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Executives

Stephen Hemsley - President & Chief Executive Officer

Gail Boudreaux - Executive Vice President, President of UnitedHealthcare

Mike Mikan - Chief Financial Officer

Rick Jelinek - Executive Vice President & Chief Executive Officer of AmeriChoice

Analysts

Josh Raskin - Barclays Capital

Matthew Borsch - Goldman Sachs

Tom Carroll - Stifel

Scott Fidel - Deutsche Bank

John Rex - JP Morgan

Justin Lake - UBS

Christine Arnold - Cowen & Co.

Charles Boorady - Citigroup

Greg Nersessian - Credit Suisse

Carl McDonald - Oppenheimer

Ana Gupte - Sanford C. Bernstein & Co.

Lee Cooperman - Omega Advisors

Nick Leventis - CRT Capital Group

Peter Costa - FTN Midwest Securities

Matt Perry - Wells Fargo Securities

Presentation

UnitedHealth Group Inc. (UNH) Q2 2009 Earnings Call July 21, 2009 8:45 AM ET

Operator

Good morning. I will be your conference facilitator today. At this time, I would like to welcome everyone to the UnitedHealth Group, second quarter 2009 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer period.

(Operator Instructions) This call and its contents are the property of UnitedHealth Group. Any use, copying or distribution without written permission from UnitedHealth Group is strictly prohibited.

Here is some important introductory information. This call will reference non-GAAP amounts. A reconciliation of non-GAAP to GAAP amounts is available on the financial reports and SEC filings section of the company’s investors’ page at www.unitedhealthgroup.com.

This call contains forward-looking statements under US federal Securities laws. Such statements are subject to risks and uncertainties that could cause actual results to differ materially from historical experience or present expectations. A description of some of the risks and uncertainties can be found in the reports that we filed with the Securities and Exchange Commission from time to time, including the cautionary statements included in our current and periodic filings.

Information presented on this call is contained in the earnings release we issued this morning and in our Form 8-K dated July 21, 2009, which may be accessed from the Investors page of the company’s website at www.unitedhealthgroup.com.

I will now turn the conference over to the President and Chief Executive Officer of UnitedHealth Group, Stephen Hemsley.

Stephen Hemsley

Good morning and thank you for joining us. This morning we reported second quarter earnings of $0.73 per share, $0.03 above the consensus street estimate. We are refining our full year earnings outlook to a range of $3.00 to $3.15 per share, which is the upper end of our prior guidance.

We would characterize this quarter as solid, with strong execution; a sharp focus on cost control and continued quality and service advances; active engagements on healthcare modernization; continued innovation in the marketplace and ongoing diversification of our business, highlighted by the proposed acquisition of Health Net’s Northeast licenses and a significant contract award from the Department of Defense.

Today we’ll discuss our results and outlook, some of our innovation activities, and some thoughts on the key elements needed to modernize and not just reform healthcare in the US. Starting with revenues, we now expect revenues for 2009 to approach $87 billion, up from our expected range back at the start of the year of $85 billion to $86 billion.

Strengthening revenues from public and senior customers in both our benefits and services businesses is expected to offset intensified recessionary pressures across the commercial benefits sector. This market balance reflects one of the values of our diversified business model.

On the Health Benefits side, our second quarter revenues increased $1.3 billion or 7% year-over-year. We have added 785,000 people in public and senior programs to-date in 2009. This is entirely organic growth. We are better organized and focused around our end markets and have elevated our performance in sales, marketing and distribution. Our Medicare Advantage growth of 245,000 people year-to-date is the best we have posted in several years and it has advanced with a risk profile similar to our existing business.

Looking to the future, our Public and Senior Markets Group will be further strengthened under the Tricare Southern Region contract awarded to us last week, covering services to 3 million people. This is one of the largest scale assignments we have undertaken. Tricare will further diversify our mix of business, adding military healthcare to our health benefits businesses, and allowing us to leverage our distinctive capabilities for our Armed Forces and their families.

In our Commercial Benefits businesses, through the first six months, group retention has improved year-over-year. However, overall attrition driven by the economy is significant, accounting for nearly half of our decrease in consumers served. Focusing on the second quarter alone, half of the membership change in full-risk business resulted from employment attrition, and attrition also constituted more than 100% of the net change in our fee-based business.

We expect some moderation in attrition for the back half of the year, given the normal quarterly patterns and given that the rate of increase in national unemployment is expected to moderate. Depending on attrition levels, we project a full year decline in the area of 1.5 million people in total.

We are holding to our pricing and underwriting disciplines on risk business. Customers and prospects are showing mounting interest in our ability to fundamentally control medical cost growth while driving quality.

Consultants and employers are responding positively to our eSync capability introduced in 2009. eSync uses advanced real time analysis of clinical data, multichannel outreach and consumer coaching to engage consumers in their own healthcare, to support prevention and wellness programs, and to significantly impact, help decision making.

Revenue generation on the services side of our business is strong despite the weak economy, increasing $458 million or 9% year-over-year in the quarter. OptumHealth continues to offset commercial membership losses with public sector revenue growth and innovative product offerings such as their integrated payroll and medical care.

Ingenix continued to produce solid growth in the public and payer sectors, in areas such as consulting services and software sales and installation, and Prescription Solutions had another strong quarter led by growth in senior business and in specialty pharmaceutical revenue.

Moving to medical costs, the consolidated medical care ratio for the second quarter of 83.6% and the commercial medical care ratio of 84.2% were well within our range of expectations. The slight year-over-year increase was largely a result of the H1N1 virus, as well as overall public sector mix at the consolidated level.

Our MCR outlook for the year remains unchanged. These results reflect consistent and progressive execution around pricing and medical cost management. One example of this work is the value AmeriChoice delivers in Michigan, compared with both the state’s fee-for-service program as well as average competitor performance.

AmeriChoice’s personal care model emphasizes primary care and prevention. Our members have 42% more physician office visits and 36% fewer outpatient hospital visits than those under the fee-for-service model. We believe this ensures more appropriate use of healthcare dollars and produces meaningful savings to the Michigan Medicaid programs.

Another example; we are directing increasing volumes of business to those care providers who distinguish their performance and receive premium designation recognition. Premium designation identifies those doctors who meet quality and cost efficiency standards, now nearly 100,000 physicians in 138 markets that cover nearly 20 million members. These clinicians represent about one-sixth of our UnitedHealthcare network and drives strong quality and better affordability, with consistent cost savings of up to 20%.

Our operating cost performance was also strong through the first half. Today we are supporting an $87 billion business, with nearly the same monthly run rate in operating costs that supported an $81 billion business at the start of 2008. We are pushing optimal resource utilization to fully realize scale benefits across all operating cost areas. Capital expenditures also drive operating costs and our CapEx run rate for the first six months of 2009 was down to three-quarters that of the first six months of 2008.

Our quality and service performance have significantly improved year-over-year. As is often the case, those go hand-in-hand with increasingly favorable operating cost performance. One example would be physician call service satisfaction, which improved 14 percentage points to 89% over the past six quarters. Overall, we are producing the strongest service statistics across our businesses that we have ever recorded.

So perhaps a few comments as to what first-half 2009 performance means for our outlook. We expect this year’s revenue growth in public and senior business to continue to more than offset the potential for further pressure in the employer market. In the second half of 2009, quarterly revenues for AmeriChoice, Ingenix, Ovations and Prescription Solutions should be up double digit percentages year-over-year.

Quarterly revenues for OptumHealth are expected to advance slightly by a high single digit percentage and for UnitedHealthcare to be flat to down slightly year-over-year, depending on attrition and revenues from investment income. We expect 2009 operating earnings to be in a range of $6 billion to $6.3 billion, and net earnings to be in the neighborhood of $3.5 billion to $3.7 billion; supported by strong cash flows from operations of approximately $5 billion.

Our capital priorities remain consistent. First, we spun the internal development of our businesses. Next we used strategic acquisitions to deepen our businesses, expand or diversify our platform or acquire new capability. Then we returned excess cash to shareholders through share repurchase at prices below our estimate of our intrinsic value.

In the current environment, we see increased opportunities for targeted acquisitions. In June we acquired AIM, which positioned Ingenix as the market leader in payment accuracy solutions for payers and hospitals.

Last evening we announced pending cash purchase of Health Net’s Northeastern licenses in its Medicare business and Medicaid business and rights to renew its commercial membership in Connecticut, New York and New Jersey. We believe the geographic and product fit are excellent, the terms are fair, and we expect our resources and cost structure to drive meaningful value for customers in this business.

We expect to have a conservative year-end debt to total capital ratio in the range of 33% to 35%, and to repurchase about $2.5 billion worth of shares this calendar year. This all suggests as we said earlier, earnings at the upper end of our prior outlook, in a range of $3.00 to $3.15 a share.

One of the reasons we are able to maintain these positive results is our commitment to driving innovations that consistently deliver medical cost savings for customers while helping improve health outcome. For example, a core group of progressives national self-funded customers that represent more than 7 million consumers. That group has seen a four year medical cost trend at 5% per year, with the last two calendar years running under 4% as our cost control program have matured into this group.

Our medical cost per member per month to deliver networked based Medicare Advantage benefits is at or below the federal government’s cost for the same benefits in the majority of our county markets. These cost savings contribute to funding valuable benefits that senior consumers receive from our private programs that are not available in the government’s historic Medicare Indemnity plan.

Individual states continue to turn to the private sector to manage their public program obligation, including our recent success in securing 65,000 CHIP participants in Mississippi. States pursue this course because they value our ability to innovate and manage overall medical and administrative costs, rather than relying solely on provider price control.

We are also growing our total care management and consulting businesses. Our enterprise services customers, including foreign governments are seeking specific expertise on how to capture and use clinical data and lower cost trend and improve results around clinical quality.

When we apply our experience, innovation, and economies of scale to specific healthcare challenges, we have real world evidence that we control costs on a sustained level, with higher quality and greater choice and access. For example, we are partnering with the March of Dimes to reduce scheduled premature Caesarian section births. The New England Journal of Medicine highlighted early C-sections as a driver of significant neonatal intensive care services, stressful for families and expensive to the health system.

The majority of people with diabetes do not comply with the guidelines for prevention and treatment. Uncontrolled diabetes leads to serious complications such as heart attacks, kidney damage and strokes.

Our enhanced benefit diabetes health plan, targets those suffering from diabetes or pre-diabetes, guides them to physicians with documented success in treatment and provides continuing education on the management of their disease and the importance of routine care. Using one large employer as an example, diabetics who complied with their care costs less than 40% less than noncompliant diabetics.

Our drug interaction alert program flags incoming prescriptions and alerts physicians to potential adverse drug events. This process improves patient safety and quality of life, while saving on estimated $13,000 for every adverse event avoided and just last week, we introduced Connected Care, the first national Teleheath network in conjunction with Cisco.

This initiative combines advanced technology to link people in underserved areas with our network of primary physicians and specialists in our clinical support. I am sure you are picking up on the heavy use of examples of innovation and cost management in this morning’s prepared comments, it is not an accident.

Practical real world innovation and cost containment experience have been at the core of our participation in Washington for several months now. Much of the current policy debate is focused on what form of tax, surtax or embedded healthcare tariffs will pay for expanded healthcare coverage. We are hoping more energy will be spent on proven private sector innovation that could slow the rate of cost growth and improve quality, which we believe are the only means to really expand coverage to more Americans in a way that its obtainable.

We’ve been getting to an outcome that truly modernizes our health system requires legislation that focuses on costs and consistent care quality by modernizing the healthcare system, not just expanding coverage or raising taxes; legislation that respects the complex in critical inter-linkages among all the components of the care system, that sets clear public policy performance goals, standards and milestones and then holds the private sector accountable, to deliver against them over a reasonable timeframe and has meaningful, broad bipartisan public and political support.

In this context, the past quarter we advanced two sets of research to enrich the discussion. We identified a sample list of 15 categories of costs where UnitedHealth Group and others in the private sector have existing real world programs in place that could strengthen the performance of traditional Medicare, and could reduce pressure on the trust fund.

We estimate savings for Medicare from using innovative programs to be more than $1.5 trillion over a ten-year period. Importantly, none of our suggestions reduce fee schedules for physicians or hospitals, all of our recommendations involve more effective use of medical resources and the health system in total.

Second, we look more broadly at the health system to identify opportunities to improve and simplify the administrative processes that support care delivery. Again, we used existing technology and innovation that has already been advanced in the private sector. We estimate these administrative savings could exceed $300 billion over 10 years, with concerted public policy and private sector action across the entire health sector to adopt more common basic data and transactional standards.

All parties would benefit; government, care providers, payers and individuals. We bring these proposals forward and will continue to bring others forward with a simple agenda. We believe our country should build an employer based coverage, instead of public health dollars only where coverage needs are most challenged.

We believe progressive, affordable coverage should be available to all Americans and that they should have access to quality care and we want to encourage and reward efficient high quality care and advance the use of modern healthcare technology, information and evidence based standards.

We are looking forward. We are seeing the possibilities for both, social success and business growth that will come from a progressively more modernized health system. We also see future new markets with new demands, including international markets, that share with the US the common need for improving the healthcare system and reducing costs that we can help address in market in a specific ways.

Before opening up for questions, let’s reemphasize a couple of observations. Our operational performance has improved markedly year-over-year, we are actively engaged in Washington DC and inside our company seeking to contribute to the health reform movement and to advocate and drive innovation and modernization internally by our actions.

Our enterprise touches a community of 70 million individual Americans. We focus on directing core capabilities, not just products to better serve that community year-by-year and we invest in innovations to better support the people we serve. UnitedHealth Group is strong financially and has maintained an appropriately conservative balance sheet.

These attributes, collectively position our enterprise to evolve and even lead change in healthcare, in its delivery, change that is inevitable with or without federal healthcare reform. We see change as our ultimate opportunity. Change provides us the opportunity to create an even more significant and diverse enterprise serving the needs of Americans across this immense and growing social marketplace and that is what we intend to continue doing. We thank you.

At this time, we would like to open it up for your questions and discussion.

Questions-and-Answers Session

Operator

(Operator Instructions) Your first question comes from Josh Raskin - Barclays Capital.

Josh Raskin - Barclays Capital

My first question is just on the Medicare strategy for 2010. You guys didn’t mention it on the call, but there’s been a lot of discussion. So maybe we could just sort of set the record straight as to what was going on there.

Then, if I can ask a follow-up, just I didn’t hear any comments at all about COBRA and I was wondering if you had any thoughts there.

Stephen Hemsley

Sure. First, I know there will be interest around Medicare through the course of the day, but you need to appreciate the fact that we are really right in the midst of a process of finalizing bids with CMS. It is a part of our routine process and we are going to be very limited in terms of what we can say, if anything with respect to where the bids stands right now, because they are truly deliberating on finalizing bids and we need to respect that process.

So I’m not sure there is a lot more we can shed light on in terms of where our 2010 bids will stand. I could ask Larry Renfro to comment further on that if he would.

Larry Renfro

Josh, its Larry Renfro. What I might start out with is to talk a little bit about the CMS bid process, we kind of look at it in three steps. The first step starts at the beginning of the year, really gets going about the March, April timeframe and we receive the CMS reg letter and then we start, what I would call our interpretation and preparation of the bid, getting ready for the June, 1 submission.

We kind of call this obviously the bid preparation and submission step. Then it moves into the second step on June 1, and that step goes from a timeframe of June to August, September and one key component I’d like to bring out talking about CMS, is that CMS is a customer and we have to treat CMS as a customer.

I use an example, if you were thinking of a corporate customer that you were dealing with and you were working on a proposal with a corporate customer, then as you were working through that you wouldn’t be disclosing that information to anyone. So we treat CMS in that same capacity and when we start working with them, we start by trying to go through the clarity of our bid.

We’d talk and go back and forth, and we try to really hit poles, what I would call the final bid approval. Again, that’s the step that we are in today, and so that’s why it’s premature and would only be academic for us to talk about exactly where the details on our bids are at. Obviously the third step is when the bid is approved and it is made public and that’s normally in the late September, early October timeframe.

We are caught in a position where we are so into the stages of final deliberation and approval. We are going to be quite limited in terms of what we can say about those bids, and I think we can hopefully be in a position where we can get into it either later as the year progresses and the bids become final, and public.

Josh Raskin - Barclays Capital

Maybe I didn’t ask it well, but I guess just curious from your point, just strategically as you think about 2010, or not necessarily specifically 2010, but your bids, were they submitted sort of letter of the law or I think the big question is what happens if there’s doc fixed and there’s no change to your reimbursement? I guess that’s the main question.

Stephen Hemsley

The best way I could answer it, under the circumstances, with CMS reviewing these right now is that I think our initial bids were made in a CMS compliant fashion. There has been, as Larry described, kind of a natural engagement in that as they deliberate, and I really can’t comment in terms of how the final benefits and bids will come out.

I would say globally that, just given the approach that CMS has taken, that there will be pressure in the private sector Medicare. I don’t think that’s a secret to anyone, that we are responding in terms of how we will be positioning our business in 2010, really focusing on how we are going to manage medical costs, operating costs, how we are going to go to market and so forth.

I’m not sure that there is really that much difference in terms of how the approaches that have been taken to Medicare, at least for our book this year for us, other than the fact that we see an administration that is putting pressure on the program itself.

Larry Renfro

Gail is on the line. Gail, do you want to comment on COBRA?

Gail Boudreaux

A little bit of perspective on what’s happening with COBRA. Essentially it’s played out pretty much as we expected. As we look at our fully insured membership over the first few quarters, it’s grown, which we would have expected as part of the stimulus and just the increasing unemployment.

At the start of the year, we were at approximately 1.5% of our risk based enrollment that was in COBRA; that represents about 2%. As we look at COBRA, again, we believe that it is covered in the guidance we gave in terms of our loss ratio, and again, that is played out pretty much as expected. The take-up rates are essentially the same as we had projected, which is roughly in that 20% range.

Josh Raskin - Barclays Capital

Any change in the MLRs on that book, has it gotten any better?

Gail Boudreaux

Again as I said, COBRA members historically do consume more, but we have it projected in our loss ratio at the 84% plus or minus 50%, which is what we had assumed.

Operator

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

Matthew Borsch - Goldman Sachs

Yes. Maybe I could pick up on that theme a bit here, and just could you tell us what you are seeing generally in terms of commercial medical cost trends as compared to the last quarter, and maybe elaborate a little bit on the H1N1 impact. In specifically what areas of utilization that's impacting and the extent to which so far as you can tell, you see that continuing into the third quarter?

Stephen Hemsley

I think let’s deal with it first on a consolidated basis. Mike, do you want to respond?

Mike Mikan

With respect to commercial trends, we are not seeing anything different than what we’ve said or expected in the past. We see continued pressure on unit costs, we are seeing continued moderation of utilization which has been consistent for periods now, and we don’t see any dramatic change in any one of the cost categories.

With respect to H1N1, we did see an up-tick in services related to H1N1. It costs us roughly $50 million in the quarter. I would say it’s a little different from the typical flu season. We didn’t see the same drug utilization or the same inpatient admissions related to the H1N1 virus.

So we suspect that it was related to a fair amount of advice and services in the physician office or through the ER, with the idea that they had H1N1 and it didn’t ultimately result in that, but we did see a significant amount of additional physician services related to H1N1 in the quarter.

Matthew Borsch - Goldman Sachs

So office visits and diagnostic testing and that sort of thing. Maybe if you could, just in terms of the outlook for the back part of the year, are you continuing to look at the same expected slope in the MCR, related to in-part a higher uptake of high deductible products?

Stephen Hemsley

I would start off globally Matt. I’m sure this question will come up and I’ll try to head it off with the pass. Our medical loss ratio was well within the guidance that we gave at the investor conference. If you recall, we expected a consolidated medical care ratio to increase about 50 basis points or so to 82.7% plus or minus 50 basis points for the consolidated group.

That was related to mix, as we discussed last quarter and previously that we were going to have a greater weight of government business versus the commercial business, which has played out that way, in addition to the fact that we had, within the government business, we had a greater mix of private fee-for-service, which is a higher loss ratio and the fact that we had improved our benefits to be more competitive broadly in the MA space.

So, that played itself out and we are seeing that in the second quarter. You didn’t see as much of that in the first quarter and it was favorable. We did have a significant amount of favorable development in the first quarter, so that was with respect to the first quarter. With respect to the remainder of the year, on a consolidated basis, if you take out reported development, you should see a pretty similar rate of change pattern for the remainder of the year as you saw in 2008.

With respect to commercial, we do expect that you will see higher loss ratios in the second half of the year and that will be related to the seasonal pattern that you noted for deductible wear-off.

We also expect continued COBRA up tick for the remainder of the year and Dan Schumacher said that in the first order and we also have vis-à-vis last year, there is a higher day content or work day content in the second half of the year, this year versus the first half of the year. So you will see a natural seasonal progression for the remainder of the year for the UnitedHealthcare loss ratio.

Operator

Your next question comes from Tom Carroll - Stifel.

Tom Carroll – Stifel

Just a couple of quick administrative questions. You mentioned $1.5 million enrollee loss for the year. Is that in total, or was that just the commercial business and then secondly, just going forward, should we assume that your annual tax rate now will be 35%?

Stephen Hemsley

I think the first one answer is commercial. The second, Mike?

Mike Mikan

35% to 35.5%.

Operator

Your next question comes from Scott Fidel - Deutsche Bank.

Scott Fidel - Deutsche Bank

Thanks, I just first a question on the Medicaid business and if you could hone in on how margins performed relative to plan in the second quarter. Then just two topical questions in Medicaid, one being if you saw any swine flu impacts there and then also just talk about sort of mix changes and if there is any cost impact from an increasing mix of commercial members coming in due to rising unemployment.

Rick Jelinek

We have experienced some moderately higher outpatient and physician costs this past quarter, partially due to H1N1 that both Mike and Steve referred to and partially due to what we refer to the new member durational effect, where new members coming into Medicaid tend to use higher services it’s dominantly outpatient and physician.

In the first for to six months of their enrollment in our plan and this usually wanes off thereafter and so, from that standpoint, these new members costs were contemplated and are in our full year outlook. I think I covered that; anything Scott asked you’d add in there?

Stephen Hemsley

He was asking if margins could be…

Rick Jelinek

Yes, from a margin perspective, we are very comfortable that we are performing in along the range. Obviously, our revenue outlook as we mentioned previously, has been at the lower end of the range, but we counteracted that with some unit cost pass-throughs that have come from the state.

We have also done a good job with our medical cost management and lastly, as it relates to our operating costs, we have generated efficiencies there. So from a performance standpoint, we are very comfortable with where we stand today and we’ll continue to see growth through the end of this year and probably into next year as a result of the unemployment and economic conditions.

John Penshorn

Rick, this is John Penshorn. I’ve got a clarifying question for you. You mentioned revenue was at the low end of the range. Are you referring to the company’s total revenue, or are you talking about the rates of reimbursement?

Rick Jelinek

Thank you, John. As it relates to base revenue increases from the state for this year, we have locked down to date about 95% of our member months, so we are very comfortable with the rate outlook, at least from the base rate coming from the states for this calendar year. So, all in all, we’re performing in and around the range of expectation that we have set for this year and membership is slightly higher due to the economic condition.

Scott Fidel - Deutsche Bank

If I could just ask a follow up, just maybe an early read on the 2010 national account season. I know it’s still early here, but maybe if you can just touch specifically on number of accounts out to bid, average case sizes, and maybe just the level of fee competition that you’re seeing out there or for ‘10 relative to 2009.

Stephen Hemsley

Sure. Gail, do you want to respond to that? Gail Boudreaux? She is not with us this morning. She is on a hookup so she is probably having technical difficulties.

Gail Boudreaux

This is Gail. Let me start with reiterating your point, it is still pretty early in the national account selling season, but I’ll give you a few points of context for what’s happening in the marketplace. One, in total, the proposal volume that we’re seeing is pretty equivalent to a year ago.

It’s not slightly higher on the lower end of the market and by the lower end, we would think of that as employers with 10,000 to 20,000 employees. The reason I point that out, that is a bit different from the 2008 cycle where we saw a lot of the very large jumbo accounts out for market. This year, that’s relative to last year, it’s a bit lighter.

The other point of context, I think in terms of the market is that, with smaller employers out to the marketplace, what we’re seeing is a bit of a later cycle in decision-making going past what would be the normal timeframe, which would be about around now where the employers are making decisions. In terms of what they’re looking for, what’s important to them right now is management on the total healthcare spend and total healthcare costs.

As Steve pointed out, I think in his earlier comments that’s been positive for us, because clinical capabilities like eSync and our ability to help manage consumer behavior in our consumer directed products I think are resonating very well with the consulting market. Overall, it continues to be a competitive marketplace on the C side. I think that gives you a bit of a perspective what’s happening on national accounts. So, we think over the next few months it will play out, given the size of the proposals in the market.

Operator

Your next question comes from John Rex - JP Morgan.

John Rex - JP Morgan

So kind of maybe perhaps a bigger-picture question here. I realize today is only July 21, but there’s some fairly obvious headwinds to operating earnings growth for everyone as you look out to next year and 2010, I think about lower commercial member months; I think about Medicare rates. Do you guys done some offsets Tricare, things like that.

I was wondering if you could just kind of, from a big-picture perspective, understanding you are not guiding to 2010, kind of prioritizes some of those, because it would seem like a challenging year for operating earnings growth, given some of those components.

Stephen Hemsley

Yes, I think maybe I can respond maybe broadly on this. I think you have to recognize that it is July 21, so it’s a little early, but certainly 2010 looks like a challenging year for us and I actually think it will be for everyone and for every industry in this country.

We will assume unemployment growth will likely advance at a slower pace, but we also don’t believe we’ve necessarily quite hit bottom. I think, perhaps most significant to 2010, we will not assume any real meaningful employment gain in 2010. We will also keep to our pricing discipline, so that will continue to be kind of a commercial membership pressure.

However, also as Gail just pointed out, we are really seeing some positive response to UnitedHealthcare in total on our offerings in 2009. We expect that response to only get stronger, not only in terms of effectiveness in terms of how well we’re managing medical cost at a fundamental level, but also as we have very balanced back to local markets, there has been a very positive response to that.

We expect Medicare margins will be under pressure given the general climate of the 2010 premium rates, but we also expect to perform strongly in sales, in medical and operating cost management. I think as Rick pointed out, AmeriChoice should continue to steadily grow and strengthen and they really have been performing quite well over the last year or more, and we expect that to continue.

I think the military healthcare should also contribute, although modestly in 2010 and I think our services business, it should be another very solid growth year like 2009 is playing out. Then lastly, I would say that we’re not assuming that investment yields will recover significantly in 2010, and that has been a factor for our 2009 comparative.

So, we have been operating through 2009 with a view, given the weighting of our overall benefit businesses that we will have a lot of work and as you say John, “headwind” to make 2010 come out well, but we are really focused on that and I think we probably tell from the commentary, we have pretty good inventory and assessment of where our businesses are, and we are very focused as a team on 2010, but it is a challenging environment. I think those comments will kind of give you a sense of each across the businesses.

John Rex - JP Morgan

It maybe too early to call, but at this point would you say, if you’re looking out, you’d be pleased to be able to get the kind of a flat operating earnings for 2010, given if particularly the commercial member months issue? Would that be considered, do you think kind of a good achievement or are you willing to characterize that yet?

Stephen Hemsley

John, I applaud your efforts for trying, but I think it’s really too early to offer that kind of view. I would say there is very positive momentum inside the enterprise we are operating, I think at a very strong level, but it is the very challenging marketplace in total. There’s a lot going on in healthcare and I think it’s just premature for us to really comment further.

Operator

Your next question comes from Justin Lake - UBS.

Justin Lake - UBS

A couple of questions, first on days claims payable, which were up a little bit more than two days sequentially. That looks like a pretty strong number compares to last year where you were actually purposefully increasing reserves, because of some issues there on the commercial business look like a whole lot of others.

So, I’m just wondering if you can parse out that increase, between what might be typical white noise versus what you might have embedded into reserves in terms of conservatism this quarter around things like corporate take up and the H1N1 pressure?

Stephen Hemsley

We’ll just take this one straight off. I think Mike is the best to answer this.

Mike Mikan

We do, as we disclose overtime, our days payable does go up. It starts low at the beginning of the year and rise throughout the year as the Part D seasonality plays itself out during the quarters, as I think you know, Justin. We did have an increase sequentially, I would say flat year-over-year though and the sequential increase, the bulk of it is related to seasonality in Part D, it’s about 1.4 days.

You probably won’t like this answer, but it’s up roughly three days, but it rounds, when you get to the actual days, it rounds to about up 2.1 days. Some of that is related to COBRA, H1N1, but I would say the majority of the change is related to what we typically experience during the year. Justin, as always we book to our best estimates. I wouldn’t call them conservatism per say, what our best estimates on reserves are.

Justin Lake - UBS

Then just a quick question on SG&A looks like, it was down about $100 million sequentially after adjusting for New York. When I had the first two quarters up, you are close to that 14% number versus guidance, which I think is 14.6%. So clearly, it looks like you’re doing a little bit better there. I’m wondering if you can just kind of parse out the drivers here. Is this good number to kind of use going forward? Basically, do you expect to be toward below that guidance point on SG&A?

Stephen Hemsley

I think, I will have Mike respond to guidance and then if we want to add color in terms of what we’re doing in there, we’ll have Dave Wichmann respond.

Mike Mikan

As you know Justin, 2008 we came into the year approximately what we called $500 million overstaffed vis-à-vis versus the volume actuals that we had versus the expectations. So, we setout to reduce our operating cost run rate by about call it $40 million a month to say. We were running, at that point in time back in the first quarter of 2008 at about $1 billion a month.

In May, we were actually slightly under $1 billion a month. So, we took a lot of action. We reduced headcount by about 5000 FTEs as we disclosed. The sequential change from Q1 to Q2 is really related to, as you know we ramp up costs and resources coming into the year and then it takes about until about April 1 or so to ramp those costs back down to the normalized levels for the year.

So the sequential change is really related to seasonal workforce FTEs coming out. We will see the strongest quarter in the second quarter and then as, we’ll start to ramp back up in the third and the fourth quarter, related to fulfillment and seasonal resources needed to staff up for the next year.

Stephen Hemsley

Dave, do you want to comment on the kinds of things we are looking at?

Dave Wichmann

As you know, for about the last 30 months or so, we have been very much focused on continuing to advance quality in our core operating performance and the good news behind that is that lower cost has become a very nice byproduct of that higher quality, as well as several initiatives around automation. Rather than talk about the past, what I’d maybe just give you some comfort that not only we have built some momentum but we will carry this going forward as well.

We have, like I said, we’ve seen nice advancement in quality and we’ve really been focused on defect elimination. That activity has improved our service quality to the levels that Steve talked about in his opening remarks. The best that we’ve seen in this company, at least in the decade that I have been here, we are continuing to advance the EDI, but not the same kind of EDI that we focused on in the past.

Our focus now is more on remittance and posting and I know that doesn’t sound really elaborate, but it is a very high cost driver in our business and you can actually see that in option number four and working paper number two as the high cost driver for the industry and that’s why we’re intensely focused on that as well. We are also nearing a point where our decommissioning activity on our old systems is beginning to take root.

We have managed to get off of a number of our acquired systems platforms and we are just doing claim run out on a number of those, but over the course of the next year or so, we will continue to advance our integration agenda and continue to move off those systems and as you might suspect those, when we move off those, we get a pretty substantive benefit associated with lower maintenance costs, but also, we get the benefit of the substantial scale that exist on our destination platforms.

Stephen Hemsley

I just a couple of other things if I may you’ve seen us really focus our capital investments and I give a lot of credit to our finance team around this, but we have gotten very disciplined around the way in which we deploy capital over the course of the last couple of years in particular and we are very focused on enterprise-wide applications and reusability across the expanse of our business as opposed to maybe investing in individual applications business by business.

Last thing I will just comment on is as we have become a more global company, we are very focused on how we source our labor, particularly around processing as well as technology development and maintenance and we are doing so in much more cost-effective locations where we can get an abundance of skilled labor.

So, I would expect us to continue to advance our operating cost agenda and to continue to advance productivity in particular. This would be real productivity somewhere in the range of 3% to 5% per year.

Dave Wichmann

Justin, to clarify on the run rate, the Q2 run rate is a good run rate, but it will be increasing for the remainder of the year. We did have the AIM acquisition which is increase in operating costs, and then please note the seasonal nature of costs as we play out the rest of the year preparing for the following year.

Operator

Your next question comes from Christine Arnold - Cowen & Company.

Christine Arnold - Cowen & Co.

I want to probe Medicare Advantage and let’s ignore 2010, because I respect the sensitivity. Do you think we are entering a period that is the same or different from kind of the BBA ‘98 to 2002 period?

Stephen Hemsley

Well, I will offer kind of a global kind of response and then maybe ask Tony Welters and Larry Renfro to also offer their views. I think that the programs have been successful. I think they are recognized as having been successful and I think they are also recognized for the value they bring and the innovation.

At the same time, I think there is going to be real rigor applied to these programs and I think that it is going to be a more rigorous environment would be the way I would describe it, but also one that I think could be pretty opportunistic, because I think that there are challenges, just broadly, in the Medicare sector.

There are challenges in terms of what the underlying costs are; there’s obviously demographic trends that are moving in that direction. I think the trust funds are under some degree of pressure and I think in that situation, we offer the private sector a lot of good opportunity and a lot of solutions in response to those very real needs and that’s why we have thought that this has been a compelling market for sometime.

It’s large; it has a interesting, diverse senior population that’s growing; and it has real needs with respect to delivering quality care at lower cost. I think we have great resources to offer the country, if you will, with respect to that need. Tony, Larry?

Larry Renfro

This is Larry Renfro. This goes back to I think a comment that, Steve made earlier. I believe, from a focus and execution standpoint, if we concentrate ourselves on sales, the medical and operating costs, couple that with the opportunity that it’s going to present itself in the industry, we really believe there is a huge opportunity here to move forward and a lot of this is just going to have to do with us executing and that’s the plan.

Christine Arnold - Cowen & Co.

So, can I ask two yes or no questions? Do you expect the market to shrink as it did post-BBA, yes or no? Do you expect payments not to keep up with medical trends for multiple years, yes or no?

Tony Welters

It’s Tony Welters. I don’t like to answer yes or no questions, because I don’t know. I will say this. The MA program is a maturing program now. The government is more experienced with it now. As a result, they’re pushing a greater value proposition. You will see a heavier emphasis around cost containment, heavier emphasis around demonstrated quality and outcome.

I think that, for those enterprises that are prepared to demonstrate that they have a value proposition superior to others, I think they can have a long and prosperous opportunity inside Medicare. MA and remember this is a small subset of Medicare. The challenge for government is; how do they reduce the rate of increasing costs in Medicare, not inside MA.

Larry Renfro

I’ll just try to get closer to your yes or no. I mean, I think, in the response that we offered, we think that this is, as you suggest in the long-term, an expanding market opportunity. We also think that there will be responsible financial support to it because we think they’re going to get good value for it. So I would be positive on both questions you asked.

Operator

Your next question comes from Charles Boorady - Citi.

Charles Boorady - Citigroup

I’m wondering if you could just step through how to think about the Medicaid outlook for the next several quarters. Specifically how is the enrollment growth going to play out from rising unemployment and any new contract wins and how that might be offset though by the higher loss ratios that you sometimes see on new enrollees who were previously uninsured, and also risks from a state budget short falls?

Stephen Hemsley

Yes, I would say our outlook on that is also in general positive, but I think Rick can add a lot more background to that.

Rick Jelinek

Charles, Rick Jelinek. As mentioned earlier, I think the outlook is positive around growth. New procurements, there’s probably not going to be a large onslaught of large procurements in the next 18 months or so. That poses well for us, because we had such a diversified book of business and in virtually every market we have the ability to grow and expand either market share, product base, or geographies within a state and that’s where we’re focused on right now is executing on the existing markets that we have.

From a standpoint of the new members and the increase, we estimate in our book that for every 1% rise in unemployment there is somewhere around 50,000 additional lives that are added to our book and that timeline is dependent upon the eligibility guidelines in a given state and the processes for eligibility to determination and backlog and that sort of thing. Usually that will come on in a four to nine month period following the unemployment events. So, you could extrapolate from the economy what that will look like from our role.

The other piece there is that we will continue to see progression in our business in fatality form in terms of getting the benefit of Tennessee, Washington, D.C., Hawaii, New Mexico, and Connecticut on a full year basis and getting that business up and going where those members are not new on Medicaid, they’re just new to our program.

So, we’re not going to have the same new member durational cost issue. So, our broadness of our business helps to in essence absorb some of the higher costs on the new members coming in from the economy standpoint. So I think, all-in-all, it’s positive from a growth perspective.

Obviously, we’re watching the state budgets closely to make sure that the revenues are matching our medical expenses. In those instances where that’s not the case, we’re going to work with the state on is there ability to modify the makeup of the service structure or the program or administrative requirements that we might have in place in order to save the state money.

As the last resort, we can reduce our counties that we operate in and I guess as a very last resort, a form of underwriting for us is to exit the market altogether, but where we sit right now, we’re not contemplating that in any of our markets.

Charles Boorady - Citigroup

So, I guess that top line growth is really easy to see and it’s pretty strong growth. It’s the only end market really growing robustly right now, which is terrific. I guess what I’m trying to understand is the bottom line impact when you also factor in the margin risk.

So, would you sort of expect to see loss ratios rise because of the state budget pressures for a period of time, while you’re absorbing the new enrollees and then see a better bottom line impact in future years? Do you think you can manage to bottom line growth in Medicaid?

Rick Jelinek

From where we sit, we obviously want to try to manage both and you are mixing a couple of different issues together. One is margin percentage and one is absolute earnings for the enterprise.

We think that we’re in a good position to grow the absolute earnings of the enterprise and while there might be some short term margin pressure related to the new members, it’s not going to be substantial to in anyway get out of our range of acceptability for the business operation. So, I think there’s a strong outlook there.

The other side of it is that we have entered into a brand new product category over the last couple of years in the long term care in the ABD business. That is a more stable book of business. These individuals have very high and medical costs and a large amount of inefficiencies exist in the system and we think we bring a very strong value proposition of increasing quality and reducing costs to the program.

My viewpoint is that I think where the pressure is going to be in Medicaid over the next few years is more on the fee-for-service programs as it is on the managed care side of it.

Stephen Hemsley

I think that response to that exchange is a good example of us having to focus resources in a specific marketplace like Medicaid. A lot of pressure margin comes from all side, but I think we’re very focused and efficient in converting new members into a good state and diversifying the new member costs against our personal care model and our medical cost base, which I think is favorable. So, I think that’s why we are successful in the Medicaid marketplace.

Operator

Your next question comes from Greg Nersessian - Credit Suisse.

Greg Nersessian - Credit Suisse

The first question was the day’s sales outstanding were up to days sequentially. Was that just a late Medicaid payment or I guess what market segment is that coming from is that economy-related and then what was the impact on cash flow?

Stephen Hemsley

Well, Days Sales Outstanding has been it increases at the beginning of the year related to government timing of payments, both at the federal level. We did see although collection efforts on the commercial side we’re very strong, we did see certain states deferring payments. We have collected them since, but there was some state payment timing and that did impact cash flow and net-net it was inconsequential to our operating cash flow for the quarter.

Greg Nersessian - Credit Suisse

Steve you mentioned the opportunistic opportunities for M&A in the current environment. Obviously, you’ve done a couple of transactions. I guess how are you thinking about that going forward in the context of a broader reform are you taking sort of a wait and see-to-see how this reform shapes up, what the opportunities that come out of it are, or do you think that the time is right to strike while the iron is hot now?

Stephen Hemsley

Well, I think, given the fact that we have been active somewhat responds to the question. We have a lot of confidence in our business and in our business model. We are very much committed to that diversified business model and continuing to build it and expand it in a thoughtful way. Ultimately, we are constructive and positive in terms of reform, that it will offer opportunities in the marketplace.

That we think we can respond to and enable in a pretty effective way, and we will be looking for to continue to build our resources along those lines. So, we are not necessarily doing a wait-and-see in terms of reform. I think the broader issues are is that there is a core cost challenge in the marketplace.

There is clearly a need for the kinds of services and responses that we offer and where we see that we can build our business, we will see those opportunities and I think that has been consistent and I think we have proven it through the course of this year as well. So, we are not necessarily holding back in terms of waiting on reforms.

Greg Nersessian - Credit Suisse

If I could squeeze the last one in there’s been a lot of talk in the context of reform of changing the way reimbursement and fee-for-service payments are structured to providers. Have you guys thought about that at all in terms of how you contract with your providers in potentially changing some of those arrangements any sort of innovative programs you guys are thinking about from a reimbursement dynamic?

Stephen Hemsley

Yes, quite a bit. We have actually several initiatives in specific markets, pilots that we have worked not only on our own but in collaboration with I think the Colorado Medical Society would be one, with IBM in Arizona, in terms of new approaches to payment and reimbursement. I think Rituxan is on the phone. I don’t know if Greg, if you can hear me, if you want to comment on that? I’m not going to wait to see if we have a technical difficulty.

I would say that we have probably got more activities going in terms of different approaches to pay-for-performance, if you will, than perhaps any company in this space. There are pilot stages in specific markets, because if you understand the nature of healthcare, it is local in nature so you really have to begin at the local level. We think there is Merit in several that are going on. So, I think we are quite active in that.

Operator

Your next question comes from Carl McDonald - Oppenheimer.

Carl McDonald - Oppenheimer

I wanted to come back to Medicare, focus specifically on the capitated portion of the business. So I guess the first question would be if you could quantify how much of the business actually is capitated on enrollment or a premium basis. Second, any major differences in the bid process for the capitated versus the fee-for-service members? Then just you’ve got any color on how much of the reimbursement for the capitated members is directly tied to the Medicare fee schedule versus how much is negotiated each year?

Stephen Hemsley

Well, that is a mouthful, but I think Jack Larsen can start to pick on some of it and if we don’t remember all the rest of it, while we’ll just ask you to refresh it.

Jack Larsen

Carl, good morning, Jack Larsen. We do have a significant amount of our business that are in capitated relationships and they have been that way for many, many years. Approximately 40% to 45% of our membership are in some form of capitated arrangement, either for primary care or more globally for the full set of services and you’ll have to indulge me. What was the second part of your question?

Carl McDonald - Oppenheimer & Co.

The second part was just, if there’s any differences in the bid process between capitated and fee-for-service?

Jack Larsen

No, no. They’re identical at the bid level.

Stephen Hemsley

Carl, I’ll just clarify though that is for Medicare Advantage in terms of capitation. Across our entire book, our capitation is less than 10%. It’s about 8% or so across our entire book of business, including commercial, Medicaid and Medicare.

Carl McDonald - Oppenheimer & Co.

Great, in the last part was just in terms of the contracting with the capitated Medicare providers. Is that directly tied to the Medicare fee schedule, or is that something you don’t negotiate with the provider groups each year?

Stephen Hemsley

It really varies by type of capitation, whether it’s a global, professional and then there is contractual arrangements around it, but they are tied to fee schedules and the bulk of them are tied to premium that we get from CMS, so as a percent of premium.

Operator

Your next question comes from Ana Gupte - Sanford Bernstein.

Ana Gupte - Sanford C. Bernstein & Co.

I had a couple of specific questions on reform and the ongoing debate in Washington and then one on Tricare. The first one is around the windfall premium tax, the notion that high premium plans would be taxed. I was wondering if you could comment on how you and AHIP are influencing the debate and where that might fall out.

Stephen Hemsley

Well, I don’t know if I’m going to respond to issues specific. I would say that we are involved, on a daily basis, with respect to these initiatives that AHIP has I think represented the industry well and engaged well.

We certainly don’t really see how a premium tax really gets to the core issue of controlling medical costs in a substantive way that can sustain coverage. We do recognize it as one of, as I think said in my prepared comments, a series of tax or surtax-related initiatives that they’re struggling for in terms of finding pay-fors for the legislative interests.

We would be more inclined to focusing on initiatives that are focused more on the real core costs than these kinds of techniques. I don’t know, Tony, if you have any further? Simon?

Simon Stevens

No, I think that’s absolutely right. I mean, we understand the argument for and against changes to the tax treatments of employer-sponsored insurance, but as a minimum, we think that whichever route Congress chooses, that we support tax equity as between health insurance bought by individuals versus health insurance sponsored by employers.

Ana Gupte - Sanford C. Bernstein & Co.

Okay. As a very big Part D player, can you comment on what you think the implications are of the doughnut hole coverage by Big Pharma? Will that likely incent more branded drug usage and potentially move seniors more quickly to the catastrophic end? Will you likely have to change your plan designs to accommodate that?

Stephen Hemsley

Simon, do you want to respond to that?

Simon Stevens

Yes, I think we obviously await any details around what this proposal would look like when operationalized and until we get that, it’s hard to be clear about the effects. Obviously, as you are implying, not all seniors used branded drugs in the doughnut hole anyway, so one of the things that obviously Congress and the administration would want to be attentive to is ensuring that there are no distorted incentives on the back of this that might actually reduce the use of the generic drugs where that would be more cost-effective for seniors themselves.

Ana Gupte - Sanford C. Bernstein & Co.

Last thing, on Tricare, can you comment on your build out of the network and what the implications are for SG&A in 2009 and then should we be looking at unit cost synergies on the provider side as part of the upside, 2010 and beyond from a network contracting perspective?

Simon Stevens

This maybe an area where it might be again little frustrating, but the actual award process is really not complete. So, we’re going to be limited in terms of what we can say with respect to the Tricare program and what kinds of initiatives will be involved and what kind of efforts and costs. Obviously, there will be a transition initiative on our part.

Obviously, network is a part of that, but we’re going to have to stay away from anything that responds to the specifics around those initiatives or numbers around them, because the awarding process is actually still active and we really can’t comment on anything that would influence it at this point.

Operator

Your next question comes from Lee Cooperman - Omega Advisors.

Lee Cooperman - Omega Advisors

I’m going to ask you a question, you might not want to respond to, but before you give me an answer or non-answer, I want to read you something. The question is, at the very beginning of the conference call, when you talked about capital allocation, you talked about intrinsic value. That’s what motivates your stock repurchase decision.

What is your estimate of intrinsic value presently and where would you stop stock repurchases or find them no longer beneficial? Let me just read you something out of the 1999 Annual Report of Warren Buffett; it’s on the kind of master to us. There was only one combination of facts that makes it advisable for a company to repurchase its shares.

First, the company has available funds; cash plus sensible borrowing capacity beyond the near term needs of the business. Second finds the stock selling in the market below its intrinsic value conservatively calculated. To this we would add a caveat. This is the relevance to my question. Shareholders should have been supplied all of the information they need for estimating fair value. Otherwise, insiders could take advantage of their uninformed partners and buyout their interest at a fraction of true worth.

So far, we haven’t done that because the buyback hasn’t been too successful. What is your view presently of the intrinsic value of the business and at what level would you kind of divert your cash flow to more conventional uses rather than stock repurchase? Any help you could would be appreciated.

Stephen Hemsley

Well, I think, as you can appreciate, it would not be appropriate. We think…

Lee Cooperman - Omega Advisors

I don’t know Warren Buffett says it’s very appropriate.

Stephen Hemsley

Well, I appreciate his views and I have a great deal of regard for him, but I think that the position of our company is that we can’t really respond to that kind of a request. We obviously believe that, on an intrinsic basis. The value of our equity is below, what its intrinsic value would support.

Lee Cooperman - Omega Advisors

How about sharing with us some of the metrics that you’re assuming? Your membership is at like a five year horizon, because we can plug it into a dividend discount model. What is a reasonable membership growth, pricing to trend, margin outlook? What kind of growth do you think you’re buying back at the present time? I’m trying to get to be academic.

Stephen Hemsley

We’ve had these discussions before and…

Lee Cooperman - Omega Advisors

Well, I’m trying to get them in an open platform, this way it open mike. So, everybody has access to the same information…

Stephen Hemsley

I will respond the same way we do when we have them directly with you and that is we really aren’t in the position to reveal all of the elements that are in consideration in our modeling. We do this on a very consistent and professional way. We use outside resources.

As I had mentioned to you before, we use and discuss this routinely with our board and collaborate with our board and feel comfortable in our positioning. I’m very much aware of and respect your point of view on this, but we are at the moment, continuing to hold to a view that. Our share repurchase program and our dividend positioning is appropriate for the times.

Lee Cooperman - Omega Advisors

I would just give one suggestion and I don’t want to belabor the point. I’m not like a redneck, but essentially the results have not been particularly gratifying. If you look at a sources and uses, far and away stock repurchase has been beyond anything we’ve done in terms of acquisitions of businesses.

In terms of capital spending and I’ve encouraged you in the past that you should devote more of the time of your presentations to analysts and the investment community regarding this decision. It is such an important decision; it is such a large decision and so far it has been a wrong decision. So, share with people what you are thinking about, to give us better insight to gain confidence that you’re doing the right thing. That’s all, a suggestion.

Stephen Hemsley

I will take that and I respect that advice and we will take that and maybe we will address it more effectively when we do our investor conference.

Operator

Your next question comes from Nick Leventis - CRT Capital Group.

Nick Leventis - CRT Capital Group

Last year, pricing was a problem and you had a high Medical Loss Ratio. This year, if you’ve fixed the pricing, why isn’t the MLR lower and is there an underlying trend here?

Stephen Hemsley

Well, I think we had responded to that. First of all, I think our pricing disciplines are well impact and I can have Gail respond to this following my comments, but I think that we explained that the care ratio was really more a response to the impact of flu and on a consolidated basis to the impact of the mix where we are seeing a relative weighting towards more of the government business which has a different care ratio profile.

At the commercial UnitedHealthcare level, COBRA has a small impact on it, but those are the elements driving it. We do not see the pricing environment, which continues to be quite competitive, to be really a factor in this ratio. Dan, would you agree?

Dan Schumacher

Yes, I would; I would agree, Steve. Our perspective is we are endeavoring price to a stable loss ratio overtime. We had a couple of factors, as Steve and Mike both commented on, in the quarter with respect to the flu as well as some additional COBRA expense that made that drift up on a year-over-year basis, but we are still inline with our expectation on the full year at 84%.

Stephen Hemsley

I think we are quite satisfied with our pricing discipline.

Operator

Your next question comes from Peter Costa - FTN Capital Markets.

Peter Costa - FTN Midwest Securities

Yes, just back to the swine flu for a minute, the first question is if it was 40% on the commercial book and 20% overall, it must not have been there much in the Medicare book. What exactly was it to the Medicaid book and then also what’s your expectation going forward since you didn’t change your Medical Loss Ratio, expectations for the year, yet this is a phenomena that mostly happened in the month of June.

It really wasn't there for the whole quarter; it probably carried into July and is tapering off at this point, but probably comes back towards the back half of the year. You haven't changed your MLR assumptions. Is there something else that’s an offset to the swine flu?

Stephen Hemsley

Yes. I think, in the first instance, I will have Rick responded to Medicaid and then maybe Mike in terms of the broader outlook in terms of our perspective for the year.

Rick Jelinek

On the swine flu side, for the Medicare side, we are estimating it’s about 20 basis points for the quarter, roughly. That is within a reasonable expectation of looking back. Obviously, we don’t have all the claim data, but as we circle back on the claims that have come in that second quarter, end of the first quarter, the beginning of the second quarter, that’s our estimate today.

Stephen Hemsley

So, no real difference in your population. Mike?

Peter Costa - FTN Midwest Securities

Even though it is more kids and I assume more this is moms taking their kids to the doctor.

Rick Jelinek

Well, it was a regional variation, so it wasn’t consistent across the board and what we saw is that, in those areas where the was a lot of news reports and TV going on, it didn’t matter whether you are a kid, an adult, a mom, that there were people going to the doctor and looking to see whether or not they had H1N1, even as they might not have had clear symptoms of the flu, just more to be cautious and obviously, there’s costs associated with that.

Peter Costa - FTN Midwest Securities

Okay, thanks and then in terms of the outlook going forward for the company as a whole why it didn’t change your MLR assumptions going forward?

Mike Mikan

Well, we’re assuming that the flu, H1N1, will moderate, will go down to normal levels. As we always do, we price for a normal flu season each and every year. So, we’re expecting that it will start to tail-off as it has been shown in the CDC data with influenza-like illness, and that ultimately will end up picking back up late fall or I mean into the winter, into the first quarter of 2010.

Should it pick up in greater degree, as it did in 2008 for the first quarter, obviously that would be an impact on our cost trends, but as of right now, we’re not assuming that.

Peter Costa - FTN Midwest Securities

Even though if you look at the CDC data, it was much greater in June than it has ever been for the flu before?

Mike Mikan

Yes, and we’ve captured that in our costs.

Peter Costa - FTN Midwest Securities

But you’re not expecting it to come back stronger at the end of the year?

Mike Mikan

We’re expecting a flu season as we always do into 2010.

Stephen Hemsley

Which is typically a pretty healthy expectation.

Mike Mikan

Yes, so it is about $175 million to $200 million for us.

Stephen Hemsley

That would be something I’d say too, in the Medicaid book is that you asked if there is a material difference. We do have a fairly high level of flu on an annual basis that is normal, because of the maybe your comment around disproportionate number of moms and kids, so this is the incremental impact on top of that.

Peter, to your point this is at some unprecedented level, pandemic kinds of, we do not have a pandemic in our outlook for the balance of the year and wouldn’t exactly know how to actually do it. So, if that is your point, we have a healthy estimation going forward, but we do not have a pandemic in our outlook.

Operator

Your next question comes from Matt Perry - Wells Fargo.

Matt Perry - Wells Fargo Securities

I’ve got a question long term on Medicare. If we think of rates coming down next year and then probably the Medicare Advantage subsidies being removed sometime in the next several years and think of those as explicit changes and then think of maybe implicit changes this administration is making versus the last administration, maybe in more regulation, more scrutiny of Medicare Advantage and the private sector’s involvement in Medicare. Can I get you to comment on what you might think a reasonable long term margin outlook is in the Medicare Advantage business and maybe Medicare in general?

Stephen Hemsley

Yes, I’ll just kind of respond broadly and then see if Larry or Tony wants to trim it up, but again, on the long term basis, we are relatively positive on this. We knew years ago, as we started to concentrate more into this space, that there would be times when there would be greater administrative and financing support and times when that would be more challenging and we’ll somewhat ebb and flow overtime.

In the long term, history has proven this out over several different administrations, that there has been a general expansion into the private sector in some form in terms of Medicare and the needs of the group are compelling and the capabilities to respond are in entities like ours in the private sector.

Whether it comes forward in contracts, whether it is in programs, whether it is in direct membership or in care management programs, we think, long term, there is a need to respond and to serve this population in a more modern way, and that we are positioned well to do it. That was very much the positioning as we went into this. It represents a huge, huge cohort of the overall healthcare marketplace, and that’s kind of the perspective we bring to it. Tony?

Tony Welters

Two things: One, I would encourage people to take a step back and look and Medicaid managed care and how it has evolved overtime. As a reference point, I kind of like to think about welfare reform.

You may recall that states, for almost 15 years, experimented with welfare reform before the federal government taking all those lessons learned and then introduced the comprehensive approach to welfare reform, highly controversial, but very, very successful. I think that, when you think about issues around healthcare modernization reform, the federal government will look to states. States have tackled the issue of cost and quality and have pivoted in the direction of an integrated approach with the private sector.

I think, as you think about the long term, it’s very reasonable to assume that the experience that states have had will find its way during the course of the next several years into the national debate and therefore into the proposed solutions for addressing for the fundamental cost issues as we think about Medicare overall. I think those lessons are real tangible lessons and I think you’ll see a trend line in that regard.

Matt Perry - Wells Fargo Securities

Steve, if I could maybe ask you to look in your crystal ball and think about the opportunities in Medicare, broadly and then the opportunities in the commercial to say, sector broadly over the next several years, which of those businesses do you think offers a better return on capital invested over the next call it five years?

Stephen Hemsley

I’m not sure my crystal ball is quite that precise. The really are two distinct opportunities and the positioning of our business for years has been to really focus on core competencies around information, around technology, around expertise in care management, and then be able to focus those competencies to the different market needs and different market sectors.

We see that there will be some probably coverage expansion in the commercial marketplace, but with economic pressures for sure and see that as a compelling opportunity that we’re well positioned for. In the government sector, that version of that is largely the same in terms of these are sponsors of health benefits that are trying to deal with costs. We’re really well positioned to respond to them in a different way that is appropriate to those government entities that sponsor those.

So year-to-year, those returns will vary, but we look at it more in a total context and really don’t want to get into a discussion of either product line or market segment return, because basically what we’re leveraging is information, our technology, our care expertise, and our networks across all of those market segments.

Well, I think that is it. I think we were generous with respect to time and the questions were quite good. We are quite positive in terms of the prospects of our business.

We are performing strongly from an operational point of view progressively, perhaps stronger than ever before. We are very focused and committed around reform and the opportunities it presents itself in the long term and in the near term. We think we are endeavoring to optimize our quarter-to-quarter performance.

So, we thank you for your attention and we’ll be back next quarter. Hopefully, we’ll be able to respond in a more specific way to areas that we couldn’t because of competitive activities in terms of Medicare, Tricare and things like that. So, thank you.

Operator

This does conclude today’s conference. Thank you for participating. You may now disconnect.

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Source: UnitedHealth Group Inc. Q2 2009 Earnings Call Transcript
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