased that we have the capabilities, between our Star HRG acquisition and our traditional programs.
I think my final point for you would be, we'd expect to see employers looking creatively at alternatives, whether they are modified, voluntary, CDHP down market or leaner benefit alternatives.
Ana Gupte - Sanford Bernstein
Just a quick follow-up. Is that a product in between translate to something like $150 PMPM? And just on the member side, are you seeing healthy, active independents dropping out and just for you and the other players, is there a threat of adverse selection as we move into the rest of the year?
Ana, I'll start. First off, relative on the product, you hit it pretty much on the head. So I think about the $150 to $180, very immature marketplace. In fact, one state program has piloted a similar benefit design down in the Southeast relative to about an $1,800 benefit for full year, covering wellness prevention and catastrophic care. On your second component, relative to disenrollment patterns, changes, et cetera, we do see signs that the disenrollment patterns are actually putting a little upward pressure on the average age within the book of business.
So therefore you are seeing either unemployment or the disenrollment pattern pushing the age levels up. Thus far, through our rate execution, we have been able to price for that, which is very important and we made some improvements in pricing and underwriting actions last year relative to dealing with that phenomenon.
Ladies and gentlemen, this does conclude today's conference. We thank you for your participation.
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