Cigna Corp. Presents at Goldman Sachs 34th Annual Global Healthcare Conference, Jun-11-2013 10:00 AM

Jun.11.13 | About: Cigna Corp. (CI)

CIGNA Corporation (NYSE:CI)

June 11, 2013 1:00 pm ET

Executives

David M. Cordani - Chief Executive Officer, President, Director and Member of Executive Committee

Analysts

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Matthew Borsch - Goldman Sachs Group Inc., Research Division

All right, everyone, we're going to get started here for the next session. Before I start, I need to read the disclosure. We're required to make certain disclosures in public appearances about Goldman Sachs' relationships with companies that we discuss. Disclosures relate to investment banking relationships, compensation received, to 1% or more of ownership. I'm prepared to read disclosures for any issuers now or at the end of this call session if anyone would like me to. however, these disclosures are available in our most recent reports available to you as clients on our firm portals, updates to those disclosures are available by ticker on the firm's public website, gs.com. In addition, disclosure is available, applicable to research, with respect to issuers, if any mentioned herein, are available through your investment representative. And also just to say, views of non-Goldman Sachs personnel may not represent the company view.

All right, with that, let me welcome Cigna's Chief Executive Officer, David Cordani, who has been here in prior years and I'm sure is known to many of you. We're going to get right into it in our usual informal format here and I really just like to start, and maybe asked David if he wants to set some stage -- set the stage with some of his thoughts on where Cigna is now, as we approach the midpoint of the year.

David M. Cordani

Sure. First off, thank you for hosting this opportunity and good morning to everybody. Just a few minutes of overview on our company. Stepping back and setting the context, as hopefully you know we position our corporation as a global health service company. We operate businesses here in the United States, we operate businesses throughout the world, focused on doing 3 things: improving health, improving well-being and improving the sense of security of individuals. When we set forth in our growth strategy known as Go Deep, Go Global and Go Individual, we set an objective to grow the corporation's EPS in the 10% to 13% range. As we look back over the last 3 to 4 years, we've not only achieved but exceeded that range.

We've done so with a very good balance of organic revenue and earnings growth, and then targeted inorganic or capital deployment decisions that have positioned us very positively. So as I step into Matthew's comment for 2013, we sit here ending 2012 with strength, which is always our objective, you want to end the year with strength. We've been able to step into 2013 with some good operating strength, both in terms of revenue growth, as well as earnings performance.

Our businesses where all oriented around, either selling direct to employers here in the United States, in excess of 80% of our health care business is self-funded or highly transparent service business. That aligns us very effectively with employers to work on incentives and engagement-based programs to help to engage individuals, to improve health and productivity. A proof point I would give you around that is, if you back test us over the last 3 years, we've either set or tied for the lowest medical cost trend in industry while delivering tremendous clinical quality outcome.

Conversely, outside of the United States, the bulk of our business is a direct to individual business because there are different markets. Here our core competency is gaining an understanding of individuals through data mining and then selling direct to individuals through either telemarketing, direct response TV, pull-through Internet or assurance channel. The reason why I want to draw to closure with that theme is, as you think about the U.S. markets changing and evolving, we have significant experience in markets throughout the world that operate different governmental programs and schemes and we have significant experience being able to bring programs and solutions direct to individuals to both augment those programs and/or be a core deliverer up against those programs. As we look to the future, we remain committed to a 10% to 13% EPS growth and we believe that we've positioned the company with some of the unique capabilities in terms of the self-funded approach, being a partner of choice for physicians, today, we have over 60 collaborative accountable care organizations up and running, and the front-end information set that we have, in terms of having a deep and thorough understanding of individuals, to understand and anticipate their needs and work on a consultative fashion to offer good solutions that they value at their respective health and life stage. With that I'll pause, I'll turn over to Matthew, because I bet he has a few questions.

Question-and-Answer Session

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Well, let me start with your very, very recent announcement that you've entered into a 10-year contract with Catamaran for PBM services and maybe for the benefit of this group, some of which -- some of whom may have listened to your call yesterday. I missed it myself, although I did take a peek at the transcript. Can you -- I understand that it's going to work towards $0.50 EPS accretion by 2015 in some meaningful but not yet specified contribution in 2014. Can you maybe break out for us or give us a directional sense of how much of that is from medical and operating? And any other comments maybe -- if this is there until -- why did it take so long to get to this type of arrangement?

David M. Cordani

Sure. So just let me start with the latter piece and then describe what we are seeking to do and then answer the first part of your question. First, we believe off a position of strength. Our PBM has performed very well. We been able to grow our PBM and, in fact, it's an important asset that's helping us deliver some of the lowest medical cost trends in industry on a sustained basis. We're seeking to build on that, grow that asset. We believe that there are 2 critical points that needed to be retained and secured.

One is the interaction with an individual and the customer experience, and two, is your ability to partner with physicians and health care professionals and not disrupt the way in which a physician or a health care professional interacts with their patient or customer, but rather the ability to enhance it. Around that, we wanted to make sure that anything we're going to contemplate doing, in addition to what we're doing today, was going to build on that, not challenge it, and be able to demonstrate demonstrable value, not just our shareholders, but to our clients and customers, to make sure you can retain that on a go-forward basis. We went through a very thorough evaluation.

It makes -- say, a long period of time, my colleagues around us would tell you that I told them it was a long period of time. And we thought to add a little bit more time to make sure that thoroughness was there, because this is a very important strategic decision and one that needs to have sustained value creation. As an example and carrying that back to your question then is, what we described to investors last night in the call is, if you think about '13 as a start up time frame, there's a half a year in front of us, right? Think about start up, think about '14 as transition, and about '15 as run rate. We've been able to structure a deal whereby we retain the clinical capabilities in the customer touch points. We're building on our business. We've been able to structure a relationship, that there is economic value creation in '13, right? There's economic value creation in '13 that will be used to offset transitional costs, of which are significant, so typically, deals might have a transitional cost negative headwind. We're not going to have that because we have value capture immediately. We'll be able to continue to create cap -- create value in 2014, Matthew, directionally, we said people to think about maybe half of that 2015 number in '14 just to provide a little bit of a boxcar and we'll build to additional value in 2015.

Two other points that are very important here, that economic string that we referenced for 2015 is off of today's base. It doesn't consider growth. We're taking known base today, known mixed consumption today and the leverage and overlaying against that. It doesn't contemplate per further neuropharmacy networks, it doesn't contemplate on going growth. Those are opportunities for us as we grow the franchise on the go-forward basis. So we're delighted with the arrangement we've been able to secure and we're delighted that we secured it in a way that we'll be able to demonstrate the value creation along the journey. We don't have to wait till a later point time with a hockey stick.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

And is the earnings benefit that you see proportionate to commercial and Medicare, you'll may be in proportion to the approximate earnings contributions of those businesses today, is that the right way to think about it?

David M. Cordani

Here's how I would ask you tho think about it, one is, importantly, if you're thinking about a $0.50 accretion number for our corporation, first, knowing the commercial business, greater than 80% of my business is self-funded. Another, almost 10%, of my business is shared returns, so think about an opportunity for a large contribution to flow back to employers, which we call clients, and individuals that we call customers. Then you have commercial and Medicare, so there's economics for both cohorts. The way the economics will be shared, they're different over time. But Medicare will have a contribution here and commercial will have a contribution, we haven't broken that out in pieces, nor that we intend to.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Okay, got it. With that, maybe -- and I'll invite questions from the audience. But if I could segue to Medicare Advantage, which remains of topic of focus amongst investors, and if you could just touch on any development in you're thinking about the impact on the business as reimbursement change is going into next year, obviously, you went through that in some detail on your earnings call, but that was a month ago, and I'm sure you've done more work and now you submitted your bid even though we would get to see those until the results of that are unveiled in October. But is there's anything more you can tell us about how you're thinking about that at this point?

David M. Cordani

The simple answer to that is, no. So maybe let me recompartmentalize the way we're thinking about it. One, important to know that before HealthSpring, Cigna was only Medicare posture within Arizona where we have a delivery system that's owned and captive before an Avstar [ph] system. Think about HealthSpring as largely having deep pockets of business in key geographies. So a lot of density in those markets. Think about, on average, about 75% of all of our combined Medicare business has having aligned physician reimbursement models, so about 75% of all of our Medicare Advantage cover lives are in aligned and incentive-base reimbursement models. And then as we go into this disruptive, and you're correct, at the end of the first quarter call, I referenced 2014 as a very disruptive environment, we have largely four major levers to work, as every entity woujld be able to work, we have different depths in some of the levers. One is, how do you work with the physicians and knowing that 75% we have an aligned incentive model, how do we work with physicians to engender a further improvement in medical cost by driving clinical quality initiatives? A derivative of that is, how do you then carry that across to sharing some of the revenue headwind with the physicians and the delivery system directly, then you're able to deal with benefit design, configuration, everybody knows the government put it -- the cap, in terms of the month you can push through that, on average, Cigna HealthSpring has a richer benefit on average that exist in the markets we compete in. So that's a good competitive position to be in but it's disruptive for everybody to confront. Then you would deal with your operating costs, admin costs, including SG&A, selling costs and then you come back to margins. So you'd work through that, that takes places in a market-by-market basis. It takes place doing basic game theory in the markets, that's all completed. That's all led by the legacy HealthSpring team that has been through this drill before. And the Cigna team is participating in that and we'll manage through the fall cycle. The last thing I'd add to this is, when we acquired HealthSpring, we had an expectation of expanding the model into additional geographies by leveraging the legacy Cigna commercial experiences and our collaboratives. Good news is, that was tracking well ahead of schedule. So the demand of organized physician groups or delivery systems to bring Medicare Advantage in the new model was extraordinarily high and where dedicated team well ahead track, in terms of number of markets, given the change in disruption in the marketplace, we're going to keep that at 2 markets. So we're not going to overreach in '14. We know what markets we want to open in '15, et cetera. I'll give you that, it's simply a good validation of a high appetite in the marketplace with our health care professional partners to continue to expand the models we go forward.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

So we should anticipate that you'll unveil 2 new markets in '14 and then probably another 2 new in '15 as well?

David M. Cordani

Correct, correct.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Can you say if you're going to pull back or retrench from any markets at this point?

David M. Cordani

I won't tell you which markets, but you could assume that there'll be a little rebalancing in the portfolio. Correct.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Makes sense. Well, let me move over, if I could, to the commercial side of the business. And I want to start by asking you about how you're seeing the market evolve ahead of reform as you put through and recognizing 80% of your business is self-funded, as you, on the guaranteed cost side, start to flow in some of the industry fee and, on both sets of businesses, as you put in the reinsurance charge, is that going smoothly or relatively smoothly? I realize we're still in an early stage here. Just curious if you're encountering pushback from customers and market competition, regulators at this point?

David M. Cordani

Yes. I smiled because you went to relatively smoothly. I think that's the best outcome we could assume, right? The amount of change that's transpiring in this industry right now, is taking everybody's breath away and you have employers, brokers, consultants, et cetera. So disruption or a dynamic environment is the norm. Relatively smoothly is the way to depict it. And important to note, again, we talk about consultative selling. So when you take the guaranteed cost side of the environment and, to oversimplify our business, think about 80% self-funded, 10% shared returns, 10% guaranteed costs, I rounded down on the first and up on the second, couple of tranches. When we go face-to-face with a broker or an employer where the guaranteed cost business exists, we're able to offer a choice. We're able to sit there and say, do you want to finance this relationship in a guaranteed cost fashion, in a shared return fashion or in an ASO fashion. That's an important set of capabilities to have in this environment, because our team could act in a consultative fashion around that and talk about the pros and cons of those alternatives and help that employer achieve their goals for that cycle. That's very helpful. So that dynamic, Matthew, if there's a change, is even more robust today than it ever has been before. Because employers are more open to looking at alternatives, as opposed to, what's my guaranteed cost renewal? And explain it to me. It's, what's the guaranteed cost renewal and what are the alternatives? And they'll let me better understand what this shared return product might be, as a 300-life employer or let me better understand what this ASO product might be as a 200-life employer. There's more of that dynamic playing out than ever.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Got it. And related to that, we're hearing some buzz in the market that there's at least some acceleration of the trend of self-insuring among smaller employers and some of your competitors, it seems, are looking to catch up with where you've been in terms of leading the industry with the platform for midsize and even some of the smaller employers who want to shift to self-insuring. So are you seeing that acceleration? To what extent? And is the competition starting to have an impact on your leadership in that segment?

David M. Cordani

So when we think about the segments, we talk about 3 major buying segments in the U.S.: Select-size; employers, 50 to 250 employees; Regional, 251 to 5,000 employees and large single state; and then National for us is, greater than 5,000 employees, in multistate. Okay? We're seeing a consistent trend of ASO, or self-funded, just moving down market year after year after year. Information transparency, looking for more value, we've seen that trend just as constant trend, and one that continues to pure point, we think, downmarket, especially in the Select space, we've been a market leader in that post-acquisition of Great West, which took place some time ago. The question is, do we see more demand than appetite for the product and service? The answer is, yes. Two, do we see more activity from competitors in this space? The answer is, yes. By the way, more activity of competitors in the space over the near term is a good thing because it changes the dialogue. When you're the only one out there talking abut something, you're trying to create a marketplace. The last thing I'd say, relative to this, just like any other product or service in any market, it's not a matter of just filing a product and making an offering, an ASO product, if you just visualize for a 150-life employer is, a very different product. And the ability to have, for example, the employer reporting and the broker reporting and transparency tools, and then consultative resources behind that, that in a monthly and quarterly basis could illuminate for an employer exactly how the money is being spent, what's driving it, and what we do about it? It's a different approach. It's fundamentally a different approach. And like Cigna, historically, we're able to do that for large employers, but to be able to do it, in scale, for smaller employers and to be able to produce the insights, the reports, to be able to deliver them effectively, electronically and otherwise, and to be able to supplement that with people or human capital, is a different approach. We've been able to prove that we have those capabilities and we're able to convert those and we've expected that competitors would evolve, right? That's the nature of innovation. It's going to evolve and we just need to make sure we're delivering value and we'll continue to evolve our programs around that.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

How low are you guys willing to go on that, the employer size continuum. I mean we've started to hear about employers, as groups as small as 10, self-ensuring, albeit they must have to have some pretty strong stop-loss protection around that?

David M. Cordani

Yes. We typically target 51 lives and greater. Technically, can you do it below that? Yes, you're in a different regulatory environment and different value proposition. So back to that Select segment, which, by the way, has been and is our fastest-growing segment in the United States, by way of percentage. The 51 to 250-life segment, think about, on average, just in excess of 50% of the new business sales are ASO stop-loss. The residual is guaranteed cost. So back to offering choice in that business.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

And staying on the commercial side, we're in the midst now of the January 1 national account selling season. I'm curious what you're seeing from the large jumbo employers? They're obviously not really in the gun sights as much, in terms of change and health reform, but is clearly an important backdrop. What are you seeing from them, in terms of preference, for product features as we head into next year and maybe what you sense maybe their appetite for carrier switching in this environment when there are a lot of other things that are moving?

David M. Cordani

Okay. A couple of things. First, contextually, when we launched the Go Deep, Go Global, Go Individual strategy, we articulated for the jumbo, or national account employers, we are repositioning that segment and focusing on employers that valued incentive and engagement-based programs, not focus on employers the typically would purchase a -- or call administrative services only contract and then I'll let card out all the other products and services. As part of that strategy, we said that our strategic objective was to hold share but change the mix of our business, and that the regional segment would be the driving force behind our franchise and the Select segment will be the fastest growth part of our portfolio. So that's by way of backdrop and our results demonstrated that over time. Within that space, within the national account employer space, again, we defined it as 5,001 employees and multi-state, I'll give you 2 or 3 trends: One, if you go back 3 years ago, it was -- maybe half of employers were really actively engaged in incentive, engagement-based programs, be they consumer directed, be they wellness programs that really had incentives and disincentives attached to them that were meaningful, modifications in networks in a more high-performing way around collaboratives. Today, it's the exception for that not to be a central part of the conversation. So that's a large change, number one. Large change number two then is, how do you bring more of those services on-site, near site or deliver them through alternative vehicles? So on-site clinics, on-site health coaches, electronic delivery of coaching wellness programs, et cetera, that are backed up against your incentives and disincentives. And then, emerging theme, but this is emerging theme number three is, let me learn more about these private exchanges. Does the private exchange introduce a different value proposition to me that I need to better understand? That's new territory for most. And so they're launching into that new territory to learn and say, okay, what are the value creators that could exist in a private exchange in account of the wise guy. Those will be the 3 themes I will give you right now.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

And on the private exchange front, I take it from the way you characterize that, that the rate of adoption at this point is maybe very low. Do you see that changing rapidly as we head into 2015?

David M. Cordani

Yes. I think that when you look at an adoption curve, right, you have the innovators and you have the early majority. As you compress, we're still on the innovator side of it and that's all I'm referencing. I'm not trying to defuse the value creation. Secondly, when we talk about private exchanges, there's a variety of them out there trying to serve different rationales. So one is, to provide a retail purchasing experience for individual customers. Another is to provide a retail purchasing experience with a multi-vended, but single-product design alternative. Another could be to do risk transfer, to do risk transfer and begin a journey of potentially going from a defined benefit to a defined contribution-type orientation. Those are very different tool sets and very different strategies and I just picked 3 different examples and you see early testing on all of the above. I think whether '15 and '16 become meaningful is really going to come back to, are they able to demonstrate step function value creation? Because there's an additive cost that goes along with it. So the need to be at least enough value creation to offset that cost and then if you value creation above and beyond that, we think there are some models out there that could be attractive, especially if you're able to better engage individuals and if you're better able to bring more transparency and more retail choice. The big step function is whether or not an employer wants to move from a defined benefit philosophy to a defined contribution philosophy, and do they get their employees ready to take on that set of responsibilities, as opposed to in a more a binary fashion cut across with a product design. That'll shake out over the next few years. We are engaged in a variety of different -- phase one, I would say, on private exchanges, currently.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Do you see the value creation -- that may be the most important element of value creation, or at least on the top of the list, being the ability to channel members into, if they select that narrow network integrated delivery assistance, which is obviously much harder to do when you're talking about an employer-wide health plan account, where you have to have a much broader network. Is that maybe the number one feature that you see?

David M. Cordani

If I step back , I'm going to answer your question partially, yes. But if I step back, it depends on the goal and the objective of the employer. So I'm just going to oversimplify. There are 2 groups of employers: Employer Group A believes that being in the business of offering a benefit to their employees is an important part of their ongoing business strategy and they're going to use that benefit as a means of, either attracting and retaining talent, but also driving productivity, presentee-ism, et cetera. What you just articulated is a big powerful lever, right? Can I use it as a mechanism to help to channel, drive, incent or enable my employees to purchase or consume the higher value services? Bucket two is, an employer says, you know what, I'm not sure why I ever ended up in this place and I might like to exit this place, but I need a responsible exit path because I can't go just like this, because I have a business to run. So with their journey I could head across to begin to transfer the responsibility to the individual and make sure along that transitional journey, I don't break my operations. There are 2 very different philosophical approaches and the way you design them are very different. And we don't believe in a one-size-fits-all approach either. There are 2 different attitudes and 2 different approaches. Back to from a Cigna standpoint, in that first tranche, we been able to demonstrate, and we have a large number of employers, as I'm sure some of our competitors do, but we have a large number of employers that we could point to. We have highly sophisticated engagement, incentive-based programs, where today the employers have a 0% medical cost trend, a minus 2% medical cost trend. Those are different conversations to engage in with that employer, as opposed to somebody dealing with a 13% to 14% medical cost trend on an outlay of the size. And that's when they start to see those benefits that they want to say, okay, now what's the multiyear strategy to retain a low single-digit medical cost trend, because I'm no longer going to capitulate to an environment that it's 8% to 10%. So we're focusing heavily on that tranche.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Great. Makes sense. Maybe to round out the discussion on the commercial side, if we could touch on the exchanges and maybe start reminding us, if you've given the specific number around the number of exchanges that you would expect to purchase, I have it's limited, but how was your thinking evolved just recently with that and maybe looking at the California unveiling as that's emerged.

David M. Cordani

Sure. So as most people I think know that by with history and backdrop, Cigna has not played in the U.S. individual primary market or the U.S. under 50-life employer market in any significance. 2 years over the last 3 years, we've run focused pilots in 10 cities, we've added somewhere between 200,000 and 250,000 lives, largely individual and micro-employer to test, to learn, in advance of the exchanges being put in place. Hoy you'd operate with no medical underwriting, standardized products, different distribution models, et cetera. And our bias has been that we would act in 2014, we'd be on a limited number of state-based exchanges, so we continue to learn as the marketplace evolves. And what we said previously, and what we said prospectively is you not look at the public exchange-based business as being a driver of us achieving our EPS goals or objectives. It presents a potential future growth opportunity off on the right side of our assessment, that if the marketplace evolves, we want to be in a position to take advantage of that. To that end, why don't we come out with a public press release, but since we filed in every state and it's all available, we filed in 5 states. Those states are Arizona, Colorado, Tennessee, Texas and Florida. You should not think about us as being statewide. You should think about us picking a limited number of MSAs or markets in those states. Think about 1, 2 or 3, being highly focused. Go Deep geographies, geographies that we have very well-developed collaborative accountable care relationships up and running and environments where we believe that the combination of the state regulatory environment, our depth and our relationship with the physicians gives us an opportunity to have an attractive offering going forward. I think it's going to be an interesting time for all of us as we go through '14 and '15 as we see how these marketplaces unfold, when we see how the economics unfold. The last thing I would say, again, as a publicly traded company, we're very mindful that we have a responsibility to be a good steward of capital for our shareholders. And you have an environment where it's a risk-based business, that's a capital-consuming business that's going to have a lower margin than has historically existed for guaranteed cost business but a high-revenue growth rate. That portends to a business line that will be a low free cash flow producing business line, which is dissimilar to the way guaranteed cost businesses typically operate in the past. So we're approaching it with caution because, again, we have a responsibility to be a good capital steward for our shareholders. But we're approaching it in an environment where we want to have optionality for our business and for our shareholders, if the marketplace evolves.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

And some of the 5 states that you mentioned are states where the -- that the state has opted out of running the exchange. So it will be the federal government. Correct me if I'm wrong, but we don't know that there isn't -- there's a lot we still have to learn from the federal government in terms of how they're going to do the rollout. So when do you expect that to happen?

David M. Cordani

First, at a micro level, the truism of your statement, there's a lot we have to learn across the board in all of this, right? These books are being written page by page as we're reading the books, state, federal or otherwise, and it's going to be an interesting environment for the country as we go into 2014, make no doubt about it. Colorado is an example of a state running a -- running their own exchange with very strong dedicated business-oriented leadership trying to operationalize something. Texas is an example of the flip side where I go like this. And by having federal-based exchanges, it gives us a different interoperability standard, right? I get a plug into one portal there. We're going to plug into the fed. It's going to be different than the way we plug into Colorado. But at a macro level, Matthew, there's an ample amount of uncertainty in every dimension, which is why stepping back from a shareholder perspective, we do not have a big bet in terms of my need to preserve disrupted revenue earning streams going from '13 to '14. And our EPS objectives when we work through our '14 numbers, we will assume that this number is a nonevent because I can't bet on these numbers to be able to deliver my commitment from a shareholder perspective. If we see that there's opportunity for upside on a go-forward basis and we think there's going to be a vibrant market, we'll commit to that level of vibrancy but change and uncertainty is the constant there.

Matthew Borsch - Goldman Sachs Group Inc., Research Division

Well, great. With that as a theme, I think that's come to a good endpoint. We're running out of time. So thank you very much to Cigna for being here again this year.

David M. Cordani

Thank you very much for hosting, and I appreciate your time today. Thank you very much.

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